Chen Rong and Zhang Wei

 

Along with the issuance of a series of the regulations and rules allowing foreign enterprises to buy out Chinese enterprises in China in recent years, foreign enterprises have stepped up their efforts to get into the Chinese market by way of cross-country buy-out of Chinese enterprises. China is now becoming a newly emerging market for multinationals to buy out enterprise, and this trend will reach its high tide in a few years. In the transaction of this enterprise buy-out are often involved the matters of intellectual property licensing and assignment. As a matter of fact, the goal for many foreign enterprises to buy out Chinese enterprises is to buy the intangible property, such as trademarks and patent, of the target enterprises. Enterprise buy-out is a painstaking, complicated investment and financing process consisting of a series of linked phases. Since such buy-out is still in its starting stage in China, foreign enterprises must know about the relevant market standards and operational rules, and will, as well, be confronted with intellectual property issues emerging in the cause of buy-out of Chinese enterprises. For this reason, they need to appoint local attorneys who are familiar with the legal system and practical situation in China to deal with the issues. The main work of an IP attorney representing a buyer is to make intellectual property-related investigation with due diligence, preside over intellectual property right negotiations, prepare intellectual property right licensing and assignment agreements and work on the integration and registration of the intellectual property rights after the buy-out is finalised.

 

Intellectual property investigation with due diligence

 

In a deal of enterprise buy-out, the transaction of shares or property often involves intellectual property. Under some circumstances, the intellectual property rights cannot be transferred together with the shares or along with other property. For this reason, the intellectual property investigation with due diligence is indispensable in carrying out an enterprise buy-out deal, and is made to determine whether any intellectual property exists, to whom the proprietary right belongs, to what extent the proprietor controls the intellectual property, what the economic and strategic value the intellectual property has, and whether any potential liability exists for infringement of any other person's intellectual property right. The economic value of the intellectual property is determined by the category and extent of the intellectual property right involved, and is related to its duration, area of protection, and possible existent of restriction under any other agreement. The strategic value of the intellectual property depends on whether it properly serves the business purposes and whether it can be effectively exploited. The findings of the intellectual property investigation with due diligence will have direct effect on the price of the deal, and, sometimes, lead to re-evaluation of, or even change in, the trade structure, or even are decisive on the success or failure of the entire enterprise buy-out.

 

The intellectual property investigation with due diligence normally comprises seven steps as the following.

 

1. Identify the purpose of purchase

 

The intellectual property attorney should, first of all, discuss with the buyer to identify the business purpose, or goal, and about the plan to be reached in connection with the intellectual property. He should be clear about what property his client expects to get hold of in the deal and how his client expects to use the property. Of course, an intellectual property attorney is mainly concerned with such intangible property as patented technology, trademark, and copyright. The attorney makes the intellectual property investigation with due diligence according to the purpose of the buy-out, and prepare report on whether the deal will give the client what it expects to get.

 

2. Identify the trade structure of the deal.

 

Only after the trade structure is identified is it possible to decide on the key points of the trade structure to be examined.

 

In shares buy-out, the intellectual property issue is relatively simple, and its trade cost low since all property of a target company will automatically be transferred to the buyer in the transaction. Even in case like this, examination remains necessary to find out whether the target company indeed owns, or has, the right to use the intellectual property which is indispensable in the business operation and whether the change in its control over the shares terminates the licensing of some important intellectual property rights.

 

In property buy-out, the intellectual property issue is relatively complicated. It is necessary to examine whether a target company owns, or has, the right to use the intellectual property concerned, such as the patent, trademark, copyright or domain name, and, as well, make clear whether it has the right to assign or license the property right and whether the assignment and license are conditional. Also, it is necessary, in the cause of transaction, to prepare a separate assignment or license agreement directed to each intellectual property right of the target company. Besides, it is necessary to keep in mind that there are different requirements for the terms of agreement to take effect in different countries. These requirements are related to approval by, or registration with, the relevant intellectual property authorities.

 

3. Examine the validity of the intellectual property rights

 

Regarding an involved patent, examination should be conducted as to whether the enterprise concerned has been paying the annuity to keep the patent valid. If necessary, the Patent Register may be consulted to find out the legal status of the patent when making the IP investigation with due diligence: whether it is invalidated, or the exclusive right is lost for any other reasons. It is particularly necessary to examine the term of validity of the trademark to find out whether an application for extension has been filed within the time limit and whether it has been approved.

 

4. Find out the true proprietor of the intellectual property right

 

Where a patent, the applicant or patentee of which is the target company, may be an invention of its employee(s), it is necessary to examine the employment contract to find out whether there is any agreement on the matter. If there is, who owns the patent should be identified according to the agreement; if there is not, the relevant provisions of the Patent Law should be complied with to determine whether it is a service invention and who is the owner(s) of the patent. Sometimes, it is necessary to examine the relations between the inventor and the target company (if the inventor is not an employee of the target company). Perhaps the inventor is the true rightholder, and the patentee in title is not. In case of a patented technology as developed by way of cooperation or entrustment, it should be first examined whether there is any agreement between the two parties concerned. If there is, the agreement is observed; if not, the patent developed through entrustment belongs to the entrusted party; the patent developed through cooperation is shared by the parties in cooperation. If the patent is jointly owned, the joint contract of cooperation must be examined to identify the rights and obligations of each party, and, in particular, find out whether there are any provisions which restrict assignment of the patent concerned.

 

The copyright is somewhat different from the patent right in ownership. Where a work is merely a service work, the author owns the copyright, and his entity only has the priority to use it. Only such service works as engineering design drawings, product design drawings, maps and computer software that are created by mainly using the material and technical facilities of the entity and with the entity bearing the responsibility, or works created under contract to this effect are owned by the entity. The copyright in a work created in cooperation is jointly owned by the authors in cooperation. It should not be agreed in a contract that it is owned by any one of the parties.

 

Special attention should be paid to the issue of ownership of intellectual property right as developed through entrustment and cooperation. Since copyright is generated without required registration, some enterprises wrongly believe that they are the copyright proprietors though they do not own the copyrights. For that matter, whether an enterprise indeed owns a copyright often should be reviewed in a comprehensive manner. If a product is developed in cooperation with another person and the copyright ownership is not clearly attributed, dispute is likely to arise. This author once made the intellectual property investigation with due diligence of a company devoted to the design of cell phone casing for a famous multinational. It was found out that the company carried on its business by way of entrustment and cooperation, so the copyright and patent right in the products it had designed were in a very complicated relation. There are nine types of agreements on the ownership of the rights. Some are clearly defined and easily dealt with; some are quite uncertain. For example, it is agreed in a type of contract that before the entrusting party pays off all the design fees, the entrusted party owns all the copyright and patent right; after pay-off of the design fees, the former enjoys the intellectual property rights in the designs it accepted. In respect of any design entrusting party does did not accept, the latter was entitled to control them in six months. But it must have the former's approval in writing before assigning them to a third party. In this case, the entrusting party must give its reply within a week, otherwise, the entrusted party may dispose of them. On the surface, the entrusted party enjoys the intellectual property right in the designs the entrusting party did not accept, and the entrusted party's application for patent for, and registration of, the copyright in the designs are legitimate and valid, and the proprietors, in name, of the intellectual property rights in the designs not accepted. But, in fact, it has to get approval of any assignment of the rights from the entrusting party who has the absolute right to disapprove it. For this reason, its intellectual property rights are extremely uncertain, and the entrusted party cannot freely assign the intellectual property rights in the designs. Worse still, owing to the loss of some records or documents in the company, it is impossible to identify the real proprietor of the patent applied for and the copyright registered in the name of the company. Given that the intellectual property rights concerned were in such an uncertain state, this writer suggested not carrying on the buy-off after the intellectual property investigation with due diligence was made. The client took his suggestion, and gave up the deal in the end.

 

5. Examine the extent of the intellectual property rights to determine whether they can serve your client's buy-off purposes and whether they can be effectively carried out by your client.

 

Take the invention patent for example, the intellectual property investigation with due diligence should not only find out whether a target company owns an invention patent, but also look into the extent of protection for it. Cases are not rare in which buyers give up buying out enterprises due to inadequately written claims of patent. The inadequately written claims of patent would render the extent of claimed protection too narrow, resulting in competitors, easy circumvention of the patent and causing furious competition in the market place. In situation like this, the expected long-term economic and strategic value of the patent would not be as high as it looked in the market place at the time of buy-out. Once a competitor finds an alternative to a patented process after study of the disclosed patent description, one would lose its competitive edge. Besides, as for the patents or patents to be granted which are badly needed in the buy-out of an enterprise, study should be done of the prospect of their grant or possibility of their invalidation after the grant, and it should also be found out whether the exploitation of the patent requires a competing enterprise's licensing any other kernel patent even if the valid patent is made available. If such possibility exists, the price and necessity of the buy-out must be re-assessed.

 

During the intellectual property investigation with due diligence, the trademark examination is focused on whether the scope of the goods on which the registered trademark is used covers the business to be undertaken by your client and whether the target company owns the exclusive right to use the trademark your client expects to have to open its overseas market. The target company's exclusive right to use a trademark should be differentiated from the right to use a trademark obtained from a third party. In the latter case, whether the target company has the right to re-license the trademark must be examined. If it does not have the right, you should try to get the trademark license from the original holder of the trademark, otherwise the buy-out may miscarry. Even at the time of buying off the shares, attention should be paid to whether the trademark licensing agreement has set forth the terms that trademark license would be recalled in the case of change of shareholders.

 

Suppose that when a company buys out the property of a Lenovo's sub-company for the purpose of attaching the "LENOVO" trademark to its own computer products, but the said sub-company has, in fact, been licensed to use the "LENOVO" trademark, and does not have the right to license another person to use it, the intended buy-out would not serve the purpose.

 

6. Find out whether a target company has ever infringed any other person's intellectual property right.

 

Enough attention should be paid to avoid the circumstance in which one suddenly finds itself infringing someone else's intellectual property. To this end, when making intellectual property investigation with due diligence, it should be found out whether the target company is involved in any intellectual property lawsuit or dispute with someone else or whether any other circumstance possibly exists of infringement of another person's intellectual property right. After you get the relevant information, the evaluation is then made of the impact of the lawsuit on the target company's business and the possible consequence of the potential dispute. If the circumstance does exist in which the target company infringes another person's intellectual property right, you should carefully weigh upon the purpose of the buy-out and the consequence of the infringement. Foreign businesses do care about the legitimacy of the target company's business operation. In the cases of buy-out in which this writer has acted as an attorney, examination has been made of whether the target company has obtained its design software, CAD software, and even office software for daily use from legitimate sources.

 

7. Prepare report of intellectual property investigation with due diligence.

 

The report of intellectual property investigation with due diligence should delineate all the facts, show the problems and risks, and present the preliminary solution on the basis of the facts.

 

Negotiate on intellectual property right and prepare purchase agreement

 

After making the intellectual property investigation with due diligence, the intellectual property attorney should, in the subsequent IP-related negotiation, further determine the structure of the trade of the intellectual property right, prepare the relevant terms on the trade for the buy-out agreement to ensure safe transaction.

 

When the seller sells only part of its business, the negotiation should be conducted on the intellectual property trade structure, make clear the part of intellectual property right to be or not to be sold, and decide on the scope, and mode of use, of the intellectual property right the buyer is going to obtain and on those of intellectual property right the target company continues to use.

 

The buy-out agreement must contain terms relating to the target company's statement and guarantee on the intellectual property right. The more rigorous and detailed the statement and guarantee are, the more the buyer will benefit from them. Only by making the intellectual property investigation with due diligence is it possible to design the practical statement and guarantee to ensure that the buyer will get its expected intellectual property right. Although they cannot be posed against a third party, the statement and guarantee will urge the target company to honour its commitment.

 

However, it is far from enough to depend only on the statement and guarantee or on a statement of a right and giving up the right. Under the intellectual property system in China, any patent and trademark assignment does not take effect unless it is approved by the Patent Office or the Trademark Office, and a patent or trademark licensing contract can be posed against a third party only after registration. Though it is not necessary to be approved by the copyright administration, a copyright assignment with registration with the copyright protection centre, and publication of change of the copyright proprietor will be more trustworthy, and the right in point be in a more stable legal status. Therefore, when conducting intellectual property negotiation and preparing the purchase contract, you should see to it that the intellectual property assignment contract' taking effect or the licensing contract's being registered is regarded as one of the pre-conditions of the whole deal.

 

Statutory requirement for a right transfer to take effect

 

It needs to be noted that after the buy-out of an intellectual property right is approved by the relevant intellectual property authority and the intellectual property right transferred to a new company, the new company becomes the true owner of the intellectual property right. Timely registration of all changes of the ownership of the intellectual property right is of crucial importance to the protection of the validity and exploitation of the intellectual property right. Accordingly, to prove that a new owner of a patent, trademark or copyright is the owner of the registration thereof, it is necessary for the buyer to prepare a separate assignment document for each intellectual property right to be filed with the relevant authority responsible for approval and registration.

 

This writer once worked as an attorney in a case in which the intellectual property attorney did not participate in the early stage of buy-out and the buy-out documents were improperly prepared, which made a smooth assignment of the intellectual property impossible. The two parties prepared only one intellectual property assignment contract to cover both the patent and copyright, without being aware that different authorities are responsible for the approval and registration of the patent and copyright assignment, and without knowing that the Patent Office requires a patent assignment contract be concluded for each patent. It is the intellectual property attorney's basic general knowledge that one general contract should not be used to cover all patents to be assigned.

 

The author: Chen Rong, Attorney-at-law of the Beijing Han Kun Law Office.

Email: estella.chen@hankunlaw.com

Zhang Wei, Graduate in the MA program in International of the Foreign Affairs Institute.