Due diligence for tech M&A in China

Due diligence

What are the typical areas of due diligence undertaken in your jurisdiction with respect to technology and intellectual property assets in technology M&A transactions? How is due diligence different for mergers or share acquisitions as compared to carveouts or asset purchases?

With respect to technology and IP assets in technology M&A transactions, to help identity issues that may affect the valuation or closing of the transaction, due diligence normally focuses on the following areas:

• title and encumbrances of the technology and IP assets (eg, whether the IP assets are owned by the target or licensed to the target by a third party, whether the intellectual property is developed by the target or acquired from a third party and whether the IP assets are subject to any pledge);
• IP-related agreements, including relevant employee invention assignment or work for hire provisions in employment contracts, IP licences or assignment agreements, and IP-related provisions in commercial contracts;
• IP disputes and infringement claims, including all past, pending and threatened infringement and other IP-related claims and proceedings;
• IT assets (eg, software systems and support services); and
• data privacy, including the target’s internal policies and practices on the collection, use, transfer and protection of personal information.

For carveouts or asset purchases, the parameters of due diligence will be the technology and IP assets to be acquired. Due diligence is also necessary to properly define and describe the scope of assets, and rights and liabilities pertaining to such assets, in the asset purchase agreement.

In a share acquisition, in addition to the typical due diligence areas for an asset transfer, the buyer should review, from a commercial standpoint, whether the target has all the technology and intellectual property necessary for operation of its business as a going concern, after closing. Particular care must be paid to the IT-related agreements to identify change of control provisions that may be triggered by the contemplated transaction.

What types of public searches are customarily performed when conducting technology M&A due diligence? What other types of publicly available information can be collected or reviewed in the conduct of technology M&A due diligence?

Public searches at the following online databases or tools are customarily performed when conducting technology M&A due diligence in China:

• the National Enterprise Credit Information Disclosure System, maintained by the State Administration for Market Regulation, for corporate particulars of the target;
• the Patent Search and Analysis System of the CNIPA for registered patents and published pending patent registrations;
• the China Trademark Database of the Trademark Office for registered trademarks and pending trademark registrations; and
• the ‘.cn’ domain name database of China Internet Network Information Centre for ‘.cn’ domain names.

The buyer may also run a public search at the website of the Copyright Protection Centre of China (CPCC) for registered copyright works (including software). Under Chinese law, copyright is an automatic right, and is not created upon registration. Many copyright owners (especially software owners) nonetheless still register their copyright works with the CPCC as evidence of title in case of potential infringement claims.

What types of intellectual property are registrable, what types of intellectual property are not, and what due diligence is typically undertaken with respect to each?

Registerable intellectual property includes patents (ie, invention, utility model and industrial design), copyrights, trademarks, plant variety rights and layout designs of integrated circuits. Non-registrable intellectual properties include trade secrets and know-how. In China, copyright works can be registered with the CPCC, but registration is not a prerequisite for the creation of a copyright.

To verify the title of registrable intellectual property, the buyer should request registration certificates or receipts of acceptance of registration applications for registered and pending registrations. Public searches with relevant registration authorities (eg, the CNIPA and the Trademark Office) are normally performed to independently verify the title of the registered intellectual property.

In terms of non-registrable intellectual property, the buyer may review confidentiality policies, non-disclosure agreements, IP assignments, and work-for-hire provisions under relevant contracts, to form a general view on ownership status of key unregistered intellectual property.

Can liens or security interests be granted on intellectual property or technology assets, and if so, how do acquirers conduct due diligence on them?

Yes, certain intellectual property (ie, registered trademarks, patents and copyrights) can be pledged under Chinese law. Pledges over registered trademarks, patents and copyrights are perfected by registration of such pledge with the competent authorities (ie, the Trademark Office, CNIPA and CPCC, respectively). The release of pledges is also effectuated upon registration of the release with said authorities. The time required for completing the process of perfecting or releasing pledges varies depending on the type of pledged intellectual property. For instance, perfecting or releasing a pledge of patents with the CNIPA will normally take a week.

If there is any encumbrance, such as pledge, over intellectual property or technology assets that are to be acquired, the release of such encumbrances, if required, is typically effected on or prior to closing and after the signing of the relevant asset or share purchase agreement.

What due diligence is typically undertaken with respect to employee-created and contractor-created intellectual property and technology?

For employee-created and contractor-created intellectual property and technology, the buyer would need to review the intellectual property ownership and assignment or work for hire clauses under relevant employment or development contracts. Public searches will also be undertaken to verify the current title of those intellectual properties if being registered or pending registration with the competent authorities.

Under Chinese law, title to copyrights and patents developed or created by the target’s employees in the course of performing their job duties or by utilisation of materials and tools provided by the target automatically vests in the target. However, unless otherwise agreed, ownership of contractor-created copyrights and patents automatically vests in the contractor. Assignment of title of contractor-created patents to the target is deemed effective upon registration of the assignment with the CNIPA. No registration formalities are required for the assignment of copyrights.

Are there any requirements to enable the transfer or assignment of licensed intellectual property and technology? Are exclusive and non-exclusive licences treated differently?

The transfer or assignment of licensed intellectual property and technology by its owner does not require consent of the licensee. Note that transfers or assignments of trademarks and patents are effectuated upon registration of such transfer or assignment with the Trademark Office and CNIPA, respectively. The transfer of registered patents or pending patent registrations by a Chinese individual or entity to a foreign individual is deemed a technology export, which may be subject to certain approval or filing requirements under the Chinese export control regime.

The transfer or assignment by a licensee of its rights and obligations pertaining to licensed intellectual property and technology normally requires consent of the licensor, unless the licence agreement states otherwise.

There is no differentiation between exclusive and non-exclusive licences in connection with the above-mentioned transfer or assignment.

What types of software due diligence is typically undertaken in your jurisdiction? Do targets customarily provide code scans for third-party or open source code?

Software due diligence undertaken by the buyer’s lawyers will normally be focused on the title and encumbrances over the target’s software copyright. In China, it is still not common for a target to provide code scans for third-party or open source code as part of due diligence.

What are the additional areas of due diligence undertaken or unique legal considerations in your jurisdiction with respect to special or emerging technologies?

Data security and protection has become an increasingly hot-button area for due diligence with respect to some emerging technologies (eg, big data). The potential buyer must have a thorough understanding of the internal policies and practices of the target on the collection, processing, storage, and transfer of personal data and the target’s privacy and information security measures. Data privacy experts may be engaged to conduct standalone data privacy due diligence on the target to assess the target’s compliance with privacy and data security requirements and standards, and to identify potential risks that may affect the valuation of the target or create any residual liabilities to the buyer.