Patent due diligence in high-tech acquisitions

Patents are a focal issue in the acquisition of high-tech companies, as the acquisition of the patents of the target company is usually the motivation for acquiring such companies. If, in an acquisition of a high-tech company, investigation of the patent situation of the target company is not thorough, it could impact the outcome of the strategic acquisition. More seriously, the acquired patents could instead become a heavy burden on the acquirer. Accordingly, in addition to carrying out the due diligence routine in an acquisition procedure, the acquirer should also do due diligence specifically on the target company’s patents.

Integrity of patent rights. The first focal point of the due diligence is confirming whether the target company has patent rights in the specific technologies, and whether such rights are without defect. First, it should be confirmed whether a third party outside the target company has asserted co-inventor rights in any specific patent of the target company. If any of the target company’s patents is a co-invention, its value will be substantially reduced, and accordingly it is best to ensure that all of the co-inventors have transferred their rights to the target company. Second, it should be investigated whether there are any disputes concerning whether any of the target company’s patents is not a service invention. This requires taking into consideration the specific provisions on service inventions in local patent law, with the focus being to ascertain whether there are written provisions between the target company and its employees on the vesting of inventions, and whether such written provisions comply with relevant laws. Finally, if the target company acquired a patent in question through a transfer, the acquirer needs to confirm whether the transfer complied with relevant provisions of the local patent law.

Effectiveness of patent management. The second focal point of the due diligence is ascertaining whether the target company has duly managed and protected its patents, with a focus on whether there are circumstances that could make the patents invalid or could make the effective seeking of infringement remedies impossible. The acquirer must confirm whether the target company has punctually paid the maintenance fee for each patent, and whether, due to a specific patent working act, the infringer in a patent suit can raise an effective patent infringement defence, e.g., the patent holder’s remissness, estoppel or implied agreement, so allowing the defendant in the patent infringement suit to prevail, causing significant impairment of the commercial benefits that the target company originally could have obtained in connection with patent exclusivity, and erecting barriers to its future working of the patent. It is also worth noting that if it is specified in local patent law that patent marking has specific legal significance, it is additionally necessary to confirm whether the target company has appropriately marked its patented products in accordance with requirements of the local patent law.

Proper acquisition of patent licences. The third focal point of the due diligence is investigating whether patent rights acquired by the target company through patent licence agreements was duly done, and whether the target company has unimpaired rights to work the patented technology. The acquirer should conduct a detailed investigation of the patent rights acquired by the target company through a patent licence agreement to confirm whether the target company has complied with the provisions of the licence agreement and whether any grounds exist for termination of the licence agreement, or that indicate a breach of contract. Before analyzing and investigating the provisions of the target company’s individual patent licence agreements, the acquirer must pay particular attention to investigating the licensor under each such patent licence agreement and the patented technology licensed from it, failing which, if there are defects and legal risks inherent in the licensor’s patent, there are likely to be knock-on effects on the licensee’s rights and obligations under the licence agreement.

Proper use of patents. The fourth focal point of the due diligence is ascertaining whether the target company has properly used its patents. Patent licences are a common means of using patents and the acquirer should familiarize itself with the immediate details of how patent licensees work such patents, ascertain whether they have breached the provisions of the licence agreements, and determine whether the target company has the right to terminate such agreements. In respect of an exclusive licence agreement, the acquirer needs to pay particular attention to whether it contains a “best efforts” clause, or an agreement termination clause, to ensure that the agreement can be terminated in the event that the licensee is unable to achieve the predetermined objectives, so avoiding the impairment of the value of the patent to the target company. The acquirer should also pay attention to the legal effect of such an exclusive licence agreement, whether it will allow the licensee to secure ownership of the patent rather than just a licence, leading to the target company losing its status as patent holder. With respect to patent use, the acquirer additionally needs to verify whether the target company exceeded the statutory scope in exercising its rights, in particular, using its advantageous position to unfairly restrict trading or competition, and thus constitute patent abuse.

Risk of patent infringement lawsuits. The fifth focal point of the due diligence is ascertaining the risk of the target company becoming the defendant in a patent infringement suit. As verification of the risk of a patent infringement suit is of utmost importance, the acquirer should require the target company to exhaustively disclose background information on any potential patent infringement suit so as to confirm whether the target company’s technology or invention truly infringes a third party’s rights, and avoid becoming the defendant in a patent infringement suit after the acquisition.

In respect of the forms of patent infringement, in addition to direct infringe- ment, the acquirer cannot ignore such forms as indirect infringement. The acquirer needs to consider the manner in which the target company is dealing with an infringement warning letter, and whether it has conducted comprehensive internal familiarizing and assessment, and formulated the specific response strategy that it can adopt, so as to assess the potential of the target company becoming the defendant in a patent infringement suit in future, and so fully assess whether the target company’s patents are really worth acquiring or the risks that could be faced after the acquisition.

Liu Zhaojun is a partner and Yang Bin is an associate at East & Concord Partners