Intellectual Property Aspects of Acquisitions x c
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Intellectual Property Aspects of Acquisitions x c
Intellectual Property Aspects of Acquisitions by Glenn A. Gundersen April 2003 xc BOSTON BRUSSELS FRANKFURT HARRISBURG HARTFORD LONDON LUXEMBOURG NEW YORK NEWPORT BEACH PARIS PHILADELPHIA PRINCETON SAN FRANCISCO WASHINGTON ll ll ll ll ll ll ll ll ll ll ll ll www.dechert.com Copyright 2003 Dechert LLP. All rights reserved. Materials have been abridged from laws, court decisions and administrative rulings and should not be considered as legal opinions on specific facts or as a substitute for legal counsel. xc Intellectual Property Aspects of Acquisitions by Glenn A. Gundersen BOSTON BRUSSELS FRANKFURT HARRISBURG Every business uses some form of intellectual property, and the buyer of a business will typically need to acquire the intellectual property used in the business along with other types of assets. Lawyers who specialize in mergers and acquisitions usually take the lead role in these transactions, but intellectual property counsel are often called upon to assist transaction counsel in drafting and negotiating the documents which relate specifically to intellectual property. This chapter is designed to allow intellectual property specialists to understand their mission in the context of the overall transaction, and to analyze the issues which IP specialists and non-specialists encounter in these negotiations. HARTFORD LONDON LUXEMBOURG NEW YORK NEWPORT BEACH PARIS PHILADELPHIA PRINCETON SAN FRANCISCO WASHINGTON Almost any acquisition of a business involves an agreement between buyer and seller which spells out the terms of the transaction. Occasionally very short, often more than 100 pages long, this document is usually captioned either as a “stock purchase agreement” (in transactions in which the stockholders of a corporation are selling the stock of the corporation which conducts the business), or an “asset purchase agreement” (in transactions in which a corporation sells the assets it uses in operating the business). Either way, the agreement details the terms and conditions under which the stock or assets will be sold, and is usually negotiated and signed weeks or months in advance of the actual sale. It is the central focus of counsel’s activity in the course of the transaction, and the bible which both parties will consult after the transaction is done. The acquisition agreement will usually include provisions which relate specifically to intellectual property. In fact, as patents, trademarks, copyrights, trade secrets, and other forms of intellectual property have become more important to businesses, these assets have received greater scrutiny by buyers in acquisitions. As a result, the intellectual property provisions of these documents have grown in length and complexity, and can be the subject of extensive negotiation. n Contents of the Acquisition Agreement The acquisition agreement is intended to comprehensively detail all of the terms and conditions of the transaction. Such agreements typically include provisions which cover the following issues: ã The date on which the transaction will be consummated. The closing date is usually weeks or months in advance of the signing of the agreement, but occasionally simultaneous with signing. Copyright 2003 Dechert LLP. All rights reserved. Materials have been abridged from laws, court decisions and administrative rulings and should not be considered as legal opinions on specific facts or as a substitute for legal counsel. Intellectual Property Aspects of Acquisitions ã Consideration. These provisions detail the price to be paid for the business (which, depending on the circumstances, may consist of cash, stock, the assumption of liabilities, and other consideration), the timetable for payment (all at closing or in one or more installments), and any adjustments to be made to the purchase price for contingencies to be determined after closing. ã A description of the property (stock, assets or a combination of both) to be transferred at closing. This language can be relatively simple in a transaction in which the buyer acquires the stock of a company – the agreement specifies the stock to be acquired, and by virtue of acquiring that stock the buyer in effect takes control of all of the assets of the corporation. Buyers need to be careful, however, that the corporation does in fact own all of the assets relative to the business. In some cases certain assets are held by particular shareholders or affiliated companies, and the buyer will need to make sure that the stock purchase agreement calls for the buyer to acquire or license those other assets. The description of the property being transferred is likely to be considerably more complex in an acquisition of assets, especially where the buyer is only buying one division or line of business and seller is retaining other businesses and assets. In such situations, the definition of assets to be sold (and those which seller will retain) is sufficiently precise to avoid confusion and dispute about what was intended. The parties usually negotiate a fairly detailed description of the assets (e.g., “all of the assets used or held for use by Seller and its Affiliates in the manufacture of spatulas”) which is supplemented by detailed lists of specific assets (e.g., spatula manufacturing plants and equipment, patents on spatula technology, etc.). ã An allocation of the existing liabilities of the business. In stock acquisitions, the buyer takes on all of the company’s liabilities by virtue of having acquired its stock. In asset acquisitions, the parties must negotiate what liabilities the buyer will assume and what liabilities the seller will retain. ã Representations and warranties about the business. In either type of agreement, the seller is typically called upon to make certain representations and warranties about the assets of the business. Buyer and seller negotiate the nature of these disclosures and representations, often at length. ã Seller’s indemnification of buyer. If the buyer discovers after closing that one of the seller’s representations about itself, the business, or the assets was inaccurate, the acquisition agreement sometimes allows the buyer to seek indemnification from the seller to compensate for the diminished value of the business or the unexpected liabilities the buyer incurred. ã Covenants of the parties. Buyer and seller typically promise to do certain things, and to refrain from certain acts, before and after the closing. Some of Dechert LLP Page 2 Intellectual Property Aspects of Acquisitions these covenants are fairly standard – e.g., a seller’s covenant not to engage in any asset sales between signing the deal and closing the deal, except in the ordinary course of business. Others will only arise in particular transactions – e.g., a seller’s agreement not to compete with the buyer in the acquired business for a period of time after the deal closes. ã Conditions to closing. Buyer and seller typically specify conditions which must be present or events which must occur before they are obligated to consummate the deal. A seller makes representations about the business as of the date that the acquisition agreement is signed, but that date may be weeks or months prior to closing, especially if antitrust or other regulatory approvals are required in order to close the transaction. The buyer will typically require that the seller warrant at closing that the representations are still true. If certain statements are no longer true, the buyer may have the option of declining to go through with the transaction as specified. Other conditions of closing may reflect issues which come to light during the negotiation of the agreement. For example, in a stock sale, if the buyer learns certain intellectual property is not owned by the corporation whose stock is being acquired, it may require that those assets either be transferred to the corporation before closing, or be transferred directly to the buyer at closing. If the seller does not comply, then buyer will not be obligated to buy the stock of the corporation. n Other Documents In most cases, the acquisition agreement does not actually effectuate a transfer of stock or assets from seller to buyer. Instead, it merely embodies the seller’s promise to sell stock or assets to the buyer under certain terms. The consummation of the transaction takes place at the closing on a later date, where the parties execute transfer documents and any ancillary agreements, and take other steps, as follows: ã Transfer documents. If the buyer is acquiring stock, the seller typically effects the transfer by signing stock powers and delivering stock certificates. An asset transaction is more complicated. While most assets will be transferred via the seller’s execution of a bill of sale at closing, a buyer will usually require that separate assignments be prepared for all patents and patent applications, trademark registrations and pending applications and U.S. copyright registrations and applications. The buyer will usually want to record these assignments in the applicable offices in each of the jurisdictions where the patents have issued or are pending, or the marks have been registered or in which applications are pending. Patent assignments, trademark assignments, and copyright assignments each require different transfer language, and the parties will typically prepare a different assignment document for each type of intellectual property. It is also preferable to prepare and record separate assignment documents for each country jurisdiction because each country has particular language, format, Dechert LLP Page 3 Intellectual Property Aspects of Acquisitions and signature requirements for the assignment form. In addition, special considerations apply when assigning patent applications which have been filed under the Patent Cooperation Treaty or trademark registrations issued under multi-country registration systems such as the Madrid Agreement. In transactions involving the transfer of intellectual property rights in multiple countries, the parties may agree that “master” patent, trademark and/or copyright assignments will be executed at closing, and that the preparation and execution of individual country assignments will occur as part of the post-closing “cleanup”. The bill of sale is usually not recorded because it is likely to be lengthy, may contain information which is confidential, and may not contain language necessary to comply with various national recording requirements. Transfers of domain names pose special issues. A bill of sale is insufficient to fully effect the transfer of a domain name, since it does not effect a change of title in the domain name registrar’s records. Counsel for buyer needs first to determine which domain name registration organization (Network Solutions, Register.com, or another) registered the name, and then to determine how to comply with that organization’s requirements for transferring the domain name. Such transfers are an aberration from the M&A lawyer’s expectation that all transfers can be effected by the execution of hard copy documents in a conference room on closing day, in that domain transfers may also require the electronic filing of domain name transfer instructions. In addition, from a practical standpoint, if the buyer is not acquiring the seller’s servers or other hardware and software used to operate the web site, the buyer will need to make plans prior to closing for a smooth technical transition on closing day to its own facilities or for having the seller provide transition services until buyer’s facilities are operational. ã Obtaining assignments of licenses. Many businesses use intellectual property which is licensed from third parties -- computer software, trademarks, technology, and so on. In most acquisition agreements, the seller provides the buyer with a list of intellectual property licenses used in running the business. As part of its due diligence, the buyer will obtain and review copies of these licenses. Often such licenses are not readily assignable. This is not a problem in a stock deal (unless the license prohibits a change of control of the licensee), since the identity of the licensee does not change. However, it causes headaches in an asset purchase, where the buyer must step into the seller’s shoes as licensee. The buyer will need to determine if it wants to assume these licenses and, if it does, will have to determine whether it can obtain the licensor’s consent to the transfer without a renegotiation of its terms. As a general rule, intellectual property licenses are not transferable from one licensee to another without the licensor’s consent. Some licenses permit transfer, but most do not. The buyer and seller will need to determine whether the obligation to negotiate and obtain such consents falls on the buyer or the seller. The acquisition agreement may even provide that the Dechert LLP Page 4 Intellectual Property Aspects of Acquisitions buyer is not obligated to close the transaction if consents from key licensors cannot be obtained, or cannot be obtained without considerable expense. ã Ancillary agreements and obligations. The acquisition agreement often specifies other obligations of the parties related to the acquisition. In the intellectual property area, the most common type of ancillary agreement is a license, either from the seller to the buyer or vice versa. This is commonplace in situations in which the seller is parting with one of its businesses, but has certain intellectual property which is used in that business as well as in businesses it is retaining. In such situations, the buyer either retains the shared intellectual property and licenses it to the buyer postclosing, or sells it to the buyer and takes a license back. The parties may also conclude that short-term licenses are needed in order to allow a party to phase out its use of certain intellectual property post-closing -- for example, a license to seller (to allow seller to use up packaging or materials bearing the marks it has sold) or a license to buyer (to allow buyer to continue using a mark seller has retained until buyer adopts a new mark and deletes seller’s mark from packaging and advertising). n Drafting the Description of Assets The first task for buyer’s and seller’s counsel in an acquisition is to agree on the definition of what property will be transferred. This is obviously an easy task if the seller is selling itself, lock, stock and barrel. It can be considerably more difficult if the seller is selling only a portion of its assets. Here are several possible scenarios: (1) Identifying the intellectual property being transferred as part of a stock sale. When the stock of a corporation is sold, the assets of the corporation do not change hands -- they remain with the corporation. The buyer of the stock in effect acquires the intellectual property owned by the corporation because the buyer has acquired the corporation. However, the buyer should not assume that all of the intellectual property used by the corporation is in fact owned by that corporation. With smaller companies in particular, it is not uncommon for individual shareholders to own patents on the inventions they developed, copyright registrations on software they wrote, or trademark registrations of marks they coined. To the extent feasible, buyer should make sure that the seller’s disclosure schedules indicate which intellectual property is owned by the corporation, and which is owned by other entities and licensed to the corporation. To the extent that ownership is public record (in the case of issued patents and trademark registrations and applications), the buyer will want to conduct its own independent due diligence search to verify that the seller’s schedules are accurate. (2) Identifying the intellectual property to be transferred in an asset sale. When all of the assets of a business are sold and the parties neglect to specify that trademarks are being transferred, the general rule is that the seller is nevertheless Dechert LLP Page 5 Intellectual Property Aspects of Acquisitions presumed to have transferred the marks of that business to the buyer. However, it isn’t always clear which marks relate to the business being sold and which do not. Moreover, this rule does not necessarily apply to other forms of intellectual property. The Copyright Act requires, for example, requires that a transfer of copyright ownership be in a written instrument executed by the copyright owner unless the transfer occurs through operation of law. 17 U.S.C. § 204(a). A bill of sale which neglects to reference copyrights or fails to include other catch-all language arguably fails to effect a transfer of copyrights. Domain names definitely cannot be transferred by same implied grant. Thus, to avoid doubt about what buyer has acquired and what seller has retained, the parties typically list or otherwise define which intellectual property assets are being transferred and which are not. From a drafting standpoint, the typical agreement will begin by defining “Intellectual Property” along the lines of the following: “All patents, industrial design rights, trademarks, service marks, trade names, trade dress, copyrights, mask works, inventions, technology, know-how, industrial design registrations, formulae, trade secrets, confidential and proprietary information, computer software programs, domain names, and other intellectual property, and all registrations and applications for registration of any of the foregoing.” Although such definitions sound comprehensive, by their nature they leave some ambiguity. For example, if the seller agrees to transfer “all Intellectual Property used exclusively in the Business,” the buyer will not necessarily know whether particular patents or trademarks fall within that definition or are used in other seller businesses as well. Thus, the parties rely in large part on schedules which list identifiable items of intellectual property being transferred. Thus, the agreement would specify that the definition of “Intellectual Property” above includes, but is not limited to, the items listed on an attached schedule. Thus, in most transactions, both parties’ counsel should recognize that schedules are not all-inclusive, but a subset of all of the intellectual property to be transferred. The buyer can reasonably expect such schedules to include issued patents and pending patent applications, registered trademarks and pending applications, registered copyrights and applications, and domain name registrations. The buyer will also want the schedules to list unregistered marks and trade names, although most sellers will be reluctant to characterize any such list as comprehensive. The seller and its counsel prepare these schedules, and newcomers to M&A transactions are often surprised to discover that they are frequently incorrect, incomplete or contain out-of-date information. A buyer will want to conduct its own due diligence search to verify that seller’s schedules are accurate. Buyers should not expect that schedules will list every item of intellectual property, in Dechert LLP Page 6 Intellectual Property Aspects of Acquisitions part because it is virtually impossible to exhaustively list (or even accurately describe) certain categories of intellectual property such as trade secrets and unregistered copyrights. The larger the company, the more cautious counsel should be about the comprehensiveness of schedules. Even if a company has sophisticated in-house intellectual property lawyers, the chances are that they are not aware of every brand or slogan used in the company, and that some errors, even if slight, have found their way into docket lists of patents and trademark registrations over time. The Internet domain name is a new kind of property right, combining elements of trademark, property right, and vanity phone number. As such, it will not appear in formbook asset purchase agreements as part of the list of intellectual property assets which are typically transferred in M&A transactions. Most asset purchase agreements would call for the transfer of the seller’s trademarks to the buyer, but that does not necessarily cover domain names, for two reasons. First, the registration of a domain name, in and of itself, does not create trademark rights in that name, and as a result one cannot assume that the terms “trademark” and “domain name” are interchangeable or synonymous. Many domain names do consist of a trademark followed by “.COM”, “.NET”, or the like, and if a buyer neglects to list domain names among the assets to be transferred, an agreement which calls for the sale of trademarks could reasonably be interpreted to also contemplate the sale of the corresponding domain names. However, some domain names consist of generic terms followed by .COM. These arguably don’t fall within the definition of trademarks (especially if they do not lead to an active web site). Moreover, the courts at this writing disagree over whether a domain name is a property right at all, or merely ancillary to a contract with a domain name registrar. Thus, a buyer will want to make certain that “domain names” are listed among the assets to be transferred in the sale of a business. The buyer will want the seller to provide a comprehensive list of all Internet domain names held or used by a company (if the entire company is being purchased) or all Internet domain names used or held for use by a business (if only one of the company’s businesses is being acquired). The buyer will want to do its own due diligence review of whether the domains are registered in the company’s name or that of another party (e.g., an employee, a web site developer, or a web-hosting firm). (3) Determining the disposition of jointly used intellectual property. In many cases, certain intellectual property may be used both in the business being sold and in the business that seller is retaining. For example, seller may sell its products using seller’s overall house mark in combination with individual product line brands. Similarly, the same patented technology or manufacturing know-how may be used in both businesses. If both parties will need or want to continue using certain intellectual property after the sale, they will need to negotiate whether the seller will retain such intellectual property and license it to buyer post-closing, or whether the buyer will acquire it subject to an obligation to license it back to seller. They will also need to decide whether the license will be Dechert LLP Page 7 Intellectual Property Aspects of Acquisitions a short-term transitional arrangement, a long-term (but terminable) license, or “perpetual”, and whether it will be royalty-free. n The Substance of Intellectual Property Representations and Warranties As with the other assets of the business being sold, the buyer in an acquisition will want information about the intellectual property needed to conduct its operations. The buyer’s checklist will typically include the following questions: ã What intellectual property is necessary to operate the business? Does the seller own all the intellectual property necessary to operate the business? If so, does seller own it free of any liens, security interests, and other encumbrances? ã If the seller does not own all the intellectual property necessary to operate the business, does it have sufficient licenses from third parties? ã With respect to intellectual property that the seller owns, is the seller in a position to transfer to the buyer all of the intellectual property used in the business, or does seller need to retain some of it for use in seller’s other businesses? With respect to intellectual property that the seller licenses from third parties, can the seller freely assign those licenses to the buyer, or must consents be obtained? ã Has the seller granted licenses of any of the intellectual property to third parties? If so, what are the terms of those licenses? Do they contain exclusivity provisions or other terms which would restrict the buyer’s ability to use the intellectual property? ã Has the seller entered into settlement agreements or consents, or is it bound by judgments or consent orders, restricting the use of its intellectual property? ã Would the buyer’s use of the intellectual property infringe any third party? Have any infringement or dilution claims been made against the seller with respect to the intellectual property? Has the seller made any infringement or dilution claims against third parties? Is there ongoing litigation involving the intellectual property? ã Are there interferences, oppositions, or similar proceedings pending in patent and trademark offices at home or abroad? ã Have any pending applications for patents, trademarks, or copyrights been rejected or refused registration? Dechert LLP Page 8 Intellectual Property Aspects of Acquisitions A buyer has two ways of getting answers to these questions. One is to conduct its own due diligence review of the seller’s intellectual property. The other is to request that the seller make representations and warranties about the intellectual property. Depending upon the language negotiated by the parties, these representations will answer some or all of the questions listed above. In some cases, the seller will be able to provide a “clean” representation, for example, that no infringement claims have been made with respect to its use of the intellectual property. More often, however, the seller will be unable to honestly make an unequivocal representation as to every aspect of its intellectual property, especially if the buyer has proposed language which makes sweeping generalizations. Thus, the seller will either attempt to modify the representation so that it is accurate, or it will make the representation subject to exceptions, which are typically set forth in a disclosure schedule. In entering into the acquisition agreement at a given price, the buyer will be relying on the accuracy of these representations. What if they prove to be inaccurate? The agreement often provides that the seller will partially or fully indemnify buyer if seller’s representations and warranties prove to be inaccurate, as discussed later in this chapter. n How Intellectual Property Law Affects Representations and Warranties The complexity of intellectual property law poses challenges to sellers in making representations, for several reasons. First, it is difficult to make simple, broad-brush statements about intellectual property in general, because different rules apply to the different categories of IP. What’s true for patents is not necessarily true for trademarks, copyrights, trade secrets, industrial designs, mask works, or rights of publicity, and what’s true in one country is not necessarily true in another (despite the worldwide trend toward harmonization of IP laws). Internet domain names raise an entirely different set of issues. The following are some examples of how differences in legal principles between categories of intellectual property law and between jurisdictions can complicate what sellers can say, and what buyers want sellers to say, about an intellectual property portfolio. Dechert LLP Page 9 Intellectual Property Aspects of Acquisitions Patents Patents create the single biggest concern for buyers in today’s environment because of the uncertainty about exposure for infringement. The contents of patent applications are kept secret for at least a portion of the prosecution process, such that other companies have no knowledge of what an applicant is claiming as patentable. However, any unlicensed users of that technology become liable for patent infringement at the point that the patent issues. Thus, users of technology are generally in the dark about what others may be seeking to patent. The advent of protection for business methods has created substantive uncertainty about what can and cannot be patented under the law. All of this doubt is exacerbated by the fact that a plaintiff’s patent infringement victory, unlike a trademark infringement claim, often results in a significant damage award. Similarly, patent suits that are settled rather than litigated often result in the defendant entering into a royalty-bearing license for the life of the patent. Therefore, potential exposure for patent infringement can carry a substantial financial risk. The representations in an acquisition agreement allocate this risk. Companies which are considering the purchase of a multinational business must be aware that patent protection is acquired on a country-by-country basis, and that the monopoly afforded by a patent only exists in those countries in which the seller has obtained or is likely to obtain patent protection, and only then if the seller has paid the requisite patent annuities. This makes disclosure schedules critical to understanding where a seller enjoys exclusivity with respect to an invention, and where it does not. Trademarks Trademark infringement claims pose a different set of risks than patents, and raise different concerns for buyers about the exposure they may inherit. Like patents, a trademark user lives with uncertainty, because it can be liable for infringement of a third party’s mark even if it was completely unaware of the mark. A trademark user can conduct a search to attempt to identify these risks, but searching is not foolproof. One cannot simply search a single database and discover all relevant third party rights. In the U.S. and some other countries, trademarks exist at common law, and need not be registered in order to be protected. Occasionally, such marks leave no “footprint” in the databases which are commonly used for searching. In addition, such databases have inherent blind spots. The primary goal of most plaintiffs in trademark litigation is to enjoin the infringing use, and damages tend to be less frequently awarded, and of lesser gravity. This means, however, that defendants are less likely to settle litigation by taking a license of the plaintiff’s mark, and face the prospect of business disruption caused by having to change or modify an existing mark and discard all of the marketing materials used with the mark. The parties to an acquisition must determine who bears the risk of these uncertainties. Dechert LLP Page 10 Intellectual Property Aspects of Acquisitions Trademark claims are complicated by the fact that owners of famous marks can allege two different grounds for relief -- infringement (asserting that the defendant’s mark is likely to cause confusion) and dilution (asserting that the defendant’s mark causes dilution of the distinctive quality of the famous mark). Dilution is relatively new as a federal claim, and confusion exists about the standards for relief, most notably about what constitutes a famous mark. Compounding the confusion is the fact that more than half the states have dilution statutes which set different (and sometimes more lax) standards for relief. The concept of dilution is also more inherently amorphous than infringement, and one can determine more intuitively whether two marks are confusing than one can determine whether one mark dilutes another. Therefore, sellers are likely to have less comfort in making representations about dilution, and buyers more likely to have anxiety about their potential exposure. Companies which are considering the purchase of a multinational business must be aware of the differences between patent protection (which either exists or does not exist in a country depending on the issuance of a patent) and trademark protection, the existence of which is less obvious. Like patents, protection is acquired on a country-by-country basis, and the fact that a seller has registered a mark in the U.S. does not mean that the mark will be afforded protection anywhere else. Moreover, the requirements for protection vary significantly between types of legal systems. Unregistered common law trademarks are recognized in the U.S., U.K., Canada, and other countries with legal systems based on British law. Other countries do not afford trademark protection unless the mark is either registered locally or is protected as a famous mark under international treaties. These differences mean that trademark rights are more difficult for a seller to comprehensively schedule, since rights in marks and trade dress may exist which are unregistered and which the seller has never attempted to catalog. Copyrights Copyright law inspires less fear than patent or trademark law about being “blindsided” by a hitherto-unknown claimant, in that liability for copyright infringement arises only if the author had access to the copyrighted work and copied it. Nevertheless, companies can be liable for copying by individual employees even if their bosses are unaware of the copying. However, copyright law raises a wealth of peculiar title issues, and the rules of copyright ownership are unique and sometimes counterintuitive. For example: ã If one commissions a copyrighted work, one doesn’t necessarily own it. Copyrighted works created by regular, full-time employees belong to an employer without the need for a written agreement, but a free-lancer retains copyright in his or her work unless he or she executes a written assignment. Many companies have the mistaken notion that they own computer software, advertising, photography, web site designs and other works that they have paid free-lancers to create, but in fact have only a license on undetermined terms. Dechert LLP Page 11 Intellectual Property Aspects of Acquisitions ã Even if a copyright owner makes a valid and outright transfer of copyright, the assignee may not receive irrevocable and complete title to the work. Some works can be subject to a reversion to the original author, and authors of works created under some foreign legal regimes can retain “moral rights” restricting the new owner’s freedom to modify the work. ã U.S. copyright law underwent a major revision in 1976 and has seen several major amendments since then. The rules surrounding works created under the new act can differ significantly from those governing older works . The most significant example is that older works may have been lost to the public domain for failure to comply with statutory formalities which no longer exist, such as copyright notice and renewal. ã The term of copyright is not uniform for all U.S. works, nor is it uniform as between U.S. copyright law and foreign copyright laws. For U.S. works created on or after January 1, 1978, copyright protection is calculated based on the death of the last surviving author. In the case of anonymous works or works made for hire, copyright protection lasts for 95 years after publication or 120 years from the date of creation, which ever expires first. The term of copyright for older works was originally 28 years followed by an equal renewal term, but the renewal term for works still under copyright has been repeatedly extended by Congress. ã Copyright law recognizes the concept of co-authorship by two otherwiseunrelated parties. A company that believes it is the sole owner of a mark may be subject to a claim that a contributor to that work is a co-author, and therefore a co-owner. A seller needs to take all of these principles into account in making representations, and a buyer needs to understand these principles in order to ask the right questions. Trade secrets Trade secret protection in the U.S. is a creature of state law, although the enactment of model laws provides some uniformity. Some countries outside the U.S. provide little or no protection for trade secrets. Thus, multinational companies will have to consider carefully what representations they can make about trade secret protection. Rights of publicity The right of an individual to prevent the commercial use of his name and likeness is also creature of state law in the U.S., with considerable variance in scope from state to state. Some states provide no protection for the deceased, and those that do provide it for varying terms after death. Laws outside the U.S. can be very different than U.S. rules. Multinational companies which have endorsement licenses from celebrities, or which may use celebrity names and likenesses in some markets without Dechert LLP Page 12 Intellectual Property Aspects of Acquisitions permission, are dealing with multiple conflicting legal regimes in making representations about compliance with right of publicity law. Industrial design rights Many countries afford protection for the appearance of products in the form of industrial design registration, which is analogous in some ways to a U.S. design patent. For some businesses, this type of protection can be important, but because it does not exist in the U.S., American lawyers sometimes neglect to include it in the definition of intellectual property or to ask for a schedule of the seller’s design registrations. Internet-related assets The advent of Internet web sites has raised new complications for the drafting and negotiation of representations and warranties. While most Internet web sites began as static, electronic versions of a company’s hard copy brochure, today’s sites contain sophisticated features, graphics, and audio-visual content. As the content has become increasingly complex, the amount of intellectual property used in creating and operating a web site has increased dramatically, and the potential for infringement disputes has grown. For example: ã The high-tech features of state-of-the-art sites require sophisticated software, which may be protected by both copyrights and patents. If the software was not developed in-house, the buyer will require licenses sufficient to permit current and intended uses. ã Certain aspects of the way a web site business operates may be sufficiently innovative to merit patent protection, and the seller’s web site may inadvertently infringe an existing patent, or may later be discovered to infringe an invention which, at the time of the sale, appears only in a pending, non-public patent application. ã Music, photography, text, graphics and other creative web site content are protected by copyright, and some companies take inadequate measures to acquire the third party permissions necessary to incorporate such material into the web site. ã Web sites which incorporate chat room or bulletin board features may create opportunities for users to post infringing or defamatory content. While many of these potential challenges will be covered under the traditional representations that a seller makes about whether its business is infringing the intellectual property rights of others, such language does not cover all the potential claims. Many domain name disputes are framed as trademark dilution claims or administrative proceedings rather than trademark infringement claims, which means Dechert LLP Page 13 Intellectual Property Aspects of Acquisitions that disclosures or representations which refer only to “infringement” may be incomplete. Real-time use of “hot news” information compiled by others may even draw a claim of misappropriation. Finally, the global nature of the Internet creates new hazards. Offering goods for sale in all 50 states, and beyond the U.S., creates exposure under state and foreign consumer protection, tax, and obscenity laws. Buyer and seller will need to negotiate responsibility for those past liabilities. n Negotiating Representations and Warranties The parties’ lawyers typically spend more time negotiating representations and warranties than any other part of the acquisition agreement. From the buyer’s standpoint, this language is important because the buyer has made certain assumptions about the business, and the wisdom of entering into the transaction hinges on those assumptions being correct. If those assumptions prove wrong, the buyer may discover that it cannot make money at the business, or at least that it overpaid. From an intellectual property standpoint, the buyer may be making a whole range of assumptions about the extent to which it can use of the acquired technology, trademarks, and copyrighted works without interference from others. The due diligence process will help shed light on the limitations of the seller’s intellectual property portfolio, but the reps and warranties are often used to “smoke out” the problems which require further investigation. The list of questions that buyers want answered is fairly standard, but the manner in which those questions are answered via representations varies considerably from transaction to transaction. The clarity and detail of the answers depends upon the structure of the transaction, the parties’ relative bargaining power, and counsel’s negotiating and drafting skills. For example, in an auction situation where a seller puts itself or its business up for bid, the potential buyers may have very limited opportunities to negotiate disclosures. In contrast, reps and warranties are likely to be more hotly contested in a one-on-one negotiation. The typical transactions lawyer has two standard form agreements to be used as the starting point in negotiating the sale of a business – one form whose terms are favorable to the company selling the business and another which favors the buyer of the business. In general, the buyer will want blanket statements which give it comfort that, among other things, (1) it will be acquiring all of the intellectual property it will need to run the business going forward, (2) the seller has good title to the intellectual property and can convey title to the buyer free of any encumbrances, (3) the seller has provided complete and accurate lists of all intellectual property, (4) the seller’s use of the intellectual property does not violate any third party rights and seller has not received any claims to that effect, (5) the buyer’s use of the intellectual property will not violate any third party rights, and (6) there are no licenses, consents, judgments, settlements, or other constraints on the use of the intellectual property. If life were so simple, lawyers would have nothing to do. Dechert LLP Page 14 Intellectual Property Aspects of Acquisitions The seller will often want to modify or qualify the representations that the buyer proposes, for a variety of reasons, including the following: ã Intellectual property law has become an increasingly contentious field, and for large companies in particular it will be rare that a seller has nothing to disclose in terms of claims, disputes, licenses, consents, judgments, or settlements. ã Intellectual property is often subject to liens, and the seller typically discloses that such encumbrances exist, linked with the condition that the debt will be satisfied at closing and the lender will release the lien. ã The buyer’s proposed language may be so sweeping that it does not accommodate the quirks and inconsistencies in intellectual property law. ã The seller may not wish to become the buyer’s guarantor as to the soundness of the intellectual property portfolio, and may resist making certain representations on that principle. Sellers sometimes try to qualify the content of representations either by limiting them to the client’s “knowledge” or by limiting them as to “materiality”. For example, rather than asserting that its use of certain intellectual property does not infringe, a seller may offer to qualify that by representing that no infringement exists to the best of its knowledge. A “materiality” qualification can be used in two different ways. A seller may resist a representation that a schedule of trademarks or license agreements is complete and accurate, and offer instead to provide a list of marks or licenses which are “material” to the business. A different type of materiality standard is applied to representations involving breach or liability. For example, rather than stating that it is in complete compliance with all licenses, a seller may represent that it has not committed any material breach (or perhaps even limit that statement to material licenses). The reps and warranties in a buyer-oriented agreement are, needless to say, likely to be more extensive than in the seller-oriented form and often over-reaching. However they sometimes contain serious omissions, failing to ask the right questions about the intellectual property being acquired. Many commonly-used representations fail to take into account the substantive differences between the different types of intellectual property assets, asking the buyer to make broad-brush statements about intellectual property which may be relevant to patents, for example, but not trademarks or copyrights. Thus, some seemingly innocuous representations in acquisition agreements are in fact wildly overbroad and impossible for a seller to make. Other representations which appear at first glance to be adequate are in fact deceivingly narrow and fail to elicit important information about particular types of intellectual property. Dechert LLP Page 15 Intellectual Property Aspects of Acquisitions The following are examples of provisions from acquisition agreements which aren’t what they seem at first glance. First are examples of those which over-reaching: “The attached schedule sets forth an accurate and complete list of all of Seller’s intellectual property.” As noted above, if a buyer is acquiring the assets of a particular business rather than the entire corporation, it will want as exhaustive and detailed a list of those assets as possible, to avoid future disputes about what was acquired and what the seller retained – thus the request for an “accurate and complete list”. It is virtually impossible, however, for a seller to make this representation if the acquisition agreement defines “intellectual property” to include such categories as trade secrets and copyrights. Few if any companies could define and catalog every item of confidential information and business know-how that they consider to be proprietary. The same goes for copyright, which protects every work of authorship created by an employee, including such prosaic items as internal memoranda, and therefore applies to countless works at the typical company. (Corporate lawyers sometimes assume that this representation is easy to make because they mistakenly assume that copyright protection only attaches when the copyright is registered). Even trademarks can be difficult to exhaustively schedule, since a company may use minor brand names and advertising slogans which it has not bothered to register or catalog. In addition, the appearance of products, packaging, and perhaps even retail facilities may constitute trade dress which is difficult to describe on a schedule. Thus, among these traditional categories of intellectual property, only patents can be exhaustively listed, since patents only come into existence when issued by a governmental office. In contrast, copyrights, trade secrets, and trademarks are a product of the user’s creation or use, at least in the U.S., without the need for registration. The typical solution? The seller represents that the schedule contains a complete list of all patents and all registered trademarks and copyrights (including pending applications for registration), and perhaps material unregistered marks as well. Even with patents and trademark registrations, however, many very large companies whose portfolios number in the thousands are reluctant to represent that their records precisely and accurately catalog every issued patent and registered trademark, and are willing to represent only that the list contains material patents and trademarks. “The use of the intellectual property in the business does not infringe upon any patent, trademark, copyright, or other intellectual property of a third party.” In order to infringe another party’s copyrights or trade secrets, a company must first have access to those copyrighted works or secret information. Not so with patents and trademarks. A company could infringe a third party’s trademarks or patents without even being aware that such rights exist. Most companies do conduct searches of prior third-party rights as part of the process of adopting a new trademark, and searches are an integral part of the process of securing a Dechert LLP Page 16 Intellectual Property Aspects of Acquisitions patent. However, such searches have significant blind spots at the time they are conducted, and can rapidly become obsolete, making it impossible to know for certain whether a patent or trademark infringement claim is lurking. Even with copyright and trade secret claims, a company cannot be certain whether an employee has engaged in copyright or trade secret infringement without management’s knowledge. Finally, a determination of infringement inevitably involves subjective determinations. Thus, a seller which is asked to represent that its intellectual property does not infringe is in effect issuing a guarantee to the buyer. The seller instead seeks to represent that it has not received any claims, or that it is not aware of the basis for any claims. “Seller has taken such actions as are necessary to ensure full protection of the intellectual property under any applicable laws.” The fundamental problem with this representation is that it does not define what actions seller must have taken “to ensure full protection”, leaving the potential for future dispute about what was required. A logical interpretation is that this phrase means that the seller has registered its trademarks in every jurisdiction in which they are used, that it has obtained patents wherever it sells, and that it has registered its copyrights in the U.S. This is seldom likely to be true for any seller, for several reasons. Trademark registration is discretionary in the U.S. and other common law countries, and while registration confers certain benefits, a company could reasonably conclude that the expense of registering every mark is not commensurate with the benefits. Registration can be much more important in other countries which afford little or no protection for unregistered marks, such that it will be important for the buyer to know if a mark is unregistered in major markets such as continental Europe or Southeast Asia. Similarly, since no patent protection is available except where a patent has issued, the buyer will want to know where the seller has obtained such protection. However, few companies have chosen to shoulder the expense of registering every mark and extending every patent to every country. Copyright registration is a creature of U.S. law, and is discretionary -- whether to register is very much a judgment call, depending upon the nature of the work and the nature of the business. A publishing or media company might be expected to have a large number of copyright registrations, while other types of businesses might reasonably have none. In sum, a seller should refuse to give this representation on the grounds that it is ambiguous and highly unlikely to be accurate, and the buyer will want to tailor it more precisely to reflect the nature of the business and its geographic scope. The following are examples of provisions which appear to provide the buyer with broad assurances, but in fact fail to elicit important information: “Seller owns or possesses licenses or other rights to use all intellectual property necessary to conduct its business.” Dechert LLP Page 17 Intellectual Property Aspects of Acquisitions Most companies are not in a position to create and develop all of the intellectual property required to operate the business, and must license some of it from third parties. Most standard-form warranty language recognizes this, but it does not always require the seller to clearly distinguish between what is owned and what is licensed. The buyer will want detailed disclosure of what is licensed so that it can determine which of those licenses are transferable to buyer without the licensor’s permission, how long each license lasts, what royalties are required, and what limits are imposed on use. The seller may have been asked elsewhere in the agreement to disclose certain contracts and agreements, but that warranty may not necessarily encompass all of the company’s licenses of intellectual property. “Immediately after the closing, Buyer will own or have the exclusive right to use all of the intellectual property free from any liens, mortgages, or similar encumbrances.” Intellectual property often comes with “strings attached,” and those strings aren’t just liens or other encumbrances on title. As discussed above, intellectual property which is licensed to the seller has various limitations. While this representation seeks to uncover any restrictions on assignability of licenses, it misses the sometimes-significant strings attached to the intellectual property which the seller owns. For example, in order to resolve disputes companies often enter into settlement or consent agreements which restrict the use of intellectual property. A company may have agreed to refrain from using a mark in a particular geographic or product market, or may have agreed to use it only with a particular logo or in combination with another mark. Similarly, the company may only have the right to use a licensed patent in connection with the manufacture or distribution of certain specific goods. This warranty does not require the seller to disclose such restrictions. While the acquisition agreement most likely contains a separate section calling for disclosures on litigation, asking the seller to disclose court judgments, it may not call for documents such as trademark consent agreements, which often result from trademark prosecution rather than litigation. “Seller has not received any claims from third parties alleging that its use of any intellectual property infringes upon the rights of any third party.” This clause requests information on “incoming” infringement claims, but fails to ask about “outgoing” infringement claims, i.e., third parties who are allegedly infringing the seller’s intellectual property rights. These claims can sometimes be as troublesome as claims against the seller, and often as expensive. In addition, using the term “infringe” is too limiting, since it does not encompass other types of incoming intellectual property-related claims such as trademark dilution. Finally, by focusing only on third party claims, this representation fails to seek the disclosure of problems which may have arisen in patent or trademark prosecution, e.g., refusals to register marks on the grounds that they are not Dechert LLP Page 18 Intellectual Property Aspects of Acquisitions protectible or are confusingly similar to other marks. Buyer will need this information to get a complete picture of the intellectual property portfolio it is acquiring. n Indemnification What happens if the seller’s representations turn out to be inaccurate. Often, but not always, the acquisition agreement provides that the seller will indemnify the buyer if the seller’s representations and warranties prove inaccurate. Although the typical indemnification clause does not specifically refer to intellectual property issues, counsel should be aware of the terms of the indemnification provision when negotiating intellectual property representations and warranties, since this provision will determine the consequences of breach. Although indemnification obligations can be mutual, the buyer generally stands to lose much more from the other party’s misrepresentations, so the buyer depends more heavily on the protection afforded by an indemnification clause. Broadly speaking, a misrepresentation by seller can injure the buyer in two ways. First, the buyer may not receive an asset specified in the acquisition agreement, such as a scheduled trademark that was previously sold to a third party. Second, the buyer may inherit a liability that was not disclosed, such as a royalty due on an inbound patent license. Although contract law may provide a remedy even in the absence of an indemnification provision, the buyer will likely insist on an indemnification clause in order to specify the duration of the seller’s representations, to ensure that the seller’s liability extends to expenses such as attorney’s fees, and otherwise to define the scope of the seller’s obligations. In negotiating representations and warranties, intellectual property counsel need to understand the nature of the transaction and the indemnification provisions, if any. There is no indemnification in acquisitions of public companies, and the representations evaporate after closing. The significance of the buyer’s pre-closing due diligence is thus magnified. In other transactions, seller may continue to be liable, but subject to various types of limitations. In negotiating the indemnification clause, the seller typically looks to include a “basket” that will limit its liability to material misrepresentations. The term “basket” can refer to one or both of two distinct types of arrangement, so it is important to examine the indemnification provision carefully to understand the seller’s obligation. In one type of arrangement, the buyer is not obligated to indemnify the seller unless damages reach a certain threshold amount. When the threshold is exceeded, the seller is liable for the first dollar of damages and every dollar thereafter. By contrast, if the parties structure the basket as a deductible, the seller will be liable only for damages in excess of the specified amount. On the other end of the liability spectrum, the seller may request a “cap” or “ceiling” that sets a maximum amount of liability under the indemnification clause. Because the agreement may specify that baskets and caps apply to certain types of claims but not to others, misrepresentations Dechert LLP Page 19 Intellectual Property Aspects of Acquisitions relating to intellectual property may have different consequences than misrepresentations in other areas. Just as the seller will seek to limit liability with a basket and cap, it will also try to negotiate a cut-off time to limit the period during which the indemnification obligation endures. If, for example, the seller remains liable for third-party intellectual property infringement claims arising prior to closing, it will want to limit the time during which the buyer can assert an indemnification claim. In addition to terms defining the scope of the indemnification obligation, the acquisition agreement may include provisions for ensuring collection, including escrows and procedures for offsetting against a deferred purchase price. The agreement may also specify which party controls the defense of a third-party claim covered by an indemnification obligation. Dechert LLP Page 20