Intellectual Property: The Invaluable Asset

Intellectual property defines who you are as an organization and what you will become in the future - your reputation, brands, strategies, research, decision-making processes, software, client lists, email communications, etc.

Developing and managing strategies involving a corporation’s intellectual property (IP) have traditionally been reserved for company management. But recent trends suggest company boards should become more active where IP matters are involved and potentially establish an IP subcommittee to ensure that the company’s goals properly align with the IP decisions and strategies being implemented.

Need To Protect Your Intellectual Property

Intellectual property is one of the most important assets of many well-known major companies. However, in India the role and value of intellectual property in business is not fully understood yet.Intellectual property protection is the essential public policy considerations of knowledge based industries and global markets. Rapid changes in key technological, economic and social drivers underscore the importance of intellectual property as it provides an increasingly critical legal and policy instrument for encouraging innovation, stimulating investments needed to develop and market new innovations, and diffusing technology and other knowledge in economically and socially beneficial ways.

There are numerous reasons to worry about IP. Firstly, Intellectual Property is very vulnerable. It is no secret that china’s economy thrives on producing knock-offs of brand name articles produced in other countries. The value of the company’s goodwill is at a tremendous risk if people are provided counterfeit products.

Given the potential financial impact IP could have on the company’s bottom line and line term objectives, directors should understand and question issues and policies pertaining to all corporate IP, including those involving patents, trademarks, copyrights and trade secrets. It is also very pertinent to note what percentage of corporate assets is represented by intellectual property.<1>

It is an emissary for your product. Ultimately, the products are known, products are sold or they acquire reputation in to the market by a particular name or a feature or the utilitarian value. The name, which you select for your products, which name with the passage of time, acquires a reputation and it is that name by which your product is known. It is demanded and that is how it plays a role of the emissary because it is something to the name, the reputation is attached and that reputation is ultimately attached to the quality of the goods, which are being manufactured and marketed by you under that particular name. However, IP’s role is different depending on the nature of work/ product. To some industries it could be only a Trade Mark, to some industries it could be only a Patent, to some industries it could be a mixture of all Patent, Trade Secret, Copyright and Trademarks. It is not necessary that the relevancy of each segment of the Intellectual Property Design, Patent, Copyright, everything would apply in every case.<2>

Need For Corporate Governance

In the words of Benjamin Franklin:

“A little neglect may breed great mischief – for want of nail, the shoe was lost; for want of shoe, the horse was lost and for want of horse, the rider was lost”<3>

Throughout the world, "corporation" is considered to be the essential engine driving the private sector economically. Corporate Governance is critical for Intellectual Property. All norms of Corporate Governance such as disclosures, audit, director’s liabilities, etc are equally applicable to intellectual property management.<4> It is important, for the company and its members to follow all internal governance requirements for better management of their IP portfolios.

Disclosures

A director, as stated in his general duties has to guard the company’s property and protect the interests of the company. It is also a director’s duty to keep trade secrets and other significant information confidential. Breach of these duties would hold the director liable.

It is important to understand when a corporation's liability can become a personal liability so that corporate officers and directors conduct themselves appropriately and proper insurance and indemnification agreements are put in place.

Sections in particular intellectual property acts<5> holds the directors and officers personally liable for infringement, the only exception being where such officer or director proves that the offence was committed without his knowledge. In the context corporate officers have been found personally liable if the officer or director intentionally, actively, and knowingly assisted in the corporation's infringement. To minimize and manage risks, company officers and directors should clearly understand the circumstances and types of activities that could result in their being held personally liable for infringements.

Often, the value of IP lies at least in part in its secrecy. However, the corporate officers must follow the disclosure requirements of the act with respect to material risks of financial unpredictability in all periodic reports.  These disclosures are required if they assist investors in evaluating the company or have a potential financial impact. Corporate officials face a significant challenge in balancing the disclosure obligations against the fiduciary duty to preserve asset value, magnified when that asset value may be diminished or destroyed by closure.

Further, under the “duty of good faith”, a corporate brand and its individual directors must act in good faith to monitor the company’s IP. Companies should assess their current IP related control, and performing an IP risk management. This will include evaluating internal information flow and the transparency of the existing IP Program.

Liability Of Directors And Promoters Of A Limited Company

Where a limited company is the defendant, in the suit for infringement of intellectual property, the directors of the company cannot be joined as co-defendants unless they have personally committed or directed infringing acts.<6> However, persons directly responsible for the promotion of a company, for example the signatories to the memorandum of association for the purpose of committing a wrongful act are liable to made defendants<7>. Where the company had deliberately engaged in a course of dishonest trading for the purpose of passing off, the directors of the company may be held liable.<8>

It should be noted that a director of a company is not automatically to be identified with his company for the purpose of the law of tort, however small the company may be and however powerful his control over its affairs. In every case where it is ought to make him liable or his company’s torts, it is necessary to examine with care what part he played personally in regard to the act or acts complained of.<9>

If there was a personal involvement by the director in the actual ordering or physical doing of the precise act which was the tort that is sufficient to make him personally liable.<10>

Intellectual Property As Security

The World Intellectual Property Organization (WIPO), among others, describes the securitization of intellectual property (IP) assets as "a new trend".<11>Over the past decades, there has been a steadily increasing focus on Intellectual Property and its proceeds as sources of funding and collateral security. More than ever, IP is being recognized as a valuable component of a company’s asset portfolio due in large measure to the growth in IP as strategic investment.  The use of IP collateral is often more attractive than other types of collateral because there is generally a lower credit risk, which results in a lower cost of financing, and pledging IP collateral will often allow a borrower to secure financing without the need to alter its capital structure.<12>

In 2000, the United Nations Commission on International Trade Law (UNCITRAL) established a Working Group to address security rights in personal property, including intangible assets. The Working Group was given the mandate to develop recommendations for an efficient legal regime for security rights in goods involved in commercial activity, including intangible assets, and to identify the issues to be addressed, including the form of the instrument and the exact scope of assets that could serve as security.<13>

Intellectual properties do have value, especially in the technology, media and pharmaceutical field. Intellectual property can be identified, registered and hence legally protected. It can create ongoing benefits. Hence, securitization of Intellectual Property is a good idea for large industries, small and medium enterprises and the economy.

It is good for large industries because, the IP assets of large industries have really good brand value and it can serve as a good source of capital. For small and medium enterprises, IP assets help to raise capital for their big ventures. It is good for the economy because the asset is not kept stale and it accelerates some sort economic activity indirectly. For example, a small enterprise with the capital raised by its research and development can plan for an expansion in its business and promotion of its products in a bigger way, thereby facilitating economic growth.<14>

IP backed securitization consists of the transfer of IP by an owner for securitization and the receipt of capital from investors in the form of lump sum payments.

Typically royalty streams from IP serve as capital for investors.  IP backed securitization remains a small portion of total backed assets securitization in terms of total investment and number of deals completed. Several factors accounts for its limited use, including piracy risk, concerns over litigation, potential changes in legislation and technological obsolesce.

Keeping these in mind, one can understand that IP backed securitization involves more technical expertise than traditional asset based securitization and consequently requires more substantial due diligence than conventional asset backed securitization. Thus, IP backed securitization may require larger transaction scales to be successfully accomplished.

Due diligence and post-transaction formalities are equally important in the process of taking security over IP. Verification of the ownership of the borrower’s IP and the identification of any earlier conflicting rights enables the lender, at the initial due diligence stage of a transaction, to satisfy itself that the borrower’s IP portfolio constitutes a viable asset upon which a loan can be secured. Post-transaction formalities, such as the above-mentioned recordal of security interests over registered IP afford the lender some comfort that its rights will be protected as against third parties.

It is important to point out that IP securitization comes with its set of troubles, such as, IP valuation can be affected by non-registered factors like know-how and confidential information. Also, infringement action can seriously erode revenue streams and plans for combating infringement through litigation must be in place to protect the value of the IP. Valuation of royalty income in patents and technology can present many unique challenges.

The assessment as to how security is to be taken over the borrower’s portfolio will be largely determined by whether security is being granted over registered or unregistered IP. When dealing with registered IP, security will usually be taken through the creation of a fixed charge. Fixed charges are equitable (as they grant a beneficial but not legal interest in secured IP) and “attach” themselves to the IP in question. The lender acquires an equitable interest in the IP but no legal title is transferred.<15> Many brands have mortgaged their ‘brand names’ and the IP associated with it.

The title to the IP secured by the fixed charge will remain vested in the borrower; however, maintenance of the IP will continue to be the responsibility of the borrower. It is therefore important that the security agreement obliges the borrower not to do or omit to do anything which may put either the enforceability or validity of the IP in jeopardy including failing to pay renewal fees or take action against infringers.

In transactions where the unregistered IP of the borrower is of little commercial value, security will usually be taken by including these rights under the umbrella of the general list of assets of the borrower secured by a floating charge. However, this may not always be the case. In India, registration though preferred is not mandatory. A trademark, even if not registered can file a suit for passing off if someone imitates their mark. An unregistered mark may also have a considerable amount of good will attached to it. Copyright registration isn’t mandated either. Therefore, a lot of factors have to be taken into consideration while securitizing IP.

Process Of Intellectual Property Securitization

Security over Intellectual Property can be created by an assignment through a security in writing or by a charge. When security is created over intellectual property rights as a general charge (by execution of a deed of hypothecation), the creator of the charge (if a company) must be registered with the Registrar of Companies.

In order to create a security over the trade mark under the Trade Marks Act, 1999, it is not mandatory to file the document. The act itself does not set out any procedure for recording security interests. However, if required, a cover letter along with a document can be simply filed with the Trade Marks Registry. If there is a change in the proprietor of the trade mark under the security or the charge, that change must be recorded with the Trade Marks Registry. However, no documents need to be filed if no trade mark application has been filed or no registration has been obtained for the concerned trade mark in India.

It is not mandatory to file the document that creates a security over the copyrighted work.<16> However, if required, a cover letter along with a document can be simply filed with the Copyrights Registry. If there is a change in the proprietor of the copyright under the security or charge being created, the change must be recorded with the Registrar of Copyright. However, no documents need to be filed if no trade mark application has been filed or no registration has been obtained for the concerned copyrights in India.

Unless it is in writing, any security interest or a mortgage in an issued patent is invalid.<17>The document must contain all the terms and conditions governing their rights and obligations. The application for registration of the document must be filed in Form 16 with the Controller of Patents and the Registration of the agreement that creates a security interest in the in the patent is compulsory under the act.

Unless it is in writing, a mortgage or any other interest in a registered design is invalid and any agreement between parties clearly sets out the terms and conditions governing the rights and obligations.<18> Such an agreement that creates a mortgage or any other interest in the registered design must be filed with the Controller General of Designs in Form 12 within six months of the execution of the instrument or within a further period not exceeding six months in the aggregate as the controller on the application made allows.

The security documents must be stamped in accordance with the applicable stamp duty law.

Intellectual Property Issues In The Sale Of Business

When a business is preparing to sell, many owners think that their business doesn't have or own any intellectual property unless they have gone through the process of registering a copyright or trademark or procuring a patent. However, items such as domain names, trade secrets, and the special know-how of a business constitute intellectual property which have value and for which the business and/or business owners have rights. Additionally, items such as third-party licenses (Microsoft Office, for example), IT maintenance and support contracts, and web-hosting and development contracts also constitute valuable intellectual property. Proper consideration and handling of these items matter greatly in the sale of a business, as failure to consider or handle them properly can cause problems for the seller at the front and back end of a sale transaction.

Intellectual Property Audit

IP audit is a systematic review of the IP owned, used or acquired by a business so as to assess and manage risk, remedy problems and implement best practices in IP asset management. IP audit involves undertaking a comprehensive review of a company’s IP assets, related agreements, relevant policies and compliance procedures.<19>

An IP audit helps a business to make an inventory of its IP assets or update it and analyzes how the IP assets are used or unused, whether the IP assets used by the business are owned by the company or by others, whether these IP assets are infringing the rights of others or others are infringing on these rights, and determine, in the light of all this information, what actions are required to be taken with respect to each IP asset, or a portfolio of such assets, to serve the relevant business goals of the company.

An IP audit seeks to uncover unused or under-utilized assets, to identify any threats to a company’s bottom line, and to enable business managers to devise informed business and IP strategies that help maintain and improve its competitive position in the relevant market(s).

The first step in the Audit process is to identify the readily identifiable IP. Assets falling into this category will include any registered trademarks, copyrights, designs or patents owned by the business, any licenses to third parties and any licenses from third parties, including cross-licenses. Also things such as in-house work manuals, databases, recipes, franchise agreements, publications and product/process know-how will be included. Once identified the IP’s are then scrutinized to determine who owns them, whether they have not lapsed (remain registered) and enforceable and whether they are being effectively used. Certain different components are also given an importance rating – by looking at factors such as whether or not they are embodied to core technologies, the life expectancy of the underlying IP in the said technology and the potential or actual exclusivity of the technology.

The second step is to analyze external or market influences. These will include the company brand, product brands, company and product get-up, goodwill, product certification, export certifications, regulatory approvals, distribution and raw material networks, client lists, and marketing and advertising programs.

An IP Audit makes sound business sense. Not only can an Audit identify company strengths and weaknesses, it is also an extremely useful tool that can be used to bring together all of the different departments within an organization.<20>

Role Of Intellectual Property In Mergers And Acquisitions

Intellectual Property has a growing importance in the field of mergers and acquisitions. In the current era, Intellectual property is one of the prime considerations that drive mergers, acquisitions and takeovers. Understanding how intellectual property rights are involved with mergers and acquisitions is essential given how merger and acquisition (M&A) activity in the intellectual property field has come to dominate, both in volume and in value, merger transactions generally.

Understanding how intellectual property rights are involved with mergers and acquisitions is essential, given how merger and acquisition (M&A) activity in the intellectual property field has come to dominate, both in volume and in value, merger transactions generally.

The driving force behind a majority of mergers completed during the past decade has been theacquirer’s desire to obtain the target’s intellectual property assets.Much of M&A activity takes place when a company wants to obtain the economic benefits of consolidation ina particular industry and it goes out and starts buying its competitors. In the health care industry, forinstance, hospitals continue to merge to acquire the economic clout necessary to force insurers to increasetheir coverage payments to the hospitals.

In most cases, it so happens that the company acquires or merges with a particular company only to acquire its brand name. The purchase of Uncle Chips by Ruffels Lays is a classic example of that.

One of the reasons Google acquired Motorola was to use the portfolio as a leverage to ward off the increasing litigations by Apple and Microsoft against Android based phone manufacturers like HTC and Samsung.<21>

Moreover, the due diligence process puts a value to the brand at the time of merger or acquisition.  Due diligence refers to an investigative process through which one or more parties to the transaction attempt to better understand the business of the target company or other parties to the transaction, both from business and legal standpoints.<22> Therefore, intellectual property becomes a crucial asset for the company. The most important aspect in the due diligence process is to identify the intellectual property rights that are owned by the target company, i.e., the intellectual property assets of the business being purchased.<23>

In a business, there may be confusion about who has ownership rights to a particular intellectual property. Although an invention or creation is usually thought of as belonging to the inventor, this may not always hold true. For example, if the invention was made during the course of employment, the rights to it may reside with the employer. In some cases, the employment brings the required clarity about ownership. In the absence of an employment contract, the scope of employment is looked into.

Like any other asset, IP can also be acquired. Acquirer should obtain the following documents and information as a part of its intellectual property due diligence. Intellectual property due diligence will usually begin with a request for documents –

1. Review of limitation on the Target’s Intellectual Property Assets.
2. Are any of the intellectual property assets owned jointly with one or more third parties?
3. Are there any royalty obligations associated with any intellectual property licenses?
4. Are the intellectual property licenses assignable by the Target?

There are different kind of documents/information are required for the proper due diligence of the Intellectual property for that purpose the IP i.e. Patent, Trademark, Copyright etc. have required different documents/information’s.

Documents which are customarily reviewed as a part of intellectual property due diligence includes such as registration documents, all licensing agreements, assignment deeds, Distribution and sales representative agreement, any agreements with third party contractors etc which is used in the course of its business can be reviewed for acquisition or merger.

Acquirer should also identify all litigation brought by or against the IP owner, whether currently pending or previously disposed of, in addition to any outstanding claims related to IP assets or any of the IP agreements. The acquirer should know the nature of claim, money value of the claim, any likelihood of an injunction preventing use of equipment/mark/work etc.<24>

The acquirer should take proper care while taking IP assets he can also get copies of any outstanding judgment, decrees or settlement agreements to which the IP owner is or has been a party.<25>

Conclusion

Intellectual property plays a much larger role in businesses these days. It is not just restricted to registrations, filing suits for infringement, licensing agreements, etc. It can make or break your merger deal, or it can be the sole driver for an acquisition, it can increase your business valuation by a considerable amount. It isn’t just about your trademarks or your patented technology anymore; it’s about the good will, the brand name, the credibility, the standing in the market. There is no escaping the fact that intellectual property and corporate transactions are more complementary than you think.

<1>http://iveybusinessjournal.com/topics/the-organization/managing-risk-and-protecting-intellectual-property Accessed on 21:30 Hrs 30^th September, 2014.

<2> “Brand Valuation: what it means and why it matters”, David Heigh, In Brands in the Boardroom, IAM supplement No.1.

<3>http://www.bartleby.com/348/authors/195.html Accessed on 22nd September, 2014.

<4> C. Vidya, Corporate Governance – Policy Perspectives (Amicus books, ICFAI University Press) Pg – 32.

<5> Section 69 of the Copyright Act; Section 114 of the Trademark Act; Section 124 of the Patents Act, 1970

<6> Heels v Stafford Heels (1927) 44 RPC 299

<7> Panhard v Panhard (1901) 18 RPC 405

<8> Oertli v Bowman <1956> RPC 282

<9> Law of Trade Marks and Passing Off,  P. Narayanan, Sixth Edition, Eastern law house, Pg 595.

<10> Besson v Fulleon <1986> FSR 319

<11>http://www.wipo.int/wipo_magazine/en/2008/05/article_0001.html

<12> Intellectual Property, A Power Tool for Economic Growth by Kamil Idris, WIPO Pub. No. 888, January 2003

<13>Official Records of the General Assembly, Fifty-sixth Session, Supplement No. 17 (A/56/17), para. 346 ff.

<14>Intellectual Property and Access to Finance for High Growth SMEs, European Commission Directorate-General for Enterprise and Industry, Discussion Paper, Brussels, November 14, 2006.

<15>http://nopr.niscair.res.in/bitstream/123456789/3563/1/JIPR%2011(2)%2098-102.pdf Accessed on 21:00 Hrs, 27^th September, 2014.

<16> Section 18 and 19, Copyright Act, 1957 as amended by the Copyright (Amendment) Act, 2012.

<17> Section 68, Patents Act, 1970

<18> Section 30, Designs Act,  2000

<19>http://www.wipo.int/export/sites/www/sme/en/documents/pdf/ip_panorama_10_learning_points.pdf Accessed on 16:00 hrs 27th September, 2014

<20>http://www.wipo.int/sme/en/documents/ip_audit_fulltext.html Accessed on 21:05 hrs  30th September, 2014

<21>https://www.google.com/press/motorola/ Accessed on 14:00 Hrs, 24^th September, 2014.

<22> David M.Klien, Intellectual Property in Mergers and Acquisitions, 2004 Edition, Thomson West, Page 136

<23>http://www.icsi.in/Study%20Material%20Professional/DUE%20DILIGENCE%20AND%20CORPORATE%20COMPLIANCE%20MANAGEMENT.pdf Accessed on 15:00 Hrs, 25^th September, 2014.

<24>http://www.mondaq.com/india/x/17241/Operational+Performance+Management/Legal+Due+Diligence Accessed on 2200 hrs,  30^th September, 2014

<25> David M.Klien, Intellectual Property in Mergers and Acquisitions, 2004 Edition, Thomson West