UK: IP Aspects Of Mergers, Acquisitions And Due Diligence

Last Updated: 22 May 2008
Article by Ilya Kazi

Often the IP due diligence aspect of a transaction is an afterthought, considered to be a complex and tedious formality, and left to the eleventh hour.

Occasionally, depending on the nature of the deal, this may not be significant. More often than not, however, failure to approach this issue thoughtfully can result in a less than optimal outcome.

It is relatively rare for the IP issues to present a last minute show stopper (one experience where this happened is related below) but much more commonly, opportunities to negotiate a more favourable price (from either side) or to make the most of a deal are often missed.

This article aims to cover some common misconceptions and pitfalls, and concludes with some simple positive advice.

Timing

Timing is critical. It may be the case that the major details of a deal can be turned overnight into a reasonable agreement reflecting the deal.

However, notwithstanding the major improvements with more and more IP offices around the globe making some or all of their data available online, there are still numerous important countries where obtaining even basic data about IP rights inevitably takes days, or weeks, as it requires formal application to the national office which will reply according to its own timetable.

The basic box-ticking exercise of confirming that rights exist and are in force is not the most important part of any due diligence, although some deals are done as if this is the only part of the exercise.

Frankly, if you are in the closing stages of a deal and presented with a schedule of rights spread around the globe, the sensible thing to do is to deal with the formalities by way of warranties (assuming you believe the person giving them will be in a position to stand behind them afterwards, which may not always be the case) than even to try to confirm the status of the rights you are acquiring in any but the "quick and easy" countries.

If you have any doubts as to whether such a warranty will be of any value, you should take care to avoid ending up in such a position; get schedules and launch an IP investigation at the start of discussions (when it will probably be more thorough and informative, and cheaper).

Much more important than the formalities, however, is the substantive review of the IP rights being transferred. If all the information and, where needed, the relevant technical people are all to hand, this can be done relatively quickly.

However, often it is appropriate to search for prior art (on any deal where one is buying IP rights it is normally prudent to evaluate their strength) or to obtain and consider official files (which are not always available online, or may be complex to unravel) or to consider the risk of infringement of third party rights. Time, typically a few weeks, is needed to obtain results from searchers or patent offices before evaluation can even begin.

Substantive review of IP rights

The importance of the IP review being substantive rather than formalistic cannot be overstated as this actual experience illustrates. A major corporation was about to close a deal with a small company, essentially based around an individual, who purported to have some important technology in a key area of interest to the corporation.

The lawyers had done the basic exercise of checking that the rights existed and title had correctly passed through the various incarnations of the target.

The seller had done an admirable job of explaining the technology and its merits to the buyer's commercial director. About a day before intended closure one of the legal team, noting that the deal hung on a few patents, pressed the buyer to get an independent view of the strength of these patents. This was agreed on condition that it did not hold the closing up.

We were quickly able to confirm that the patents did, on the face of it, cover the technology of interest (which the buyer was itself also developing) and were in force, without any serious formal issues. However, the inspection possible in the time revealed some areas of substantive concern and we reviewed the patents with the buyer's technical expert.

This confirmed initial suspicions that it would be relatively easy to design around these patents (or invalidate them), and that there was in fact not much real value in the patents themselves. Moreover, it was not clear what actual technology, other than the disclosure of the patents, was being bought.

We reported that the patents could be circumvented (in a particular way) and noted our view that, if the deal was for technological know-how and a step forward in a specific area, the patents added something but, in the absence of a complete solution, the buyer should seriously consider developing an independent solution, for which the patents may not be essential, as discussed with his technical expert.

Apparently our report arrived on the fax shortly before the deal was signed, as a result of which the deal was aborted. The buyer subsequently developed its own technology without having spent several million on an acquisition which would have added little actual value to its business. All of this could have happened much less dramatically and the substantial costs of the abortive acquisition saved had this (relatively small) combined analysis of the technical, legal and commercial situation been conducted at the outset.

The value of IP in negotiation

The above was an exceptional incident. Commonly, however, by being a buyer in a position to point out the potential weakness in the other party's position one can negotiate a better purchase price. Also, by considering how one can creatively improve the position after the acquisition one can turn the acquisition into a much more valuable asset.

As a seller, often in a financially weaker position (or else you may not be selling), being able to give the buyer an informed explanation as to why, regardless of any other business issues they may have seized upon, it is fundamentally in their interests to have the IP you are offering (rather than it being something you throw in to the deal) in order to continue their business plans can put you in a much stronger position.

Rights acquired versus freedom to operate

It remains a surprisingly common misconception that acquiring IP conveys the right to use that IP. This is fundamentally wrong. One could spend millions acquiring a vast portfolio of patents and a raft of know-how then discover that a third party holds one or more key other patents and is unwilling to licence rendering it worthless, or requires a fee which doubles the cost of the deal. It is common practice to try to insert broad ranging indemnities and warranties into all manner of deals.

One cannot in practical terms research the totality of patents which might be relevant to a particular product. Even if one has done detailed (and expensive) searching directed to the core concept (which is the exception in practice), it is an impractical task to consider every component, ranging from software, hardware, mechanical features, manufacturing techniques, operating methods.

As a seller, it is therefore very unwise to give an indemnity unless very limited or any warranty which is not fully qualified by actual knowledge.

As a buyer, you should expect a properly advised seller to resist an indemnity and not expect it to be particularly valuable in any event. It is doubtful whether a board would find convincing an explanation that an acquisition costing millions of dollars, plus fees, for technology which cannot in practice be used was sound because of the indemnity (from a company whose assets have now been acquired).

As noted, complete searching is not possible and searching will in most cases throw up potential issues. Moreover, in the US in particular, which is uniquely litigious, having contingency fee litigation for plaintiffs, unfettered by cost penalties, there is the added issue of treble damages for wilful infringement; just searching for risk and not dealing with what is found properly can make the problem worse, not better. So what should one do?

The answer is to do intelligent, directed, risk assessment. What that involves varies considerably on the specifics, including the stage of technology, the competitors, the markets, and the sizes of the players involved. It is not something that can sensibly be done at the last minute. It may be important not only in helping to negotiate a realistic selling price but in deciding overall risk mitigation strategy (and possibly identifying other acquisition targets).

After the deal

Experience suggests it is rare that the original owner of IP rights has in fact made the most of them, particularly in so far as they may relate to the new business, often due to funding constraining their activities and not least because they did not know the new business plan.

Simply keeping the IP rights as purchased risks wasting money on retaining rights of little value but more importantly failing to capitalise on potentially valuable assets. Creatively analysing whatever you have acquired and considering "twisting" it to fit your own business can be surprisingly fruitful. Ideally, some guidance on possibilities may already have come "for free" in the preacquisition due diligence as an offline aside to the formal report explaining why they should be sold for less, but this should be developed regardless.

Practical Advice and Conclusions

That general rules do not underestimate the potential value of IP rights in a deal and do not leave assessment of them to the last minute seems almost too trite to mention but it seems most helpful to break down further advice into buyer and seller categories.

Advice to Sellers

This is more often overlooked; the seller is often to a greater or lesser degree cashstrapped and assumes the buyer will do the hard work. Remember that you are trying to position your proposition so that the buyer, or each of them, will want to buy, or be worried about not doing so. The fear of your IP rights being bought by someone else and preventing the buyer carrying out his business plans can be a strong motivator.

Investing, within your constraints, a small amount in preparing a targeted explanation as to why the buyer is potentially likely to infringe several of your rights, even if not actually pressing those rights to grant, may raise the buyer's interest. Taking sensible steps to make your IP of interest to potential buyers, rather than focussed on your immediate strategy, should be part of your overall IP strategy from the outset. Often a few thousand pounds spent on protection for a growing company can add a few million to a selling price a few years later.

Advice to Buyers

Always look at the substance of what you are buying. Consider, creatively and from both perspectives, what would happen if you did not have that IP, whether you might be sued, whether you could design around it, whether you might invalidate it, whether you could make more of it, whether someone else might make more of it.

You should have a clear understanding of the pros and cons of acquiring it, coupled with an authoritative report putting your negotiating position forward, when you negotiate with the other side.

Even if IP is only a small part of the deal, it can make a surprising difference to the value; you might agree to buy a dilapidated factory because the seller is unknowingly sitting on an IP goldmine or you might get an important business asset at a big discount because of IP issues you can bring to the attention of the seller that they have not fully considered.

Conclusion

The above, I hope, makes clear my strongly held view that underestimating the importance of IP aspects of a transaction can have very negative consequences.

One final general observation, not covered in detail above, does not appear universally shared. That is, do not over-sell or overstate the IP position.

You may very well appear to get away with it initially as IP rights are often a black art to advisers more interested in numbers but, assuming the other side employs a competent IP adviser, you may end up making the whole deal smell unnecessarily.

By all means, portray your position in the most favourable light, but do not make or persist with assertions that do not stand up to inspection.

Employ someone who, while keenly and authoritatively selling your position, will tell you clearly where you stand, and where you might fall. As with all things in business, do not set yourself up for a surprise; it is over-optimistic to assume it will be pleasant!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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