Intellectual Property in California Mergers and Acquisitions: A Due Diligence Checklist

When intellectual property, or "IP" assets, form a significant part of a merger or acquisition, thorough due diligence becomes critically important. This process is essential not only for establishing an accurate valuation and verifying ownership of the IP assets, but also for identifying potential risks that could undermine the value of the IP.

A notable example highlighting the complexities of IP due diligence took place just two months after Facebook's acquisition of Oculus VR in 2014, where ZeniMax Media sued Facebook, claiming that a former employee-turned-Oculus CTO had taken proprietary technology and trade secrets from ZeniMax-owned id Software. Although Oculus was not found guilty of stealing trade secrets, ZeniMax was awarded $500 million for non-disclosure agreement violations, a sum later reduced by half upon appeal. This high-profile case underscores the critical importance of thorough IP due diligence to reduce the risk of costly legal disputes and ensure that the strategic goals of the acquisition are met without unforeseen complications.

The following checklist provides an overview to help evaluate a potential target company's IP assets. This checklist covers the scope of IP holdings, dependencies on third-party IP, the potential for IP infringements, and assessing how the transaction may affect a buyer’s rights to these assets.

  • Equity vs. Asset Purchase: Determine how the structure of the deal will impact the management and transfer of IP assets. In equity purchases, buyers acquire all IP owned by the target company. In contrast, asset purchases require explicit transfer of IP assets through the purchase agreement. In both cases, clear documentation of what IP is included and what should remain with the seller is necessary.
  • IP Assets Included in the Transaction: Clearly delineate which IP assets are included in the transaction. This may include patents and/or patent applications, trademarks, copyrights, trade secrets, 'Doing Business As' (DBA) names, domain names, publicity rights, software, customer lists, and other databases. Ensure that the scope of IP assets transferred is adequate to maintain the business operations of the target company post-transaction or otherwise meets the objectives of the buyer. This may involve detailed listings and schedules in the purchase agreement.
  • Ownership Verification: Verify ownership of IP assets through comprehensive searches in national and international IP databases and thorough review of internal documents and agreements. This also involves checking for any chain of title issues, and ensuring there are no recorded liens or pending legal proceedings that could impact the ownership and transfer of the IP. Patents and other IP can be owned by the inventor/founder rather than by the selling company and therefore making sure the selling company owns the rights to sell the IP is an important fact to confirm. Special attention should be given to Joint IP ownership as this can lead to complications, such as each owner having the right to exploit the IP independently. Understand the terms of any joint ownership agreements to ensure they align with the strategic goals post-acquisition.
  • Employee and Consultant IP Agreements: Review agreements with owners, employees and consultants to ensure that IP created by these individuals is properly assigned to the company. This includes confirming that invention assignment agreements are clear and comply with specific regulations protecting employee inventions under California law, such as those outlined in the California Labor Code section 2870, which provides certain protections for employee-invented IP. Similarly, copyright such as in development of software, manuals, web content, and other works of authorship should include appropriate work for hire and assignment language signed by each individual involved in creating or improving the work.
  • Review and Negotiation of License Agreements: Scrutinize existing license agreements to identify any terms that might confer exclusivity, ownership, or usage rights to third parties. Buyers will typically acquire IP rights ‘subject to’ any existing licenses. In cases where IP assets are commingled across divisions, and only one division is being sold, it's crucial to address the need for both the buyer and the seller to maintain access to these shared assets. In this case it may be necessary to negotiate an ongoing license agreement that clearly defines the terms of use for each party to ensure smooth operations post-transaction.
  • AI and IP Rights: Assess the role of artificial intelligence (AI) in the target company's operations. Given the evolving nature of copyright laws regarding AI-generated content, it’s important to determine whether the target's AI-generated IP can be copyrighted and to identify any potential legal challenges including infringement risk.
  • Review Any IP Disputes: Evaluate the target's involvement in ongoing or past IP disputes, including the nature of any disputes, the outcomes of past litigation, any cease and desist letters, and any coexistence agreements or other settlements pertaining to IP.
  • IP Protection Measures: Protecting trade secrets and other sensitive IP is vital during and after the M&A process. Assess the robustness of the target company's IP protection measures, such as non-disclosure agreements, cyber security, and physical security protocol measures.
  • Regulatory Compliance Check: Ensure that the IP portfolio complies with current IP laws and regulations. This is particularly critical in California, where business practices are influenced by the California Business and Professions Code, which includes provisions against unfair competition and protection of trade secrets under the California Uniform Trade Secrets Act. Verify that the target company has not engaged in any practices that might be considered anticompetitive or infringing on other parties' IP rights under these statutes.
  • Evaluate Know How: Evaluate whether the target business has sufficient documentation of its internal methods, processes and procedures. Many businesses are highly dependent on the legacy knowledge of their key employees. If that legacy knowledge is not widely shared and reduced to writing, the business can be at a competitive disadvantage if that key employee were to leave the business. Every business is different, and often times a transition period of a few months will help with knowledge transfer and training, as will incentives for key employees to continue their employment with the buyer. Any complicated know how, such as unique manufacturing processes, or recipes, should be reduced to writing.
  • Strategic Alignment and Future Use: Consider how the acquisition will influence the strategic utilization of IP. Evaluate whether the acquisition aligns with your long-term business goals and how it will affect the company's competitive edge in the market.

As you embark on this critical process of intellectual property due diligence, remember that the depth and thoroughness of your investigation can significantly influence the outcome of your M&A transaction. To protect your investment and position your business for future success, contact Adams Corporate Law at (714) 619-9360. Our team of experienced M&A attorneys and IP experts will provide a comprehensive evaluation and facilitate a smooth transition of intellectual property assets, ensuring that your acquisition is both legally sound and strategically advantageous.

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