Whether you know it or not, due diligence has become a part of our daily lives. For example, before crossing the street, you look to the left and right to make sure that you have time to cross the street before traffic comes. First you look to see if there are any cars — identification. If there are cars, you will then determine whether they are moving towards you or are parked — investigation. For the cars moving towards you, you then determine whether there is enough time for you to cross the road — evaluation.
These same three phases (identification, investigation and evaluation) are all part of due diligence, including intellectual property due diligence. And this is especially true in mergers and acquisitions where you want to merge with or purchase another entity. Intellectual Property due diligence includes not only understanding the type and nature of the other party’s IP, but also knowing the strengths and weaknesses in their IP.
Before beginning IP due diligence, it is important to learn the flow of the deal. Every deal is different. One way to begin to understand the deal is to review a Memorandum of Understanding (“MOU”) or a Letter of Intent (“LOI”). The deal principles are generally agreed upon in a MOU or LOI setting out the goal or purpose of the deal. The first task then is to understand the deal. This means understanding what each party brings to the negotiating table, including each party’s IP assets (mature or immature); their product lines; cash; factories, fixtures and other capital; and their employees. It is also important to understand what each party desires to take away at completion of the deal – i.e. what assets, the ability to engage in what activities, etc.
The main objective of the identification phase is to identify all IP or IP-affecting-agreements which impact the merger or acquisition deal.
In the identification phase, it is important that the different types of IP assets, whether they be patents, trademarks or copyrighted material, be identified and/or inventoried.
With respect to patents, a company’s IP assets include issued and granted patents, patent applications and identified ideas that may or may not be patented. As patents are connected with the products or manufacturing processes of a company or the research and development of the company, it is important to review product lines and manufacturing, product making facilities and R&D groups. It may even be necessary to review lab books of R&D engineers or scientists, which might document ideas for which a patent has not yet been granted. It is also important to not only look for product patents or process enabling patents (patents covering aspects of a product or process), but also to look for defensive patents (patents which may not cover any product being sold or process being used, but which may be useful to assert against competitors to protect market share or profit margins).
It is also necessary to identify and inventory all types of trademark IP. This would include registered trademarks and trademark applications. As trademarks are connected with promoting products and services, as well as furthering product/company goodwill, then those portions of the company concerned with these tasks (e.g. marketing departments, sales departments) are likely places to investigate.
In the identification phase, all types of copyright IP should also be identified. This would not only include copyrightable documents or products which are owned by the company, but also those which are owned by third parties. This may include training and product documentation as well as manufacturing documents and advertising literature. It could also include internally generated software, product software or firmware, manufacturing software, and ‘front of the house’ software (e.g. accounting, legal or human resources software).
All practices, documents and information related to trade secrets should also be identified and inventoried in the identification phase. This includes manufacturing processes (e.g. product engineering notes and manuals), product related documents (e.g. product development documents, engineering notebooks) and administrative or executive documents such as internal financial reports, business plans and customer lists. Also, stated and actual corporate trade secret policies need to be documented, as well as access control policies such as employee badge policies and visitor escort policies.
And, of course, other intellectual property such as design registrations needs to be identified. This includes design registration applications, granted design registrations and other product designs which may be protected by design registrations.
Finally, in the identification phase, it is also important to identify licenses and other IP related agreements. This includes non-disclosure/confidentiality agreements; employee invention assignment agreements; patent, trade mark and copyright licenses; License-In licenses (e.g. copyright licenses for training material) and License-Out licenses (e.g. copyright licenses for manual excerpts, photos and publications). Also, all types of software licenses need to be inventoried, including site licenses; manufacturing process licenses (licensed with purchase of manufacturing equipment or not); accounting, payroll and other administrative software; office computer software licenses (e.g. Microsoft Office), and IP assignment agreements.
The investigation process is concerned with determining the status of the IP. The status of course, will depend on the type of IP in question. For example, the status of the IP could be granted, issued, filed but rejected, filed but not examined or unfiled.
For patents, a patent IP might be granted or issued, or it could be a pending patent application. There may also be unfiled inventions in the form of invention disclosures or in the form of ideas in an employee’s lab book. When dealing with the realm of IP, there may also be burdens on the IP in the form of a commitment to license, an agreement to except from a license, or IP invented under government contracts, university sponsorship agreements or collaboration agreements. Thus, when performing patent investigation, one needs to not only consider the status of the patent, but also consider any current and/or prospective uses of that patent by the owner, the nature and impact of prior art and burdens on the patent, and the effect of other patents and other IP in the portfolio of the current owner and the prospective portfolio on the patent. For example, a patent may have more value to the acquirer if the acquirer has complementary patents in the present portfolio. Or the patent may have more value to the acquirer if it has an immediate defensive or offensive use against a competitor of the acquirer.
With respect to trademarks, a particular mark may be registered, pending registration, or unregistered. There may also be joint ownership issues or licensing issues to consider. For example, use of a joint trade mark may be subject to notice and, possibly, assent by the joint owner. Therefore, use may be restricted by the joint owner. Where a trade mark is licensed, further issues may arise because acquisition of that trade mark does not extinguish the license. The acquirer must therefore honor that license and the licensee can continue to use the trade mark unless otherwise agreed.
For copyright investigation, issues such as authorship, assignment, joint authorship or work for hire need to be considered. Joint authorship presents the same issues as joint ownership, in that one may need to get assent from the joint author before taking any action with the copyrighted material or the acquirer and the joint author can take action independently with the copyrighted material, including action to the detriment of the joint author. In regards to software, issues of free or open source software need to also be considered. While open source software appears to be provided without any license, this is not true. There is a license under which open source software is provided, and the terms of most of those licenses require the licensee to pass the software on under the same terms and conditions of those licenses and to provide derivatives of the software under the same terms and conditions. So, if open source software is used in proprietarily authored software, that software must be provided as open source software.
When investigating trade secrets, issues surrounding the disclosure of confidential information, the protection of confidential information, identifiable or unidentifiable trade secrets, know how versus trade secrets, duty of confidentiality, employment issues and third party issues must be investigated. For example, it may be necessary to investigate whether a departed employee who has joined a competitor has also taken with him confidential information behind a key product or process. Also, there may be a disclosure of confidential information for which the party did not obtain a Non-disclosure agreement, thereby destroying the ability to protect the confidentiality of that information. In addition, a consultant may have performed some service in product or process development and may have agreed to maintain confidential information in confidence but have been able to take “know how” with him as part of the consultant agreement – it would then be necessary to understand what constitutes “know how”, and what constitutes confidential information.
The Evaluation of IP is the process of attaching a monetary value to a piece of IP. Unfortunately, this process remains more of an art than a science, with subjective appraisals of various factors. For the purposes of IP due diligence, a general value for IP may be determined using value factors such as the intrinsic value of the IP, market effects on value of the IP and burden(s) on the IP.
The intrinsic value of IP depends upon many factors and is dependent upon the business. For example, intrinsic value can be determined by the cost that has gone into developing and registering the IP. Alternatively, the intrinsic value can also be determined by looking at the value of similar IPs within a market relevant to the business. Further, intrinsic value can also be determined by possible future economic benefit of using the IP in the business. Other factors also affect the intrinsic value of the IP, such as whether the IP is registered or not, whether the IP enables a product (e.g. an enabling patent or a trade mark which distinguishes the product from other products in the market), whether the IP enables improved manufacturing, or, in the case of patents, whether it is a dominant right or not. Factors such as an employee’s continued employment as pertaining to his/her importance to company operations and/or to ongoing IP development or the effect of enforcement of trade secret protection policies can affect IP intrinsic value. For example, if a key employee is departing as part of the merger or acquisition, then the possibility of further improvements to present technology and projected roadmaps of product development may be severely impacted. Also, if trade secret protection policies have been only loosely enforced (e.g. no employee exit interviews and/or no follow up on departed employees using trade secrets in their new job), the ability to enforce trade secret protection after the merger or acquisition will be greatly diminished. As to patents, if a patent is not a dominant right, then a license-in from the dominant right holder would be necessary to practice the technology of the patent.
However, the intrinsic value of a piece of IP can also be affected by extrinsic effects. These extrinsic effects may have the effect of positively or negatively affecting the IP value. One type of extrinsic effect on IP value is extrinsic market effects. Factors such as the number of competitors in the market, the quality of competitor products, the product’s or its technology’s effective lifetime, the IPs contribution to profit margin and the sustainability of that profit margin are all extrinsic market factors which affect IP value.
Burden on an IP is recognition that there are factors related to the IP which have a negative effect on the IP. These factors can arise from how the IP was developed (e.g. funding received for IP development or collaborative effort in the IP development). For example, there can be use and transfer restrictions on the IP, field of use limitations or territorial limitations on the IP use, restrictions on the transferability or sub-licensing of the IP, or requirements to license the IP resulting from SSOs or free and open source software. With regards to patents, the burden on patent IP may depend on the phase of development of the IP (i.e. is it only an idea or has a technology been developed incorporating the IP or has a product or process been commercialized which incorporates the IP), markets of interest or IP ownership (i.e. whether it is self-owned or owned by a potential collaborator or jointly owned or competitor owned or owned by a non-competitor third party).
Approaching a merger or acquisition without adequate IP due diligence can have an effect similar to crossing the street without due diligence—you are unaware of imminent dangers. So, before entering into a merger or acquisition, consult professionals who can help you identify, investigate and evaluate these dangers in order to adequately address them.
Daniel R. Collopy
Spruson & Ferguson (Asia)
Dan Collopy is Special Counsel at the law firm of Spruson & Ferguson (Asia) which provides intellectual property legal services across Southeast Asia and is an Adjunct Fellow and Instructor at the Singapore IP Academy. In addition, he is a Director with Inflexion Point Strategy, a Silicon Valley company which represents technology companies and institutional investors in buying, selling, and investing in intellectual property. Dan has extensive experience in designing, negotiating and executing complex corporate transactions in which IP plays a central role, including M&A, joint ventures, and IPOs. He has also prepared and/or prosecuted more than 500 patents in diverse software, electronics, mechanical, and design areas. Dan's corporate IP experience includes more than a decade as an IP attorney with Motorola and several years as Associate General Counsel for Advanced Micro Devices. More recently, Dan served as an IP Consultant for Exploit Technologies, the commercialization arm of Singapore’s Agency for Science, Technology and Research.