Intellectual Property Due Diligence
Introduction
Whilst the concept of conducting an
investigation into the material aspects of a commercial transaction
is not new, such due diligence investigations often focus on the
tangible assets and ignore or at least give insufficient weight to
the intangible assets. Yet, the most valuable part of a business is
often the intangible assets, in particular intellectual
property.
A high-profile example of due
diligence failure was the 1998 purchase of the legendary Rolls
Royce automobile company. Volkswagen and BMW were in a bidding war
to purchase the company and, ultimately, Volkswagen posted the
winning bid of nearly US$800 million, acquiring almost everything
necessary to make a Rolls Royce automobile ? the plant,
machinery and designs.
Unfortunately Volkswagen overlooked
arguably the most valuable part of the business ? the
right to the Rolls Royce trade mark. After the deal closed,
Volkswagen could make a luxury car that looked like a Rolls Royce,
but could not call it a Rolls Royce.
Another company (producing Rolls
Royce airplane engines) owned the Rolls Royce mark and had licensed
the mark to the Rolls Royce automobile company under a licence that
terminated in the event that the automobile company was sold.
Soon after, BMW acquired the rights
to use the Rolls Royce trade mark on automobiles for significantly
less than Volkswagen had paid for the tangible assets.
The story highlights the need for a
prospective purchaser or licensee to conduct adequate due diligence
prior to completing a transaction for the transfer or license of
intellectual property rights.
In this article, the term
"vendor" will be used to refer to either a vendor in a
sale of IP or a licensor in a licence. Likewise,
"purchaser" will refer to either a purchaser or licensor.
However, the nature of the due diligence enquiries required for
each may differ depending on the circumstances of the
transaction.
Purpose of Due Diligence
At the most fundamental level, the purpose of due diligence is
to determine whether to go ahead with the transaction at all, and
if so, on what terms. Due diligence should ensure that:
the purchaser is fully informed before making a final
commitment;
the IP is priced appropriately given all available information;
and
risk is efficiently allocated between the purchaser and
vendor.
Due Diligence Process
The due diligence process in most cases should start before any
agreements have been entered. At the stage an opportunity arises, a
purchaser should conduct at least very basic due diligence to
determine whether to invest the time and effort in commencing
negotiations in the first place.
This may involve some background research on the other party to
the transaction, investigation of the markets involved and
operators in those markets, and perhaps quick title searches on the
specific IP in question.
In the course of complex negotiations, the parties may enter
into a heads of agreement or memorandum of understanding that will
encapsulate the fundamentals of the deal, subject to the completion
of full due diligence enquiries. However, prior to commencing the
negotiations leading to a heads of agreement, the prospective
purchaser should also consider whether to request a period of
exclusive negotiations, to ensure the time spent in negotiations is
not ultimately wasted through a third party purchasing the IP
during the course of negotiations. The vendor will likely try to
avoid this because interest from a third party may result in a
better price.
The process of in-depth due diligence will involve a visit to
the offices of the vendor's patent attorney, and may also
warrant a site visit to the premises of the vendor.
Upon completion of the full investigation, a due diligence
report should be prepared to highlight any risks that could not be
investigated, or that were investigated but remain a risk
(including the level of risk and whether this makes it a deal
breaker)...
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