A Primer on IP Representations and Warranties in Asset Purchase and M&A Deals
Date: February 2, 2023
This brief article focuses on the seller’s RWs concerning its intellectual property (“IP”) assets in an M&A or an asset purchase context, including the general scope of such RWs and how they are often negotiated from the perspective of each party. Failure to dedicate an appropriate focus on the IP assets in a purchase transaction may lead to a number of negative outcomes for the parties, including potentially an irrevocable loss of the assets and the corresponding losses in business value and competitive position. To avoid these pitfalls, buyers and sellers should work carefully with their IP counsel during the due diligence period and the subsequent negotiations.
Like other RWs, RWs concerning the IP assets serve a number of important functions in M&A transactions and are often subject to intense negotiations. First, the IP asset RWs provide the purchaser with disclosures of the true state of the IP assets and any related liabilities. Additionally, they present an opportunity for the parties to address any specific considerations and concerns that may have been identified during the due diligence process, and to ultimately allow the parties to allocate the risk of liability (often in the form of termination or indemnity rights) in connection with this class of assets.
Specific assurances about those IP rights are provided, in part, through the appropriate RWs, which usually address the key areas of concern noted above. First, the buyer typically requires the seller to represent that it owns or otherwise has the right to use the IP assets free of any liens, and that the buyer will acquire the rights necessary to continue using the IP assets after the closing in the same manner as the seller used them in the business. The parties typically and carefully address the definition of any lien or encumbrance, which directly impacts the foregoing RW. If the IP assets are subject to any third-party licenses, in addition to the appropriate RWs from the seller, the buyer should take great care during due diligence to confirm that the buyer can avoid restrictions on the buyer’s right to use the IP assets. Ideally, the buyer remains licensed under the same agreements following the closing, but frequently separate license agreements are required with third party licensors.
Second, the buyer typically seeks RWs concerning the validity and enforceability of the IP assets. A frequent point of negation here concerns a later determination that the IP assets are currently invalid or unenforceable. Closely related RWs concern non-infringement, whereby the buyer seeks from the seller assurances that (1) the IP assets do not infringe, dilute, or misappropriate IP rights of any third party, (2) no third party is infringing or misappropriating the IP assets of seller in any manner, and (3) all pending actions or known claims concerning the scenarios described in (1) and (2) are identified in the associated disclosure schedules. This inquiry will help the buyer to assess the expected risk of litigation if it acquires the target business, and if there is or has been any such violation, the expected expenses and the value of possible damages. Any identified disputes or administrative proceedings concerning the IP assets should be carefully evaluated by the buyer’s IP counsel, to assist the buyer in fully understanding all liabilities for any pending or unasserted claims.
Each of the RWs can become a heavily negotiated point, and there are a number of different mechanisms to address a potential impasse. The most common qualifiers employed to curb the scope of IP RWs, and most RWs more broadly, include (1) knowledge qualifiers and (2) materiality qualifiers.
Knowledge qualifiers restrict a particular RW to the constructive or actual knowledge of the seller, a subset of its representatives, or both. The following is an example of a knowledge definition in the context of an IP RW:
“Knowledge” means as to Seller, all facts known, or that reasonably should be known, by the Seller’s Chief Executive Officer on the date hereof after reasonable inquiry as to the matters at hand.
In turn, a knowledge-qualified RW may be:
To Seller’s Knowledge, Seller Intellectual Property does not infringe, misappropriate, or otherwise violate in any manner the intellectual property of any third party.
Most asset purchase and M&A agreements will include a specific definition of the seller’s knowledge, and the variations of this definition often turn on the following aspects: (1) whether the definition includes actual or constructive knowledge, or both; (2) whether the seller’s knowledge is imputed from a particular representative of a seller, or a group of representatives or specifically named individuals, and (3) whether a reasonable inquiry is required or imputed.
In particular, the seller will often seek a knowledge qualifier in connection with a non-infringement RW, in an effort to limit liability for any currently unknown and unasserted claims that may later be brought against the buyer. From the buyer’s perspective, a knowledge qualifier may not be appropriate for all types of IP assets. For patents and trademarks, where infringement liability attaches regardless of the infringer’s intent or knowledge of third party IP (i.e. intent is not a required element of infringement), the parties may be more likely to agree that a knowledge qualifier should apply, thus holding the seller responsible only for the infringement risks known to the seller. Conversely, the buyer may view the seller as being in a better position to identify any trade secret appropriation risks. An appropriation of a trade secret typically involves an element of knowledge—an acquisition by a person or entity who knew or had reason to know the trade secret was acquired by improper means—such that any qualification of knowledge in that instance as part of a RW may not be viewed as appropriate or reasonable from the buyer’s perspective.
Materiality qualifiers restrict a particular RW only to the extent it materially impacts either (1) the target business, or its assets or operations, or (2) the ability of the seller to consummate the contemplated transaction. The parties often heavily negotiate a myriad of exceptions to the materiality qualifier definition, and common exceptions include any effects stemming from general economic, financial market, or geopolitical conditions, changes in applicable laws, and other force majeure events. In connection with the IP assets, the parties may seek to address the liabilities concerning the loss or expiration of any such asset through a material qualifier. In all instances, IP counsel should be consulted on the application and the definition of the material qualifier.
The same is generally true for all of the issues discussed in this article– each should be thoroughly explored during the due diligence period and carefully negotiated with the assistance of IP counsel, enabling both parties to get a clear picture of the status of the IP assets involved in any asset purchase or M&A deal.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.