Intellectual Property Due Diligence in M&A Transactions

Keywords: Intellectual Property, Due Diligence, Target Company

(Adv. Meyyappan Kumaran S is a II year, L.LM student at the Tamil Nadu Dr. Ambedkar Law University, School of Excellence in Law)

INTRODUCTION TO DUE DILIGENCE:

A Merger is a transaction wherein a company merges with another to form one company and an Acquisition refers to a transaction where one company acquires another company. When a company merges with or acquires another, it also absorbs its assets and liabilities as on the date of the Mergers & Acquisitions (M&A) transaction, and therefore very careful due diligence must be carried out before concluding the transaction.

Due Diligence refers to the process that the buyer company undertakes to make a thorough analysis of the target company and its finances, contracts and customers. Due diligence happens when a Letter of Intent (LOI) is signed at first. Due diligence is important to help the buyer understand the position of the company and whether it is financially viable to merge with or acquire the concern. It also shows the potential buyer, the risks involved that the company has placed itself into. Such risks are essential to be known to the buyer in advance to help him make careful decisions and to uncover any potential financial threats the company may be facing prior to signing the M&A Agreement.

INTELLECTUAL PROPERTY
Intellectual Property (IP) Law aims at protecting the intellect of a person (Humans) and to create economic value for their information to prevent individuals from copying the work of another. IP Law deals with a plethora of intellectual properties. For a company, IP includes Patents, Trade Secrets, Trade Marks, Designs, and Copyrights and in some transactions, this is the sole reason to buy a company itself by another concern. Hence, it is of utmost importance to conduct an due diligence audit before signing the Letter of Intent.

IMPORTANCE OF IP DUE DILIGENCE IN M&A
The importance of conducting due diligence before investing or acquiring a technology company is more so important because the main reason for buying the technology-driven company would be for its Intellectual Property Assets (IPA) and the value of IP enhances the overall value of the M&A deal to be struck. An IP Due Diligence is mainly to audit and assess the quality of IPAs licensed to the target company (the company that is going to be acquired or merged in the transaction).

The IP due diligence may be the sole criterion to enter or to not enter into such a transaction as its protection is very important, without which the case to acquire the company or to merge with it would become weak for the buyer. This can be done by the target company itself to fix a value for their IP or by the potential buyer to enumerate the risks involved if the IP is purchased.

STAGE WISE APPROACH IN DEALING WITH IP DUE DILIGENCE OF A COMPANY

STAGE 1:

IP lawyers practicing in IP due diligence would be able to tell us the ground rules for conducting a due diligence of the IP owned or licensed by the business concern. This stage would help the buyer know whether to buy the asset or structure it like a share purchase. The buyer should verify the level of IP protection by the target company for it to make an informed decision regarding the M&A of the target company.

A process called ‘high level IP mapping’ is done, wherein the buyer evaluates if there are any obstacles to the deal and which IPAs are core to the business of the target company and for this, the buyer should first evaluate the current level of technology in the target company and identify gaps (if any), the level of IP protection they have, the licences granted to them (if any), and the transfer of such licences, its processes and so on. The important aspect to note here is to include in the M&A agreement about any post-transfer litigations like a patent litigation which would be a costly affair for the buyer, if such a case arises.

STAGE 2:

In this stage, the buyer does a process called a ‘Traditional due diligence’ which is carried out more meticulously, wherein all the IP ie. Copyrights, Patents, Trademarks, Trade secrets, Design, are evaluated in an in depth manner to ascertain the ownership title for the IP, legal protection for the IPA, and use of free and open software and shared IP.

CONCEPT OF SHARED INTELLECTUAL PROPERTY:

A Company may be sharing its IP with another company and the buyer intending to merge with or acquire the firm, should evaluate the potential aspects of shared IP and evaluate whether they would like to continue having such a shared IP with another firm. If they wish so, they must:

a) draft a fresh licensing agreement with the shared IP company post-M&A.

b) If the buyer wants such an IP only for a limited period of time, they need to draft a traditional license at closing of the deal.

c) draft a traditional services agreement in case of shared software wherein, the company may be sharing its pay-roll or telecommunications with its service provider and until the buyer wants to use it or replace it with a company of the buyer’s choice.

TITLE TO THE INTELLECTUAL PROPERTY:
The buyer should study whether the target company owns the IP it purports to own, as any such disputes may cost the buyer dearly to resolve in the courts of Law. The buyer should ascertain whether:

a) ownership records of the IP are clear;

b) whether it is listed in public records;

c) the right to use is with the company and whether the company is currently abiding by usage of such IP so that any legal issue does not crop up in the future.

The due diligence by the buyer should also ascertain the legal protection accorded to the IP of the target company and this exercise requires expertise in due diligence of IP.

SOME OF THE FORMS OF IP-DUE DILIGENCE:

1. TRADE SECRET DUE DILIGENCE

A Trade Secret is an IP of the Company generally not known by any other company in that industry based on which the owning company of such a trade secret gets a competitive advantage over the others in the business arena. Therefore, this is protected under Trade Secrets and they may include patterns, method of preparation, method of production, and the like.

Trade Secrets are primarily protected through secrecy and not merely on paper. Hence, the buyer must carefully analyse the due diligence on trade secrets and launch a study to find out whether the employees haven’t shifted jobs to competitor companies where they let out this trade secret and the form & manner in which this trade secret is documented so as to ensure no reproduction of such a trade sceret is done. If the trade secrets have already been let out, and the buyer would want to litigate the matter, then such costs would have to be incurred which therefore would reduce/diminish the value of the IP further and make it an unviable proposition.

2. SOFTWARE DUE DILIGENCE

While conducting software due diligence, the buyer needs to keep in mind the software licenses granted, whether such a software is needed to continue running the business or the new buyer can get a different software for themselves to use it in the business. If in case, the software cannot be transferred whether there would be any other substitute software he can use, the ways and manner in which the software will be used post closing the deal.

There are basically two types of software that a company may generally use:

a) proprietary software, and

b) third party software.

Proprietary software is owned by the company, if its employees have indigenously developed it. If it is developed by a consultancy firm (third party software), then the target company might only have rights to use the software which must be verified and seen whether such a right can be transferred to the buyer. Consent of the third party is required to be used afresh by the buyer even in case of shrink-wrap and click-wrap licenses.

Also, the buyer company must ensure if all the necessary payments to the software provider are paid up to date when the deal is struck, including any licence fee payments, insurance payments, warranties, maintenance of software, cap on liability, and so on. Otherwise, the buyer will need to pay all this if lapsed and also lose out on protection in case of an unfortunate event. All these are potential risks involved and must be evaluated before signing the deal and reduced into writing.

3. EVALUATION OF QUALITY OF TITLE
The Quality of Title shows the buyer the present worth of the IP of the target company, so as to test if the target company has granted any licenses to the software (which includes conditions and retained rights, the liens and security interests on the title) and if any infringements on the title were done. Like a software, even copyright needs to be evaluated for quality of title and the buyer company has to hire an expert lawyer in this field to carefully conduct the due diligence for them.

CONCLUSION:

We can come to a conclusion on how important it is for a buyer to ensure and verify the status of the IP of the target company before entering into the M&A transaction, as it is extremely important to avoid future litigations due to the pre-M&A faults of target company. IPAs must be scrutinised for their current protection status before signing the deal as IP litigations would cost the buyer company dearly and is a result of not running background checks on the IP of the Company. Hence, whoever intends to enter into an M&A, must do an IP Due Diligence to ascertain the status of the protection accorded to the IP of the target company.

REFERENCES:

https://www.dorsey.com/newsresources/publications/2003/12/intellectual-property-in-ma-transactionswhat-dil__

https://www.corporatelivewire.com/top-story.html?id=ip-due-diligence-in-ma-transactions