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IP Due Diligence: Why So Important?

Intellectual Property

Did you know that within the last quarter century, intellectual property (IP) and intellectual capital have emerged as leading assets? In fact, the majority of technology companies’ assets are intangible ones, such as IP and intellectual capital.

Given the profitability and prominence of IP and intellectual capital, undesirable IP due diligence findings can make investors lose interest in a target company.

IP or intellectual capital may refer to various assets, including a company’s trademarks, patents, designs, copyrights, trade secrets, proprietary information or know-how.

Imagine an investor, looking to acquire a target that relies heavily on its name and brand – like a big player in the fashion industry. What if the IP or intellectual capital of the target does not have a business value?

What if the target company has poor IP management that could result in a negative image? What if this poor IP management causes the target to lose its great reputation, along with its brand value?

In order to ensure content investors, a detailed IP due diligence for mergers and acquisition (M&A) transactions – and identifying the transaction’s true value is significant.

I. Know the business.

The first and essential step is to identify the motivation behind the transaction.

The parties may not always have a specific type of transaction in mind. It is crucial to understand the parties’ objectives. The legal counsel can offer appropriate advice, only after defining a transaction type.

II. Know the role of IP in the transaction.

The roles of IP rights vary according to the nature of the sector and the target company’s product or service. A patent would likely be more valuable than a copyright for a biotech company, whereas the opposite might be true for a software startup. It is always important to identify what IP rights the business needs in order to operate.

Whatever the nature of the sector and the target company’s product or service, understanding how IP fits in the target company’s business strategy and the transaction is vital. Understanding the role of IP will provide useful insight into the company, which will come in handy when determining the company’s dynamic internally, as well as with its competitors, customers, partners and suppliers.

III. Know the key IP issues.

Conducting IP audits or searches are as not as simple as they seem. Successful IP due diligence must be more than detecting the missing information of a trademark portfolio.

Although proprietary searches are necessary, to complete basic information of registered IP rights by way of a simple review is unfortunately not enough.

In Turkish law practice, IP due diligence often reveals that the target company may have been using IP rights without a registration and/or valid license agreements. It is always important to remember that use of unregistered IP rights and/or use of IP rights without a valid license agreement may lead to serious infringement claims.

Some IP issues may become significant even years after a transaction’s closing. Potential issues can be anticipated and curtailed by understanding the target company’s business, trends and trademark vulnerabilities prior to, during and after the transaction.

IV. Know the owner.

One of the most important requirements of IP due diligence is the proprietor check. Sometimes, in transactions that include several parties such as parent companies, group companies and subsidiaries, the IP scheme may not be clear and straightforward.

In practice, it is also common to see standalone entities incorporated to own all IP rights, i.e. IP holding companies within a group. In an IP “dream-scheme”, we would expect to see the ownership of an IP right to lie with the target, but this is unfortunately not always the case.

Making a list of all related parent companies, group companies and subsidiaries, as well as the IP holding companies of the group is highly recommended.

Needless to say, the same goes for IP rights developed by the employees of a target company. Also, in practice, there are many independent consultants who develop IP rights for companies based on agreements executed by and between the target company and the consultant. Proprietor check is also recommended in such cases, since an employee or consultant may have certain claims on the developed IP rights.

V. Do not buy a lawsuit!

A superficial IP due diligence may impose IP claims on the buyer which could have been avoided by conducting an in-depth IP due diligence.

It is always important to question whether there are any potential IP disputes and to ascertain that the target company’s IP rights are not subject to any legal challenges. It is recommended to know the third parties and make sure that the target company’s activities do not infringe their IP rights.

Under Turkish law, a target company’s challenged trademarks can be invalidated due to third party lawsuits. The target company would have to cease using the relevant trademark, otherwise the opponent can file a claim for trademark infringement to cease further use.

Regarding the target company’s IP related pending lawsuits and potential damages, specific indemnities should be considered for any infringement claim, potential loss and damages based on an unauthorized trademark use or loss of rights of the challenged trademarks.

If lawsuits are initiated, which is a decision based on the significance of the challenged trademarks and whether they are crucial to the business, it could cost the parties involved years and a significant amount of funds before a judgment is reached. Do not forget time and money are always valuable!

In Turkish law practice, the Turkish Patent and Trademark Office records sometimes reflect that a target’s trademarks were seized. It is recommended to make sure that these seizures are lifted. If seized trademarks are actively used in the target company’s operations, it is strongly recommended that the release of the seizure of these trademarks to be a condition precedent to closing.

In case the seized trademarks are not used in the target company’s operations, it is also important to include a warranty in the transaction documents that these seized trademarks are not used in the target company’s operations. Indemnification provisions are always beneficial.

It should be noted that if the target fails to pay its debts and defaults for any reason, the pledgees may apprehend the pledged trademarks and obtain their receivables from the target.

In case the target company owns or has the authority to use all of the IP rights needed to run its business, it is important to ensure that the contemplated M&A transaction will not affect its right to continue using these IP rights.

In other words, avoid buying a lawsuit!

VI. Adopt today.

A properly conducted IP due diligence is never limited to addressing the above issues only. More necessities may arise, depending on the type of IP rights, jurisdiction, parties and/or type of the transaction. In fact, an IP due diligence process may also reveal more potential issues. However, today, even a compact analysis of key IP issues can sometimes help avoid serious consequences.

Given the changing and wider landscape of IP, it is time that we all adopt a smarter practice of 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.

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