It seems that at least once a month I receive a call from one of my attorney friends telling me about a client who is considering the purchase of a small or mid-sized business. The caller usually wants to know what is needed to ensure that the client’s purchase properly covers any intellectual property owned by the seller (or "target"). What the client needs to do, in short, is conduct due diligence on all the intellectual property issues in advance of the investment, license, joint venture, distributorship, marketing, merger or acquisition of the business itself or its technology. Due diligence means an evaluation, performed by investors or their agents, into the details of a potential investment or purchase, where the evaluation involves a verification of all the material facts relevant to the investment or purchase. Due diligence can be thought of as critical insurance, and it should be completed before any agreement is signed.
Unless the business largely involves intellectual property (in which case diligence becomes even more critical) the time and money spent on intellectual property due diligence should be commensurate with the size of the transaction. It would be foolish, under most circumstances, to spend twenty thousand dollars on due diligence if the value of the "target" is around twenty thousand dollars.
Properly conducted, an intellectual property due diligence analysis can benefit both the buyer and seller, and result in a lasting long-term relationship for both. A few of the principle issues to consider when conducting the analysis are: (1) what is the status of the intellectual property in terms of ownership, title, maintenance and lien/debt/security interest? (2) what is the strength of the intellectual property of the seller? (3) what are the potential liabilities in acquiring the intellectual property (i.e., threatened possible or pending litigation whether in a court or before a regulatory agency such as the Patent and Trademark Office)?
Although it is impossible to fully discuss all intellectual property due diligence issues in an article of this length, what follows is an examination of the major intellectual property issues a client should address when purchasing or investing in a business.
Patents. Many small businesses do not actively file patent applications. However, even if the "target" business has no issued patents and no pending patent applications, a number of things should be investigated during the "due diligence" period, such as whether there is any technology that could be patentable. If the "target" has issued patents, the first issue to investigate is whether the patents are still in force. Most patents expire 20 years from the date the application was filed. An issued patent cannot be renewed, but it can expire early if the required maintenance fees are not paid. Maintenance fees must be paid three times during the life of a patent (with the exception of design patents). Determining if the maintenance fees have been paid for a patent is free and usually easily accomplished by going to the website of the United States Patent and Trademark Office (uspto.gov).
In addition to investigating whether a patent is still in force, the buyer needs to determine who owns the patent rights. In the United States a patent application must be filed in the name of the inventor(s), and it is the inventor(s) who own the entire interest in the subject matter of the patent unless there has been an Assignment to a third party (such as to the inventor’s employer ). It is not uncommon for the "target" company to have neglected to execute the Assignment (and, preferably, record it). Therefore, if no Assignment is on file, the purchaser may be buying a lawsuit from an inventor claiming to have patent rights superior to those of the employer.
Due diligence analysis of patents or inventions owned by the "target," should, at minimum, investigate the following:
(1) Does the technology infringe upon the intellectual property of others? (Was a novelty search done?)
(2) What measures has the "target" taken to secure secrecy? (This applies to trade secrets as well.)
(3) Was there any disclosure by the "target" to third parties?
(4) Is the "target" providing any warranties?
(5) What are all the names under which the "target" may have operated?
(6) What strategic relationship has the "target" had with other companies?
(7) What are some competing companies of the "target"?
(8) What former intellectual property counsel did the "target" have?
(9) Are there any other patents or applications held by the "target"?
(10) Are there any foreign applications or patents owned by the "target"?
(11) Are there any technologies associated with the "target" that are not included in the deal? Derivatives?
(12)Has a search been conducted for a list of publications (if any) related to the technology or to the inventors of it?
(13) Has there been a search for existing litigation, liens or security interest in the patents or inventions?
(14) Has a list of all co-inventors been obtained?
(15) Have outside funds been used to develop the technology? (This would include secret investors who may have a claim to the technology, including the United States government.)
(16) Are there any extensions for FDA approval?
(17) Are current employees (in any) willing to work for buyer after the purchase?
(18) Are there any covenants not to compete with current employees?
(19) Are there any other patents or applications owned by the "target"?
(20) Is the Assignment binding (Illinois has special laws regarding employee assignments)?
The extent to which these issues are investigated should be directly proportional to the value of the technology being sold and the size of the transaction.
Copyrights. One of the major copyright issues that face small-to-mid-size businesses is determining who owns the copyright to the company website and to its contents. The smart practice is to reach a Work-For-Hire agreement with the web designer before the designer start work on the website. Of course, in the real world this often does not happen. If a Work-For-Hire agreement cannot be found or was not executed, purchaser could have problems in the future with the web designer claiming copyright ownership of the website.
Although it is unlikely that any "target" could provide a definitive list of its copyrighted material (because even small companies usually have an extensive copyright portfolio), the potential buyer should, at minimum, obtain a list of copyrighted material that has existing or potential market value. For example, a brief article about the "target" on its company website would probably be less important than the software, databases, books, music, and the like that is owned or licensed out by the "target." The purchaser may consider conducting a search in the Library of Congress for any registrations owned by the "target."
Trademarks. Possibly the biggest intellectual property issue facing the buyer of a small-to-mid-size business is the trademark portfolio. A trademark is a name, symbol or other device (called a "mark") that is used to identify a product or service and which is legally restricted to use by the owner. A business may have any number of trademarks. For example, the word "McDonald’s" is a trademark, as is "Big Mac," and the company slogan, "You deserve a break today." McDonald’s probably has sought approximately five hundred trademarks. Most small companies only have one or a few trademarks, including the company name, slogan and logo.
For those trademarks of the ""target"" that are important to the buyer, there should be an examination of their strength and status. If the business has any registered trademarks or pending applications, an Assignment from the buyer to the seller should be made at the time the business is sold, unless it is a merger or stock purchase. The Assignment should contain a "good will" clause stating the trademark is not being sold solely by itself, and it should vest buyer with rights to sue for past, present, and future infringements. The Assignment should also be recorded in the United States Trademark Office. Finally, the buyer is going to want to make sure that any trademark registrations are properly docketed for the required renewal with the Trademark Office. Failure to renew a registered trademark will result in cancellation of the registration.
When conducting a due diligence analysis for any trademarks owned by the "target", the purchaser should investigate, among other things, the following:
(1) What is the status of all the trademarks which have been applied for, registered, abandoned or canceled by the "target" (including foreign trademarks)?
(2) What is the status of any assignments filed and/or recorded for the above trademarks?
(3) Were any searches conducted for any of the above trademarks or any non-applied for trademarks?
(4) What is the status of the use in commerce of all the above trademarks or any other non applied for trademarks?
(5) Has there been any action taken by or against the "target" based on infringement of any trademarks?
(6) Has there been any action taken by the "target" to monitor the trademarks? Has there been any licensing of any trademarks by the "target"?
(7) Are there any domain names owned or not owned by the "target" that may act as a trademark? (It may be advisable to conduct a domain name search for domain names similar to the trademark.)
Trade Secrets. A trade secret is a formula, practice, process, design, instrument, pattern, or compilation of information used by a business to obtain an advantage over competitors or customers. The holder of a trade secret may have a cause of action against another who improperly uses, misappropriates, or shares the information without authorization. For example, if the staff of a business finds in a file cabinet information it was not intended to have, and later uses the information, there may be have a cause of action under trade secrets law.
Because there is no such thing as the filing of a "trade secret application" with the government, trade secret law is the least talked about area of intellectual property law. Yet, unlike patent, trademark or copyright issues, every business has trade secret issues. Generally, a trade secret is a formula, pattern, customer list, customer information, business plans and strategies, physical device, idea, process, compilation of information or similar items that have value and that are treated as a secret by the business, and which provides the business with a competitive advantage. For example, your grandma’s famous secret recipe for chocolate chip cookies would be a trade secret if she sold the cookies. A trade secret could be as simple as hanging a paperclip on a specific part of your printing machines in order to make the machine produce one additional copy of your newspaper each day. It may not sound like much, but trade secrets could also be the most valuable aspect of a business. One need only to look to the Coca-Cola Co. for an example. Coca-Cola keeps its soft drink formula a trade secret. Had its formula been patented, it would have entered the public domain after 20 years, leaving the competitors of Coke free to produce the same product and put their name on it.
When conducting a due diligence analysis on the trade secret of the "target", one should look at how well the "target" protected its trade secrets within and outside the "target" company. Typical due diligence analysis would inquire whether non-disclosure agreements have been signed by employees as part of their employment, by suppliers, and by others outside the ""target"; as also whether confidential information has been stored, and if so, who has had access to it.
Justin Lampel received his Bachelor of Science degree in biology/chemistry from Illinois State University. After college, he worked for an environmental company and was certified in asbestos analysis. He then attended the John Marshall Law School in Chicago where he received his Juris Doctorate. Mr. Lampel is a member of the Intellectual Property Law Association of Chicago, the American Intellectual Property Law Association, the Illinois Biotech Network and the Greater O’Hare Chamber of Commerce. He also serves as a volunteer for the Chicago Legal Clinic volunteer.