Copyright risks in M&A transactions

Corporate acquisition is one method by which a company may secure and strengthen its intellectual property (IP) rights against its competitors to increase its market share. Corporate acquisition is generally divided into three types – corporate merger, equity acquisition and asset acquisition, which involves more complex IP issues.

During an acquisition, companies must keep in mind that copyrights have unique IP features that can give rise to legal risks. The Copyright Law specifies four moral rights, namely publication, attribution, integrity and revision rights. The Copyright Law also lists 12 economic rights, including those for reproduction, distribution, rental, and the catch-all “other rights”. Although these rights are listed in the Copyright Law, judicial debates on the meaning and application of these rights are not uncommon. Therefore, the acquisition agreement must expressly detail the rights involved to avoid any misunderstanding.

Copyright restrictions. As there are no regulatory procedures for approving or granting copyrights, the scope of rights protected can cause disputes. Furthermore, articles 22 and 23 of the Copyright Law, which regulate statutory licences and fair use, may limit the scope of copyrights. To meet the purposes of the transaction, the acquirer needs to identify the valid scope of work protected, and verify the scope of exercise for the IP rights being acquired.

Title. Pursuant to article 11 of the Copyright Law, in the absence of contrary evidence, the person who signs the work is the copyright holder. A work created by a citizen to complete work for a legal person or an organization is service work, and the author is the copyright holder.

However, under two exceptions, the copyrights are held by the entity and the author only has the right of attribution. The first is service work, such as project design drawings, maps and computer software, which are created mainly from material and technical resources of a legal person or an organization, and the liabilities for which are borne by a legal person or an organization. The second is service work for which copyrights are vested in a legal person or an organization as provided by law, administrative statutes or contract. If an acquisition involves service work, risks may be avoided only by completing full due diligence on the title to the copyrights in accordance with the law and contract.

Copyright defects. The Copyright Law specifies that the copyright holder has the right to license a third party to use his or her copyrights. A licence granted before an acquisition could result in a rights defect that could have an impact on the asset value of the IP rights being acquired and the acquisition itself. First, separate sole licence contracts to which the acquirer and the acquiree respectively serve as the licensor may cause conflicts after completion of the acquisition. If the parties to the acquisition are competitors, the new entity formed after the acquisition will need to consider a new arrangement for the original sole licence to avoid failure of performance or breach of contract.

Second, separate copyright licence contracts under which the parties to the transaction respectively serve as licensees will also impact the acquisition. The copyright licensor may have included terms restricting the licence contract in order to prevent a competitor from securing a copyright licence through acquisition, for example, a clause stating that in the event of an acquisition, the original terms become null and void. The principle of freedom of contract applies to restrictions directed at licensees in IP licences. If such a provision exists, the acquirer needs to assess the risks and the value of the related assets before the acquisition.

ANTI-MONOPOLY ISSUES

IP rights are exclusive, making them an effective tool for restricting competition. However, certain provisions placed in an acquisition transaction, such as mandatory tied sales or unreasonable buyback provisions, could cause anti-monopoly-related legal risks. Parties in an acquisition need to consider the ramifications of the Provisions of the State Council on the Criteria for Business Operator Concentration Filings, and the Interim Provisions of the Ministry of Commerce on Assessing the Impact of Business Operator Concentrations, on the acquisition of copyright assets.

SOFTWARE COPYRIGHT

In China, copyright is the main way to protect software IP rights. A cross-border acquisition could involve the transfer and licensing of domestic and foreign software copyrights. Article 22 of the Regulations for the Protection of Computer Software specifies that where a Chinese citizen, legal person or an organization licenses or transfers software copyrights to a foreigner, he/she is required to comply with relevant provisions of the Administrative Regulations for Technology Imports and Exports. These regulations categorize exported technologies into three groups – those prohibited or restricted from, or permitted for, exportation. The Ministry of Commerce has issued the Catalogue of Technologies the Import and Export of Which Is Prohibited and Restricted by China pursuant to the regulations.

It should also be noted that types of software to be exported for an acquisition fall into different categories, depending on their content, function and purpose. Pursuant to the regulations, they are: technologies (software) prohibited from exportation; technologies (software) restricted from exportation and subject to administrative permits and approval prior to exportation; and technologies (software) permitted for exportation after registration.

Reverse engineering. The reverse engineering of computer software means the reverse dissection and analysis of the object code of a third party’s software, and after studying the same, seeking the source code through disassembly to derive its functions, organizational structure, processing flow, algorithms, etc., and then applying the same in one’s own software. In an acquisition, if the software copyrights to be acquired were obtained through reverse engineering, it is necessary to pay attention to whether terms prohibiting reverse engineering or disassembly are expressly set out in the click-wrap contract or shrink-wrap contract, and whether the disassembled software is protected by the Patent Law, Trademark Law or other laws.

Charles Feng is a partner with East & Concord Partners