Intellectual Property Due Diligence

22 November 2016

In today’s technology and innovation-driven world, the strength of a company’s intellectual property (IP) can be the driving factor in the value of a corporate transaction. However, IP assets can be particularly difficult to assess due to their intangible nature. As a result, conducting a thorough investigation of a company’s IP has become a crucial aspect of due diligence.

IP due diligence is essentially an audit of the quantity and the quality of a company’s IP portfolio, usually in the context of a business sale. This investigation will cover registered IP such as trade marks, patents, designs and domain names and business names, and unregistered IP including confidential information, computer software licences, unregistered trade marks and designs, and copyright. It allows a vendor to identify potential any surprises that may derail negotiations, and a prevent a purchaser from receiving any surprises after the purchase takes place.

A failure to properly consider IP assets in a transaction can have disastrous consequences. In 1998, Volkswagen outbid BMW to buy Rolls Royce and Bentley for $900 million, including the manufacturing plant, designs and machinery, and the ‘Spirit of Ecstasy’ mascot. However after the sale was settled, Volkswagen discovered that the deal did not include the right to use the Rolls Royce trade mark; arguably the most valuable IP asset in the transaction. A thorough IP due diligence investigation may have revealed the agreement that allowed the trade mark to be licensed to BMW from under Volkswagen for $78 million.

Some examples of key issues to be considered in IP due diligence include:

1. Who owns the IP?

Ownership is particularly important to establish as a company may not always be the owner of the IP it uses. This can be because the IP is owned by the parent company and licensed to the vendor; there has been a failure to update the title after corporate name changes or acquisitions; or the IP has not been properly assigned and is therefore owned by an employee or contractor, or jointly owned with another entity.

2. Is use of the IP subject to certain conditions?

Particularly in the case of licensing agreements, IP may be subject to certain conditions. For instance, a licence may contain a ‘change of control’ provision, giving a party certain rights (such as consent, payment or termination) enlivened by a change in ownership, or the licence may be non-transferrable resulting in the purchaser being unable to use that IP. Alternatively, the IP may be subject to certain conditions of use, or a type of Exclusivity Agreement which may restrict use of the IP.

3. Is the IP properly protected?

The Coca-Cola recipe is allegedly only known by two senior executives at any give time, and the written recipe is kept in a steel vault with both a palm scanner and a numerical code, guarded 24 hours a day. Whilst it is unlikely a vendor needs this level of security, it should be determined that any Confidential Information in the transaction is protected in some way, whether by internal policies, encryption, or confidentiality agreements.

A company’s registrations should also be queried: are trade marks registrations being maintained? Are domain names due for renewal? Have all key brands been registered in key markets? Asking these kinds of questions can reveal deficiencies in IP protection early on.

4. Infringement

When a business has unregistered brands, it may be necessary to conduct searches to determine if a brand is infringing on a third party’s IP rights, such as a registered trade mark or design, or if an invention infringes on a Patent. Conversely, it may be necessary to determine if a third party is infringing on the vendor company’s IP rights. Either situation may expose the potential Purchaser to the risk of litigation after the transaction.

In summary, early and thorough IP due diligence can reveal the true value of a corporate transaction, and provide parties with an edge during negotiations.

This article was written by Luke Dale, Partner and Mary Szumylo, Solicitor.

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