IP reps and warranties in M&A

In the knowledge economy, intellectual property rights such as patents, trademarks, copyrights, trade secrets and industrial designs are important company assets. Consequently, IP rights are receiving increased focus from purchasers in M&A transactions. This increased focus is evident in both the due diligence phase of the transaction and the negotiation of the purchase agreement. The main part of the purchase agreement that deals with allocation of IP-related risks associated with the business or company being sold is the section dealing with the seller’s IP representations and warranties. The seller’s IP representations are often extensive and are frequently paired with a corresponding disclosure schedule that itemizes the seller’s IP portfolios and material IP agreements. 

The seller’s IP representations and warranties typically fall into several main groups, as follows: 

• Warranties that the IP portfolio and material IP agreement information listed in the disclosure schedule is accurate and complete (and could include a validity warranty); 
• Warranties that the seller owns or has the right to use all IP rights required to carry on the business being sold; and 
• Warranties that the conduct of the business being sold does not infringe upon any third-party IP rights (this warranty is often knowledge qualified). 

The purchaser and its IP lawyers devote a lot of time and attention to drafting and/or negotiating the seller’s IP warranties to have the seller assume the IP-related risks associated with the transaction. However, it is typically more difficult for the purchaser’s IP lawyers to negotiate the remedies for breach of the IP warranties. One reason for this is the remedies are in a separate section of the purchase agreement and typically apply to most or all the seller’s reps and warranties. Consequently, changing the remedies to take into consideration the unique issues associated with the IP warranties may impact other warranties. If separate remedies provisions are created for IP warranties, this adds complexity to the agreement and can often cause resistance from the seller’s lawyers. 

In some cases, purchase agreements will set aside a small portion of the purchase price (for example, 15 per cent) as an escrow fund. One remedy for breach of IP warranties (and other warranties) is for the purchaser to be compensated from the escrow fund for its damages. Remedies for breach of certain warranties may be capped to the escrow fund amount or, if there is no escrow, a small percentage of the purchase price. If mitigating IP risks is a priority for the purchaser, it is important to exclude IP warranties from this type of cap, as damages from certain IP risks (especially patent infringement claims) can far exceed typical caps. 

Another key concern with the remedy provisions for seller’s warranties is that they often require that the seller’s warranties are limited to claims made within a relatively short period of time from the closing date of the transaction. The period may be as short as six months, but, in the most generous cases, it is usually not longer than two years. This warranty claim expiration period is another provision that requires the attention of the purchaser’s IP lawyers because IP claims covered by the IP warranties can often take many years to come to light. For example, a patent has a 20-year term. 

Consequently, a patent-related claim covered by a warranty in the purchase agreement may not be asserted for many years after the transaction closes. Purchasers should pay careful attention to these limitation/expiration provisions. Otherwise, extensive IP warranties successfully negotiated by the purchaser could be rendered effectively useless by a short warranty expiration period. 

As technology becomes ubiquitous in every industry, the negotiation of IP representations and warranties is becoming an important aspect of every M&A transaction. Purchasers need to pay attention not only to the scope of the IP warranties themselves but also to other provisions in the purchase agreement that, if overlooked, can negate the benefit of robust IP warranties negotiated with the seller. 

Victor Krichker is a partner and patent and trademark agent with Bereskin & Parr LLP and is the head of the firm's licensing and transactions practice group. 

Paul Blizzard is an associate and a member of Bereskin & Parr’s artificial intelligence practice group. His expertise focuses on all aspects of patent drafting and prosecution, licensing and trade secrets.