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Good IP management key to M&A

A session today on mergers and acquisitions will present attendees with lists of draft covenants to consider. But don’t worry, says Simon Crompton. As long as your IP is in good shape, everything is easy.

There are more M&A deals today where intellectual property is a crucial factor, for two reasons. First, IP is seen as of greater importance by investors looking to buy companies increasingly on the basis of intangible assets. Second, IP has proved to be crucial to several deals over the past few years—some of which have gone wrong. The result is the rise of the IP lawyer specialising in M&A work, and the growing role of the in-house IP counsel.

A good example was the sale of the Australian branch of Schweppes by Cadbury for A$1.1 billion ($813 million) in 2009. Kristin Stammer, a partner at Freehills and the moderator of a session on M&A later today, represented Cadbury on the deal. “It was a perfect example of this kind of IP-rich transaction,” she says. “A big portfolio of brands, with several complex license arrangements—all of these made IP key to the deal.”

The biggest effect of having specialist IP counsel involved was that issues were discovered earlier. Often, intellectual property is an afterthought in a transaction and is therefore not considered until it is too late to substantially change any aspects of the deal. Whether you’re representing the buyer or the seller, both need to be able to do their own due diligence first in order to communicate effectively with the other side.

“I was working on a deal recently in Australia where there were over 800 licenses involved,” says Stammer. “When you have that degree of complexity a license specialist is required. Other areas that always need checking are the registrations of patents and trademarks, names and upcoming renewals. It’s often surprising how many errors can be found in the simplest IP registrations.”

Stammer will chair a panel that has a good geographical reach. Alongside her representation of Asia-Pacific, the team includes Daniel Glazer from Patterson Belknap Webb & Tyler in the U.S. and Adrian Smith from Simmons & Simmons in the UK. Alongside them, giving the in-house view, will be Elisabeth Bradley of Kraft Foods.

Increased deal flow


Both Glazer and Stammer are on the project team for this year’s meeting in San Francisco, and had been interested in including an M&A session for a while. Glazer adds that a third reason for the increase in IP-intensive M&A is simply the improvement in the economy, which is leading to more people working on more deals. “This session wouldn’t perhaps have been as useful at the 2009 or 2010 Annual Meetings,” he says. “The deal flow now in the U.S. is becoming much more consistent and anecdotally I hear that’s true in Europe as well.”

The biggest IP risk when you’re buying a business is infringement, in Glazer’s experience. Whether it is trademark or patent infringement, the litigation is costly, lengthy and extremely disruptive to a business—which presumably the acquirer is trying to get running as quickly as possible. Patent infringement can often go all the way to trial, while trademark infringement will often lead to injunctions and, perhaps most disruptively, changing all the marks associated with the new business.

During the due diligence phase of a transaction, this is what external IP counsel will be focused on—the risk that the company being bought is infringing the patents or trademarks of a third party. Part of this is working out whether the company has performed all the searches it can to make sure it is not infringing, such as a freedom-to-operate search or other clearance searches.

The transaction is made a lot easier if this is obviously the case or the company is prepared to state that it is the case. “Which is where the battle lines are drawn—over the representations and warranties,” says Glazer.

“Ultimately, it’s very difficult for either the buyer or the seller to get 100% certainty that there’s no infringement. At the end of the day someone has to take on some unknown, unasserted infringement risk. And the more work the seller has done in advance—like those freedom-to-operate searches—and the better it has run its company generally as regards IP, the more likely it is that the buyer will be prepared to take on some of the unknown, unasserted risk.” Which, to return to Stammer’s earlier point, is a good reason to have specialist IP counsel working with the seller early. It could save the company taking on substantial risk in its representations and warranties.

Specifically, the negotiations over the non-infringement representation will be heavily skewed towards the buyer. This clause is now included as standard in all M&A transactions, whether stock purchase, asset purchase or merger. It says something along the lines of “the operation of the business does not infringe third-party intellectual property rights.” The negotiation comes over whether this clause will be qualified with something like “to the seller’s knowledge.” If that qualification is included, then the risk of unknown, unasserted infringement passes to the buyer. The seller is only at risk of being discovered to have hidden knowledge of a potentially infringing product or mark.


Open-source code


The use of open-source code in transferred software is another big risk in M&A. This code is available for anyone to use in programming, generally without a fee, but under certain terms and conditions. This can include licensing restrictions, such as the requirement that if you make alterations to the code in order to create something new, this is also made freely available—in the spirit of open source.

Indeed, the most restrictive conditions require that the code cannot be used in conjunction with any other software, unless you are also prepared to make that software freely available. This could lead to a buyer being forced to give up proprietary software that was a key target of the acquisition.

Unfortunately, an increasing amount of software includes open-source code because it is free, easily accessible and usually very useful. “A few years ago you could easily put in a representation that said no software contains open-source code,” says Glazer. “Now it’s a big due diligence issue and hard to get into a contract.”

Sometimes a seller will be able to list the open-source code used in proprietary software as part of the due diligence process, and state the license terms of that code. It is much harder to convince it to sign a representation taking responsibility for any adverse consequences of the use of that code.

So intensive diligence followed by intensive negotiation. It’s no wonder more IP counsel are being called into deals earlier in the process.

With trademarks, the big issue is how much so-called quality control has been exercised in recent years. In other words, how much money the seller has spent tracking misuse of the trademark and enforcing its rights in the face of infringement. Lawyers report a big variation in the attitude towards enforcement, even among the big western brands that have recently been acquisition targets and for which intellectual property makes up a big proportion of their value.

Other important trademark issues include chains of title and trademark liens. Fortunately, the speakers agree that the size of the potential problems is directly related to how well intellectual property has been managed in the past, rather than to the size of the company or its portfolio. Indeed, smaller companies with fewer brands are often harder to deal with because they may consider good trademark practice less of a priority. So if your company’s IP is in good shape, don’t worry. If it isn’t, get it in order now.

IP provisions in an M&A deal


As part of today’s session, attendees will be talked through the kind of provisions often inserted into stock purchase agreements concerning IP. These include definitions of the words 'intellectual property' and 'registered', a disclosure schedule, representations of the ownership of IP and non-infringement, and pre-closing covenants.

In each instance the speakers will present a hypothetical proposal made by the buyer and by the seller, with notes on how negotiations are likely to run and the key positions taken by each side. On pre-closing covenants concerning the conduct of business, for example, the seller will aim to use a brief text promising not to miss deadlines on registered IP. The buyer will propose a much lengthier text, in order to try to ensure that absolutely no valuable IP is lost between the execution date on a deal and its closing.

Other points to cover include so-called wrong pockets, which deal with IP assets that are not part of the original transaction, but which both parties later decide should be part of the deal. In that case they are held by the seller for the benefit of the buyer and transferred after closing. One of the lengthier provisions concerns a temporary trademark license, where there is a period between the deal closing and the new business rebranding and therefore ceasing to use those trademarks. Typically this lasts fewer than 120 days, but where it is longer the provision lengthens in parallel, to cover more eventualities.

These provisions will be available during the session as written materials, so thankfully attendees will not have to take down the detail themselves.

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