Don’t have a big idea? Buy one, but be careful!
Companies expand by purchasing technologies, other companies or other companies’ technologies. Typically, in these situations, the sellers also profit. But, finalizing a deal, as well as avoiding future disputes, may prove difficult when intellectual property issues exist.
Most attorneys performing the IP due diligence have a typical checklist, among other things, addressing the ownership of the IP rights, agreements with employees and third parties, IP identification and value thereof, and IP litigations and claims threatened. But actually understanding the risks and knowing what to do with them requires skill and experience.
First and foremost, immediately upon entering into purchasing discussions, you need to protect your company in the non-disclosure agreement (NDA) in the event the deal fails. A typical scenario is as follows: A start-up, small company or individual attempts to sell technology to a larger company. It so happens that the larger company already was working in the area of the offered technology. The parties cannot reach an agreement on a deal. Unsurprisingly, the larger company later markets its own product. The jilted smaller company or individual believes its non-patented technology was misappropriated and sues.
To protect against such causes of action, the NDA should provide that a patent infringement or copyright infringement claim is the only course of action (arising out of due diligence) that the parties can bring against one another if the deal fails. Language included in a typical NDA is as follows:
Each Party releases the other Party, its subsidiaries, and affiliated companies from any liability for any non-public reproduction of the Confidential Information, except for liability for claims of patent or copyright infringement.
Even with an NDA in place, risks still exist with IP rights. Below are four ways to share the risks, which will oftentimes allow the deal to happen.
1. Patent holdbacks. The deal agreement may include a provision that holds back a certain amount of the purchase price to address any future patent claim that a third party brings against a product involved in the deal. This is referred to as a patent holdback. In turn, the buyer releases a portion of this patent holdback on certain anniversaries of the commercial-release date of the product, unless a third party brings a patent claim against which the funds need to be applied. As time passes and the risks related to non-asserted third-party patents diminish, the patent holdback monies are released to the seller.
2. Freedom-to-practice holdbacks. If a significant period of time elapses between the closing of the deal and the commercial release of a product involved in the deal, the agreement may include another key provision to address newly discovered patents. Within a certain amount of time after approval of the product for commercial release, the buyer conducts a freedom-to-practice analysis on patents or patent publications that issued after completion of the buyer’s initial due diligence. If the buyer identifies a freedom-to-practice issue, it consults with the seller regarding any remedial action to be taken. The agreement may provide a sharing of the costs and expenses as appropriate for any remedial action.
3. Special indemnification for attorneys’ fees. Often, a deal involves a seller with a commercially released product where a third party has sent a letter identifying a patent that the seller should analyze with respect to the seller’s product. Although the parties may develop strong defenses against the third party’s assertions, litigation may ensue. To account for the costs related to such litigation, the parties may include in their deal agreement a special indemnification with respect to such claims.
4. Fair target patent claim. The buyer may seek to purchase a start-up company that only has patent applications on file and no issued patents. At this stage, there is uncertainty about the scope of patent claims to be allowed. Although the seller is expectedly optimistic on a broad scope of patent protection, the buyer may be unsure. Thus, both sides generally have different views as to the value of the patents. This results in a different understanding of what the purchase price should be.
One solution is to draft a fair and objective target patent claim that provides the buyer the claim protection it seeks, but to hold back a certain amount of the purchase price (another type of patent claim holdback). If the seller obtains an issued patent claim that is identical or equivalent to the target patent claim, then the seller will receive the patent claim holdback. If the seller fails to obtain an identical or equivalent claim, then buyer will retain the patent claim holdback.
In conclusion, a potential buyer must be innovative in protecting itself and developing ways to share the risks with the selling entity. Once companies identify IP hurdles and obstacles, identified, they must share those risks between the buyer and the seller for a successful deal to move forward.
Greg Vogler is one of the co-founders of McAndrews, Held & Malloy. He focuses on patent, trade secret and trademark litigation, as well as IP due diligence related to acquisitions and mergers. He has argued over 10 times before the Court of Appeals for the Federal Circuit, and on February 5, 2013, he obtained a $70 million jury verdict for infringement of a surgical irrigator patent on behalf of Stryker Corporation against Zimmer Holdings, Inc. in Michigan. Greg can be reached at firstname.lastname@example.org.