By: Jeanne Hamburg
October 2004

In Part I of this two-part article, we described how early assessment and consideration of all intellectual property (IP) assets of a business—so called “due diligence”—is critical in a number of respects. As noted in Part I, the culmination of the due diligence process is the drafting of the agreement which will effect the transfer of assets. Part II will focus on reducing the agreement to a writing that comprehensively addresses the IP issues while at the same time not unduly exposing either seller or buyer to risk.

The most significant provisions of the agreement from the IP attorney’s perspective are: (1) definitions of assets and IP; (2) the scope of the transfer; and (3) representations and warranties. However, many other provisions of the agreement may touch on IP and it is important, even for counsel retained only for IP advice, to review the entire agreement to be sure nothing is missed.

That said, the representations and warranties, indemnification provisions, and disclosure schedules will often be the focus of the IP-related drafting. That is because the seller’s (and purchaser’s) exposure for IP-related damages will turn on the language in these sections. If a seller makes and then breaches that representation and warranty, typically it will be obligated to indemnify the purchaser for some or all monetary consequences of that breach. Worse yet, if the representation and warranty is intentionally misleading, the seller may be liable for fraud.

Disclosure schedules are also critical because typically the seller is not liable, unless the purchase agreement otherwise provides, for any monetary damages resulting from disclosed events. For example, if the seller discloses that a third party’s consent for transfer of an important contract is required, and that third party withholds consent despite the seller’s “reasonable best efforts” to secure such consent, the seller is typically not liable for monetary consequences of the refusal to provide consent.

Representations and warranties are often qualified by the disclosure schedules—that is the seller makes the representation of a certain fact “unless otherwise disclosed.” Typical representations and warranties/disclosure schedules include: lists of all the IP the seller owns, has licensed from someone else and has licensed to someone else (often defined by reference to a disclosure schedule); the seller’s representation that it hasn’t given any IP or other rights away unless it’s disclosed; a list of all transactions affecting IP; and the seller’s representation that it owns or has acquired sufficient rights to exploit the works in the way it is doing so currently.

Additional representations and warranties include the seller’s representation that it has good and marketable title; the seller’s representation that there are no liens or judgments against the seller’s IP; that all registrations and applications to government entities with respect to IP are valid and in full force and effect and all registration and renewal fees due up to closing are paid; that seller has the right to use computer systems and software and to transfer such rights to the purchaser; that there are no pending, threatened claims against seller unless it discloses otherwise; that seller is not violating any third-party rights unless it so discloses; that no third party is violating any of seller’s rights unless it so discloses; that there are no pending, threatened claims asserted by seller unless it discloses otherwise; that domain names and trademarks are still in full force and effect as of closing and that there are no pending or threatened challenges to domain names, opposition, cancellation, etc. as to trademarks; that contracts and rights thereunder are assignable; and that the seller owns rights to customer information, supplier information or other lists included in the IP assets being sold.

As counsel for the seller, you will want to qualify representations and disclose any vulnerabilities. As counsel for the purchaser, you will want to obtain the broadest, least-qualified representations and warranties and press for early review of the disclosure schedules and early commitment to a “final” draft of the schedules.

To illustrate how important drafting is, let’s use a hypothetical. Assume that you are General Counsel of a publishing company which wishes to sell its assets. You have alerted your CEO, CFO and other appropriate business people that it will be important to “come clean” with respect to the forms of publishing agreement that the company has used for the past 40 years. This is especially important because counsel for the purchaser has written into the first draft of the asset purchase agreement a broad representation and warranty that the forms the company has entered into are modeled on the forms which the seller disclosed to the purchaser early in deal talks. However, unlike these forms, older forms of publishing agreement used by the company are not assignable in the event of a change of control and do not capture rights in “new media.”

Before you call opposing counsel, of course, you must also have arrived at a creative solution that will accommodate the purchaser’s desire for some comfort on rights granted to the seller, but also protect your client from exposure. You are prepared to make the following counter-proposal to the draft language sent to you: (1) disclosure at your client’s office of pre-1996 forms, with “representative” examples from each year going back to inception of the company; (2) a representation and warranty that the post-1995 contracts take the form appended to the agreement except as otherwise disclosed; and (3) disclosure of the pre-1996 forms on the schedule of contracts not assignable or not assignable without the third-party’s consent.

The qualified representations and proposed disclosure will enable you to make an accurate, and hopefully acceptable, representation about the state of the client’s IP and its transferability. You will make an accurate representation about the forms the client has used and when those forms were in effect. Moreover, you will qualify the representation about assignability of IP assets by excepting the disclosed contracts.

You plan to reason with the purchaser’s counsel that it is practically unheard of in the business to have early forms of agreement that take into account “new media” like the post-1995 forms do; that the older works do not account for a significant percentage of the seller’s revenues; and that inspection of the older forms coupled with the representation as to the newer ones should provide sufficient comfort. Counsel for purchaser, after inspecting the older forms and conducting due diligence related to your revenue analysis (which thanks to your early efforts is already fully assembled), agrees to the proposal. In sum, all your early evaluation of the IP aspects of the proposed transaction and due diligence in the IP area has resulted in a creative solution which protects your client while giving reasonable assurances to the purchaser.

As this hypothetical situation illustrates, at the end of the day, thorough due diligence will inevitably lead to a contract which best protects the client and furthers the interests of both parties in a fair (and realistic) transaction. The importance of due diligence in the IP area should not be underestimated whenever any valuable intangibles change hands.

Please do not hesitate to contact any member of our IP Group to discuss the foregoing or any other IP matter in further detail.