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)...