Merger and acquisition transactions often succeed or fail on the basis of adeptly performed due diligence. The results of the due diligence process will often determine core deal terms, transaction structure, and whether the deal itself even moves forward. Transactions where intellectual property (“IP”) is the key or sole asset to be acquired require their own particular considerations and inquiries that may not be obvious to a general practitioner.
Types of Intellectual Property
There are four major types of intellectual property that a business may own: copyrights, trademarks, patents, and trade secrets.
Copyright protects original, creative works that are “fixed in a tangible medium of expression.” This would include, for example, literature, photographs, drawings, music, video, and software. Copyright allows the owner to prevent others from using the work without the owner’s permission, or creating a new work that is “substantially similar.”
Copyright protection begins at the time of creation and lasts the life of the author (or last remaining author) plus seventy years. If the work was created for the business as a “work made for hire,” which means that the “creator” of the work is the company and not the person who actually created it, then protection lasts for 95 years from publication of the work or 120 years from creation, whichever is shorter. Registration with the Copyright Office is not required in order to obtain a copyright, but it is essential to the proper protection of the copyright.
Trademark protects names, logos, slogans, and other expressions that are used “in commerce” and identify products or services of a particular source from those of others. This would include brand names, logos, slogans, colors, and sounds.
Trademark protection continues for as long as the trademark is used in connection with the sale of goods or services. Similar to copyrights, trademarks do not need to be registered with the United States Trademark and Patent Office (“USPTO”) in order to be protected, but registration is often recommended as it grants extra rights to the trademark owner. These rights include the right to use the ® symbol next to the trademark and the ability to file an infringement lawsuit in federal court. The USPTO will deny registration to any other trademark it considers to be confusingly similar.
Patent protects processes, machines, articles of manufacture, and compositions of matter that are new, useful, and non-obvious. To benefit from patent protection, an invention must be registered with the USPTO. Patent registration gives the owner the right to exclude others from using the invention for twenty years from the filing date. Once patent protection expires, the invention enters the public domain.
There are three types of patent registrations in the United States:
- Utility Patent: Any new and useful process, machine, article of manufacture, or composition of matter, or any new and useful improvement thereof.
- Design Patent: A new, original, and ornamental design for an article of manufacture.
- Plant Patent: The discovery and asexual reproduction of any distinct and new variety of plant.
Trade SecretsTrade Secret protects confidential information that is used continuously by a business and is not generally known within the industry. Trade secrets are protected for as long as they are kept secret, which is typically done by requiring anyone with access to them to sign a non-disclosure agreement. Confidentiality is the only means by which trade secrets are protected – there is no registration process.
The below chart gives a quick overview of the differences between copyrights, trademarks, patents, and trade secrets.
Types of M&A Transaction Structures
There are four main ways that an acquisition of a business may be structured:
- Stock Purchase: The buyer purchases a controlling interest in the target company, taking control of its management.
- Asset Purchase: The buyer purchases all (or substantially all) of the target company’s assets and liabilities.
- Merger: Two companies combine into one surviving entity.
- Carve-Out Transaction: The buyer purchases a separate business from a larger enterprise, which may be separately organized as a subsidiary.
What type of transaction structure is optimal depends on a variety of factors specific to the situation at hand. What assets the buyer is seeking to purchase, what liabilities the buyer desires to avoid, and any potential tax impact are all major considerations in determining what type of acquisition structure will be used.
- What IP is critical to the target’s business
- What IP is critical to the buyer’s future plans
- What IP is owned by the target, both registered and unregistered
- Pending applications for registration, upcoming maintenance filings, and abandoned applications/registrations
- What IP is owned by third parties and licensed or otherwise used by the target company, and whether those licenses may be freely assigned by the target company
- Current and future potential IP disputes (threatened and actual lawsuits, USPTO office actions, TTAB proceedings, UDRP arbitrations, government investigations, etc.)
Once the key IP and any potential related liabilities have been identified, the buyer should request all pertinent documents related to the IP to be acquired, including:
- All agreements with directors, officers, advisors, employees, contractors, consultants, interns, and other service providers who may generate IP, including:
- All registrations and pending applications with the USPTO, Copyright Office, and international equivalents
- All assignment and license agreements for IP (for both the target company IP and any IP licensed from a third party)
- All collaboration or joint venture agreements involving IP
A search for any security interests or liens against the target’s IP should also be conducted. These may be filed with the Copyright Office, USPTO, and/or the state under the Uniform Commercial Code via a UCC-1 filing. Prior to the transaction closing, the buyer should ensure that a release is filed with the appropriate government office for any security interests that are no longer active.
Common IP Issues
There are a number of issues that may arise during the due diligence process. Several of the most common are described below:
- Registered Under the Wrong Name – copyrights, trademarks, patents, and domain names might be registered under the name of a founder, employee, or contractor instead of the target company
- Exclusive Licenses – if IP has been licensed to a third party on an exclusive basis, the target may have relinquished or restricted its right to use it
- Termination Rights – critical IP license agreements may allow the licensor to terminate without cause, resulting in lost value, and under certain circumstances copyright assignments may be terminated by the creator
- Jointly-Owned IP – IP that is shared with third parties may be subject to certain restrictions or accounting obligations
- Assignment Restrictions – critical IP license agreements may prohibit or restrict the assignment of the agreement or a “change in control” of the target company, creating the need to obtain the assignor/licensor’s consent prior to transferring the rights to the buyer
- License of Affiliate IP – a license or other agreement may license the IP of the target “and its affiliates,” thereby potentially including the buyer’s IP in the license after the transaction closes
- Group/Enterprise Licenses – in a carve-out transaction, the target may lose licenses made on a group or enterprise basis to the target’s parent company
- Failure to Timely Register Copyrights – statutory damages, attorneys’ fees, and other benefits are available in an infringement action if copyrights are timely registered
- Reversion Rights – copyright assignments (not WFH) may be terminated by the author 35 years after the grant (56 years for pre-1978 grants)
- No Work for Hire Agreement – works created by employees are generally works-made-for-hire (“WFH”), but contractors must have a written agreement for copyrightable works to be WFH or assigned
- Open Source IP – use of open source code may subject the target’s IP to restrictions or cause it to lose IP protections
- Intent-to-Use (“ITU”) Trademark Applications – ITU applications cannot be assigned until proof of use in commerce has been filed with the USPTO, unless assigned to a successor of the business
- Non-Use and/or Inappropriate Use of Trademarks – trademarks must be used continuously in commerce and in a consistent manner to maintain trademark rights
- Trademark Coexistence Agreements – may limit the ability of the company to expand into new businesses under a certain brand name
- Limited NDAs – trade secrets may lose protection if confidentiality obligations are limited in time or scope
Standard Representations & Warranties
All of the target company’s registered IP, material unregistered IP, and license agreements will typically be listed on a Disclosure Schedule attached to the transaction agreement. Trade secrets may be omitted from the Disclosure Schedule in order to maintain their confidentiality.
In the transaction document, the buyer may require the target to warrant and represent that:
- It owns or has the right to all IP used in its business/on the Disclosure Schedule, free of all liens
- All IP assets are valid and no claims challenging their validity exist
- The IP does not infringe any third party’s rights, and to target’s knowledge no third parties are infringing on the IP
- All IP agreements are valid and in full force and effect, and target is not in breach of any IP agreement
- No lien on or license of the buyer’s IP will be created as a result of the closing of the transaction
- The target has the right to use the IP assets it uses in its business
- The rights to the IP used in the target’s business will survive the closing of the transaction
- In a carve-out transaction, all transferred IP and licenses are sufficient to operate the target’s business in the same manner as prior to the closing
When the proper care has been taken in performing due diligence on key intellectual property to be acquired, counsel will be able to structure the transaction agreements in a way that addresses any deficiencies in obtaining and protecting the rights to the IP in order to more effectively protect their client.