As cash rich businesses hunt for bargains in the current climate, they must check the legal status of a target’s intellectual property to ensure they are really getting what they think they have paid for. There are real risks for the overeager or the unwary.
Volkswagen’s troubled acquisition of the Rolls-Royce/Bentley company illustrates what can happen if a buyer fails to nail down intellectual property assets. Volkswagen acquired the automotive arm of Rolls-Royce in 1998 but appears not to have identified a very important fact – the Rolls-Royce trade marks were owned by the Rolls-Royce aircraft company. Volkswagen reportedly paid £430 million for the tools, dies, assembly lines, facilities, automotive designs, and the rights to build one of the world’s most famous cars, so long as it did not use the Rolls-Royce name! [1] In the meantime, BMW licensed the trade marks from the aircraft company for £40 million. Volkswagen did a deal - it kept the Bentley brand and the Rolls-Royce factory, but BMW got the Rolls-Royce name.
Intellectual property assets often form a substantial part of the value of an M&A target, and may even be the raison d’être of the deal. Buyers must identify the key IP assets of the business, and what is needed to keep running it as it was previously run. They should ask themselves two questions - am I getting all the intellectual property assets I need, and am I really getting all the intellectual property assets I think I have paid for?
Some Traps for the Unwary
There are several ways in which buyers might end up paying for a brand name, patent, design or copyright that the target business simply does not own.
Licences & Termination Clauses
A business may only have a licence to use a particular intellectual property asset, be it software, a brand name, or a key piece of patented technology. Many IP licences include a clause that allows the licence to be terminated if certain trigger events occur, such as a change in ownership or control of the company, or if a receiver or an administrator is appointed to it. Buyers must check all licence agreements, lest they find themselves subject to the whim of a licensor that wants to charge a fee to transfer the licence, impose conditions or, worse yet, terminates and leaves the buyer without a key IP asset.
Group Structures
Even where an intellectual property asset is held within a corporate group, closer scrutiny may reveal that the asset is owned by a holding company or some other entity that is separate from the operating company. The buyer must target the right entities and corporate structures to ensure the appropriate IP assets are secured.
Initial Protection Measures
Buyers may find that appropriate steps were not taken to secure protection for the intellectual property assets in the first place. That prized piece of technology may not seem so valuable if it was never patented, and can be copied or reverse engineered by competitors at will. In respect of patents and designs, IP owners generally need to apply for registration before releasing the product or even talking about it outside the corporate walls. This makes purchasing an asset now, on the assumption that you can fix up its IP protection later, a risky proposition.
The Strength of IP Protection
Similarly, although an intellectual property right may be registered or appear to be protected, further investigation may show that the protection offered is weaker than was first thought. Any number of examples could be given, but we’ll briefly mention four.
Firstly, a trade mark may not be enforceable against a third party who has used a similar mark honestly and concurrently.
Secondly, if a separate holding company owns a trade mark, it must exercise a certain degree of control over the operating company’s use of the mark. If it has not exercised the requisite degree of control for a period of 3 years, the trade mark may be liable to be removed from the trade mark register for non-use.
Thirdly, and turning to a patent example, the mere grant of a patent does not necessarily mean that it is valid. Virtually all defendants who are sued for patent infringement cross claim on the basis that the patent is invalid. We often say that the grant of a patent is the grant of the right to attempt to prove that the patent is valid in the Federal Court. A prudent buyer will recognise the risk that the patent could be revoked, assessing any special features or circumstances that increase or reduce that risk.
Fourthly, a patent might be ‘designed around’ by an ingenuous competitor. If that competitor can provide a similar product or result through different (non-infringing) means, the patentee may find that the patent simply does not provide the competitive advantage that had been envisaged.
Ownership Complications
The ownership of intellectual property rights may be disputed or unclear. There is no register for copyright, for example: copyright ownership is established by investigating and proving the chain of title.
Similarly, many intellectual property assets can be charged or mortgaged to lenders as security [2]. Buyers need to identify which IP assets are encumbered, and deal with them according to the priority scheme imposed by the Corporations Act and the various IP Acts (a topic beyond the scope of this article).
IP Due Diligence in a Financial Crisis
For all these reasons, it is essential that purchasers of businesses or assets undertake proper due diligence, and thoroughly explore the intellectual property issues wrapped up in M&A deals.
In these turbulent times, many M&A transactions are occurring at the three-way intersection of IP, M&A and insolvency laws.
The Federal Court’s decision in Prismex Technologies Pty Ltd v Keller Industries Pty Ltd [2006] FCA 1504 illustrates how deals of this nature can go wrong, and is a good reminder to buyers that they do need to seek expert advice about these kinds of transactions. Although Prismex is a case from late 2006, current business conditions means that it is probably of more interest now to business owners, buyers, lawyers and insolvency practitioners that it was at the time of the decision.
Lessons from Prismex Technologies
A holding company, Prismex Technologies, owned an Australian patent for an illuminated display system. An operating company, Interium Pty Limited, exploited the patent by actually producing and selling the display systems. Prismex had given Interium an exclusive licence to exploit the patent, but a formal licence agreement was never executed by the parties. Interium also registered the trade mark “Prismex”, which it used in the course of trade.
Interium went into administration.
Prismex wrote to the administrators, asserting that Interium could not sell its licence to exploit the patent without first obtaining Prixmex’s permission. Prismex stated that if Interium ceased trading, the licence agreement would be immediately terminated.
Interium ultimately ceased trading and went into liquidation, and the situation rapidly deteriorated. The liquidator sold Interium’s business and assets to Keller Industries. The buyer, Keller Industries, asserted that it had purchased a valid licence to exploit the patent from Interium. Prismex, on the other hand, asserted that Interium’s licence had been terminated when it ceased to trade, and purported to give a new licence to a third party.
Prismex sued Keller Industries for patent infringement. If Interium’s licence to exploit the patent had been validly terminated, Keller Industries was using the patented technology without a proper licence and was infringing the patent.
The Court looked at the circumstances in which Prismex and Interium had been set up and the licence given, and found that Prismex could terminate the licence if the liquidation of Interium was imminent. Prismex had validly terminated Interium’s licence, and Keller Industries had failed to secure the key IP asset when it bought Interium’s assets from the liquidator.
The awkward result was that Prismex (and its new licensee) still had the patent rights, but because the “Prismex” trade mark had been validly sold to Keller Industries, they could not use the “Prismex” brand which had become associated with the signage. Keller Industries had infringed the patent, but had the exclusive right to use the “Prismex” trade mark.
The case turned largely on construction of an unwritten patent licence granted in convoluted circumstances (and involved other allegations including trespass and conversion). But it does serve to illustrate the effect that company structures, licence arrangements, termination clauses, and IP ownership disputes can have on the purchase of businesses and their intellectual property assets.
The case is a real example of the need to thoroughly identify and scrutinise a target’s intellectual property. These risks can be minimised if purchasers do their homework - to ensure they are really getting all the intellectual property they need, and all the intellectual property assets they think they have paid for.
Stephen Cartwright, Lawyer
Intellectual Property & Technology Group, DibbsBarker
With thanks to Michael Sutton, Senior Associate, and the DibbsBarker M&A Group.
Footnotes
- Volkswagen could continue to use the trade marks up to 1 January 2003, but had no rights to them thereafter.
- Registered trade marks, registered designs, patents, and copyright can all be charged or mortgaged. Unregistered trade marks cannot be charged or mortgaged independently of goodwill. Confidential information is not a proprietary right but an obligation of confidence arising from the circumstances (Moorgate Tobacco Co Ltd v Philip Morris Ltd [1984] HCA 73), and it probably cannot be used as security.
