Caveat Emptor or 'Let The Buyer Beware' Applying Diligent Investor Principles to Trademark and Copyright Issues in Mergers and Acquisitions

Article by Miriam Claire Beezy* Partner and National Chair, Trademark & Copyright Practice Group Co-Chair, Entertainment & Media Industry Team

* Former chief trademark counsel of The Walt Disney Company

Introduction

A fundamental premise in analyzing trademark and copyright issues in merger and acquisition transactions is the importance of due diligence. An investor seeking to maximize the value of a transaction should conduct robust due diligence to determine the risks and benefits associated with the assets to be acquired. The "diligent investor," whether a potential merger partner or a potential acquirer should take the Latin maxim, caveat emptor or "let the buyer beware" to heart when assessing the complete value of a potential transaction.

While the diligent investor principles presented herein potentially relate broadly to various forms of intellectual property, including patents, the focus in this paper is on trademarks and copyrights and a discussion of trademark and copyright law from the U.S. perspective. As trademark and copyright laws differ from country to country, appropriate action may require tailoring depending on the home country of the target company1 or when the target company has a portfolio that includes non- U.S.-based trademark and copyright assets; however, the general principles regarding diligent investment should remain the same.

A second premise of this paper is that many transactions involve "key" intellectual property assets. Key intellectual property is intangible property that contributes materially to the value proposition of a transaction. For example, a diligent investor seeking to merge or acquire a company with both brick and mortar assets and an extremely strong brand name faces a different value proposition than a diligent investor seeking to acquire a company with identical brick and mortar assets, but without the brand name. In the former case, the target company's intellectual property assets, most likely legally represented by its trade name, trademarks, logos and other trademark properties, create a specific value proposition for the deal. As such, before acquiring or merging with this target, the diligent investor should give specific and thorough attention to investigating the soundness, benefits, and risks associated with the target's trademark properties.

Similarly, a diligent investor seeking to acquire or merge with a target company whose business relies on the use or creation of copyrightable material, such as software, jewelry, textile or entertainment properties, should conduct thorough due diligence with respect to that company's significant owned and licensed copyrights. In addition, this due diligence should extend into the actual practices of the target to ensure that, on an ongoing basis, its business methods minimize the risk of copyright infringement.

The diligent investor takes both legal and pragmatic steps to investigate the value proposition of a potential transaction. As set forth below the importance of both the key terms of legal documents that underlie mergers and acquisitions - as well as the pragmatic steps that a diligent investor should take when carrying out due diligence on key trademark and copyright assets - cannot be overemphasized.

Key Legal Terms for Diligent Investors

Warranties, Representations, and Indemnifications in Asset Purchase and Merger Agreements

In a merger or acquisition, a diligent investor takes both legal and practical steps to ensure that the intellectual property assets to be acquired represent more value than risk to the transaction. The primary legal documents underlying these transaction types are merger agreements and asset purchase agreements, both of which memorialize the parties. legal rights and responsibilities in executing the transaction. In transactions where intellectual property - including trademarks and copyrights - form important assets in the deal, a series of intellectual property-related warranties, representations, and indemnifications offer important legal protections to the acquirer or merger partner. The most important of these provisions fall into five categories: scheduling, sufficiency, ownership, noninfringement representations, and disclosure representations regarding prior litigation or disputes.

The "scheduling" representations and warranties in an asset purchase agreement or merger agreement are the seller's statements that the schedules or lists of intellectual property provided to the other party are accurate and complete. Generally, the diligent investor will require the other party to represent and warrant that all intellectual property registrations, pending applications, and key in-bound and out-bound licensed intellectual property - including trademark, copyrights, and patents - are set forth accurately. These schedules should include registration serial numbers and also identify any official responses, filings, or fees coming due within a given number of days.2 In the case of trademarks, the schedules should also include any unregistered common law marks.

Often schedules do not include unregistered intellectual property assets. Accordingly, the diligent investor should require "sufficiency" warranties and representations for all of the intellectual property assets, including those which are "unscheduled." Unscheduled assets often include intellectual property of a type for which registration is unavailable, impractical, or simply not yet obtained, such as trade secrets, trade dress, designs, copyrightable subject matter, customer lists, or other proprietary information. A sufficiency representation is usually a statement by a party that all of the intellectual property assets being transferred - including the unscheduled intellectual property and in-bound licensed intellectual property - are sufficient to carry out the business of the company as conducted on the closing date and as contemplated by a written business plan or other prospective.3

The third category of typical warranties and representations are "ownership" statements. The diligent investor should require the seller to represent that, to the knowledge of the seller,4 the seller has sole and exclusive right, title, and interest to the intellectual property that it claims is wholly companyowned. 5 The diligent investor should also require the seller to identify thirdparty ownership interests in non-wholly owned intellectual property assets. These ownership statements should also include a representation that any key intellectual property developed by non-employees, contractors, or other parties on behalf of the company, has been properly assigned to the company or was developed under sufficient work-for-hire agreements.6

The fourth, and perhaps most important, category of typical representations and warranties are "non-infringement" statements. Such a statement by a party usually warrants and represents that (a) to the knowledge of the seller, any and all seller-owned intellectual property does not infringe or misappropriate the trademarks, trade secrets, copyrights, patents or other intellectual property of third parties and (b) to the knowledge of the seller, no third party is infringing seller-owned intellectual property.

Another important representation and warranty relates to litigation risks and history. The diligent investor should require a statement to the effect that the seller has not received complaints or been involved in litigation relating to its use of intellectual property or, that if it has, all related correspondence and information has been disclosed. An often overlooked aspect of this warranty relates to correspondence received by the target that is not a direct threat of litigation, but instead requests that the target enter into a license agreement with respect to the disputed intellectual property. 7

The above provisions should be coupled with an indemnification clause in which the seller agrees to indemnify the buyer for any claims or damages suffered due to the seller's breach of its warranties and representations. Realistically, the protection that such an indemnity offers may be thin. Even if an escrow fund or some other means is set aside for indemnification purposes, the joinder of the companies may de facto result in the joinder of their liabilities in true mergers or acquisitions of all or substantially all of a target's assets.

Given the limits of indemnification protection, the legal protections offered by an asset purchase or merger agreement must be accompanied by practical steps. Namely, the diligent investor should conduct thorough due diligence with respect to the key intellectual property assets in the deal. Such due diligence, if properly and thoroughly carried out, will give the diligent investor a robust picture of the value and risk proposition of the target's intellectual property assets. In some cases, these due diligence efforts may increase the value proposition of the deal. In other cases, such due diligence may indicate problems with the intellectual property assets that are serious enough to stop the deal from going forward at all. Accordingly, our focus now turns to the practical due diligence efforts a diligent investor should undertake with respect to key trademark and copyright properties.

Conducting a Trademark and Copyright Asset Inventory

Understanding the assets to be acquired is fundamental to any merger or acquisition. This principle should be no less true for the tangible property involved in an acquisition, such as machinery, personnel, or facilities, than it is for the intangible intellectual property, including the trademarks, copyrights, patents, and trade secrets. However, assessing a target's trademark and copyright properties is not wholly intuitive due to the varying rights and ownership structures associated with these two types of property.

Trademarks and Asset Inventory

The diligent investor should identify and locate...