Cash-rich Japanese companies are again increasingly looking outside of the domestic market and taking advantage of the strong yen to make overseas acquisitions. Indeed, Japan's outbound mergers & acquisitions (M&A) activity in the second quarter of 2011 was the highest quarterly volume since the third quarter of 2008.1 Within this context, the role of intellectual property (IP) in M&A transactions is more important than ever.
Previously, IP did not play such a central role in M&A deals. This was due to various factors, including the notorious difficulty in valuing IP assets. However, several high-profile disaster stories – IP deals where the purchaser failed to consider and include in the deal significant IP assets – coupled with an increasing awareness of the value of intangible assets, has contributed to a new M&A environment. Currently, we are seeing a shift in emphasis in asset valuation from physical property to IP and to the legal rights associated with that property. IP is now often the most significant asset acquired in an M&A transaction.
Acquisitions in the technology and pharmaceutical sectors exemplify this trend, with patents held by the target company increasingly being viewed as having a value independent from its business. Moreover, overseas acquisitions undoubtedly appear to be the focus for Japan’s largest innovative drug companies: in the context of a strong yen and low interest rates, Japan’s pharmaceutical companies have already invested $16.8 billion in outbound M&A this year (as at the end of June 2011).2
Key practical issues
Against this background, what issues should an informed purchaser be aware of to ensure that a target entity's IP assets are dealt with appropriately in any M&A deal?
As part of the due diligence process, a purchaser should identify, verify and evaluate the IP rights and obligations of the target company.
Ideally, the purchaser should review relevant agreements concluded by the target company and make a thorough assessment of the ownership of relevant IP. Risks that should be understood and accounted for include the actual or potential infringement of third party IP, and contingent liabilities, such as risks regarding employees' inventions. The latter will be affected by the national laws governing the transaction, as discussed below.
Where the target company has acquired or granted licences, careful examination should be made of the terms of those agreements. Some jurisdictions, for example, do not imply terms into a licence agreement to permit sub-licensing by the licensee, or terms to require the licensor to also license improvements.
Due diligence processes naturally vary depending on the type of target entity acquired and its business. For example, where a pharmaceutical target company has concluded a research agreement with an academic institution, careful examination should be made of the contract to confirm whether the target has agreed to co-ownership of the resulting IP, whether there is any arrangement by which certain ownership rights vest in the individual academic employee who produced the IP, and whether a right of first publication has been granted to the institution.
Warranties and indemnities
In reality, a complete investigation during the due diligence process of all relevant issues (including the points mentioned above) is rarely realistic given the limited time available and the specialised knowledge necessary to assess every point thoroughly.
As such, including express warranties from the seller in the transaction documents (e.g. the share purchase agreement, asset purchase agreement or a separate IP assignment agreement) is important to protect the purchaser. Such warranties may confirm, for example, the ownership and registration of patents and that any employee-generated IP has been validly assigned to the target entity.
It is important to note that unlike certain other civil code jurisdictions, some jurisdictions will not imply terms - including warranties - automatically into an IP assignment agreement.
The purchaser may also wish to seek indemnification from the seller to compensate it for any loss in relation to specific material IP related risks, such as litigation challenging the validity of key patents owned by the target.
IP transactions are affected by the national legal framework governing the transaction, and it is never safe to assume that IP laws are unified, even in the context of the European Union, where differences can be marked between the civil code and common law approaches.
The content or form of an IP assignment may be dictated by national IP laws and will need to be reflected accordingly where the acquisition is by way of an asset purchase. Similarly, employees' rights in respect of the IP they create can differ extensively by jurisdiction. In certain European countries, an employee is entitled by law to receive additional compensation for inventions that benefit his or her employer. Further, in some jurisdictions, an employer's rights over employee-generated IP can lapse in certain circumstances if steps are not taken to secure such rights. Expert local law advice is essential to avoid such pitfalls.
Valuation / tax issues
IP is increasingly the core asset being acquired in M&A transactions and IP valuation techniques have, in turn, become increasingly sophisticated. The intangible property of the target entity may need to be separately appraised and an appropriate method for valuation agreed upon in light of the objectives of the M&A transaction. IP professionals valuing patents, for example, will consider factors such as the strength of registered patents and patent applications, litigation risks, and the potential for competitors to design around patents held by the target.
Taxation consequences should also be considered. In certain jurisdictions, if an organisational restructuring does not meet specific requirements, asset transfer gains or losses are subject to taxation and intangible assets may have to be valued and taxes paid.
Purchasers should also be aware that the target entity will often face a dilemma: it needs to disclose confidential information to the potential purchaser to support the purchase price it seeks; however it must attempt to protect itself from loss in the event the transaction is ultimately unsuccessful. Confidentiality agreements are therefore commonly entered into at the outset of M&A negotiations and sometimes the target may suggest disclosure of key IP information only to an independent third-party valuer.
A well-considered, efficient and cost-effective action plan for assessing IP issues is essential and should be prepared well in advance of any planned acquisition. While specific details will differ depending on the transaction, it is usually valuable to bear the following points in mind.
- Create a comprehensive, specific and relevant list of information requests for the due diligence process.
- In doing so, identify the material IP owned by the target or to which the target has any rights (for example, under a licence).
- Analyse the IP agreements to which the target is a party. Identify any potential competing rights and determine whether the terms of the agreements are appropriate for the on-going business of the target and the purchaser's post-acquisition business plans.
- Take advice on national laws which may affect the validity or content of IP-related agreements.
- Review the processes by which IP is created, acquired and protected by the target.
- Interview key employees of the target who are knowledgeable about IP issues, along with the target's outside IP counsel if possible.
- Assess the target's likely and worst-case exposure in any material IP-related litigation.
- Where applicable, agree with the seller an appropriate method for valuing the IP assets of the target.
- Include appropriate warranties and/or indemnities from the seller in the transaction documents.
- Obtain advice on relevant taxation laws and applicable regulations.
As a growing number of Japanese companies look to enter new markets and build their brands abroad, whether in Asia, Europe or elsewhere, overseas M&A transactions are one way to challenge their global competitors. The value of IP increasingly accounts for a greater proportion of the value of target entities, augmenting the importance of IP as a driver of value within the context of an M&A transaction. Skilled assessment and handling of IP assets can greatly benefit the purchaser, and expert legal assistance can help the purchaser to avoid overlooking or undervaluing the target's valuable assets.
Should you wish to discuss such matters further, or have any queries concerning this newsletter, please do not hesitate to contact the authors.