Importance of intellectual property due diligence in M&A

By Frank Liu, Shanghai Pacific Legal
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In a mergers and acquisitions (M&A) deal involving intellectual property (IP), due diligence is generally required to establish the IP status of the acquired entity and prevent potential risks. Although there is usually a regular checklist for IP due diligence, the importance of matters listed varies in different transaction backgrounds.

It is therefore, necessary to pay attention to the core IP and important risks most probable in specific scenarios, in combination with the actual transaction situation. This article examines IP due diligence in two foreign-related transactions to illustrate some concerns requiring attention.

Frank Liu, Shanghai Pacific Legal
Frank Liu
Partner
Shanghai Pacific Legal

Case 1: Core technology is not patented, protected only by know-how. In the transaction of Chinese enterprise A acquiring European enterprise B, although varieties of IP were involved, the transaction’s core IP was enterprise B’s advanced technology in the industry. The transaction intended technology acquisition through M&A, applying the technology to product manufacturing and sales in the Chinese market.

The product reputation of enterprise B was grounded on its advanced, effective technology, guaranteeing market realisation of its technology and products. However, in the IP due diligence stage before the transaction, it was found that enterprise B protected its core technical solution by know-how – and made no application for a patent in its own country, let alone in China.

Advantages: In this case, the advancement and reliability of enterprise B’s technology had been monetised through products, and verified by mass production and market. As enterprise B was small in scale, it was clear which personnel controlled the core technology.

In addition, the core technology was protected in the form of know-how, rather than a patent, effectively preventing potential competitors from competing in R&D of its technical solutions. Absent in many transactions, these favourable conditions had obvious advantages for promoting the transaction.

Disadvantages: However, if the technology was introduced with large-scale production and sold in China, the conditions for enterprise B to keep the technology closely under control in its domestic production environment would no longer exist, and enterprise A might face the risk of technology leakage and difficult implementation.

Solutions: After communication and analysis with enterprise A it was proposed to examine and classify key points of the technical solution in detail, and adopt comprehensive protection by combining know-how and patent application in China, according to specific characteristics of the technical solution.

Case 2: Some technologies are patented, but core technology information is unclear. This transaction was the acquisition of Chinese enterprise D by European enterprise C, with technology acquisition the primary objective. In the IP due diligence, it was found that enterprise D had applied for patents in China, mainly for utility mode and some inventions.

However, enterprise D’s technology was still in the experimental stage and had not gone into mass production, so it was impossible to conduct market verification through product performance.

Advantages: For the acquirer, the advantage was that enterprise D had provided relevant patents and public information as a preliminary basis for fundamental technology analysis and comparison. Moreover, enterprise D could be required to make supplementary detail available on this basis.

Disadvantages: As it was impossible to rule out the possibility that the core technology was protected by know-how other than patents, if enterprise D failed to disclose fully, the core technology could not be identified only according to the patent list provided.

Additionally, enterprise D stated that all the patents it provided were core technologies, but after preliminary inquiry and analysis, enterprise C harboured doubts about this statement.

Also, enterprise D’s main patents were the utility models, whose stability was relatively weak. As the technology had not been mass-produced and verified in the market, it may fail to meet expectations in actual implementation.

To date, patent applications had only been made in China for enterprise D’s technologies, and most had exceeded the priority period so could not be registered in enterprise C’s home European country. Therefore, the risk remained that implementing the technologies in enterprise C’s country may infringe the IP rights of others.

Solutions: For the problem of unclear core technology, unless enterprise D made truthful disclosure, it was difficult to identify clearly and definitely its technology protected by know-how.

Enterprise C might require enterprise D to provide various agreed guarantees and clarify its obligation of providing technical support to achieve the technology implementation.

In addition, for patents and technical improvements still within the priority period, applications for their patents should be made in time in the country where enterprise C will implement the technologies.

On the other hand, due to the unclear core technology of enterprise D, it would be necessary to conduct a freedom-to-operate (FTO) search in the country where the technology is to be implemented before implementation, regardless of whether the patent application is successful, to prevent unknowingly infringing the IP rights of others.

In addition, in the IP due diligence of the above-mentioned cases, it was also found that different owners of rights and problems – such as environmental impact assessment and business licensing – may be involved in filing or approving and implementing technology import and export.

Such problems need to be considered in advance to avoid the inability to implement this technology after completion of the technology transfer/licence.

KEY TAKEAWAY

To sum up, as IP increasingly becomes the main subject of transactions, IP due diligence is, in tandem, of growing importance in cross-border transactions.

Only by assessing the actual situation of a transaction and conducting targeted due diligence according to importance and commercial impact can IP risks be really reduced or eliminated, promoting smooth implementation.

Frank Liu is a partner at Shanghai Pacific Legal

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Email:
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