United States: IP Holding Companies: Trade Secrets & Trade Secret Asset Management

As a special feature of our blog—guest postings by experts, clients, and other professionals—please enjoy this blog entry from Donal O'Connell, Managing Director of Chawton Innovation Services Ltd.

Introduction

An IP Holding Company exists to hold intellectual property on behalf of one or more other companies but does not necessarily manufacture products or supply services based upon the IP held.

Prior to establishing an IP Holding Company, it is important to first ask what one wishes to achieve with one's IP. What is the business environment? What are the business goals of the company? How could IP help? If the business concept is risky, then maybe there is value in having the IP separate as a plan B.

Rationale for establishing an IP Holding Company

Some companies set up IP Holding Companies purely for tax reasons. The IP Holding Company may therefore be located in a tax friendly jurisdiction.

An operating company may not want to be associated with an aggressive IP licensing entity, so having the two separate helps with PR and image issues.

It may just exist purely for helping with administrative matters.

For example, a large multinational company may have many separate divisions in different countries, or within the same country. If a patent is granted in the USA to a European-based arm of a multinational company, the U.S. arm of that same company cannot make use of the invention in the USA without infringing the patent. It is also legally dangerous to ignore any infringement of a patent even if that infringement is by an associate company since it might create a legal assumption that you are not intending to defend your patent rights.

Consequently, many multinationals set up an IP Holding Company in a tax-favorable country or U.S. state and then sell (i.e. transfer or assign) all of the IP rights for the company as a whole to that IP Holding Company. The IP Holding Company can then focus on the task of granting licenses to the different divisions of the multinational as well as to third parties if so desired.

OECD BEPS Guidelines

One simply cannot ignore the OECD BEPS Guidelines when establishing an IP Holding Company.

The Organization for Economic Co-Operation and Development (OECD) is at the forefront of efforts to improve international tax co-operation between governments to counter international tax avoidance and evasion.

The OECD/ G20 Base Erosion and Profit Shifting (BEPS) package of measures has been agreed upon and over 100 countries and jurisdictions have confirmed their commitment to the consistent implementation of this comprehensive package.

Essential new feature of the new regulations is an emphasis on intangible assets. It is increasingly recognized that intangible assets create a substantial part of the business value. However, until now there is no single definition of intangible assets in use by tax authorities or the OECD, and no proper guidance on how such assets should be reported.

The accurate and complete identification, taxation and valuation of intellectual property and other intangible assets is now recognized as one of the most important areas of the international tax reform and transfer pricing legislation.

Establishing an IP Holding Company

A number of tasks need to be completed when establishing an IP Holding Company, some of which depend on the rationale behind it. If it needs to be independent, then it needs its own management and its own funding. It should be an independent business unit with its own targets (both short term and long term).

In certain countries, there are special requirements about setting up a company, the board structure, number of employees, etc. These rules need to be followed.

There can be overlap between the operating company and the IP Holding Company but some care is needed here as otherwise it may not be seen as separate.

Corporate Governance

Corporate governance issues need to be given due consideration. It is just like running a normal company and it should be like that. It must be run professionally and have clear business targets and be measured against these targets. It needs a business model just like any other company.

Location of the IP Holding Company

Where should the IP Holding Company be located? Or rather what factors should be considered when selecting the location? Clearly, the tax situation is one key issue to be considered. If planning to do IP enforcement here in the EU, then it is best that the IP Holding Company is also based in the EU (one reason being German and UK security for costs issues). Ireland and Luxembourg are very attractive for tax reasons.

Transferring IP into the Holding Company

One important task relates to the identification, tagging and transfer of the IP into the IP Holding Company. With registered forms of IP, one makes assignments from the earlier owner to the new owner and registers these assignments in the IP Offices. Some countries ask for specific language in the assignments, while some ask for the fees to be logged.

With unregistered IP, there may be value in first registering the IP (e.g. copyright material can be registered in the USA) so that ownership is clear. A log should be created and maintained of all of the IP assets involved.

Trade Secrets

Trade secrets are a very important part of any IP portfolio. It is no exaggeration to say that virtually every business possesses trade secrets, regardless of the size of the organization or in which industry sector it operates.

A trade secret is a formula, practice, process, design, instrument, pattern, commercial method, or compilation of information which is not generally known or reasonably ascertainable by others, and by which a business can obtain an economic advantage over competitors or customers. The scope of trade secrets is virtually unlimited.

A trade secret is therefore any information that is:

  • Not generally known or readily accessible to the relevant business circles or to the public.
  • Confers some sort of economic benefit on its owner. This benefit must derive specifically from the fact that it is not generally known, and not just from the value of the information itself. It must have commercial value because it is a secret. Commercial value encompasses potential as well as actual value.
  • The trade secret must be subject to reasonable steps by its owner to keep it secret. What is reasonable can vary depending on the specific circumstances.

On reflection, perhaps it is better to say that every business has assets that could and should be protected as trade secrets, but the truth is that many fail to do so properly.

Trade secrets are an important, but oftentimes an invisible component of a company's IP portfolio of assets. However, trade secrets can also be the crown jewels within the portfolio.

Will trade secrets be transferred into the IP Holding Company?

Relationship between Operating and IP Holding Companies

The relationship between the Operating Company and the IP Holding Company needs to be discussed and agreed. The exact nature of this relationship depends to some degree on the degree of separation between the two entities, and if the operating company wishes to hide the fact that it has links to the IP Holding Company. It also depends on the funding model of the IP Holding Company (one off payment from the Operating Company to the IP Holding Company to get it established, regular payments between the two, or the IP Holding Company funded independently.

The assets of the IP Holding Company

What assets should be in the IP Holding Company? Ideally it should be an IP Holding Company and just contain IP assets. It could also have R&D activities included but not necessarily. However, it is best that there is a legal agreement between the Operating Company and the IP Holding Company telling that the innovative and creative ideas are transferred from the Operating Company to the IP Holding Company and what fees are to be paid. The Operating Company cannot transfer assets to the IP Holding Company without getting some payment back. It does not have to be immediate payment and it can be revenue share but there needs to be some sort of payment.

Valuing the transferred assets is not easy. If too high, then the Operating Company may have to pay lots of tax. If too low, then it may adversely impact the IP Holding Company when it is arguing with a potential licensee that these are valuable assets.

When new IP assets are created later on, the process is then basically the same as when the IP Holding Company was first established. However again the process should be defined – are the IP assets to be transferred when they are created, transferred once per year or something else. This is important to potential licensees who wish to know what they will get.

IP Licensing

What if the IP Holding Company decides to also do IP licensing? Well, it can be one and same entity, or another legal entity or entities can be established to conduct licenses. If the IP portfolio is be divided into clusters, then it may be worthwhile to isolate all of the IP from the licensing entity with a specific cluster to be licensed. The Operating Company should be kept away from managing the IP and any licensing and litigation activities.

Image and PR issues need to be considered. This basically asks how much does the Operating Company wish to hide itself away from the activities of the IP Holding Company. What communication message is planned when the IP Holding Company is first established or when it conducts IP license deals?

Active Rather than Passive

It is most important that the IP Holding Company is actively managing the IP. It is critical that a significant percentage of the IP related activities of the IP Holding company are being handled by the IP Holding Company and not by the Operating Company. The IP Holding Company should be an active rather than a passive entity.

Trade Secret Asset Management

What does active management of trade secret assets actually mean?

Trade secret asset management is about the policies and procedure, processes and systems, education and governance defined and taken into use to help manage such assets.

Simply deciding to keep something secret is not sufficient!

I suggest that trade secret asset management consist of a diverse range of elements, such as:

  • Having a trade secret policy in place
  • Designing, developing and deploying a trade secret process within the organization
  • Taking a robust fit for purpose trade secret asset management system into use to underpin that process
  • Including a section on trade secrets to the basic IP training for all employees
  • Identifying trade secrets across the entire organization
  • Identifying any trade secrets shared with 3rd parties
  • Identifying any trade secrets belonging to 3rd parties and entrusted to the company
  • Putting the appropriate administrative, legal and technical protection mechanisms in place
  • Gathering metadata about the trade secrets for management purposes
  • Installing a culture of confidentiality within the company as far as trade secrets are concerned
  • Putting a governance structure in place

The IP Holding company will somehow have to demonstrate that it is actively involved in the above.

Final Thoughts

I trust that this short paper is of interest and of value. It should be clear now that a number of political, financial, cultural, technical and legal issues need to be considered when first establishing an IP Holding Company and then when properly and professionally operating such an entity.

If the IP Holding Company is to manage trade secret assets, then it is imperative that the IP Holding Company has a deep understanding and appreciation of both trade secrets and trade secret asset management.

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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