A due diligence analysis of intellectual property rights is an important step when acquiring or making a significant investment in a business. It is particularly important in the case of a technology business, where IP rights are assets that account for almost all the value in a business. A due diligence analysis provides a more accurate picture of those assets and of any potential problems associated with them.
Various types of intellectual property can be the object of a due diligence analysis. Most often it is trademarks, patents and trade secrets that are assessed, although copyrights can be involved as well, such as when a business has rights to the source codes of a computer program. However, it should be kept in mind that all forms of intellectual property require careful consideration.
In Canada, trademarks can be assigned under the Trade-marks Act1, whether they are registered or not. It is therefore important to trace the trademark’s chain of title back to when it was first used. If the trademark is registered, it will also be important to determine whether the goods and services declared at the time of registration adequately match the operational reality of the business as well as whether the reported date of first use is correct. In fact, a registration can be invalidated if the actual date of first use is found to be later than the date that was declared.
With respect to patents, a distinction must be made between pending applications and patents actually granted. If a patent application is pending, it is important to review any correspondence received from the patent offices, notably for any indication that the patent will not be granted or that its scope will be restricted. If the application was filed under the Patent Cooperation Treaty (PCT), it is advisable to analyse any preliminary opinions issued under the framework of this treaty. Since a patent application is predominately a technical document, it might be necessary to ask an expert in the field for his or her opinion concerning the scope of the invention. While a patent that has been issued is presumed valid, it remains essential to assess its scope in relation to the invention the business is exploiting commercially.
Patent rights generally belong to the inventors, unless a written agreement provides otherwise. In consequence, any agreements signed with the inventors should be examined.2 In this regard, there are two situations that should be avoided. The first one is the situation where various inventors have assigned their rights to more than one business, thereby putting those businesses in a co-ownership situation that is difficult to manage. The second one is the situation where the inventors declared to governmental authorities that they are not, in fact, the true inventors. A patent obtained without designating the correct inventors could be impossible to enforce or perhaps even invalid altogether.3Lastly, if the patent or patent application is the subject of successive assignments, one must make sure that each assignment has been made in writing in accordance with the requirements of the Patent Act.4.
The Copyright Act5 contains a presumption that any work (including source codes for computer programs) made in the course of employment are the property of the employer. However, there is no such presumption if the work was made by a subcontractor or a consultant, so more extensive verification is needed in such cases. In a noteworthy decision, the Ontario Court of Appeal recognized that an arrangement of computer program elements can be copyrighted even if the elements themselves cannot be protected individually.6 Furthermore, although it is not mandatory to register a copyright, any assignment of copyright or any licence granting an interest in a copyright will only be valid if made in writing by the copyright owner, which should also be subject to verification.
As for trade secrets, a business cannot derive any economic benefit from the information unless it is truly secret. Hence the importance of verifying any confidentiality and non-competition agreements as part of the due diligence process. It could also be essential to verify which measures are in place to protect the secrets. Such measures can include IT restrictions that prevent employees who are not involved in a project from accessing certain files, or “need to know” restrictions that partition knowledge between various divisions or business units.
Lastly, the purchaser or investor will need to verify that there are no administrative or judicial proceedings which could affect any intellectual property rights and that there are no third party infringement claims that have been made either verbally or in writing.
At times the due diligence analysis might lead to the abandonment of the investment project altogether. In other cases, the due diligence allows for corrective measures which the vendor of the business will need to implement in order for the sale to proceed, or which the buyer of the business will want to put in place in order to protect its investment in the long term.
1 R.S.C. 1985, c. T-13.
2 For example, see Élomari c. Agence spatiale canadienne, 2004 CanLII 39806 (QC CS).
3 For example, see Ethicon, Inc. v. United States Surgical Corp. 135 F.3d 1456 (U.S. Fed. Cir. 1998) and Pannu v. Iolab Corp., 155 F.3d 1344, 1351 (U.S. Fed. Cir. 1998).
4 R.S.C. 1985, c. P-4.
5 R.S.C. 1985, c. C-42.
6 Delrina Corp. v. Triolet Systems Inc., 2002 CanLII 11389 (ON CA).