«I. INTRODUCTION Understanding how intellectual property rights are involved with mergers and acquisitions is essential given how merger and ...»
INTELLECTUAL PROPERTY ASSETS IN MERGERS &
LANNING G. BRYER**
SCOTT J. LEBSON
Understanding how intellectual property rights are involved with mergers
and acquisitions is essential given how merger and acquisition (M&A) activity in
the intellectual property field has come to dominate, both in volume and in value, merger transactions generally. This situation was true in the 1990s, and it is still true now. The driving force behind a majority of mergers completed during the past decade has been the acquirer’s desire to obtain the target’s intellectual property assets.
An interesting feature of M&A activity is that it occurs both in boom and bust times. The boom side of the equation was amply demonstrated by the M&A activity during the mid to late 1990’s which accounted for a significant percentage of the world’s economy. Global M&A activity in the year 2000 was valued at nearly $4 trillion, or a robust 40 percent of the estimated $10 trillion American economy. While economic markets worldwide have slowed significantly in recent years, M&A transactions still occur in less economically vibrant times. Much of this activity takes place when a company, to obtain the economic benefits of consolidation in a particular industry, goes out and starts buying its competitors.
In the health care industry, for instance, hospitals continue to merger to acquire the economic clout necessary to force insurers to increase their coverage payments to the hospitals.
Issues pertaining to M&A activity are not simply relegated to large, multinational corporations. Small and medium size businesses can add significant value and revenue by exploiting the full potential of their valuable intangible rights. In many instances, this means obtaining the necessary financing to acquire established properties and intellectual property rights in order to expand their business or to simply improve their performance and competitiveness. In the alternative, divesting certain intangible assets for a premium at the opportune time can yield significant financial returns for small or medium size businesses.
Finally, intellectual property rights have enabled small or medium size businesses in relatively few years achieve large entity status with enormous capital values, such as Microsoft and Sun Microsystems.
The dominating presence of intellectual property in M&A coincides with the emergence of several new intellectual property-oriented M&A considerations.
First, M&A activity was originally dominated by the United States. This circumstance, particularly during the 1990s changed with the sweeping globalization of intellectual property-oriented mergers. For example, in 1999 the U.S. merger volume rose to a record 1.7 trillion whileEurope’s merger volume more than doubled from the prior year to 1.23 trillion. Indeed, the largest hostile takeover ever, and for intellectual property assets at that, did not occur in the United States but rather in Europe with British Vodafone’s acquisition of Hannesmann of Germany for $183 billion.
Second, because of the difference between tangible assets (such as inventory and factories) in contrast to intangible intellectual property assets, methods ordinarily used to value mergers involving tangible assets do not work well when applied to acquisitions of intellectual property. Despite the fact that M&A’s involving intellectual property have dominated the merger scene for several years, merger participants are still failing to apply appropriate M&A valuation procedures.
Third, it is unquestionable that Europe has established itself as a major player in the global M&A scene. EU competition law has, in turn, become a major determinant in whether mergers of significant magnitude will proceed. In a global economy, it is critical for most companies to be capable of conducting business internationally. Companies must become knowledgeable about other nations' competition laws or their equivalent.
In an increasing fashion, the value and importance of intangible assets are the driving force behind national and international mergers and are playing a greater role than ever before in terms of assets received through mergers, acquisitions and takeovers.1 Among these intangible assets are the traditional intellectual property assets such as patents, trademarks, copyrights, know-how and trade secrets. More recently included in this category and of ever-increasing importance are mask-works and Internet domain names.2 In the event of a merger or other type of corporate restructuring, the acquiring party should obtain equitable and record ownership of these intangible assets, or at the very least, acquire the appropriate license to use such intellectual property.
II. MEANS OF ACQUIRING INTANGIBLE ASSETS
It is critical for executives, counsel, accountants and financial advisers to understand the transfer of intellectual property as an essential aspect of a larger transaction, not simply the transfer of intellectual property rights by itself.3 The transaction should be construed in the context of a sale of an entire business in which those intangible assets are used. Generally, businesses are sold either by the purchase of the stock in a corporation or though a purchase of assets used by the business to be sold. Under either scenario, two basic sets of documents, an “acquisition agreement” and “transfer documents” will be prepared and negotiated.4
An Acquisition Agreement is prepared for the express purpose of detailing those terms and conditions under which either the stock purchase or sale of assets will be sold. The purpose of the Acquisition Agreement is to identify the issues essential to the specific transaction, such as the stock or assets, the purchase price, method of payment, date of closing and any conditions precedent which the seller or buyer is expected to meet prior to the “closing” date. Additionally, in the specific context of intellectual property, the seller will usually be asked to make certain representations and warranties in connection with the intangible assets to be sold. The need to list the assets and liabilities is greater in terms of an asset purchase as opposed to a share purchase, since purchasers of assets will typically acquire those assets set forth in the transfer agreement. On the other hand, share purchases will transfer the entire rights in the intellectual property by operation of law. However, regardless of the nature of the transaction, asset schedules in the context of intellectual property play a key role in determining the representations and warranties to be included in the agreement.5 American agreements tend to focus more specifically upon identification and scheduling of intellectual property and other assets while European agreements tend to emphasize the representations and warranties concerning the validity of the intellectual property.6 In transactions where certain intellectual property is being used both in the business being sold and in the business that the seller is retaining, it will be necessary for the parties to determine who will maintain “record” title to the specific types of intangible assets. For example, the seller may not be willing to relinquish title to its “house” trademark, but willing to include those marks covering certain product lines as part of the overall transaction. In this context, licensing of the specific mark, either by sale and license back to the seller or by imposing an obligation upon the seller to guarantee the grant of a license to seller post-closing.7 The Representations and Warranties to be incorporated into a typical purchase agreement tend to be one of the more heavily negotiated aspects of any purchase agreement. Typically included by a seller in its representations and warranties are statements to the effect that the schedule of intangible assets is complete and accurate, it is the rightful owner of such intangible assets, no liens or encumbrances exist with respect to such intangible assets, the intellectual property does not infringe the intellectual property rights of a third party, the buyer is indemnified, seller will assist buyer in performing due diligence in connection with the intellectual property being transferred and other disclosures such as existing licenses, settlement agreements, consent agreements, ongoing litigation, opposition, interference or other actions which may affect the use of the scheduled intellectual property. 8
Transfer documents are generally executed separate and apart from the acquisition agreement discussed above for the purposes of effecting the sale. If the acquisition is structured as a stock purchase, documents transferring the assets generally are not necessary, instead, documents which transfer the stock will allow the buyer to indirectly become the owner of the assets. In the context of intellectual property assets, very often they will be separately transferred to a holding company and either licensed back to the operating company or become the subject of a subsequent sale to the ultimate purchaser.9 If the transaction is structured as an asset purchase, the intellectual property assets will be either specifically mentioned in the acquisition agreement or become the subject of a separate bill of sale. However, very often intellectual property assets are the subject of a separate agreement in light of the fact that they require recordal of the new owner in the respective jurisdictions in which they are validly owned and used. Furthermore, the forms and requirements for valid transfers differ from country to country and become a matter of public record.10 The parties to the transaction should anticipate these contingencies and a separate or perhaps several agreements with respect to intellectual property assets should be contemplated.
Sale of Assets
If a party acquires trademark rights by acquiring a business vis-à-vis a sale of assets, it is not unusual for the transfer agreement to forego specifically mentioning trademark or other intellectual property rights. If a business is sold as a going concern, the intent to transfer trademarks and the goodwill associated therewith is presumed, even though not expressly provided for. An exception to this concept lies in the context of transactions between parent corporations and their wholly-owned subsidiaries. Asset-based purchases in this context will not automatically include intellectual property rights, rather, ownership of the intangible assets will remain with the parent corporation unless the underlying agreement expressly provides for transfer to the subsidiary.11
In the context of a stock purchase acquisition, ownership of trademarks and other intellectual property still remains with the acquired company. Purchase of shares will not affect distinct property rights in intangible assets or other intellectual property to be properly transferred, although a separate agreement is usually necessary to underscore the parties’ intentions.12
III. TAX CONSIDERATIONS
Depending upon the scope of the business activities of the purchaser, it may choose not to simply obtain record title to intellectual property assets received in a merger or acquisition, rather, it may choose to sell its newly acquired intangible assets to a third party (which it may or may not own a substantial portion of the shares) and receive a license to use same. Very often, this can be achieved in the most tax efficient manner by placing ownership of the intangible assets in a holding company which then licenses back the assets for use by the operating company.
For example, in the United States the establishment of a Delaware Investment Holding Company (a “DIHC”) provides an excellent framework for this model. Typically, title to the intangible assets will be transferred to the DIHC who subsequently licenses the use of the intangible assets to whichever operating entity the purchaser (normally the party who has dominant ownership and created the DIHC) desires the assets to be used by in exchange for a royalty.13 Not only is the DIHC exempt from Delaware’s income and gross receipts tax, but the royalties received by the DIHC are exempt from Delaware taxes as long as the activities of the DIHC are confined to maintenance and management of intangible assets.