A question arose recently that I believe merits further and wider discussion:
Can “representation and warranty” provisions in acquisition agreements be an acceptable substitute for conducting intellectual property due diligence (IPDD)?
This question was originally asked in a recent webinar, but we wanted to give it some serious and public thought as other legal professionals may have pondered the same thing.
In a transaction, IPDD and representation/warranty provisions are often complementary components of risk management. As important as they are, representations and warranties are not a substitute for IPDD – especially when the IP is essential to the deal.
The Role of IPDD in a Transaction
Intellectual property due diligence is the thorough, systematic review of the IP owned and used by an entity involved in a transaction in order to determine the value of the IP being acquired or financed and any risks that may be associated with that IP. The three operative words in this definition are ‘owned’, ‘value’ and ‘risks’.
When IP is a fundamental aspect of a transaction, IP due diligence is a critical step in the pre-closing process. Before entering into an agreement, a buyer would likely want a clear picture of the ownership/chain of title for a target IP asset. Any ownership issues that would inhibit use of the intellectual property could influence the price of acquiring the target company or be a deciding factor in whether the buyer enters into the agreement at all. Issues related to ownership, registration, licenses and infringements that are uncovered through thorough IPDD can be addressed in the deal documents with representations, warranties and indemnification provisions.
IPDD Informs Representations and Warranties Provisions
These representations and warranties may present significant ongoing obligations and possible liability for the seller, so they can become hotly negotiated items. In some cases, the parties may negotiate liability caps, set-asides or holdbacks from the deal proceeds with respect to identified potential copyright, trademark or patent IP risks. Such contractual protections generally have a limited effectiveness period, which is why it’s critical to identify and assess any IP risks before the transaction closes.
While representation and warranty provisions often address the terms of how a buyer can be compensated in the event of a breach, they don’t take into account the time and resources that the buyer may spend on seeking damages or the risk that the seller is not solvent at the time legal action is taken. Furthermore, representation and warranty protection does not guarantee that the buyer will have full (or any) rights in the IP after the legal dust settles.
Risky Business Without Due Diligence
I’ve asked seasoned transactional legal colleagues this same question and they too were not at all comfortable with merely relying on the sellers’ representations and warranties pertaining to the rights, title, encumbrances and use of any intellectual property that is the subject of a transaction. In fact, this belief wasn’t limited to a sellers’ intellectual property assets but to all of their assets.
The main takeaway is that regardless of the asset type or class, forgoing proper due diligence – including intellectual property due diligence – and relying solely on the sellers’ representations and warranties is considered an unacceptably risky practice.
What’s your opinion? Share your thoughts in the comments below.
Access the recording of the webinar that inspired this question:
IP Due Diligence: What You Need to Know and How to Do It.
This content is provided for informational purposes only and should not be considered, or relied upon, as legal advice.