ROLE OF INTELLECTUAL PROPERTY DUE DILIGENCE IN MERGERS AND ACQUISITIONS
In the last few decades, the Mergers and Acquisitions (M&A) have become the most popular growth strategies of the business world. M&As have facilitated the companies in expanding their customer base, improving profitability and to enter into different spheres of business. A merger has been defined as an arrangement where the assets of two (or more) companies become vested in, or come under the control of one company (which may or may not be one of the original two companies).[i] Acquisition, also known as a takeover or buyout refers to the taking of the possession of another business (Business of the target company) by way of share purchase or asset purchase.
Intellectual Property in general terms may be defined as that intangible property which is created by the human intellect. The owner of the Intellectual Property possesses a Right in Rem (Right against whole world) which protects the creativity, invention etc. of the owner. Some of the examples of intellectual property include trademark, copyright, patent etc. As discussed above the process of Mergers and Acquisitions (M&A) involves the transfer of assets of a business and because of the technological advancements and innovations in the modern-day corporate world, the Intellectual Property Rights (IPRs) constitute a significant share in the company’s assets.
A study of the Fortune 500 companies titled as “The Linkage between Intangibles and Intangibility“, found that the share of tangible assets of a company dropped down from 60% in 1975 to just 25% in 1995.Meaning thereby that the intangible assets formed a significant share in the market value of the company. The intellectual property being one of the intangible assets is thus the most intrinsic asset that a company may wish to assess (IP Due Diligence) while trying to initiate the M&A transaction. However, it can be strongly argued by some that in spite of its importance, the teams conducting the Due diligence while initiating an M&A transaction tend to ignore the Intellectual property aspect. Moreover, many companies do not even recognize most of the intangible assets in their financial statements.
IP DUE DILIGENCE AND STEPS INVOLVED
As discussed above conducting a successful IP Due Diligence is very essential in a merger or an acquisition. To ensure the successful completion of the due diligence there are certain factors which must be taken into account such as:
- The first and foremost requirement is a legal framework which should lay a basis upon which both the parties could proceed further. A non-disclosure agreement is signed between the parties restraining them from divulging any sensitive information shared between them regarding the merger or acquisition. The confidentiality agreement must contain the modus operandi, the deadlines within which the work has to be completed and also the attorney-client privilege.[ii]
- Every corporation or a business enterprise must maintain an IP register consisting of all their patents, trademarks, designs, copyrights as well as the technical know-how.[iii] The status and application number of each IPR must also be included. The register should be up to date and well maintained as the details included in the register play an important role while conducting the IP due diligence.
- It is another essential factor that the IP due diligence must be conducted by experienced personnel such as Intellectual Property lawyers. The presence of a professional is a sine quo non as they possess the technical and working knowledge of the IP laws and they could ensure that while conducting due diligence the acquiring firm remains focused on the IP assets which are relevant to them. IP assets of a company include not only the patents but other assets such as brand name, logo, etc. as well.[iv] For example, the brand “Coca-Cola” alone costs $ 79.96 billion.[v]
- A proper and thorough investigation of the company’s IP assets is also an important factor while conducting IP due diligence. Many a times it happens that the companies do not fully disclose the actual ownership of all their IP assets which becomes a very common reason for the fall of M&A transactions.[vi] Also an investor may find after the completion of the transaction that it may not actually possess the IP assets for which the deal was originally concluded or that the assets have been transferred or restricted by a third party.
For example, in 1988, Vickers Plc the owners of Rolls Royce sold Rolls Royce Motors to Volkswagen Group. In the deal, the Volkswagen Group acquired the factory and the rights to use the mascot as well as the shape of the radiator grille of Rolls Royce Motors. Afterwards, the Rolls Royce brand name and logo which were owned by Rolls Royce Plc and not by Rolls Royce Motors were sold to BMW. After the deal as it turned out, Volkswagen Group had the right to use the mascot and the shape of the radiator grille of the Rolls Royce and not the name and logo and on the other hand BMW had the right to use the brand name and logo of Rolls Royce but the mascot and shape of the radiator grille.[vii]
- Another important factor in the IP due diligence is to identify any potential source of income from the IPRs which have not yet been harnessed but may become a huge deal of profit for the acquirer in the future.
- Identification of IP assets which may attract legal liability in the future is also an essential component of IP due diligence. This risk of litigation may arise when the top management employees of a firm are employed as they might have signed the non-disclosure agreement with the previous firm regarding their trade secrets or any other sensitive information.
- While conducting IP due diligence it is very essential to keep in mind that there might be some information which has not been disclosed by the company in order to preserve their trade secrets. This is why it is important to check thoroughly about any such undisclosed piece of information before proceeding forward.
For example, in 2008 a Japanese pharmaceuticals company named Daiichi Sankyo Co. Ltd., bought 34.82% stake in Ranbaxy Laboratories Ltd., owned by Singh brothers for $ 2.4 billion. After some time during the scrutiny of Ranbaxy by the US Food and Drug Administration it was found that there was some misrepresentation of data which was mentioned in the 2004 self-assessment report of Ranbaxy. The owners of the Ranbaxy were aware of this report but it was not disclosed to the Daiichi at the time of the deal. An arbitration case came to be filed in Singapore by the Daiichi group alleging fraud and misrepresentation on the part of Singh brothers. The court ruled in the favor of the Daiichi group and Ranbaxy was ordered to pay $ 385 million to the Daiichi group.[viii]
After the completion of a merger or an acquisition there might arise some other factors in the future which may result in losses to the acquirer. That is why it becomes very essential while conducting the IP due diligence to ascertain the risk factors in advance so as to avoid or mitigate any losses which may arise. These factors could include:
- The existing technology may become obsolete owing to the issuance of the new patents. New patents also pave a way for the competitors to enter into the similar field of business which ultimately results in losses to the existing company.
- The patents which have already been issued in the name of the company still bear the risk of being challenged for their invalidity. It is a common practice for the competitors to challenge the patents on the grounds that they have not been developed by the inventor and that the invention is very obvious and has been in use for a long time by others.[ix] If the competitors succeed in their challenges it may result in invalidation of the patent and the license which will ultimately incur losses for the company.
- Another risk while doing a cross border merger or acquisition is the difference in IP laws of the two countries. A careful and thorough understanding of the laws of both the countries regarding IPRs is also very important to mitigate the losses.
One of the crucial issues of the process of ‘Due Diligence’ is valuation of intangible assets. Intellectual Property being one of those assets is no exception. Generally, there are three methods for valuation of Intellectual Properties. First being the Income Based Method according to which the asset is valued based on present value of future net income stream that the assets in question are expected to generate.[x] Some of the factors which are important for the application of this method are- the amount of income that the asset (intellectual property) is expected to generate, the time over which such income is expected to be generated and the risk for realizing that future income.
Second, the Cost Based Method, wherein the future benefits of ownership are calculated by measuring the amount required to obtain or develop identical IP asset in question.[xi] The major factors which are important for the application of this method are- a sufficient number of comparable asset transactions, access to price information of such comparable assets and existence of the active market for the valued asset.
The last one being, Market Based Approach, which is the most, used approach in case of a merger or acquisition. According to this method, the actual value of an asset is calculated by comparison to equivalent or similar transaction of unrelated parties on the market.[xii]
From the above discussion, it is quite clear that the Intellectual Property Rights (IPRs) play a very important role in a Merger & Acquisition (M&A) transaction. Following are the suggestions with respect to IPRs which both the companies shall take into account.
- Recordal– Since the IPRs acquired after an M&A deal is to be transferred immediately to the new owner, the timely and comprehensive recordal of it is most important as the delay in recording would lead to diversion from the main purpose of IPRs. Also, the new owner will not be able to sue anyone for infringement of his IPRs, unless they are recorded.
- Costs– The companies shall decide, preferably include in the agreement as to who will bear the future costs, if any, related to the IPRs. Some examples of the cost include the costs for filing, renewal, maintenance etc.
- Audit– It is advisable that the company acquiring the IPRs must conduct another IP audit, even if once it has been done during the Due Diligence process. It is quite likely that the priorities of the buyer company is different from that of the target company, so the gaps in both shall be highlighted and the buyer can therefore take decisions according to it.
From the discussion above it is quite clear that Intellectual Property Rights (IPRs) of a company play an important role in a Merger or an Acquisition. Meaning thereby that, the Intellectual Property laws are highly relevant for the purposes of securing the Intellectual Property Rights in the Merger & Acquisition transaction. The company acquiring the target company must look into the benefits of an IP asset and thereby must know how important the process of due diligence is. Similarly, the target companies must also undergo the process of due diligence before the M&A deal to exactly know their marketability and the worth of its assets. On the other hand, the intellectual property assets can also pose certain challenges for an acquiring company such as the asset becoming obsolete in the near future, the competitor challenging the validity of the patents on it being invented by some other inventor and most importantly the challenge that is posed in cross border M&A deal wherein the laws of different jurisdictions pose major problem for the acquiring company, if at all it doesn’t conduct the process of due diligence properly. Indeed, Intellectual Property plays a vital role in a Merger & Acquisition transaction and can generate a huge amount of revenue for the company therefore it is important that the IP assets owned by it are properly administered and protected against the potential future risks.
[i] Wolters Kluwer, Mergers and Acquisitions in India 15 (Ernst & Young eds. 4th ed. 2016)
[ii] Find Law, “Due Diligence and Protection of Confidential Information”, (https://corporate.findlaw.com/law-library/due-diligence-and-protection-of-confidential-information.html)
[iii] Kauffman,” Understanding the Various Types of Intellectual Property”, (https://www.entrepreneurship.org/articles/2006/08/understanding-the-various-types-of-intellectual-property)
[iv] Office for Harmonisation in the Internal Market “Intellectual Property Rights and Firm Performance in Europe: An Economic Analysis”, (https://euipo.europa.eu/tunnel-web/secure/webdav/guest/document_library/observatory/documents/IPContributionStudy/phase2/executive_summary_en.pdf)
[v] Statista, “Coca-Cola’s Brand Value from 2006 to 2018 (In Billion U.S Dollars)”, (https://www.statista.com/statistics/326065/coca-cola-brand-value/)
[vii] Bentley & Rolls-Royce | The Ultimate in Luxury Cars, (https://isuperdrive.com/blog/bentley-the-ultimate-in-luxury-cars/)
[viii] Reuters, “Japanese drug maker Daiichi wins damages from former Ranbaxy owners”, (https://www.reuters.com/article/us-ranbaxy-daiichi-sankyo-idUSKCN0XW19K)
[ix] Alex Harding, “Shedding Light on the Obviousness of Gene Patents”, (https://jolt.law.harvard.edu/digest/obviousness-gene-patents)
[x] SMITH,G.V. and PARR,R., Valuation of Intellectual Property And Intangible Assets 164 ( John Wiley & Sons eds., 3rd ed. 2000)
[xi] PARR, R, Singapore – WIPO Joint training course for Asia and the Pacific region on Intellectual Property and Technopreneurship development 11 Module 6: IP Valuation Issues and Strategies, 1999
[xii] DANIEL, B., Financial Aspect of Licensing Agreements: Valuation and Auditing 94 (John Wiley & Sons eds., 3rd ed. 2000)
Author: Shubhi Singhal,
National law Institute University, Bhopal IV Year