This week’s article comes from our partners at Carpenter Wellington.
Mergers and acquisitions frequently concern many important issues concerning intellectual property risk. This is especially the case for companies that are privately held in the technology sector. With a private company acquisition, the seller hasn’t had the opportunity to be scrutinized like those in the public markets.
By the same token, the acquirer doesn’t have the ability to gather all of the intellectual property-related information it needs from public sources. As a result, before an acquirer can definitely move forward with an acquisition, it usually will conduct thorough due diligence on the selling company’s patents, copyrights, licenses, trademarks, and other intellectual property.
This article will examine the most critical activities and issues concerning intellectual property risk in a typical acquisition of a privately held company.
Documentation Reduces Intellectual Property Risk
The selling company must prepare a full list of all of the intellectual property (and related documentation) that’s relevant to the seller’s business for the acquiring company to review. This includes materials such as the following:
Patents and patent applications;
Confidentiality and assignment agreements with employees and consultants;
Critical trade secrets;
Proprietary processes, formulas, systems, software, and databases;
Trademarks and service marks;
Intellectual property risk indemnification contracts;
Any intellectual property legal actions for infringement;
Liens or encumbrances on the intellectual property; and
Social media accounts.
The Development and Acquisition of the Intellectual Property, and its Value
The acquiring company should ascertain the value of the intellectual property that’s critical to the selling company’s current and anticipated business. Accounting valuations, or purchase price allocations, are usually used to determine an asset’s value in a merger or acquisition.
Intellectual Property Risk Relating to Representations and Warranties
The seller will want to be certain that it’s not required to make any representations and warranties as to its ownership of intellectual property for the period after the closing because there may be factors beyond its control that restrict the right of the seller or the acquirer to exploit the intellectual property. The same type of analysis must be done for representations and warranties related to intellectual property infringement.
Any Intellectual Property-Related Disputes
The acquiring company must examine the seller’s involvement in any ongoing or past intellectual property litigation for potential intellectual property risk, as well as the potential for pitfalls and liabilities in the future.
The Scope of Indemnification by Seller on Intellectual Property Issues
The acquiring company will insist on the seller or its stockholders providing indemnification to the acquirer for breaches of intellectual property-related representations, all known claims (including pending litigation), as well as possible future claims concerning the seller’s intellectual property.
Intellectual Property Risk: Disclaimers by the Seller
One of the most serious allegations that a dissatisfied acquiring company can make against a seller is that it committed fraud. To avoid this, sellers should implement precautions that have been approved by the courts. The acquisition agreement should include an express disclaimer from the seller that is acknowledged by the acquirer that the seller is making only the representations and warranties explicitly stated in the agreement. The acquiring company should expressly state in the acquisition agreement that it has done its own investigation of the business of the seller and is not depending on any representation or warranty of the seller (or any of its officers, employees, or advisors) except what is stated in the acquisition agreement. Finally, sellers should provide a precise definition of the term “fraud” to avoid intellectual property risk.
Assignment and Change of Control Issues
One other important issue is that intellectual property licenses and agreements usually have terms that require the consent of the other party to a change of control of the selling company or an assignment of the agreement by the selling company. The seller should thoroughly review the “anti-assignment provisions” included in all of the selling company’s intellectual property licenses and other intellectual property-related agreements.
If the seller has important intellectual property that is only transferable to the acquiring company with the approval of third parties, it may want to get that consent before entering into the definitive acquisition agreement. Of course, obtaining this consent requires the disclosure of the proposed acquisition to a third party, which creates confidentiality issues.
This list is just the tip of the iceberg because there are a multitude of details to consider with respect to intellectual property risk in mergers and acquisitions. Be sure that your company begins the process early and leverages the expertise of veteran M&A legal counsel.
You can read more about Carpenter Wellington’s mergers and acquisitions practice.