When Volkswagen purchased the Rolls Royce and Bentley automobile assets for nearly $800 million in 1998, it acquired almost everything necessary to make a Rolls Royce: the legendary plant at Crewe, the designs, and the machinery. Unfortunately for Volkswagen, those assets did not include the right to use the Rolls Royce trademark! After the deal closed, Volkswagen could make a very high-end car that looked exactly like a Rolls Royce, but it could not call it a Rolls Royce. The Rolls Royce airplane engine company had licensed the Rolls Royce mark to the selling auto maker under a license that terminated in the event of such a sale. The owner of the Rolls Royce trademark had hoped that BMW would prevail over Volkswagen in the bidding war for the auto maker. Although Volkswagen won that war, the owner of the Rolls Royce trademark sold the rights to use the Rolls Royce mark on automobiles to BMW.
Imagine spending hundreds of millions of dollars to be able to make and market Rolls Royce automobiles and then discovering that you could not polish them off with the Rolls Royce insignia. After that, imagine one of your competitors sweeping in and purchasing the rights to the mark! In a monumental agreement rumored to have been reached over a round of golf, and in an effort to avoid litigation, BMW agreed to permit Volkswagen to continue to make cars branded with the Rolls Royce trademark until December 31, 2002. After that time, only BMW will manufacture Rolls Royce cars.
Several years ago, Coca Cola's chairman wrote in his annual letter to shareholders that even if every physical asset of the company were destroyed, the company could raise $150 billion on the strength of one intangible asset - the Coca Cola trademark. At the other end of the spectrum, when the dot-com bubble burst, Pets.com was liquidated, and the only asset sold was its trademark "sock puppet." These examples illustrate the often-overlooked importance of IP to businesses.
Many acquisitions, financings, and bankruptcies over the last 20 years consisted primarily of the transfer or security of intellectual property, mainly brands. Parties rely on their lawyers to make certain that they actually acquire the assets needed to run the business. As in the Rolls Royce example, however, purchasers sometimes end up with far less than expected or desired. In some cases, this situation is due to the rush of doing the deal. In some cases, it results from purchasers using lawyers unfamiliar with intellectual property principles to conduct due diligence. In others, non-IP lawyers fail to include specific language in the purchase agreement to protect the buyer from a variety of complex IP issues that can arise in verifying title and transferring large, worldwide intellectual property portfolios.
But the Schedule Said the Seller Owned Pine-Sol. . .What's the Problem?
If the buyer wants to take a popular brand and leverage that brand into new markets, the attorney must make certain that the scope of the intellectual property rights being transferred by the seller will meet the purchaser's needs. Take, for example, the purchase by the Clorox Company of the Pine-Sol business and trademark from American Cyanamid. As Pine-Sol was a famous brand for liquid cleaner and Clorox was a huge manufacturer of cleaning products, Clorox naturally planned to leverage the strength of the Pine-Sol mark into other product areas. Unfortunately for Clorox, it purchased the trademark rights subject to a restrictive trademark agreement that Cyanamid had entered into with the owner of the Lysol trademark to settle a trademark dispute 30 years earlier. That agreement prevented Clorox from marketing any product under the Pine-Sol mark primarily as a disinfectant or as anything other than a general "cleaner." Clorox subsequently brought – and lost – costly antitrust litigation aimed at voiding the terms of the restrictive trademark agreement. While Clorox acquired everything necessary to continue the Pine-Sol business, it did not acquire everything necessary to fulfill its expansion goals for that business.
Few mergers or acquisitions would take place if there were not some "intangible" benefit sought to be gained by the purchaser. All too often, however, due diligence focuses less on the intangibles, and more on the "nuts and bolts" of the business. Some people (including, unfortunately, some transactional attorneys) simply assume that intellectual property rights will be transferred with the assets and will be trouble-free, that there are no IP issues in a stock deal, or that all IP issues can be cured by general IP representations and warranties in the purchase agreement. They can mistakenly assume that, because the client is buying all of the plants, machinery, and formulae necessary to make a branded product, that the client will also have the right to use that brand name on the product. Rather than taking such risks, corporate IP attorneys, knowledgeable in what questions to ask and what issues to spot, should be brought into the deal at the earliest stage.
A Whale of a Story
All attorneys know the value and importance of due diligence. When IP rights are involved, however (and they rarely are not), too many times the need for experienced IP lawyers as part of the transaction team is overlooked. The result, all too often, is that subtle points are overlooked in the due diligence process. Here's another example: After acquiring the Sea World parks, Anheuser-Busch learned that the trademark "Shamu" was not owned by the seller. Anheuser-Busch purchased theme parks with "Shamu" signs everywhere; the killer whales in those parks had all performed for years under the name "Shamu." But when the deal closed, the buyer was left without the legal right to refer to those whales as "Shamu" or to keep those signs hanging. The key to avoiding outcomes like these is knowing specifically what questions to ask and what documents to look for to ensure that you get all the IP rights you think you are getting. Some business lawyers simply do not realize the significance of an arcane IP agreement. The failure to investigate and properly secure intellectual property rights can turn a great deal into a huge mistake. While strong representations and warranties must be included in any purchase agreement, falling back on representations and warranties as the only remedy can doom the deal to failure and relegate future business plans to the trash bin. If the rights the client seeks to obtain are vital to success, then those rights must be investigated and understood.
Doesn't the IP Just Come with Every Deal?
When a merger, divestiture, refinancing, or purchase of bankruptcy assets involves intellectual property, a corporate IP attorney should be part of the team from the start. The business purpose of the transaction and the future business plans for the IP assets must be discussed. The buyer must clearly communicate what it expects to get from the deal and what it expects to be able to do with the assets. That guidance will enable the IP lawyer to perform the due diligence and advise whether the transaction will meet the client's business expectations. The questions asked by IP lawyers can often lead to a revaluation or changes in the structure of the transaction. As such, those questions must be asked in the early stages, rather than just days before the closing.
What kinds of questions should be asked? First, what is the proposed structure of the deal? A stock deal can be simpler, and less costly, from an intellectual property perspective. Whatever assets the selling corporation owns will automatically go to the buyer. Even in a stock deal, however, the next question must examine whether or not the target really owns, or has the rights to use, the IP assets necessary to run the business. If so, will a change of control terminate important licenses? An asset sale is more complex (and expensive) from an IP standpoint. Deeds of assignment for each patent, trademark, copyright, and domain name must be prepared for every country where there are intellectual property rights. If an IP lawyer drafts appropriate language requiring the other side to bear this responsibility, the purchaser can save hundreds of thousands of dollars in post-closing costs.
You're Fired! . . . Can We Please Have Our IP Back?
Once the deal structure is set, the corporate IP lawyer should perform the necessary IP due diligence to protect the client's goals. Determining whether or not the seller actually owns the intellectual property is, not surprisingly, a very good place to start. For example, companies may think that they own rights to inventions that were conceived of by employees prior to their employment with the company or that were invented by independent contractors. Employee inventors may also have "shop-rights" in certain states pursuant to those states' laws. If they do, even if the client does gaintitle to the invention, those "shop rights" may allow that employee to license the invention to the client's fiercest competitor.
The Software You Own May Not Be Your Own
If the seller hired an independent contractor to develop its software programs, unless there is a written agreement to the contrary, the independent contractor will own the copyright to those programs. If any technology being purchased could be patented, but the seller has not yet taken steps to do so, it may be too late. In the U.S., the deadline for filing a patent application is one year from the first offer for sale, commercial use, or publication of the invention. Absent patent protection, anyone can freely copy an invention you just purchased. Because of these ownership issues, it is crucial that the history and circumstances surrounding the creation and scope of rights in the intellectual property be thoroughly explored, especially in situations where the intellectual property will play a key role in the ongoing business. Relying on a naked claim to title and a registration could leave the purchaser owning nothing at the end of the day. Under U.S. law, an assignment of title to patents and trademarks must be recorded in the Patent & Trademark Office, while copyright assignment must be recorded in the Copyrights Office, in order to be valid against a subsequent purchaser.
Why Does IP Matter if I'm the Seller?
IP issues do not only arise on the buyer's side; a seller can also have significant IP interests to protect. As noted, sellers often believe they own intellectual property rights that they do not actually own. It may be counterintuitive to think that they paid thousands of dollars for a software program they do not own, or that an employee-inventor could license an invention he or she owns to someone else, but that could easily be the case. Without proper guidance, sellers will sign an inaccurate representation or warranty that could deprive them of all of the purchase price, or more, in the future. Whichever side of the transaction you are on, ownership issues will be crucial, and a simple examination of title documents and beliefs is frequently not enough to resolve those issues.
Once ownership is established, the scope of those rights needs to be determined by a corporate IP lawyer. For example, to record and perfect a lien against both patents and trademarks in the United States, UCC filings need to be made. Most lenders also record the security agreement in the U.S. Patent and Trademark Office, since this is the first place an IP lawyer will look for a lien. However, such recording is not legally required (although it is a good way to give notice), and as such, the absence of liens filed with the USPTO does not mean the intellectual property will be lien-free. Under U.S. Copyright law, however, only a lien recorded in the Copyright Office will perfect a security interest in copyrights. Outside the United States, the laws vary jurisdiction by jurisdiction on how to obtain a lien on intellectual property.
Restrictive agreements, such as the one affecting Clorox's ability to market Pine-Sol, must also be reviewed. If the transaction involves a popular brand that the purchaser intends to expand geographically or into new product lines, trademark searches should be conducted for those new markets and product lines to determine whether or not such expansion will encounter infringement problems. All intellectual property licenses must be reviewed. If the seller has IP licenses from third parties that do not permit assignment, the client could be buying a business that really doesn't exist. In a bankruptcy case, trademark licenses are treated quite differently from patent and copyright licenses.
Why Do You Need To Actually Look at the Seller's IP Files?
All prosecution files, litigation files, policing files, licenses, and enforcement files relating to the intellectual property must be reviewed for important issues. The seller's past failure to enforce its rights could result in the seller having nothing to transfer. In addition, the client may want to take steps to ensure that the assets it acquires will not infringe upon the rights of others. Often, an experienced corporate IP lawyer can look at a few of the seller's files and have a good idea if the seller really owns what it claims, and the scope of the problems in cleaning up title issues and ultimately transferring the IP to the seller.
Yes, Domain Names are Valuable IP
Internet domain names are treated slightly differently from the more traditional forms of intellectual property. The ability to transfer the domain, and the procedure for doing so, will vary from domain name registrar to registrar. One of the most overlooked details in many transactions is the expiration date of the domains. Registrars will send notices of expiration to listed administrative and billing contacts, but often those contacts no longer care about the domain and do not pass the notice on to the purchaser. Once a domain expires and is released by the registrar, it's gone, and anyone may register it. As with other forms of IP, each domain name requires a separate assignment document, signed by the seller, in order to transfer title to the domain name. Since Internet domain names are being sold for millions of dollars, failing to transfer a domain to the buyer properly can be an expensive proposition.
These examples merely scratch the surface of the intellectual property issues that arise in conducting due diligence for business transactions. The most important factor is to include someone on your team who knows IP and can spot these thorny issues early in the process. Then, it is a matter of taking corrective action, where needed, and negotiating specific IP representations and warranties to protect the client.
Further Information
This Jones Day Commentaries is a publication of Jones, Day, Reavis & Pogue and should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general informational purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at its discretion. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship.
Readers are urged to contact the principal authors of this publication, Joseph Dreitler (telephone: 614-469-3902; e-mail: jrdreitler@jonesday.com ) and Brian Downey (telephone: 614-469-3894; e-mail: bjdowney@jonesday.com ) or their regular attorney at Jones Day concerning their own situations or any specific legal questions they may have. General e-mail messages may be sent via the Internet to counsel@jonesday.com.