Intellectual property (“IP”) is a key business asset that provides important rights and competitive advantages. In the merger and acquisition (“M&A”) context, IP is often given special consideration when negotiating the purchase price and deal terms (representations and warranties, indemnification obligations, etc.).
Due diligence is critical for accurately identifying the IP assets, assessing potential risks, and determining post-closing obligations and liabilities. Where a transaction involves registered IP, including trademarks and patents registered with the U.S. Patent and Trademark Office (“USPTO”) and copyrights registered with the U.S. Copyright Office, a buyer must determine whether the seller (and/or target company) has valid ownership rights. This article addresses IP ownership issues to consider during M&A due diligence, focusing primarily on chain of title issues.
Registering an IP asset carries important benefits for the registrant, including enforcement rights against infringers. A “chain of title” is a public record that tracks ownership of a registered IP asset from the initial owner to the present. These records are used to establish ownership status and must be kept up-to-date to effectively protect and preserve IP rights.
Gaps in the chain of title occur where an IP owner fails to properly record any of the following with the appropriate federal, state, or foreign IP registry:
- An assignment transferring the IP interest to a new owner.
- A corporate merger where the assets of two companies are merged into a new or existing entity.
- A change in entity type.
- Any change in the name of the entity.
A seller may undergo corporate restructuring, including reorganization under §368(a)(1)(F) of the Internal Revenue Code, as part of its M&A strategy. Such restructurings often result in a change in entity type (e.g., conversion from a corporation to a limited liability company) and a name change (e.g., “ABC, Inc.” becomes “ABC, LLC”). Entity changes should be promptly recorded with the appropriate IP registry following reorganization to prevent gaps in the chain of title.
Regardless of whether a buyer is purchasing specific IP assets or inheriting a company’s existing IP portfolio upon purchasing a controlling interest in the entity, chain of title issues can cause complications in M&A deals. Chain of title discrepancies cast doubt on who is able to exercise ownership rights and can result in a loss of IP rights if left unresolved. If the chain of title is incomplete at closing, a buyer will encounter issues down the road enforcing IP rights against infringers and filing the forms and fees needed to maintain the IP registrations. An inaccurate chain of title can also prevent a buyer from timely recording an IP assignment after closing. Depending on the materiality of the registered IP, a loss of purchased IP rights can be a costly hit.
If a transaction involves registered IP assets, a buyer must carefully review public ownership records and identify any gaps in the chain of title during its diligence period. Ownership information for federal registrations is available in the databases maintained by the USPTO and the U.S. Copyright Office. Commercial databases can also provide access to state or foreign databases otherwise not publicly available online. In some cases, a buyer may need to engage local agents to manually pull ownership records in the relevant jurisdictions.
Note that database searches by owner name may be incomplete if registrations and applications are recorded in the name of a prior owner or under a different entity name. To avoid missing valuable IP assets in its diligence review, a buyer should require the seller to identify:
- All IP covered by federal, state, or foreign registrations or pending applications;
- The relevant jurisdiction covered by each registration or application;
- The patent, registration, and application numbers; and
- The filing, registration, and issue dates.
In its diligence review, a buyer should also confirm whether there are any unreleased liens affecting the IP assets by (i) reviewing security interests recorded against patents, trademarks, and copyrights registered with the USPTO and the U.S. Copyright Office and (ii) conducting UCC-1 searches in the relevant states. The parties should identify which liens must be released prior to closing and coordinate filing termination documents with the appropriate agencies.
Depending on the jurisdiction and the accessibility of prior owners (and their authorized signatories), resolving chain of title discrepancies can be a costly and lengthy process. The parties should identify these issues early on in an M&A deal and allow sufficient lead time for resolution.
At closing, the parties must execute valid, recordable transfer documents to proactively avoid future chain of title problems. For an IP assignment to be recordable, it must be in the proper format. For example, trademark assignments need to clearly identify the transferred assets (e.g., by listing the specific marks and applicable registrations numbers on an accompanying schedule) and must include assignment of the “goodwill of the business” to be valid.
Any assignment of IP rights should be recorded as soon as possible following the closing and must comply with any jurisdiction-specific deadlines. Under U.S. law, a patent or trademark assignment is void against a subsequent purchaser for value unless recorded with the USPTO within 3 months of the date of the assignment or prior to the subsequent purchase.
Post-closing assignments can be complicated where a transaction involves the transfer of rights in foreign IP assets. Foreign jurisdictions often have more cumbersome transfer requirements and, to avoid delays, a buyer should be prepared to get any required documents at closing. Where a buyer acquires all or substantially all of a seller’s assets, a seller often winds up and dissolves its business after the closing. If a buyer waits too long to get the required documents, the necessary signatories may be unavailable (or unwilling) to sign.
At the end of the day, a buyer wants to ensure it will receive the full panoply of IP rights promised (and paid for) under the purchase agreement. Where the benefits of registered IP ownership are diluted by chain of title discrepancies, a buyer pays premium for rights it may not actually be able to use.