Intellectual Property Issues in Mergers and Alliances

For many businesses in high technology and other growth industries, acquiring technology is more expedient than developing it.  Parties to technology transactions make critical intellectual property (“IP”) decisions in negotiating, structuring and documenting the terms of the transaction.

Various issues must be resolved at the earliest possible negotiation stages in order to permit a successful acquisition or alliance.  Careful attention must be paid to each step in the process, including negotiation, determining a fair market price and due diligence.
The buyer or transferee should focus upon the creation of the assets, ownership rights, procedures to perfect and maintain rights in the assets and the risks that the uses may infringe ownership claims or contractual rights of third parties.  These concerns require access to detailed information regarding the IP assets involved in the transaction.  The exchange of such information occurs during the due diligence investigation.
The company’s objective in entering an acquisition or alliance affects the negotiation and other strategies adopted by the acquiring party.  The scope of the investigation, disclosures and covenants from the owner depends on the strategic value of the technology to the buyer and the time and expense which the buyer is willing to incur.
In many cases, the target company’s or alliance partner’s IP rights may be the prime inducement.  Practical benefits of buying or sharing technology include accelerating entry into a market relative to in-house development of the technology.  If IP considerations are controlling, the buyer or partner may gain several benefits, including access to new technology, key personnel and expertise, a inter-connected product line and access to new distribution channels.
The value of IP rights depends on the owner’s ability to protect the assets and use them productively in business without competing claims or infringing acts of third parties.  The primary objective of the buyer or transferee is to ensure that it will be able to freely pursue the competitive advantages associated with the IP rights being acquired.

Cost-Benefit Analysis
The acquiring party needs to make a cost-benefit analysis to determine the extent of the examination.  In certain cases, due to time and cost constraints, the buyer may decide to limit detailed analysis to certain key issues such as the risk of trademark litigation or the review of procedures needed to independently develop a product which might be substantially similar to that of a third party.

Mergers, acquisitions and alliances are essential growth constituents of technology and other companies.  Mergers and acquisitions (“M & A”) in technology industries have intensified in recent years.  The dollar volume of M & A transactions doubled between 1993 and 1994 and reached a total of nearly $60 billion in 1994.
During the past several years, a variety of companies in the pursuit of the next generation of technology products have initiated mergers.  Companies use acquisitions to expand their product base and technology.  Computer hardware companies frequently make acquisitions to obtain complementary products and to enter or expand into the software market.Alliances
Content and technology alliances are commonplace.  Such alliances often incorporate license arrangements through which one member may control the terms and conditions under which its IP rights may be exploited by its business partner.  A common example occurs when a copyright owner of a novel licenses the novel’s usage by a multimedia producer for the production of a CD-ROM.  Other examples occur when a patent holder of a new technology licenses the technology to a computer company which will create a new product utilizing the technology or when a video game company licenses its trademark to an alliance partner to use in connection with a new computer game.
Content based alliances involve intangible assets, including copyrights, trademarks and publicity rights.  These assets may be composed of a bundle of rights which must be understood and protected carefully by knowledgeable legal counsel. 
Creation of alliances to develop new software, computer networks or other technology are subject to uncertainties because current intellectual property laws are inadequate.  Traditional intellectual property concepts need modernization to permit protection for modern technology, including computer software and hardware.  During the creation of multimedia works in which a content user synthesizes works from a variety of content owners, the negotiation of licenses is quite complex.

Alliances may be based on the commercialization of new technologies.  Formation and implementation of these alliances presents complex legal issues.  Patents and trade secrets must be carefully protected.  Because new technology is often affected by industry standards, it is essential for technology alliances to understand the standards and to participate in the organizations setting such standards. 

Access to New Technology
The threshold question in a technology purchase involves determining whether the target company owns or has exclusive rights to the technology.  The buyer must trace the chain of title for each intellectual property component.  The identity of all inventors and developers of each product must be uncovered.  The selling business must disclose whether each inventor signed an employment contract which included a confidentiality obligation and invention assignment agreement.
Employee agreements substantiate ownership of the employee's inventions by requiring disclosure of inventions made prior to joining the company.  Each employee should assign all inventions developed during employment to the employer.  If a gap exists in the chain of title between the invention and the target company, the target must obtain the inventor’s assignment of all intellectual property rights to the company. The assignment of rights should be recorded with the appropriate government office.
There are legal uncertainties involving the perfection a security interest in IP rights by means of recordation under the UCC or under the relevant federal statutory framework.  Typically, security agreements are filed or recorded both under the UCC and with the appropriate federal agency.  Patent and copyright searches are essential to confirm that the company owns the IP rights under negotiation.
A UCC search of the state UCC filing office should be conducted to discover any security interests in the collateral.  The appropriate federal register should be searched to confirm that the company retains title to the intellectual property.  All key agreements should be reviewed to discover if any third parties own security interests in the intellectual property to be transferred.  If security interests exist, the security holder should give its consent to the assignment. 
There are several pitfalls in examining security interests, including registration rules, recording “look back” periods and various technical rules, which should be analyzed by specialists.  Recordation of assignments protects assignees against subsequent purchasers, however, the look back provisions in the federal statutes leave an assignee exposed for a few months after an assignment occurs.

Purchase and Alliance Agreements
The purchase or alliance agreement should include representations and warranties by the target company that it owns or has exclusive rights to license the IP rights to be transferred.  The buyer or partner must obtain adequate assurances that the target has exclusive rights to its technology as a prerequisite to determining the value of the technology and the target.  Licenses should be reviewed to determine the licensee’s entitlements to source code, derivative works or other parts of the technology.
If the target company or alliance partner owns only a non-exclusive license to a critical patent, the value of the company is significantly less than if it owned an exclusive license because the patent owner will be entitled to license other parties.  Licensors often grant exclusive licenses covering differing fields of use when the technology has applications in divergent fields.  Inventors may license patent rights to another company in exchange for royalties for products developed from a patent which are outside the scope of the buyer’s applications.  There are various complications and alternatives in transactions which are based largely upon the IP portfolio of the target company.

The buyer or prospective partner must carefully assess the value of the intellectual property portfolio of the target.  The initial step involves isolating the target's or partner’s ownership interests in the desired technology.  An estimated value should be placed on the target's or partner’s intellectual property company in order to appraise the strength of the IP portfolio.
Patents should be reviewed to determine their applications and the scope of coverage.  Prior art searches and analysis of potential infringements should be conducted.  The acquirer or partner should also interview the inventors and patent attorneys and appraise patents owned by the target's or partner’s competitors.
It is difficult to obtain formal agreements during the negotiation of the purchase of a company or alliance.  Start-up companies often lack formal agreements necessary to ensure that the company properly owns the technology.  Transactions may be delayed, restructured or terminated because of the ownership questions cannot be resolved in a satisfactory manner.Due

Intellectual property assignments are often embedded in larger transactions involving the sale of a business or alliance.  A buyer or prospective partner must review all documents to ensure that the various requirements and procedures have been followed to provide adequate safeguards for the buyer.

Due diligence is much more involved than merely reviewing public records and taking inventory of the seller's goods.  Proper due diligence requires a precise review of a various resources, including the target's or partner’s files and Patent & Trademark Office (“PTO”) and Copyright Office records.

The buyer or partner must identify all relevant intellectual property rights.  The first review should commence with examination of the company's IP files and search of IP owned by the company in various databases constituting records of patents, trademark registrations and applications, and copyright registrations.  Such database searches provide information in limited areas.  Detailed reviews of corporate files, key products, manufacturing, advertising and promotional materials, and business records, and interviews with persons who understand the development, manufacturing, sales, and marketing aspects of the company are essential to identify unregistered copyrights, trademarks, trade names, and trade secrets.Employment Concerns

The acquiring party must obtain a list of all employees of the target.  It is essential to ascertain whether the technical employees each signed an employment, confidential information and assignment of invention agreement and to review such agreements.  Non-technical employees should agree that all company information will remain confidential and that inventions are the property of the employer.

Due diligence includes review of employment agreements with employees concerning intellectual property, including agreements which the employees entered into with former employers.  If any employees had disputes with former employers, the employee's rights to assign his inventions to the current employer may be affected.  If an employee was previously employed by a competitor and had access to its trade secrets which are related to the employee's current functions, there are risks of challenge by the former employer.
It is essential to review the company's relationships with independent contractors for assignments of rights in copyright works, as well as confidentiality obligations.  Works created by employees within the scope of employment may be “works made for hire" under the Copyright Act and owned by the employer as if the employer were the author.
The acquiring party should determine all persons who were involved in creating each IP item to avoid future claims against the company.  The acquiring company may attempt to obtain new agreements regarding the technology with the key developers of the target.

Hidden Liabilities
Target companies often are subject to hidden liabilities.  For instance, the buyer should discover liabilities which may have been inadvertently omitted from the seller's balance sheet. Employee claims often constitute hidden liabilities.  Technology companies which characterize workers as consultants or independent contractors to avoid employee withholding payments may be subject to substantial future liabilities.  The IRS may subsequently determine that independent contractors were in fact employees, thereby imposing on the acquirer withholding tax liabilities and penalties generated in the past by the selling party.

Prepaid royalties paid to the target company may constitute hidden liabilities. If the licensing target company fails to exhaust its prepaid royalties under a license prior to the acquisition, the buyer may be liable for remaining prepaid royalties if the licensee later files a claim against the licensor.  Damages in such situations may be reduced by requiring the seller to retain a portion of the purchase price in escrow until the prepaid royalties have matured.  Moreover, the buyer must include indemnification provisions in the purchase agreement.Summary
A prime goal of numerous M & A and alliances is the acquisition of new technologies and entry into new markets.  Successful M & A and alliances may rejuvenate faltering companies and strengthen developing companies.

Due to the rapid changes in technology businesses, it is often more productive and less costly to acquire technology than develop it.  However, because the hazards and complexities of negotiating M & A and alliances and of managing them are diverse, careful structuring, due diligence and analysis are essential.

Isolating all ownership interests in the technology to be acquired is a prerequisite for a technology transaction.  The value of IP rights is fundamentally affected by the exclusivity or non-exclusivity of licenses.  Many licensees negotiate exclusive licenses for technology in a particular fields.  IP due diligence is complex because the property is intangible and may or may not be the subject of governmental registration.

Because business users and consumers favor high-technology companies which offer integrated solutions, M & A activity will increase in the future, despite the complexities and risks involved.  Companies involved in these arrangements must evaluate the benefits and risks and the impact on the growth of the surviving company.

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