Elizabeth S. Dipchand and Dan Pollack of Dipchand LLP participated in The Art of Deal Making: Using External Expertise Effectively

Foreword by Andrew Chilvers

For ambitious companies eager to expand into overseas markets, often the conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.

If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.

These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.

Elizabeth S. Dipchand and Dan Pollack discussed The Art of Deal Making: Using External Expertise Effectively as part of the IP chapter.

What is your best practice approach to IP due diligence as part of the deal making process? E.g. Schedule of IP and establishment of transferable ownership rights?

The prominence and wealth of innovative companies whose value mainly derives from intellectual property has exponentially increased this century. The complexity of the transactions that these innovative clients are now engaged in – from M&As to co-ventures – is compounded by the IP that makes these companies so valuable. With the importance of IP due diligence increasing dramatically, effective IP diligence should start well before the deal appears on the horizon.

Implementing IP diligence is not limited to merely listing assets but involves taking a tailored approach informed by factors specific to the deal and parties. These strategy considerations generally include:

• Industry.
• Operational territories.
• Nature of the parties.
• Transaction/deal structure (share, asset, license, venture).
• Transaction timeline.
• Access to critical people and information.

Regarding the nature and status of the IP, essential considerations include its genesis, development, ownership, exclusivity, registration, jurisdiction, third-party leverage, and carve-outs, not to mention the most critical issue: the materiality of the IP to the business moving forward. Understanding the deal context allows us to craft efficient IP diligence strategies to focus resources on what’s essential rather than checking items off a list. In brief, we want to identify the asset and how it is protected (patent, trademark, copyright, industrial design, etc.), if it is registered/unregistered/ registrable, and its importance to the transaction.

At Dipchand LLP, we strongly believe in the comprehensive management of both registrable and unregistrable intellectual capital and intangible assets in Canada and globally – namely, their identification, acquisition, maintenance, management, and enforcement. Active management of these assets ultimately streamlines IP due diligence. However, even in situations where this groundwork has not been laid, significant efforts should be devoted to IP due diligence underlying the transaction as it will form the basis of effective IP management moving forward. It’s never too late to start!

Which methods of valuing patents, trademarks or trade secrets are most common in an M&A deal in your jurisdiction (e.g. cost, value or market approaches)? Any examples?

Valuing IP in Canadian M&A transactions involves sound judgement and collaboration. Legal counsel is predominantly responsible for IP due diligence, which forms the basis for the valuation by Certified Business Valuators (CBVs), making the collaboration between counsel and CBV critical. Given that most of our clients operate in multiple jurisdictions, this exercise is usually not limited to Canada nor registered rights.

The ephemeral nature of intangible assets compounds the typical challenges of valuation. Registered rights – patents, trademarks, copyrights – are a common starting point in the valuation process to identify what you can legally exclude others from doing. This process will also examine the client’s intangible unregistered assets to determine their value, which are generally more difficult to quantify than registered rights. However, note that copyright registration is not required in Canada for potentially crucial assets such as software.

The two common approaches to valuation – quantitative and qualitative – both seek to determine advantages that the client’s IP confers over competitors. In the M&A context, quantitative analysis predominates. The three quantitative approaches applied in Canada are similar to many other jurisdictions, namely, the cost approach (IP value measured by development expenditure), the market approach (IP value measured by recent comparable transactions between independent parties), and the income approach (IP value measured by potential future benefits/revenue).

Ultimately, it is the nature and type of often overlapping IP assets (i.e., brand, technology, artistic, data/trade secret, etc.) that will impact this choice. For instance, a technology that is expensive to develop may have an inflated valuation using the cost approach where the market cannot support substantial future revenues. Conversely, the technology may be challenging to value from a market perspective if it is unique without transactional comparables. There is no one size fits all approach for valuing IP in an M&A transaction.

What warranties and indemnities do you recommend putting in place to ensure IP value is fully preserved?

Canada is a common-law jurisdiction that has inherited the principle of caveat emptor where, absent a warranty, the buyer bears the risk in a transaction. This principle holds true in transactions relating to IP and intangible assets. Similar to other jurisdictions, the Canadian “warranty” concept encompasses the promises or guarantees regarding the transacted IP and any latent deficiencies. “Indemnity” provisions govern the damages arising from third-party claims involving a breach of the warranties.

The very nature of intellectual property and intangible assets adds a layer of complexity in crafting warranties and indemnities into these deals. On the one hand, a buyer’s interest should be focused on obtaining the thing or right that was the subject of the contract. But when the items at issue are intangible, it becomes critical to include warranties and indemnities focused on the fundamental aspects of the IP in question. Such warranties most commonly relate to ownership (including ideation, creation, development, acquisition and assignment), registration status and territory, non-infringement, encumbrances, validity and enforceability, legal disputes, and the waiver of moral rights for copyrights. The related indemnity commonly holds the buyer harmless against any third-party claims arising from breach or deficiencies of such warranties before, during, and potentially after the contract’s termination.

Conversely, the seller should be wary that their warranties and indemnities do not stray beyond the scope of what is reasonable or reasonably known about the assets. To this end, the warranty language should not be “absolute” but should be drafted to limit their scope to the seller’s knowledge, best efforts, and/or what the seller ought to have known. Further, it is essential and common to limit the seller’s direct liability in the case of a breach or deficiency of a given warranty.

Top Tips – To Accurately Establish IP Ownership Process

• Don’t Dismiss Unregistrable Intellectual Capital – All intellectual property and intangible assets should be identified at the outset regardless of the registrability to determine their importance which will dictate the acquisition, leveraging and enforcement strategy.
• Chain of Title – records, contracts and documentation that clearly evidences the ownership of intellectual capital at all stages of development from conceptualization through to commercialization, including use by clients and other third parties.
• Materiality of IP – Identify the critical IP that is key to the company’s operations, revenues and competitive advantages in order to ensure focus on its management and further development is maintained.
• Considered Registration Strategy – Just because you can, doesn’t mean you should. A considered registration strategy focuses resources on the IP and intangible assets that underpin the company’s success now and in the future with a focus on the forest rather than cultivating trees planted in the wrong place.

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