M&A activity in 2002 remains down substantially from recent levels; Thomson Financial reports that through September 2002, 4,086 transactions closed in the U.S., down from 4,979 in the same period in 2001 (18%). More dramatically, the value of closed deals fell 59%, from $939 billion to $383 billion. Nevertheless, deals are still being done, and M&A will continue to represent a way of life in corporate America and throughout the world.
Concern about intellectual property issues in M&A transactions has been growing. The importance of intellectual property and how it will be handled is dependent on the facts of each transaction. The factual context drives many of the issues, including the significance of technology or brands (trademarks) to the target, whether the technology or trademark is owned or licensed, whether the target is a stand-alone business or is a division or subsidiary of a larger corporation and whether the purchaser will operate the target as an independent business or expects to use its technology or trademarks with existing businesses or products.
This article focuses on patent and trademark due diligence issues.
Due Diligence
Due diligence is simply an investigation into the status of a business. It includes a discovery or confirmation about what's right and what's wrong. Due diligence is multi-disciplinary, involving executives of the businesses involved and outside experts, particularly accountants and lawyers.
In most cases, a significant disparity exists between the information the buyer and the seller have about the target. Due diligence is intended to remedy this disparity.
IP due diligence must be tailored to the target. Businesses' dependence on technology and branding varies significantly. However, virtually every business uses computer software and owns trademarks, meaning that some IP due diligence must be done. Today we look at trademarks and patents, beginning each section with a hypothetical.
Trademark Due Diligence
Hypothetical: In an asset purchase, you think you have purchased broad trademark rights over the mark GIZMO in the U.S. and Canada and plan to sell a variety of products using the GIZMO brand in both countries. You hear that another company is using the exact same GIZMO mark in Canada. You determine that the firm that handled your due diligence failed to tell you that: (1) you cannot use the mark in the U.S. on your planned goods because the U.S. trademark registration you bought covers a very narrow list of goods and 15 other companies are using and have registered the GIZMO mark for various goods in the U.S. and (2) you have no trademark rights in Canada because the company from which you bought assets did not register or use the GIZMO mark in Canada and the other Canadian company has been using and has registered the mark GIZMO in Canada for 30 years. In other words, you did not get the intellectual property you expected in your deal. What could have prevented this?
1. Communicate Strategy and Plans One of the most important steps in trademark due diligence is for the client to tell the trademark due diligence team both the reasons it is interested in the deal and its brand strategy for after the completion of the deal. If the client provides the following information, the due diligence team will have the perspective it needs to conduct meaningful due diligence:
- What are the most important trademarks (brands, names, slogans, logos) the target company owns?
- What are your plans for using these trademarks once you own them? On what products or services will they be used?
- In what geographic areas will you use them?
- Will you use them on the Internet? If so, how?
- Who are the target's biggest competitors?
If the client in the hypothetical had communicated its plans to sell a variety of goods under the GIZMO mark in the U.S. and Canada to its due diligence team, the team could have alerted the client before the transaction was done that the target company's trademarks would not support the client's plans.
2. Identify Rights and Verify Ownership After the client communicates its plans, the trademark due diligence team crafts a due diligence plan. Part of the plan includes identifying the trademarks and Internet domain names owned by the target. Trademark attorneys use information provided by the target and from electronic databases, websites and other public sources to identify trademark and domain name assets and to verify that the target owns them.
In the hypothetical, if the trademark attorneys had known the client's plans, they would have ascertained whether the GIZMO U.S. trademark registration covered the relevant products and whether the target had Canadian trademark rights.
3. Assess the Strength of the Trademark Rights Trademark ownership is not a binary thing - usually a company does not own all rights in a mark or none. Trademark rights can be strong or weak. To advise the client on the strength of key marks, the trademark due diligence team considers:
- The distinctiveness of the mark on a spectrum ranging from coined (XEROX), arbitrary (APPLE for computers) and suggestive (COPPERTONE for sunscreen) to descriptive (RAISIN BRAN for cereal) and generic (USED CARS for used cars). The strongest marks are at or close to the coined end of the spectrum.
- Whether others are using the same or similar marks in connection with the same or different goods or services. Extensive third party use will weaken a trademark.
- Whether others have licensed use of the mark. Licenses may limit the uses the acquiring company may make of the mark.
- Whether others are infringing the mark and what the owner has done to stop the infringement. If the target company has not policed its marks, the mark becomes weaker and weaker over time.
- The degree of commercial exploitation of a mark. If the mark is famous (like MCDONALD'S), it is strong.
If a mark is especially important to a deal, a trademark attorney should consider ordering a full trademark search to assess the strength of the mark vis a vis third party rights.
In the hypothetical, if the trademark due diligence team had researched whether others had registered or were using similar marks, it would have advised the client that its rights in the mark would be limited to use on a narrow list of goods and would be weak due to the number of third parties using the same mark.
Patent Due Diligence
Continuing with the hypothetical purchase of GIZMO, you also believe that you have purchased the patent rights to GIZMO for the U.S. and foreign countries, including Canada. You are planning on selling GIZMO products covered by the issued claims of one U.S. patent. You hear that another company is selling GIZMO products that you believe fall within the scope of the claims of the issued U.S. patent. Worse yet, there are GIZMO products being sold in other countries! Feeling a bit shell-shocked, you find that the firm that handled the patent due diligence failed to tell you that: (1) you don't own the U.S. patent because the patent had previously been sold to a competitor; (2) you may have rights to foreign counterparts, but the previous firm failed to determine whether you or another party owned such rights; and (3) your planned GIZMO product may infringe a U.S. patent owned by your biggest competitor! Again, you did not get the intellectual property you expected. What could have been done to prevent this disaster?
1. Involve Competent Patent Counsel When you believe a patent may be involved in a deal, speak with patent counsel. Communicate your concerns, or ask how to avoid purchasing a patent with problems that would prevent you from ever profitably utilizing the technology. Issues to discuss include:
- What is the key technology you wish to purchase?
- In which countries would you pursue patent protection and where would you sell the product?
- Who are the biggest competitors? Your counsel should assess whether the competitors have a patent or whether the competitors are already selling goods or services in the market without a patent. The latter could indicate that the competitors consider the technology to be in the public domain.
In the hypothetical, the client and the patent counsel should have discussed the client's goals and how patents can be used as one basis to evaluate whether the deal should have been struck in the first place.
2. Verify Ownership After the client discloses its business strategy, its patent counsel should carefully inspect "title" records of the target company. Most patents are "assigned" to a company and that assignment is recorded with the U.S. Patent Office.
The patent counsel considers: Was the patent application assigned by an employee to the company? If no assignment was made, is there an employee agreement that requires such an assignment? If not, the employee may own the invention and, ultimately, the patent. Have loans been taken against the technology? If so, a secured party may have a superior ownership interest in the technology. Lastly, are there any licenses of the technology? If so, the client may own the technology, but be unable to practice it because another party has those exclusive rights.
In hypothetical above, the client and the patent counsel should have discussed the implications of not having clear title to the property.
3. Evaluate the Strength of the Patent Let's assume that the U.S. patent was properly transferred to you. Your patent counsel should consider whether you could make, use, sell or offer to sell GIZMO worry free. Other patents in the field could block your plans or require you to pay a hefty license fee to another party. Competent counsel can identify "dominating patents" through patent searches.
Also, your patent counsel should evaluate the type of claims issued in the U.S. patent. Are they broad – so broad that they could require a competitor to license technology from you? Are they so narrow that a competitor could easily engineer around them? Patent due diligence should identify infringement issues to better understand how the patent(s) may withstand challenge by third party rights.
Each country in which you intend to sell the technology must be considered separately, so your patent counsel should help determine whether foreign protection is cost effective and whether use in each country would infringe third party rights.
In the hypothetical, your counsel should have assessed the risk of infringing your competitor's patent.
Conclusion
When purchasing IP, you should work closely with your IP counsel. Outline your goals and what is most important; otherwise, you may focus on an unimportant issue and miss a vital roadblock. Ownership and infringement of other's rights are two important issues. These two issues aren't necessarily deal killers but may refocus the transaction's structure, your goals, or what you are willing to pay for the IP assets.