In this article, Shreya Bambulkar, of ILS Law College, Pune discusses IP issues in M&A reconstructions.
In the past decade, the Mergers and Acquisitions (M&A) landscape has evolved significantly in India. It has become an important aspect of corporate strategy for organizations worldwide. According to an assurance, tax and advisory firm Grant Thornton, there were 1,147 deals (M&A and Private Equity) worth $60.54 billion in 2017. A merger has been defined as an arrangement where the assets of two (or more) companies become vested in, or come under the control of one company (which may or may not be one of the original two companies). The merger of two or more companies to form a new company such that all their liabilities and properties are transferred to the surviving company is known as amalgamation.
Transfer of Technology in M&A Deals
With the advent of technology, acquiring high standard technology in the business can give the company huge market monopoly power. Upstream technology can help save transaction cost and downstream technology can assist in developing new products and technologies. Corporate diversification strategy is the rationale behind acquiring unrelated technology.
Technology knowledge transfer in M&A deals (know-how, know- what or know-who) creates problems as far as Intellectual Property Rights are concerned, as it differs from transfer of products in the following ways-
- Exchange of knowledge cannot be reversed
- Every country has different laws regarding knowledge protection (in case of International M&A)
- Assembling the necessary parts of knowledge required to develop future IP is a complex task
- In certain cases it is difficult to verify if specific piece of knowledge has been used.
Steps Involved in Technological Acquisitions
- Identification of attractive technologies or partners with technological capabilities
- Assessment of these opportunities, selection of the most promising ones and consideration of the terms of the acquisition
- Negotiation of the terms of acquisition between acquirers and sellers
- Transfer of the technology to the acquirer, if these negotiations have been successful. (technology acquisitions).
Means of Acquiring Intangible Assets
- Acquisition Agreement- the main purpose of this agreement is to detail the terms and conditions of the acquisition. It identifies the issues specific to the transaction, the purchase price, the method of payment, date of closing and conditions precedent (if any). The seller also makes certain representations and warranties in respect of the assets.
- Transfer Documents- documents which transfer the assets, will allow the buyer to indirectly become the owner of the assets. They are executed separate from the acquisition agreement. The forms and other requirements for valid transfers differ from country to country.
- Sale of Assets- If a party acquires business vis-à-vis sale of assets, the intent to transfer trademarks and the goodwill associated with it is presumed, even though it is not expressly provided for. An exception to this concept is in the context of transactions between parent corporations and their wholly-owned subsidiaries.
- Stock Purchase- in a stock purchase acquisition, ownership of trademarks and other intellectual property still remains with the acquired company. A separate agreement is usually necessary to lay down the parties’ intentions.
IP Due Diligence
Due diligence procedure can be a source of significant information for both the parties in an M&A deal. Intellectual property and technology assessment are the key determinants of the deal. IP due diligence is inherently difficult because of the issues faced in the valuation of IP. Poorly structured or inappropriately applied business strategy is amongst top listed reasons for ultimate failure of IP driven M&A. Hence, a well structured and comprehensive due diligence is fundamental. It provides vital information specific to future benefits, economic life, ownership rights and the limitations of the assets.
Perceived as functional filter, due diligence procedure should identify potential risks, capable of harming inherent interests of the parties to the contract. The following questions may be included in the due diligence-
- Does the main impetus of M&A strategy reside in obtaining intellectual property assets?
- What entities currently use given technologies or other IP, what is their position in relation to the acquirer and what other players on the market are interested in the given technology?
- Is the respective industry prone to litigation or not?
- How sophisticated is the intellectual property policy of the target company?
- Is an asset purchase or stock purchase considered by the parties?
- What important objectives of the transaction may be identified?
- What is the level of concentration on the given market?
- How are the targeted intellectual property assets consistent with pursued IP business strategy of the acquirer?
Assuming that all the confidential information is shared in the due diligence stage, it is crucial that parties enter into a non- disclosure agreement. This will provide a safeguard to the interests of the parties if the M&A deal gets cancelled in the future. From the IP point of view, such agreement protects mainly copyrights (software programs), inventions that were not filed for patent yet, trade secrets, know-how, databases, list of customers, business methods.
An important requirement for protection of information under the non- disclosure agreement is that the information should be secret i.e. not in the public domain.
TRIPS agreement specifies the requirements for information, which is eligible for such protection:
- the information must be secret, not generally known or readily accessible for people working in the respective field
- the secrecy of information attributes it with certain value
- the owner of the information must have taken steps for protection of information from leak to the public domain.
IP being an intangible asset, its valuation is a crucial issue in the process of due diligence. The following factors have to be considered for IP valuation- Given industry, market share of the owner, profits, occurrence of new technologies, concentration and level of competitiveness on the given market, barriers to entry in respective industry, expansion prospects, granted legal protection, remaining economic life.
Following are the methods of IP valuation-
- Income based method – The income-based method values the asset based on present value of future net income stream that the assets in question are expected to generate. The application of income method requires four variables, as presented below –
- Amount of net income the asset is expected to generate.
- The time period over which the income is expected.
- The present value discount rate for the future income (a risk free rate of return plus an inflation adjustment.
- The risk of realizing future income.
- Cost based method – The cost-based method is designed to measure the future benefits of ownership by quantifying the financial amount required to obtain or develop identical or similar IP asset in question.
- Existent active market for the valued asset ( for patents, trademarks and copyrights)
- Sufficient number of comparable asset transactions.
- Access to price information of comparable transactions.
- The comparable transactions must be performed on arm’s length. Market based approach – it is widely accepted and used in case of valuation of tangibles. The actual value of an asset is calculated by comparison to equivalent or similar transaction of unrelated parties on the market. In order to classify the transaction as comparable, four cumulative requirements must be in place.
Suggestions for Protection of Intellectual Property in M&A Deals
- Worldwide Recordal of Intellectual Property Rights – IP rights acquired after an M&A deal need to be transferred immediately to the new owner in each jurisdiction where the right exists. Timely and comprehensive recordal as delay in the same can lead to loss of the purpose of trademark- as a true indication of origin. The new owner may not be able to sue for infringement or attend to renewals. It may also lead to a possible loss of royalties.
- Arbitration clause – The parties may decide to submit their disputes (if any) to arbitration to avoid the court delays and ensure a speedy and effective remedy.
- Future costs – The parties may decide as to who will bear the expenses of that might occur in the future. For example- The expenses of filing, registration, renewals and maintenance of patents, trademarks etc.
- Warranty and liability – These clause are crucial to the M&A deal as they ensure that the aggrieved party will get a contractual remedy, most commonly the damages. The parties can also decide a cap on the parties’ liability as a part of risk allocation.
- Protection clauses in M&A agreement – The agreement should protect the interests of both the parties. Apart from the standard form of the agreement, additional clauses may be added to cater to the specific needs of the deal –
- Parties changing their mind – A ‘right to exit on notice at will’ can be included in the agreement to provide safeguards to the weaker i.e. the smaller firm in the deal. It gives the party a right to terminate the contract in case of breach by the other. It can also involve termination payment to the innocent party.
- Use it or lose it – this clause can ensure that parties comply with their obligations in the specified time. This is useful where transaction fee is linked to the outcome of the M&A. For example – Sharing the royalties earned by the sale of products in which the acquired IP used.
- Third parties rights – the parties may include clauses to protect the interest of the third parties with whom they already have legal relationships. For example – A condition that the acquirer shall not refuse to provide technology to the parties mentioned by the acquired.
Reconciling IP Laws with Competition Laws
An appropriate IP law designed with focus on transfer and dissemination of technology can help the developing countries to achieve their technological goals. But alone it cannot regulate all the technology transfer inflows or prevent the anti-competitive practices. IP laws can help develop a balance system of law to promote competition and innovation as well as consumer welfare. Countries can also customize procedural aspects of their IP related competition laws to make it as a threat to foster technology transfer.
Protecting company’s IP assets in the M&A deals is the most crucial task at hand since the company’s survival, goodwill and profit depends on it. Every step of the M&A deal has to be taken with great caution to ensure benefits to both the parties of the transaction.
The Government continues to send all the right signals through the economic reforms to encourage M&A in India. The land acquisition bill, labor law changes and GST will bring crucial changes in the corporate field. Also the M&A prospects are expected to remain steady in the coming future.
- Corporate India’s M&, PE deals cross $60bn in 2017, THE HINDU. (JAN.28,2018)
- Wolters Kluwer , Mergers And Acquisitions In India 15 (Ernst & Young eds. 4th ed. 2016)
- Id. at 15
- Letizia Mortara & Simon Ford, Technology Acquisitions- a guided approach to technology acquisitions and protection of ideas, Center for Technology Management, Institute PF Manufacturing, University of Cambridge, 2012 at 4.
- DePamphilis, D.M.: Mergers, Acquisitions And Other Restructuring Activities 136 (ELSEVIER eds., 6th ed. 2012).
- Berman, B. ET AL, From Assets To Profits : Competing For Ip Value And Return 207(John Wiley & Sons Inc eds., 2009).
- Bosch, M.C. and Burgy, A.L., Demystifying IP Due Diligence, Managing Intellectual Property, (JUNE. 6, 2006) [link]
- Agreement on Trade related aspects of Intellectual Property Rights (TRIPS) , Art.39
- PARR, R, Singapore – WIPO Joint training course for Asia and the Pacific region on Intellectual Property and Technopreneurship development 11 Module 6: IP Valuation Issues and Strategies, 1999,
- SMITH,G.V. and PARR,R., Valuation of Intellectual Property And Intangible Assets 164 ( John Wiley & Sons eds., 3rd ed. 2000).
- Id. at pg 164-168
- Parr, supra note 9 at pg 13
- DANIEL, B., Financial Aspect Of Licensing Agreements : Valuation And Auditing 94 (John Wiley & Sons eds., 3rd ed. 2000)
- Parr, supra note note 9, at pg 181
- TU THANH NGUYEN, Competition Law, Technology transfer and The TRIPS Agreement: Implications for Developing Countries 34(Edward Elgar, Cheltanham, 2010).