This article is written by Akshay Verma pursuing Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.
In the current scenario, IP rights are getting great focus from buyers in M&A transactions. Intellectual property rights such as copyrights, trademarks, patents, industrial designs, and trade secrets are considered as important assets of the company. Intellectual property rights play a huge role in M&A deals, especially involving those Companies whose majority of business is carried online such as developing games, music, etc.
There are certain representations and warranties that each company will request from each other related to several things involving intellectual property rights. An acquirer is always concerned about the risk for huge unknown claims of infringement related to IP that third parties may bring against the acquirer after the signing and closing of an agreement. In this article, I will talk about representations and warranties relating to ownership of IP in an M&A deal and its importance.
Importance of intellectual property
If the acquirers undervalue or ignore the potential of IP, they can weaken strategies of negotiation, decrease the outcomes of securing future licensing agreements and destroy their ability to receive financing. The acquirers must do the necessary due diligence to completely understand the IP portfolio of a target company. There are transactions that involve hundreds and thousands of patents, so it is evident that a considerable amount of work has to be done as a part of IP investigation. Due diligence helps the purchasers to understand and identify the exact IP they are purchasing. Once the purchasers and their advisers identify the relevant IP, they can evaluate possible risks and prepare a plan to address those risks before completing the transaction.
If the ownership issues related to IP are complicated and messy, then it can prove disastrous to a transaction. A purchaser has to see if existing licensing agreements restrict future exploitation of intellectual rights or is there any risk of litigation, such as pending damages and infringement claims. A purchaser should also see whether the target company depends on third-party licenses and will these survive the transaction. These are the things that may restrict future commercial exploitation, so it is very important to conduct careful due diligence.
Factors to consider while doing intellectual property due diligence
1. Identify the portfolio
The acquirer and his advisers should request a list of all the assets related to IP used or owned by the target organization. This should include traditional intellectual property assets, such as registered and unregistered trademarks, patents, trademark applications, patent application, both registered and unregistered copyrights, as well as non-traditional intellectual property assets such as domain names, software, social media accounts, trade secrets, territory rights, customer lists, publicity rights, etc.
2. Verify status, ownership, and chain of title
Every asset should be reviewed to verify the status and ownership of the IP. In the case of a registered intellectual property, the proper registry should be reviewed to ensure that the intellectual property is registered in the seller’s name, and there are no gaps in the chain of title. One should also consider costs that must be incurred to record transfers of intellectual property.
For any intellectual property, whether registered or unregistered, the sources of each asset should be verified and relevant documents should be requested depicting the transfer of title, involving work-for-hire, invention assignment, and non-disclosure agreements with all service providers, key personnel, contractors that participated in the development of the intellectual property.
3. Evaluate the scope and proposed use of intellectual property
The purchaser’s proposed exploitation of the intellectual property should be assessed. In case, the purchaser plans to geographically expand, relevant jurisdictional issues should also be looked upon to find whether the intellectual property can be exploited in the proposed jurisdiction.
For IP-related issues, all the relevant agreements, not just limited to IP-related agreements, should be reviewed. IP-related issues can arise in various contexts such as development agreements, consultant agreements, license agreements, endorsement agreements, manufacturing agreements, collaboration agreements, distribution agreements, and many more. Change of control or anti-assignment clauses, limitations on the scope of use, exclusivity, rights of first refusal, restrictive covenants, and effect of governing legal provisions should also be investigated.
5. Consider enforcement strategy and IP protection
Enforcement and protection strategy can have a huge impact on the value and strength of the IP and should be reviewed to find weaknesses. The information should be sought including present and prior disputes, subscriptions to trademark monitoring services, quality monitoring protocols for any licensee products, etc.
6. Do not ignore foreign assets
Usually, all the transactions in the present times include a foreign component. It is necessary to remember that title, enforceability, and validity of IP assets are subject to the law in each distinct jurisdiction in which the asset is used or registered, and may vary from nation to nation. A basic blunder is ignoring foreign assets. Failing to conduct due diligence on foreign intellectual property assets can prove to be disastrous.
Earlier, intellectual properties were excluded from representations and warranties because these were considered uninsurable. In the present scenario which is tech-oriented and where lots of intellectual property rights are involved in various forms such as trademarks, patents, and copyrights; it would not make any sense if there is not any representations and warranties policy that protects the buyer from any kind of breach. Under Reps and Warranties Insurance Policy, the IP protection can vary depending upon the scope of the reps and warranties related to the IP in the acquisition agreement.
Have you ever wondered what big organizations like McDonald’s want to ensure while making any acquisition? In 2019, McDonald’s made three significant acquisitions of innovative tech organizations: Dynamic Yield, which provides logic technology and personalization, Apprente, which is famous for its voice-based conversational technology, and Plexure, which is known for creating mobile apps. The aim was to incorporate technology from these organizations to install more personalized and efficient ordering through mobile devices, self-order kiosks, and drive-throughs at McDonald’s locations.
When organizations like McDonald’s make acquisitions, they want to ensure that the IP they are purchasing is free of any encumbrance and all the representations and warranties related to IP are true.
Not only McDonald’s, but every company also wants to make sure that the IP they are purchasing is not disputed and all the representations and warranties made by the seller are true. If the acquirer finds the representations and warranties made by the target company are not true, the acquirer may no longer be required to consummate the transaction and may be entitled to terminate the agreement. The acquirer may also ask for compensation for the damages arising due to any misrepresentation or breach related to representations and warranties by the seller.
The acquirer wants to feel comfortable and safe that the seller is the sole and exclusive owner of the intellectual property and that such intellectual property is not subject to any limitations or encumbrances that unduly limit the ability of the seller to exploit such intellectual property or give IP related rights to third parties that materially detracts from its value and not appropriate.
There may be several factors that can be beyond the control of the seller that restrict the right of the seller to exploit the intellectual property owned by him. Given below are the various instances that may encumber or restrict the ability of the seller to exploit the intellectual property owned by him following the closing of an acquisition:
- Claims made by third parties that patents are not valid.
- Liens on the intellectual property in favor of lending institutions or banks.
- Claims by the third parties that the IP infringes their patents and or other intellectual property rights.
- Insufficient evidence that the contractors or employees who contributed to the making of intellectual property assigned their rights in the intellectual property to the seller.
- ROFR (Right of First Refusal), exclusivity, or identical rights in favor of third parties concerning the IP.
- The failure to obtain consents of the third parties essential for the IP to be transferred to the seller (if not originally made by the organization).
- Broad licenses to the intellectual property in favor of third parties that may compete with the seller.
- The failure of the seller to register the intellectual property with the requisite governmental body.
Let us consider an example, ABC Sports Limited is a company that specializes in developing various action games on the internet. After the huge success of some games, it now desires to develop other kinds of games and for this purpose, is looking to secure an investment to the extent of INR 3 crores. Since the entire business of the company is carried online, its major assets comprise the intellectual property in the games that it has developed.
Given below is a sample clause on representations and warranties that investors may request from the founder of the investee company as regards the intellectual property in the games developed by the company.
- All intellectual property rights (IPR) used by the company in connection with its business have been registered in the sole name of the company.
- The company has not granted and is not obliged to grant any licenses or assignments (whether express or implied) under or in respect of any IPR owned or used by the company. The company has not disclosed and is not obliged to disclose to any person (other than an employee or consultant under enforceable obligations of confidence) any confidential or secret material owned or used by the company.
- The company has not received notice of any infringement by it of any intellectual property rights of any third party and none of the company’s business activities infringe the intellectual property rights of any third party.
- There is and has been no infringement of the IPR owned by the company.
- All fees for the grant or renewal of registered IPR owned by the company have been paid.
- All know-how owned, used, or exploited by the company is, to the extent reasonably practicable, recorded in writing and has been kept secret and confidential and has not been disclosed to third parties.
- To the best of the company’s knowledge, all persons who are or have been engaged by the company, whether as a consultant or an employee, in relation to any of its products or software have either assigned all rights they may have in relation to the products and/or software to the company or are engaged under contracts which require them to transfer any IPR developed (whether inside or outside the course of their employment) to the company and none of the processes, products or activities of the company give rise to a liability to pay compensation or fees of any sort to persons who are or have been engaged by the company, whether as a consultant or any employee.
- Every agreement entered into by the company for assigning, licensing, or granting of the use of any of its IPR contains adequate provisions to safeguard the rights of the company to own and exploit the IPR that is the subject matter of such agreement.
- To the best of the company’s knowledge, all IPR owned by third parties and used by the company is subject to binding and enforceable licenses from third parties in favor of the company;
- Of which no notice to terminate has been received.
- All parties to which have fully complied with all obligations in those licenses;
- In relation to which no disputes have arisen or are foreseeable; and
- In relation to which, no circumstances exist which might lead to their modification or termination.
To recapitulate, intellectual property rights play a significant role in M&A deals. In the current scenario, tech companies are growing at a rapid pace and their major assets now comprise intellectual property rights. When an acquirer is looking to acquire any target company, it will make sure that IP rights acquired by it are free of any encumbrances and there is no litigation risk involved in it.
Representations and Warranties related to IP are considered so important today that any breach or misrepresentation can lead to the termination of the agreement between the parties. In present times, almost every agreement of acquisition contains reps and warranties clauses which provide for necessary assurance and remedies in case of any breach resulting in any damages.
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