Beyond Reps and Warranties: Why Intellectual Property Due Diligence Can Make or Break an M&A Deal

In today's service and technology driven economy, a company's intellectual property (IP) is often its most valuable asset. Yet, in the realm of Mergers and Acquisitions (M&A), Intellectual Property Due Diligence (IPDD) is frequently misunderstood or assumed to be covered by other departments. Buyers often make the mistake of relying solely on standard public record searches or the seller's representations and warranties. As highlighted in a recent webinar hosted by Cogency Global, failing to conduct thorough IPDD can lead to disastrous consequences.

Why Representations and Warranties Are Not a Substitute for IPDD

It is a common misconception that strong representation and warranty provisions in an acquisition agreement are enough to protect a buyer. While these provisions are important for risk management and encouraging seller transparency, they are not a substitute for thorough IPDD.

Reps and warranties present ongoing obligations and liability for the seller, but damages for a breach of warranty will rarely make a buyer whole if a critical asset is lost. Furthermore, representation and warranty protection cannot guarantee that the buyer will actually retain the rights to use the IP after the legal dust settles. Proper IPDD is necessary to ensure that rights are firmly in place before the agreement is signed, verifying ownership, identifying liens, and uncovering any third-party challenges.

The Danger of Relying Solely on UCC Searches

Another major pitfall in M&A transactions is relying exclusively on Uniform Commercial Code (UCC) searches to uncover IP encumbrances. While security interests in patents, trademarks, and copyrights may appear in state UCC records, these records have major limitations.

The UCC is merely a notice and priority system. Financing statements often only indicate the collateral by type (or a broad "all assets" designation) and rarely identify specific IP properties. Most importantly, UCC records do not prove ownership, establish a chain of title, or reveal all competing security interests in the IP. To get a complete picture, buyers must conduct Federal IP searches through the U.S. Patent and Trademark Office (USPTO) for patents and trademarks, and the U.S. Copyright Office (USCO) for copyrights.

Cautionary Tales: When IPDD is Ignored

Failing to properly investigate IP ownership and restrictions can severely devalue a purchase. The following examples highlight what happens when buyers don't get what they thought they were paying for:

• The Rolls Royce Misstep: When Volkswagen purchased the plant, machinery, dies, and designs from Rolls Royce, they thought they were acquiring the complete brand. However, the actual "Rolls Royce" trademark was owned by a separate entity, Rolls Royce Aircraft, from which Rolls Royce only held a non-transferable license.  Volkswagen did not obtain ownership of the trademark, and Rolls Royce Aircraft subsequently sold the rights to the name to BMW. Volkswagen was left unable to use the most important asset in the deal. The immense value of these specific trademarks is well-documented; Rolls Royce has fiercely and successfully litigated to protect its iconic "Classic Grill" and "Flying Lady" (or "Spirit of Ecstasy") hood ornament from unauthorized duplications by customization kit manufacturers, proving that these symbols alone hold immense brand equity.

  
  

• The Pine Sol Buyout: The Clorox Company purchased the Pine-Sol trademarks from American Cyanamid in 1990, intending to use the famous brand to penetrate new cleaning markets. Unfortunately, a prior 1987 trademark settlement agreement between American Cyanamid and Sterling (the owners of the Lysol trademark) strictly limited the types of products that could be sold under the Pine Sol brand. Clorox was legally bound by these restrictions, which required Pine Sol to be advertised primarily as a cleaner rather than a disinfectant, and Clorox was prevented from marketing certain types of disinfectant products under the mark. As a result, Clorox was never able to use the Pine Sol brand exactly as it had intended when making the purchase.

  
  

The Bottom Line

IP due diligence seeks to answer a fundamental question: Am I getting everything I think I am paying for? By looking beyond standard reps and warranties, and by conducting thorough searches at both the state and federal levels, buyers can uncover hidden liens, verify chain of title, and ensure that they can fully utilize the assets they are acquiring.