Topic : Importance of intellectual property in mergers and takeovers

Article Details :

1. Introduction :
Intellectual Property ('IP') is one of the prime considerations that drive mergers and takeovers especially in
knowledge-based sectors such as biotech, high technology and the media industry. The IP owned by a
company makes it an attractive target for acquisition or merger. It is also not uncommon for companies to
leverage their IP to make themselves an attractive target for acquisition.
This article :
1. Briefly explains the various types of IP and the rights associated thereto;
2. Studies the strategic reasons for acquisitions and mergers in the context of IP-driven transactions;
3. Explains the mechanism of mergers and acquisitions with specific reference to the flow of IPR;
4. Examines the need and importance of an IP Audit in IP-driven M&A transactions.
2. Intellectual property :
Intellectual property rights ('IPRs') are rights that are generally bestowed upon the creator/originator for
protecting his creative ideas or original expression. IP generally can be protected under patents, trademarks,
copyrights, domain names, designs, confidential information, etc. However, for the purposes of this article we
shall restrict the study of IP to patents, copyrights and trademarks.

Patents :
A patent is a protection granted to any invention that is new, not obvious and useful. It is an exclusive
statutory right to use or exercise an invention granted to a person for a limited period in consideration for the
disclosure of the invention. Patents are of great importance in biotech and high technology industries as the
new technologies, products and processes are usually protected by patents.

Copyrights :
Copyright is the exclusive right granted to the owner to do or cause to do certain acts in relation to literary,
dramatic, musical or artistic work, cinematography film and/or sound recording. Copyrights are of prime
importance in the media and music industry as the programmes, serials, movies and musical works are
protected by copyright. Similarly copyrights are of great importance in the software industry as software too is
usually protected by copyright.

Trademarks :
Trademarks are symbols/names that differentiate the goods manufactured or otherwise dealt with by the
proprietor of such symbols/names from other similar goods. Companies spend tremendous amounts of time,
effort and money to promote and advertise their trademarks. Trademarks build up the goodwill of a company
and are therefore highly valuable in-tangible property; e.g., the brand names Coca Cola and Marlboro are
valued at $ 47 billion and the IBM brand is valued at $ 23 billion.
3. Strategic reasons for mergers and acquisitions :
If a company is merely interested in obtaining the right to use a patent, copyright or a trademark, or if a
company is merely interested in obtaining revenues from the IP it owns, the IP could be either assigned or
licensed. A merger or takeover would burden the acquiring company with administrative, cultural, HR and
other issues, apart from the inheritance of all its assets and liabilities. A licence or assignment of the above IP
would seem to satisfy the requirements of both the companies, as the company that requires the intellectual
property would obtain the right to use such IP and the owner of the IPR would obtain fees/royalties for
licensing/assigning such IP. This is common in the technology industry where there are various licences and
cross-licences of patents.

The purchase of the Crocin brand by SmithKline Beecham from Duphar Interfran, purchase of the Uncle
Chipps brand by Ruffles Lays, etc., are examples of transactions where a company is merely interested in
obtaining a brand name. Since brand-building can be an arduous effort, involving substantial investments and
with high risk of product failure, acquisition of brands is often an attractive proposition for companies in
certain sectors. The acquisition of an established brand can significantly help a company add substantial
market share at one stroke. Thus the acquisition of just the brand name/technology would seem to satisfy the
needs of both the companies involved in the transaction.

However, there have been various instances where instead of merely acquiring the brand names/technology,
companies have chosen to merge with or acquire other companies. There could be various strategic reasons
for a company to acquire or seek to be acquired by another company. As an illustrative scenario let us
consider a small emerging technology company that wishes to be acquired and a large technology company
that wishes to acquire it, and examine the reasons for such acquisition.

A small company may wish to be acquired to seek liquidity for its founders and investors or it may seek the
complementary resources and the infrastructure of a large company to enable it to grow at a faster pace. A
large company may seek to acquire a smaller company (Target Company) to obtain a key technology, gain
creative, technical or management talent or to eliminate a competitor or to consolidate its position in the
market. A large company may adopt the acquisition route if it is a more effective means of obtaining a
technology than developing such technology internally. Another common trend that is gaining ground
especially in the technology sector which obtains a lot of private funding, is that of small companies preying on
large companies, so as to give them a position of respectability in the market and a chunk of the market share
at a price.
The strategic reasons for the two companies to proceed with the merger plan are tabulated below.
Emerging technology company Large established company
Access to complementary products and markets Acquire key technology
Access to working capital Acquire a new distribution channel
Best liquidity event for founders and investors Eliminate a competitor
Best and fastest return on investment Expand or add a product line
Faster access to established infrastructure Gain creative talent
Gain critical mass Gain expertise and entry in a new market
Improve distribution capacity Gain a time-to-market advantage
More rapid expansion of customer base Assure a source of supply
The recent acquisition of SwitchOn Networks Inc., by PMC-Sierra, Inc for $ 450 million is an
example of technology driven acquisition. SwitchOn, a pioneer in wirespeed packet classification
and inspection technology, is engaged in the business of providing standard semiconductor and
software components. These enable applications such as QoS, Load Balancing, URL Switching
Firewalling, etc. at wire speeds exceeding OC-48. SwitchOn had a patent pending on a
technology that enabled it to build devices that are scalable in performance and the number of
policies they support. PMC-Sierra has expertise in broadband communications and has
worldwide technical and sales support network. The addition of SwitchOn's packet classification
expertise was complementary to PMC-Sierra's broadband communications strategy and helped
PMC-Sierra gain some of the best packet classification technology in the world, along with
knowledgeable and talented design team of SwitchOn. The acquisition by PMC-Sierra was
beneficial to SwitchOn as it could increase its customer base significantly due to PMC-Sierra's
extensive market reach .

Another example would be the acquisition of vEngines by Centillium Communications, a

Nasdaq-listed company, for $ 43 million. vEngines is a Bangalore-based company founded in
January 2000, that is a pioneer in the development of a chip-level product for voice-data
networks. The acquisition was a natural culmination of mutual benefits to both vEngines and
Centillium. Centillium already has a voice product and buying vEngines gave Centillium a
headstart in its next generation voice product. For vEngines, this merger gave an easy
introduction of its technology to the existing customer base of Centillium .

The merger of AOL and Times Warner can probably be viewed as the merger of two equals,
which was also driven largely by considerations of IP. AOL had built a brand, a customer base
and (by Internet standards) healthy profits, but lacked ac-cess to the leading source of broad-
band and content to distribute through such broadband. Times Warner had one of the largest
cabletelevision system in the US and proprietary content magazines, books, movies, music,
 programming. The merger was beneficial to both the companies as AOL now has access to
content and Times Warner has secured an outlet to market music in cyberspace.

The acquisition of Tetley catapulted Tata Tea into the global arena, as Tetley is an international
brand with a presence in over 44 countries. Tetley has a presence in India, Canada, the US,
Australia and Europe, and is the world's second largest tea brand. The acquisition will help the
Tatas obtain a big foothold in the UK and European market and use Tetley's expertise and
infra-structure in sourcing teas world-wide for the Indian market.
4. IP-Flow in mergers and acquisitions :
Since the focus of this article is on the importance of IP in mergers and acquisitions, we shall
not dwell too much in detail on the actual mechanics of mergers and acquisitions. However, it
might be useful at this juncture to take a brief look at the effect of mergers and acquisitions on
the IP. In a merger, all the assets and liabilities of the amalgamating company (the company
which will get merged out of existence) get assumed by the amalgamated company (the
surviving company) by operation of law. The Scheme of Merger or Amalgamation usually
provides for this specifically, which is further validated by the order of the High Court u/s.394 of
the Companies Act, 1956. Therefore, by virtue of the merger, all IP owned by the
amalgamating company get assumed by the amalgamated company. The transfer of IP through
a merger can be depicted diagrammatically as follows :

A merges into B

company A (Owns IP) -------------------------------> Surviving company (B)

(IP of a becomes property of B)
( IP of A transferred to B)

In a corporate acquisition on the other hand, there is no transfer of interest in the IP. Company
A, which owns the IP, gets acquired by Company B and by virtue of such acquisition, Company
B gets control over all assets of Company A, including its IP. Therefore, in a takeover, the
ownership over the IP continues to remain with the Target Company, though the acquirer
company gets effective control over the IP. It is not uncommon in this regard therefore, for
acquirer companies to have the necessary corporate action taken to have the IP of the target
assigned to the acquirer at a nominal price.
5 IP audit :
Since IP is a driving force in mergers and takeovers, as evidenced by the above examples, it is
very essential to conduct an IP audit to ensure that the company that is being acquired is
actually the owner of the IP. Such an audit is also recommended for a company as an on-going
business to ensure that the IPRs are being effectively maintained and for any company that
wishes to become a target for acquisition. In an IP Audit, the various IPRs stated above are
analysed to, inter alia :

(1) Determine ownership of the IP

(2) Ensure that there is no infringement of the IPRs of any third party
(3) Examine licensing, sub- licensing, cross-licensing or any other issues that could affect the IP
rights.

Patent :
If patents are driving the acqui-sition, it would be necessary to determine if the company has
obtained a patent or whether it merely has filed for a patent. A mere patent application does
not confer any property right in an 'invention'. It may also be pertinent to note that there is an
increasing trend for companies to merely file for patents to enhance their ability to attract
potential investors and increase valuation.

It is advisable to conduct a patent search to verify that the patent has been registered in the
name of the Target Company. It is also advisable for the acquir-ing company to examine the
patent claims to determine the patentability of the invention on the touchstones of novelty,
non-obviousness and utility. If a patent has already been granted, it would be necessary to
ascertain if the patent has been opposed or is likely to become the subject matter of any future
litigation. There could be situations where the employees have created inventions in the course
of their employment with the companies, but patent applications have not yet been filed. The
ownership of these inventions would be contentious in the absence of a specific agreement
between the company and the employee assigning such invention/rights in such inventions to
the company, because unlike in the case of copyrights, there is no statutory provision that
confers ownership of patents for inventions developed while in the course of employment, on
the employer.

Trademark :
Trademarks may be registered or unregistered. If the Target Company claims to have a
registered trademark, it would be advisable to conduct a trademark search to verify that the
trademark being acquired has been registered in the name of the Target Company. If the
trademark has not been registered, it would be necessary to determine if the mark can be
registered as a trademark or is capable of protection (the Trade and Merchandise Marks Act,
1958 prohibits the registration of certain kinds of trademarks). The value of the trademark
would depend on the strength of the mark and the ability of the mark to indicate a particular
company as the originator of goods/services. If the mark consists of an invented word or is
inherently distinctive, the registrability of the mark would increase. If the mark consists of a
descriptive or generic word, geographical location or a common surname, the mark is prima
facie not distinctive and may not be registrable. However, if the mark has achieved
distinctiveness or secondary association due to extensive use, then the chances of registering
such mark as a trademark, and consequently the value of the mark, would increase.

It would be necessary to deter-mine if the Target Company is the owner of the trademark by
conducting a trademark search in the office of the Registrar of Trademarks. If the use of the
trademark by the Target Company is licensed by a third party, it would be necessary to deter-
mine the scope of licence and the rights granted to the licensee, duration and grounds of
termination of the licence, consequences of termination, etc. to determine the rights of the
licensee in the trademark. If the Target Company has licensed the use of the trademark, the
terms and conditions of such a licence should be examined to determine the control exercised
by the Target Company over the mark and to check if there are any onerous clauses in the
agreement which may imperil the Target's ownership over the trademark in question.

Copyright :
Registration of copyright is optional, as copyright vests automatically on creation of the
copyrightable work. However, it is advisable to register copy-rights as registration is prima facie
proof of ownership. If the Target Company claims to have a registered copyright, it would be
advisable to conduct a search in the office of the Registrar of Copyrights to verify that the
register mentions the name of the Target Company as the owner of the copyright. If there is no
such registration, the acquiring company would have to determine if the work can be protected
by copyright; i.e., whether the work is original and does not violate the copyright of any third
party. This would be an issue that would have to be established on the basis of fact and may
not be easy from a due diligence perspective.

The person who creates a work becomes the first author and the copyright automatically vests
with such person. Under the provisions of the Copyright Act, if a work is created by an
employee of the Target Company in the course of employment, the copyright in such works
would vest with the employer as it would amount to a work-for-hire/commissioned work.
However, if the author is an independent contractor, i.e., there is no employer-employee
relationship, it would be necessary to specifically assign the rights to the company. Similarly, by
way of abundant caution, it needs to be ensured that even in case of employment, copyrights
over all copyrightable works developed by the employees are assigned to the Target Company.
 Apart from the specific issues pertaining to each of the IPRs which have been discussed above,
from a general perspective, it is also necessary to determine if the above IPRs have been
licensed or sub-licensed, as this could affect the value of the IP. If the IP has been licensed to a
third party, it would be necessary to determine the scope of the licence, the rights granted
thereto, the conditions and consequences of termination and the royalties payable, etc., to
determine if there are any restrictive conditions on use or further licensing of the IP.

Further, one must never forget the importance of having to rectify the registers relatin to the
ownership of IP after an acquisition is completed. Post-acquisition compliances can often be as
important as the pre-closing compliances, as these give fruition to the fundamental objectives
of the acquisition. Therefore, acquiring companies should ensure that after the acquisition,
wherever necessary and applicable, they make suit-able applications and follow them up with
the appropriate authorities to get ownership or licence rights over any patents, trademarks or
copyright of the acquired or amalgamating company to its name. As pointed out earlier, though
this issue is addressed by having an assignment effected reflecting the acquiring company as
the new owner of these IPs, it is always better to have the registers relating to these IPs
suitably rectified as a post-closing measure, in order to better secure the interests of the
acquiring or surviving company.
6. Conclusion :
The knowledge era has witnessed the growing importance of intangible assets such as IPR. The
emergence of a large number of companies in India who want to go up the value chain and not
be mere service providers, has spurred the desire of companies to become the owners of
intellectual properties.

A large number of research-intensive companies have been able to develop key technologies
that compete with the services of well-established and large companies. A merger of the above
companies would be beneficial to both, as there would exist a synergy between the companies
as they are in the same space. Since brand building can be an arduous effort, involving
substantial investments, there have been several acquisition of brands as they are less
timeconsuming and have a ready market.

The success of the new knowledge era companies based on the strength of their IP has now
forced even old economy companies which till recently did not lay much emphasis on their
intangible assets to conduct IP audits to ascertain their IP and its value.