Purchase and Sale of a Business: Protecting and Transferring Intellectual Property and Technology Assets

© 2001, 1994, Deeth Williams Wall LLP. All Rights Reserved. By: Michael Erdle

Table of Contents

1.What is "Intellectual Property"?

Patents

• A monopoly to make, use or sell an invention.
• Limited to a specific country.
• Granted for a specific time (in Canada 20 years)
• Invention may be a product, machine or process.
• Invention must be novel, useful and not obvious to a person skilled in the field.
• Patent rights may be assigned, in whole or in part; assignment must be in writing.

Trade-Marks & Trade Names

• Exclusive right to use a word, phrase or design.
• Trade name identifies a person, partnership or other business entity.
• Trade names are registered provincially, under company or consumer laws.
• Trade-marks identify a specific product or service and must be distinctive of the products or services of a specific person.
• Trade-marks are registered federally in Canada and United States; separate registrations required in most other countries.
• Trade-mark rights may also be acquired under common law without registration; rights are based on use and are limited to scope of actual use.
• Rights are perpetual, as long as the name or mark is in use, it remains distinctive and registrations are maintained.
• Trade-marks may be assigned, in whole or in part, but multiple ownership of a mark may destroy its distinctiveness.

Copyright

• The exclusive right to reproduce, perform or publish a literary, dramatic, artistic or musical work.
• Granted by country, according to nationality or residence of the author
• Recognized elsewhere under international treaties.
• Limited term (generally the life of the author, plus 50 years).
• Protection extends only the specific expression of the work.
• Underlying ideas are not protected, and may be used in other works.
• Author has "moral rights" to maintain the integrity of the work.
• Moral rights can be waived, but not assigned.
• Copyright may be assigned in whole or in part (by time, territory or type of work).
• Assignment must be in writing.

Industrial Designs

• A hybrid of patent and copynght.
• Grants exclusive rights to the design of useful articles.
• Registration protects the form of the article, not the idea.
• Protection is limited to pattern, decoration, ornamentation or shape.
• No protection for the useful elements of the article.
• Registration is for five years, with a five year renewal.
• An industrial design registration can be assigned; but an application cannot.

Semiconductor Chips

• Protected under the federal Integrated Circuit Topography Act.
• Protects the design of integrated circuits; similar to copyright.
• Exclusive rights for 10 years to produce, manufacture, import or commercially exploit the design or a circuit incorporating the design.

Trade Secrets

• Common law rights, relating to breach of confidence.
• May be protected by either express or implied terms of a contract.
• May also arise in other situations where there is obligation of confidence.
• Information is protected as long as it remains secret (potentially forever).
• Remedy is limited to damages for breach of confidence.
• Contractual rights may be assigned.
• Rights arising in other ways may not be assignable.

License Rights

• A grant of a limited bundle of rights (rather than transfer of all rights).
• Rights may be granted for limited time, purpose or territory.
• Patents, copyright, trade-marks and trade secrets may all be licensed.
• Generally, a license must be in writing to be enforceable.
• License rights may be registered.
• License rights may be assigned unless the license restricts assignment; many agreements require the consent of the licensor.

2. Identifying Assets and Due Diligence

The Due Diligence Process

• The purpose is to better define the IP assets being acquired and to assemble as much information about the assets as possible, to avoid surprises after closing.
• The first step is to understand the transaction as a whole; share purchases raise different issues from asset purchases; if there are multiple steps to the transaction, all must be taken into account when reviewing IP issues.
• Due diligence is a team effort; the IP team should include sales and marketing, manufacturing or production, and engineers or other technical experts, in addition to the lawyers and accountants.
• Limited resources must be allocated, especially if the transaction is to close quickly; the focus should be on the rights which are most critical to the business.
• IP issues vary greatly from one industry to another; for example, in manufacturing businesses, patents and trade secrets are most important; with consumer products, trade-marks are the key assets; software companies rely heavily on trade secrets and copyright.
• Establish a clear understanding of the nature of the business and Purchaser's plans for the assets and products being acquired; concentrate due diligence efforts on the assets that are most important to the Purchaser's long-term plans.
• Physical inspection of products and premises is a useful starting point.
• Products, packaging and advertising materials will show Vendor's trade names and trade-marks.
• A tour of the premises will give a general idea of manufacturing processes and technology, which may be patented or involve trade secrets.
• Pay particular attention to third party products and technology.
• Computer Systems and software should be reviewed thoroughly; these may include design and manufacturing systems, office and accounting Systems; even the smallest business uses some computer software.
• Material contracts should be reviewed by someone who is alert to IP matters, particularly the grant of rights by or to the Vendor and change of control clauses.

Patents

• Determine whether any patents have been issued to, or applications have been filed by, the Vendor.
• List patents and patent applications by country.
• Determine whether there are any other inventions used in the business which may be patentable.
• If there are, check whether there have been any activities (such as publication or disclosure of invention) which may prevent patenting.
• Confirm that all inventions have been properly assigned to Vendor.
• Confirm that Vendor is the registered owner of all patents and applications and has not transferred or encumbered rights to patents or other inventions.
• If patents are critical to business, conduct independent review to determine whether they are valid and enforceable.
• Determine status of pending applications.
• Inquire whether Vendor's patents have been infringed by others.
• Inquire whether Vendor's business infringes patents held by others.

Trade-marks

• Make a complete inventory of all trade-marks and trade names used in the Vendor's business.
• Determine the products and services for each mark.
• List the registered trade-marks, and pending applications, by country.
• List other trade-name registrations by jurisdiction (usually, province or state).
• Identify other "common law" trade-mark rights (unregistered names or logos).
• Confirm that Vendor is the owner of all registered marks and applications and has not transferred or encumbered rights.
• If marks were originally acquired from another business, review acquisition to verify that Vendor has clear title and there are no restrictions on use of marks.
• If trade-marks are critical to business, conduct independent review to determine whether they are valid and enforceable.
• Determine status of pending applications and renewal dates for existing registrations.
• Inquire whether Vendor's trade-marks or trade names have been infringed by others.
• Inquire whether Vendor's business infringes trade-mark rights of others.

Copyright

• Identify types of works in which Vendor has copyright.
• With most businesses, copyright is limited to literary works, but there may be artistic or musical works (in promotional materials, for example).
• Determine authorship of any works that are critical to the business.
• If author was an employee acting within scope of employment, employer is owner of the copyright.
• If author was a contractor, author is owner unless there is a written assignment.
• Determine whether author waived moral rights (both employees and contractors).
• Confirm that Vendor has not transferred or encumbered copyright.
• Determine that any published works have been accompanied by appropriate copyright notices.
• Determine whether copyright has been registered, particularly in any countries where registration is either required or recommended (for example, in United States, registration is required if author or owner is a U.S. citizen and is generally recommended in other situations).
• Inquire whether Vendor's copyright has been infringed by others.
• Inquire whether Vendor's business infringes copyright of others.

Trade-secrets

• Any information which is confidential and gives the business a competitive advantage can be a trade secret.
• Examples include product formulas, new product plans, pricing and discount policies, customer lists, customer and supplier contract terms.
• Determine how the information was acquired; is it truly proprietary and secret?
• Review internal procedures to maintain confidentiality of trade secrets.
• Review agreements with employees, contractors, customers, suppliers and any others who have access to confidential information to ensure that all are required to keep the information confidential.
• Inquire whether Vendor's trade secrets have been infringed by others.
• Inquire whether Vendor's business infringes trade secrets of others.

Licenses

From Vendor:

• Determine what rights Vendor has granted to others to use Vendor's IP assets.
• Review scope of grant (product, territory, duration, exclusivity, etc.).
• Review warranties and limitations of liability and make assessment of legal risks.
• Determine whether Vendor has granted any options to licensees to renew current license or acquire additional rights.
• Review compliance by licensee, particularly if Purchaser wishes to terminate any licenses,

To Vendor:

• Determine whether any IP used in the business is licensed from others.
• Examples include computer software, other technology, trade-marks.
• Determine scope of rights granted (product, territory, duration, exclusivity, etc.).
• Determine whether licensor's consent is required to assign rights to Purchaser.
• If Purchaser is acquiring shares, rather than assets, check for change of control provisions.
• Consider seeking confirmation from key licensors that license is in good standing and there are no breaches by Vendor.

Other Agreernents

The following agreements frequently contain licenses or other terms affecting IP rights; I have listed some issues which are specific to each of these relationships, there may be other general IP issues, as well.

• Advertising Contracts: terms relating to use and ownership of advertising materials; personality rights of performers.
• Contractor Agreements: assignment of IP rights and non-disclosure clauses.
• Co-ownership: restrictions on use or disposition of jointly owned rights.
• Co-packing Agreements: use of trade-marks on product packaging. Distributor Agreements: use of trade-marks in marketing; access to trade secrets.
• Employee Agreements: nondisclosure and non-competition terms; assignment of IP rights; waiver of moral rights.
• Franchise Agreements: use of trade-mark and trade secrets; copyright in manuals describing the franchised system.
• Manufacturing: use of patents and trade secrets in manufacturing process.
• Joint Venture: ownership of assets acquired or created by joint venture; assignment of assets by venturers.
• Research and Development: ownership of research materials and resulting inventions; confidentiality and non-competition.
• Reseller Agreements: use of manufacturer's trade-marks; obligations to provide "value added" services.

Searches

• Searches are an important step in due diligence, but intellectual property is a form of personal property and there is no comprehensive ownership registry.
• Business names should be searched under provincial statutes.
• In Canada, the federal government maintains registries of patents, trade-marks, copyright, industrial designs and semiconductor chip rights.
• Copyright searches are not very effective, since registration is optional, but search should be done, to check whether an assignment has been registered.
• Searches will also disclose whether licenses given by or to Vendor have been registered.
• Searches must be made in each other country where IP rights are registered or applications are pending.
• Purchaser may also consider searching rights held by competitors or Vendor, particularly if there are infringement concerns.

Security Interests or Other Encumbrances

• Security interests may be registered against IP assets under provincial statutes such as Personal Property Security Act (Ontario).
• Security interests, usually in the form of a conditional assignment or mortgage, may also be registered under federal statutes (Patent Act and Copyright Act).
• Purchaser should conduct searches under both provincial and federal statutes to confirm that no lenders have registered a claim against IP assets.

Permits and Regulatory Compliance

• If Vendor is in a regulated industry, determine whether use of any IP rights by Purchaser requires a government permit or other regulatory approval.
• Examples include sale of food and drug products in Canada, exports of certain "high tech" products.
• Many products require Canadian Standards Association approval in Canada (Underwriters Laboratories, in United States).

3. Representations & Warranties Definition of IP Assets

• Purchaser will want the definition to be as broad as possible, to ensure that all relevant assets are being acquired.
• Vendor will want to limit definition, if it is being asked to give warranties for all assets.
• One possible solution is to split the definition -- a broad definition to define the assets being transferred; a narrower definition for specific representations and warranties.
• All registered patents, trade-marks or copyright and all pending applications should be listed in a schedule; other rights may also be described in the schedule, but are virtually impossible to list.

Ownership

• Since there is no search that a Purchaser can do to verify ownership of IP assets, Purchaser will usually require Vendor to warrant title.
• However, Vendor cannot absolutely determine IP rights, either.
• For example, Vendor may have been using a trade-mark for years without any problem and may even have registered it, but that does not guarantee that Vendor has an absolute right to that name.
• Another example: Vendor may be manufacturing widgets, using a secret process it developed; but those widgets may infringe someone else's patent, completely unknown to the Vendor.
• Purchaser will want a broad warranty of title and ask Vendor to assume risk of unknown claims.
• Vendor will seek to limit warranty to specified assets and rights, such as issued patents or registered trade-marks.

Validity and Enforceability

• Purchaser wants to ensure rights are valid and can be enforced against others.
• Vendor cannot guarantee validity; even registered patents and trade-marks may prove to be invalid, if they are challenged.
• Vendor will seek to limit unqualified warranties to facts it knows for certain.
• Other warranties may be limited to Vendor's current knowledge and available information (the usual phrase is "knowledge, information and belief').
• Purchaser may require that Vendor warrant that it has made "due inquiry" (which raises the question of what inquiries ought to be made to give the warranty).
• "Enforceability" is also difficult to warrant, since IP rights may be enforced broadly or narrowly and against a number of potential defendants.

Utility of Inventions

• An invention must be useful, as well as novel and non-obvious, to be patented.
• The Purchaser may seek a warranty of utility for key products or processes.
• The Vendor must be careful about giving such warranties and should narrowly define the conditions to be met by the Purchaser (for example, the warranty may be limited as to location, related technologies, use of specified raw materials or use of trained personnel).

No Infringement

• The Purchaser will want a warranty that the business being acquired does not infringe the IP rights of any other person.
• However, due to the nature of IP rights it is impossible to state for certain that no rights are being infringed.
• As with other warranties, the Vendor will be reluctant to give an absolute warranty, since there may be claims or potential claims of which it is not aware.
• The purchaser will likely insist on a warranty that the Vendor has received no actual notice of any claim.
• The Purchaser will also seek a warranty that the Vendor is not aware of any infringements by others of its IP rights.

Contracts

• The Purchaser should require that all contracts relating to IP rights be identified in a schedule.
• The Purchaser will seek a warranty that neither the Vendor nor the other contracting party are in breach of any contract obligations.
• The Purchaser will also want to know that the important contracts may be assigned by the Vendor without the consent of the other party (or that if consent is required, it will be obtained before closing).

Pending Litigation

• It is impossible for the Purchaser to conduct comprehensive searches to determine whether there are any pending infringement claims against a particular company or relating to specific IP rights.
• If there are any pending infringement claims, whether the Vendor is plaintiff or defendant, the claims should be described in detail and the Purchaser's counsel should review the claims to assess their likely outcome.
• Purchaser will seek warranty from Vendor that there are no claims or threatened claims.

Regulatory Compliance

• The Purchaser will ask the Vendor to warrant that the conduct of the business complies with all applicable laws and regulations.
• The Vendor will seek to limit the warranty to specific permits and regulations, since it is virtually impossible these days for any business to be aware of all laws.

Risk Allocation

• Ultimately, all representations and warranties are a matter of deciding who should bear the risk of any deficiencies in IP rights.
• IP representations and warranties should be treated seriously, because the risks and costs of IP claims are significant.
• Patent claims, in particular, can cost more than $100,000 to prosecute or defend.
• Damage awards in patent cases can be in the millions.
• Other IP claims can also have a crippling effect on the conduct of the business.
• The Vendor may retain responsibility for claims relating to activities before closing, with the Purchaser assuming liability for future activities.
• The Vendor and Purchaser may agree on a materiality threshold, before there is any recourse against the Vendor.
• The Vendor may also seek to limit its financial exposure by limiting the duration of its warranties and limiting the total amount the Purchaser may claim under any indemnity.

4. Transferring Assets

Assignments

• Most IP statutes specify the form of assignment which is required for the transfer to be registered.
• Generally, individual assignments are required for each type of IP right, for registrations and pending applications, and for each country where the assignment is to be registered.
• Licenses and other contracts should be transferred by way of an Assignment and Assumption Agreement.
• A General Conveyance should refer specifically to IP assets, as defined in the Purchase Agreement, to transfer all assets which are not covered by a specific assignment.

Vendor/Purchaser Licenses

• Many transactions involve licenses between Vendor and Purchaser, generally where the Vendor is selling only part of its business.
• It is usually preferable to have one party own the IP rights and license them to the other, rather than have joint ownership.
• Deciding which party should be the owner and which should be the licensee is often difficult: as a general rule, the party with the larger or longer-term interest in the asset should be the owner.

Examples include:

• Vendor requires a license to continue using the trade-marks to dispose of existing inventory of products not being acquired by the Purchaser;
• Purchaser requires patent license to manufacture specific product; and
• Purchaser acquires an operating division from Vendor and requires Vendor to continue providing accounting and other services until the operations can be incorporated into Purchaser's office systems.

Restrictions on Transfers

• In some situations, an outright assignment may adversely affect rights.
• For example, a registration may be assignable, while a pending application is not; or a third party consent may be needed to assign a license or other contract.
• In such cases, it may be necessary for the Vendor to retain certain rights, in trust for the Purchaser, until they can be validly transferred.
• If possible, third party consents should be obtained before closing at least for licenses or other contracts which are necessary for the conduct of the business.
• Consider delaying closing, if the risk of a refusal to give consent is too great.

5. Post Closing Steps

Register Assignments

• Assignments should be registered promptly in each jurisdiction.
• Failure to register may result in a subsequent assignee for value without notice acquiring a prior interest in the asset.
• Generally, assignments should be registered by local counsel, although assignments of U.S. rights may be registered from Canada.

File New Applications

• File trade-mark applications as soon as Purchaser has determined its plans for the relevant products and services.
• File patent applications immediately: applications can be filed only for a limited time after the invention is known or products have been sold; in many countries, patents are awarded on the basis of the "first to file", rather than the first to invent.

Notify Suppliers. Customers & Others

• Other parties to material contracts should be notified of the transaction, even if no consent is required.

Resolution of Other Issues

• Many of the issues identified in the due diligence process cannot be resolved before closing and are not important enough to hold up the transaction.
• Action items should be established to deal with these matters.
• Determine who will obtain any third party consents which have not been given before closing.
• Determine whether Vendor or Purchaser will assume responsibility for outstanding litigation; decision will depend in large part on which party has the greater stake in the outcome of the litigation.
• If there are licenses or other contract rights which are not properly documented (or which are not being exercised in a manner consistent with the contract), Purchaser must determine whether to take steps to renegotiate or document the relationship or whether it is safer to let sleeping dogs lie.

Conclusion

• Lawyers and business people must always remember that the legally correct course of action is not always the one which makes the most business sense.
• It is the lawyer's job to determine the legal risks from the information available and to advise the client what steps can be taken to reduce those risks.
• It is the client's responsibility to decide which risks to assume and how much time and effort should be spent to reduce the risks to an acceptable level.
• The purchase of a business is never risk-free, particularly when it comes to intellectual property.

Contact Michael Erdle for more information on purchasing or selling a business.