A brief discussion of intellectual property focused due diligence
By Ying Yihong(Associate of Rouse)
Updated: 2012-11-23

II. Consideration of the industry in which the business operates and the client’s business objectives

When conducting an IP-focused due diligence exercise, it is necessary to take into consideration both the industry in which the transaction is taking place and the client’s business objectives.

It is particularly important to have a sound understanding of the industry in which the target company is operating e.g. if it is an agricultural company, in addition to identifying the usual forms of IP, copyright, trade mark, patent, and domain names, it may be necessary to consider plant variety rights. Further, only by understanding the business objectives of the acquiring company, and its strategic reason for the transaction, will it be possible to identify all IP issues that may be relevant. In some cases, it may be advantageous for the company to acquire only the IP; in others, e.g. where the goodwill in an unregistered mark is not separable from the business in relation to which it is being used, it may be necessary to acquire at least some of the company’s assets. Being aware of the business objectives will also enable the lawyer to determine how valuable the IP will be to the company e.g. if the association between the target company’s IP and its major products/market share is strong, the value of the IP to the acquiring company is likely to be high.

III. Establishing a basis for assessing the value of the IP

Depending on the company’s business objective, IP may be valued from various points of view: technical, economic, or strategic. A successful IP-focused due diligence should aim to provide sufficient data from all pertinent perspectives to arrive at an accurate assessment of the value of the IP to the acquiring company.

Depending on the type of IP involved, a number of substantive issues should be examined. Taking a Chinese utility patent as an example, one may need to 1) collect the basic publicly available information (such as patent claims, description, drawings, records of licenses, assignments and pledges) from public registers including the patent register; 2) determine the currently effective status and scope of the patent; and 3) analyze the underlying legal and technical issues. In relation to the third point, it will be important to assess whether the scope of the patent claims is sufficient to provide useful protection, whether the claims can be easily designed around, or whether the patent may be easily invalidated. This assessment will usually require a high level of technical knowledge. If the patented product/technology may be easily designed around, the patent might have little practical value. Further, it is also worth taking into account issues such as protection period versus product cycle, geographical coverage, claw-back of ownership, etc.

Even though a company may own the IP, it may not have effective control over it. The ability to control IP can be affected by a number of factors. The contemplated transaction may, for example, trigger a contractual clause relating to change of ownership. Further, the transaction may lead to future business conflicts which would reduce the value of the IP.

The collection and review of all relevant information relating to the IP assets, should provide a basis for assessment of the value from a technical, economic, or strategic view point.

IV. Analysis of the risk of infringement

Analyzing and assessing the risks of IP infringement is a very important aspect of IP-focused due diligence. It involves the analysis and assessment of two types of risk: the risk of infringement by others, and the risk of infringing the IP rights of others.

The former risk could be easily overlooked, yet it is important for companies relying heavily on certain types of IP, know-how or trade secrets e.g. if a company does not afford sufficient physical or systemic protection to its confidential technologies, it may not be in a position to protect its trade secrets or take action in the event of a dispute. In that case, a good due diligence report will identify the issue, enabling steps to be taken to rectify the weakness.

The latter risk will vary depending on both the type of IP asset involved and the operation of the business e.g. in the case of the production and exportation of branded products it may be worth checking the trade mark registration in both the production country (namely China) and the target country of export, in order to avoid the risk of trade mark infringement in either jurisdiction.

V. Post due diligence tasks

After an IP-focused due diligence has been completed and the report submitted, there is still a long way to go before closing the deal. After identifying the relevant IP-information, it will be necessary to ensure that all relevant transactions such as licenses and assignments, are in place and properly documented.

In relation to assignments, it will be necessary to take account of the specific requirements that exist in relation to IP e.g. trade mark and patent assignments will not be effective until they have been approved by the China Trade Mark Office or the State Intellectual Property Office respectively. Depending on the type of IP, this may require additional time.

VI. Conclusion

When carrying out an IP-focused due diligence exercise, consideration of these issues will help ensure that all relevant issues are identified before the close of the transaction. It is, however, important to be aware that with rapid developments taking place in both industry and IP law and practice, some of these issues, and the strategies to be adopted in relation to them, will change over time.

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