This article continues to discuss Core Intellectual Property Issues in M&A and Investment. The first part of this article was published on Chinalawinsight on September 2011.
V. The Effect of the M&A on the IP Rights Agreements of the Acquiree
During the due diligence in a merger, special attention should be paid to the effect of the investment or merger on the intellectual property rights of the acquiree, especially the effect on license contracts. Two common problems are when the acquisition triggers a clause in a license contract changing control in a way that alters the effectiveness of the agreements, or some other clause in the agreements hinders future business of the acquired entity.
Case 5: A transnational company intended to purchase the domestic mobile communication department of another transnational company. During the due diligence investigations, we found a license contract between the acquiree and a state-owned enterprise ("SOE"). In this contract the acquiree licensed the core technology of the department to the SOE for exclusive use, and ensured that the core technology would not be transferred or licensed to any third party in specific locations. We contacted the management team of the acquiror and learned that the acquiror intended to transfer the technology to other domestic entities of the acquiror for implementation and management pursuant to its business framework. Therefore, we advised the acquirer that the acquiree should negotiate with the SOE to amend the license contract to ensure that the business could operate according to plan after the transaction.
In the above case, if the potential problems can’t be found and resolved timely in the due diligence investigations, the acquirer may be at risk of breach of contract liability after the acquisition.
VI. The Transfer of IP Assets after the M&A
The transfer of IP assets is a critical step in the acquisition process. Even though agreements have been reached in the transaction documents, problems may still arise during the performance.
Case 6: A company purchased the intangible assets of a related and famous franchisor whose primary business is in products and services for parents of young children. The intangible assets include brands, training courses, tutorials, and more. The transfer of the IP assets were listed and enumerated in the agreements. However, during the performance of the agreements, a dispute arose because the list only showed the title of the assets to be transferred. During performance, both parties had quite different understandings of the listed assets.
Usually, if the IP assets to be acquired involve trademarks, patents and registered copyright works, the transfer procedures are comparatively simple. However, if some IP know-how without related certificates or copyright works without registration are involved, complications arise. It is better for the two parties to reach an agreement on these issues during the due diligence investigations and clarify the carrier of these intangible assets.
VII. The Transitional Arrangements for the Transfer of IP Assets
With respect to some registered IP rights, despite the simple transfer process, the length of time for transfer should be taken into consideration. For example, it takes 10-12 months to complete the assignment of a registered trademark and 1-2 months to complete the assignment of a patent or an application for a patent in China. During the transition, the two parties should consider how to agree on the rights and the obligations of both parties to make sure the IP rights can be enjoyed and executed favorably in the transition.
VIII. The Risks and Liabilities of IP Infringement
During M&A, the analysis and evaluation of the risks of IP infringement is an important part of an IP due diligence investigation. Many transnational companies seek to acquire Chinese companies with the intent to use them as global production bases to sell their products to markets outside China. Therefore, we have to carefully evaluate the risks of infringement existing in the current business of the target to avoid significant potential losses in the future.
Case 7: Through fierce competition, a world-renowned investment bank succeeded in investing in a leading company in the new energy industry. The company was very promising since it was the leader in the emerging industry. However, the company was charged with patent infringement for listing one of its main technologies as acquired through a license. Complications arose because the licensor believed the company exceeded the extent of its license to sell the products overseas, didn’t disclose financial documents for audits and didn’t pay a sufficient license fee. The two parties became entangled in a prolonged dispute and the schedule for listing was repeatedly delayed.
Investment banks, PEs and venture capitals are usually not keen on specific due diligence investigations on IP because the capital for investment flows in and out quickly. Because of the fast paced environment of these companies, long-term management is rarely sought. However, as the IP scandal of the companies to be listed intensified, the SFC paid more and more attention to the IP issues. Unfortunately, such cases are increasingly common.
Case 8: A world-renowned pharmaceutical company intended to purchase the rights to of a newly developed drug achievement. Since the IP rights were the core assets to be acquired, the pharmaceutical company authorized us to carry out the IP investigations, including research on current patents and analysis of non-infringement. Through the analysis, we found that the implementation of the new drug achievement was based on several preexisting patents which included several improvements over the preexisting patents. However, the new drug achievements owned novelty and inventiveness all over the world. If the company wanted to commercialize and produce the new drug, they needed to either acquire the licenses of the preexisting patents or wait for the expiration of these patents. However, these preexisting patents were only authorized in certain countries and regions including China, Europe and the US. Through several rounds of internal negotiations, the company finally decided only to purchase licenses of the technology in a region of Southeast Asia. This was done so the technology could be placed in commercial service immediately without having to purchase licenses, since preexisting patents hadn’t been applied for in these regions.
In the above case, IP lawyers can assist the clients not only in finding existing infringement risks in the M&A, but also in determining the best business solution for specific clients.
Because of the intangibility of active M&A activities, IP assets are easily neglected and can become a controversial issue. However, most of these issues can be identified and solved in due diligence investigations so as to avoid pitfalls. This can save enterprises large costs of solving potential disputes after the fact.