Intellectual property due diligence is a component of nearly every M&A and private equity transaction. When acquiring or investing, a buyer's primary interest in a target company is often the perceived value of its IP portfolio. Even when the buyer isn't initially targeting IP per se, the IP portfolio nearly always forms a material part of the transaction, especially given that most authorities peg the value of intangible assets at anywhere from 25% to 80% of the average company's total valuation.
Because of the expense of patent litigation and the increasing activity of the IP market makers, the deal can hinge on high-quality IP due diligence. The goal is to accurately map out the territory that the target company has procured for itself in a volatile IP landscape, and identify the soundness of the assets being purchased and potential risks.
Major components of IP due diligenceA thorough IP due diligence investigation should create high confidence in the answers to the following questions:
- Does the target company actually own its IP outright? Does the company enjoy clean title to its IP assets and does it own them free of liens and encumbrances?
- Is the target company's IP portfolio complete? Has the company protected all inventions, works of authorship, brands and proprietary information in the company that are capable of being protected?
- Is the target company's IP strong and enforceable? Will the IP withstand the claims of invalidity and unenforceability that will inevitably be leveled against it in a litigation context?
Due diligence in practiceIdentifying IP title defects requires ascertaining whether proper ownership agreements were signed between the company and the people who created the IP assets, especially if those creators were not full-time employees at the time they did the work. It is insufficient to review a blank form that the company says is the agreement that the relevant parties have signed; executed drafts of every applicable contract with every creator must be reviewed carefully. Special attention must be given to the dates on which these contracts were executed in comparison to the dates on which the IP assets were created.
Identifying completeness defects is a matter of taking a complete inventory of all inventions, works of authorship, brands, and confidential information in the company and matching them to corresponding IP assets and filings. Also ripe for examination during this phase of due diligence are the company's internal procedures for identifying and assessing the IP potential of its innovative creations.
Identifying strength and enforceability defects requires that the IP be reviewed from a strategic perspective to ensure the company's innovations are being protected in light of the competitive landscape in which they will be deployed.
Look behind the disclosures
Buyers are cautioned not to rely solely on the responsive disclosures of the target company to determine the metes and bounds of the target's IP portfolio. An independent search for undisclosed IP is often necessary. The goal of that search is to locate IP pending in governmental registries under the name of the inventors or authors, as opposed to the company, for example.
Further independent investigation may also be required to obtain a complete list of people who have invented and authored the company's IP assets. A common unfortunate scenario is for the target company to fail to disclose the contributions made to the company's core innovations by its very earliest participants, or "forgotten founders," who typically play a material role in the some initial inventive leaps, but then depart before the effort matures into a company.
Because they never signed officially with the company, forgotten founders fall out of the institutional memory, leaving the company more likely to downplay their contributions and assume that they needn't be listed as inventors or authors in official company documentation. Unfortunately, the contributions forgotten founders made can qualify them as bona fide owners of the resulting IP. Given that the company's lack of documentation about them undoubtedly assures that no IP ownership assignments are on file, the forgotten founder can constitute a fatal flaw in the target's IP portfolio, which can be expensive to correct.
The target company should be asked to disclose all information about past failed attempts to secure IP registrations, including any filings that were rejected or permitted to expire. These items can work to undermine the validity and enforceability of later IP filings.
Practitioners should request and conduct an independent search for security interests filed with respect to the IP, and should review all relevant out-licenses and other agreements and restrictive covenants under which the target company may have reduced its interest in the IP or agreed to restrict its own activities in some material way.
Of course, careful attention must be paid to identify all the myriad issues that can undermine the value of the target's IP: an unexecuted work-for-hire or assignment agreement; a nondisclosure agreement that terminates too early; a patent application that was filed too late; a trademark search that was not diligently reviewed before a brand was put into commerce; poorly drafted IP contracts. No stone can be left unturned, lest the pending transaction proceed without the benefit of a full understanding of the legal risks.
Cross-trained experts required
Unlike due diligence for financial controls or environmental compliance, the management of IP assets does not have the guidance of any standard-setting body or regulatory agency. While the U.S. Patent and Trademark Office registers patents and trademarks, and the U.S. Copyright Office registers copyrights, neither entity has any purview over how those assets are used, recorded, tracked, controlled or otherwise managed.
Moreover, IP law is esoteric, arcane and often counterintuitive. Normal assumptions about asset ownership and strength often do not apply, and reliance upon them can be disastrous.
Thus, success of IP due diligence turns on the ability of the investigators to analyze complex issues of both intellectual property law and corporate law, as well as the scientific, engineering, artistic and other substantive principals inherent in the underlying innovative assets. And all of this must be presented in a context that is meaningful to the buyer's business goals. -
Brent C.J. BrittonBrent C.J. Britton, a graduate of the MIT Media Laboratory and a former engineer, is a lawyer in the Tampa, Fla., office of Squire, Sanders & Dempsey LLP, practicing intellectual property and corporate law. He also serves as president of the MIT Club of Tampa Bay.
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