Legal risks in equity investment by means of patent rights

Equity investment by means of patented technology has become a more common business activity nowadays, and given rise to legal disputes as a result. For example, if an investor has not expressly agreed with a company on the ownership, transfer and other matters related to a patent, whether the company has the right to transfer the patent to a third party can easily lead to disputes. This article explores relevant legal risks involved.

Scenario 1: an investor injects a patented technology into a company as an equity investment, but it has not made changes to the bibliographic description. In this case, although the patentee recorded at the competent patent registry is the investor, the real patentee is the company. This situation is extremely unfavourable to the company because it is likely to bring legal risks against it. Usually, if the company is founded by the investor, the investor, as the legal representative or actual controller of the company, has interests consistent with those of the company, and the company is exposed to very low risk.

Legal flaws

In practice, since the real patentee is separated from the actual holder of patent rights, it is still able to instruct the investor to transfer or license the patent in the interest of the company even after the licence of the company is cancelled, revoked, etc. Of course, this move has legal flaws because the investor has not fulfilled its obligations for the registration of its capital contribution.

However, if the investor is not a legal representative or an actual controller of the company, its interests may not be exactly the same as those of the company. If it transfers the patent to a third party upon acceptance of an appropriate consideration, and has made changes to the bibliographic description, and the third party is not aware that the real patentee is the company, then the third party is likely to be able to acquire the ownership of the patent.

In practice, once a company sued its investor and a third party, and demanded the return of the patent. Even though the investor had no right to dispose of the patent after making an equity investment using the patent – it only had a fiduciary possession relationship with the patent – it still had the capacity to change the bibliographic description.

If a third party is assigned a patent at a normal price without knowing or having to know that an investor has assigned the patent illegally, the third party has acquired the patent “in good faith”. This acquisition is legitimate and effective, while the company has lost the patent right.

Malicious conspiracy

In practice, if the company wants to reclaim the patent, it needs to prove that the third party knew, or should have known, that the company is the patentee. It is usually difficult to do so, but there are exceptions. In judicial practice, once several shareholders of a company transferred a patent to themselves without the consent of the legal representative of the company, and then transferred it to a company in which they served as the legal representatives and shareholders. The court found that since such acts constituted malicious conspiracy, the transfer was invalid.

Scenario 2: an investor injects a patented technology into a company as an equity investment, and changes the patentee in the bibliographic description to the company. In this case, when a dispute arises between the investor and the company, the interests of the company will be more secure, but the investor will often be in an unfavourable position.

In another dispute over patent right ownership, an investor, after making an equity investment into a company with a patent, left the company because it was not happy with the co-operation. Subsequently, the company transferred the patent to a third party who was in competition with the investor. The investor took the company to court, asking for confirmation of the invalidity of the transfer and the return of the patent right.

Safeguard interests

The court found that from the date of change to the bibliographic description for the patent, the patent right was owned by the company, and so the company had the right to dispose of the patent, and the third party’s acquisition of the patent was legal and valid. The investor is able to safeguard its own interests only through equity transfer or liquidation proceedings.

Scenario 3: an investor injects a patented technology into a company as an equity investment, and the company directs that another party be registered as the patentee. In this case, the risk lies in whether the nominee is reliable or not. If the nominee disposes of the patent without the permission of the company, and a third party “acquires it in good faith”, then the company will not be able to reclaim the patent, and can recoup its losses only by suing the nominee.

In judicial practice, it is difficult to assess the value of a patent in a reasonable way. In the event of a dispute, unless the plaintiff can provide sufficient evidence, which is difficult to do, a court will often make a conservative estimate of the value of a patent.

And even if a claim is sustained, it is often difficult to make the nominee fulfil its liability for indemnity. Moreover, if the nominee dies in an accident, for example, the company will not be able to instruct the nominee to exercise the patent rights. It can confirm the ownership of the patent only through litigation.

If the evidence is not properly preserved beforehand, and the heir of the nominee fails to co-operate, the company will be exposed to more prominent risks, and is likely to lose the relevant interests in the patent.

Define ownership

Various legal risks are involved in capital contribution by means of patent rights, probably as a result of the development of the external market, or the legal flaws in capital contribution by internal shareholders.

We would like to remind business parties to strengthen preventive measures by defining the patent ownership, transfer and other specific legal issues in the articles of association and capital contribution agreements.