IP due diligence in corporate transactions
The strength of a company’s intellectual property portfolio often drives the value of corporate transactions. Regardless of whether you are the acquisition target or the buyer in a transaction involving IP, the due diligence process should be designed to reveal the value of the intangible assets—patents, trademarks, copyrights, and trade secrets. IP due diligence should ideally be conducted at the onset of negotiations. This not only allows a more reasoned value of the IP to be determined, but also enables proactive corrective action if any legal concerns are identified that may otherwise affect its valuation.
IP due diligence typically begins with a fact-based investigation to answer initial questions including:
- What are the products and/or services involved with this transaction?
- Does the existing IP cover those products or services?
To answer the initial questions, the various products or services should be inventoried and the IP must be carefully reviewed to determine whether it includes those assets. By keeping the investigation focused on the relationship between the products and/or services of interest and the relevant IP, the investigation should remain on a path that parallels the goals and objectives of the transaction.
After documenting the IP, the investigation turns to focus on one or a combination of the following legal analyses:
- Freedom-to-operate considerations
- Scope-of-protection, validity, and enforceability concerns
- Ownership issues
- Existing agreement obligations
The substance of each aspect of the legal analysis is briefly discussed below.
Freedom to Operate
A freedom-to-operate (FTO) analysis evaluates whether the buyer will be able to make, use, and/or sell the target acquisition’s products or services, if acquired, without infringing the IP rights of a third party. This analysis identifies potential legal obstacles, such as valid patent claims of others that may be infringed and therefore stand in the way of using the target company’s IP. If potential blocking patents are identified, a more detailed analysis will likely be warranted. As counsel for a potential buyer, in addition to conducting your own FTO you may also want to consider executing a common interest agreement to review any FTO analysis or opinions of counsel that the target acquisition may have already conducted.
Scope, Validity, and Enforceability
The scope, validity, and enforceability analyses determine the scope of protection and strength of coverage of the target company’s assets. For example, determining the scope and validity of a patent begins with construing the claims. Validity assessments usually include evaluation of the novelty and non-obviousness of a patent’s claims, compliance with formal requirements such as the written-description, enablement, and best-mode requirements, as well as judicially created doctrines like obviousness-type double patenting. Enforceability centers on whether potential allegations of inequitable conduct exist, and the compliance by the inventors, assignee, and prosecuting counsel with the duty of disclosure. Concerns about the validity of key patents, the narrow scope of important claims, or about possible inequitable conduct, may result in a reduced valuation of the IP in the transaction. These issues may or may not be deal breakers, depending on their significance to the overall objectives of the transaction and their ability to be managed or addressed.
Ownership is often one of the first issues explored in an IP due-diligence investigation since it can be a deal-breaker. A series of questions are often asked about each piece of IP to establish the target company’s rights in it and whether those rights are free of any encumbrances and can be clearly transferred. Initial questions may include:
- Who are the inventors?
- Did those inventors properly assign the IP rights to the target, and have those assignments been property recorded?
- What are the target’s rights to transfer and assign?
- Are there governmental rights from funding?
- Have there been any third-party challenges to those rights?
The answers to these initial questions should help identify those areas of ownership rights requiring further investigation.
The existence of agreements, such as IP licensing agreements, is another area to explore to determine whether any of the IP is encumbered. For example, the investigation can focus on whether the target has licensed and/or is licensee of any IP, identifying the third-party licensor(s)/licensee(s), whether those licenses are exclusive or nonexclusive, and whether any sublicensing relationships exist. In addition to determining what obligations may exist, it should also be determined whether any of the products and/or services of the target and/or of the third party are subject to milestone or royalty payments, and, if so, what commercial activities trigger those payments. Finally, employment agreements and vendor or contractor agreements should be reviewed to investigate potential IP ownership issues, as mentioned above.
No matter what the composition of the IP portfolio (patents, trademarks, copyrights, trade secrets, or a combination thereof), no matter what the type of transaction (acquisition, merger, license, or joint venture) and no matter what the corporate arena is (domestic or international markets), the approach to IP due diligence must be based on combined business and IP perspectives. This approach enables the involved risks to be identified and mitigated or managed so that expectations and business objectives can be met.
Engaging IP counsel at the outset of a potential corporate transaction is a smart step toward ensuring you have the proper edge at the negotiating table. Contact Daidre Burgess for more information.