United States: Patent Issues Relating to Acquisitions: Conducting Intellectual Property Due Diligence

Article by Pavan K. Agarwal Partner and Leader, Electronics Practice Group and
Steve Maebius¹ Partner and Leader, Nanotechnology Industry Team.

Thorough and comprehensive Intellectual Property (IP) due diligence requires much more than compiling a listing of the company's IP assets. Rather, IP due diligence requires assessing the strength of the company's IP rights in the marketplace, the strength of the competitors' rights in the marketplace, and the effect of the IP on the base company's products and other IP rights.

Often times, business realities are such that the business transaction is ready to take place and the due diligence must be done quickly in very short order. The IP due diligence team needs to be experienced and focused; otherwise, critical issues will be missed that affect the bottom line. Prioritization of key areas of inquiry based on business objectives of the deal is critical to success.

While every IP due diligence must be tailored to meet the particular business situation at hand, certain basic steps should at least be considered:

• Identify Products and Services

• Identify Corresponding Intellectual Property

• Prioritize Analysis (if necessary)

• Analyze State of Relevant Industry

• Determine Scope of Protection Provided by IP Assets

• Verify "Exploitability" of IP Assets

• Conduct Non-Infringement Investigation

• Review Warranties and Indemnities

• Review Any Other Considerations

• Establish a Value

The following discussion outlines these points in greater detail.

The first step is to understand the company's basic products and services. This includes not only understanding the current product and service offerings of the business, but also understanding projected products and services. This knowledge can be a driving factor for many of the later steps.

Another preliminary step in the due diligence process requires taking inventory of the company's intellectual property rights. Of course, all forms of intellectual property should be carefully accounted, including patents, trademarks, copyrights, trade secrets/know-how, and agreements that affect IP. The IP rights should be matched up with the product areas or business units, as appropriate. This IP should be assessed in some detail, as outlined in "Determine Scope of Protection Provided by IP Assets" below.

The third step in the IP due diligence is prioritizing the analysis. One possible prioritization is understanding the mature versus emerging technologies, and focusing on certain forms of IP necessary to protect each one. For example, mature technologies require greater consideration of goodwill, while emerging technologies may require greater assessment of the trade secret aspects of the technology.

One of the most important steps in an IP due diligence is understanding the company's competition, both from a business perspective and an IP perspective. One must assess the IP rights of the significant competitors as well as known patent holding entities. This includes a careful assessment of the competitors' patents, trademarks, copyrights, and - to the best possible extent - the trade secret rights of that company. Once the IP is identified, this information should be reviewed to understand its true impact on the company's freedom to operate in market. See "Conduct Non- Infringement Investigation" below.

Another very important step in the overall analysis is recognizing the scope of protection being provided by the IP assets that have been identified. Done through the filter of prioritizing the analysis and recognizing the areas where the competition is the fiercest, this step will provide at least some core areas where the IP assets must be strong.

Another important aspect of determining the scope of IP protection is to analyze the license agreements that the company has entered into (a) to confirm that the rights will be transferable in light of the corporate structure changes, and to understand what procedural steps must be taken to have those rights transfer, and (b) to assess the impact of the change in corporate structure on the licenses (e.g., due to a change in controlling interest in the company or the company becoming a subsidiary of another company).

One common approach is to "map" the types of patents that exist against the particular products to gain a deeper understanding of the level of protection. Generally, it is easier to make out a case of infringement for a product claim of a patent than for a method of use or process of manufacture patent, since infringement of a method claim may require proof of inducement while infringement of a process patent may be just difficult to detect if the process steps leave no "fingerprint" on the final product. For example, one may utilize a table such as the one below to identify the relative levels of protection for a pharmaceutical product:

A further aspect requires understanding what IP will not be transferred and what effect that potentially can have on the company's on-going and future business plans.

A related aspect of determining the scope of IP protection is confirming the exploitability of the IP rights. This includes verifying the ownership of each IP right and the validity of those rights. An extensive patent portfolio that reflects the prior art is worth much less than a few basic patents in a given technology. Special emphasis must be placed on the form of IP especially crucial to the specific aspect of a company's business (e.g., trade secrets may be the most important issue for particular emerging technologies).

A further aspect of verifying exploitability involves assessing any on-going litigation in that company and making a reasoned determination of how that litigation will affect the IP rights at issue. This step includes assessing the synergies with the buyer's business plans, which can include how to use the IP to create a barrier to entry for competitors in the marketplace, or at least placing a price premium for competitors to enter or remain in that market.

With some understanding of potential areas of impediments caused by a competitor's IP, the true value of that IP must be considered. Will that IP cover what the company in question wants to do? Does the company have a basis for noninfringement of that IP? Can we find the basis to invalidate the IP, should the case ultimately arrive?

As a standard step in any due diligence, the warranties must be considered, as should some analysis of the strength of any indemnification agreements that may exist.

Every business transaction has its unique issues, whether due to the particular technology, the geographic market, the level of competition, or the litigious nature of the industry. The due diligence team must assess how the unique aspects may ultimately affect the resultant corporate structure and its place in the market.

The IP due diligence can establish a value for the IP, which often requires input of an expert having specific industry knowledge. The value can directly affect the relative bargaining position in the transaction and may lead to requirements such as non-competition agreements from the seller in the transaction.

Whether performed with plenty of time to closing, or expedited by a pending closure, IP due diligence involves numerous factors that must be specifically tailored to the transaction at hand. One must work carefully but efficiently through the basic steps recognizing where deviation from these basic steps is required. Nonetheless, the basic steps outlined herein provide a base point for conducting IP due diligence.

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.