During due diligence, counsel for a prospective acquiror identifies an IP license agreement in which the target company has granted a counterparty a license under "all patents in the Licensed Field owned by target or any of its Affiliates." The license agreement includes a common definition of "Affiliate"i.e., any entity controlling, controlled by or under common control with targetthat expressly includes all entities who qualify as an "Affiliate" on or after the effective date of the license agreement. Buyer's counsel realizes that after the contemplated transaction closes, buyer and its affiliated companies will be target's "Affiliates," such that buyer's and its affiliates' patents in the Licensed Field may be subject to the target's license grant. Because of this "poison pill," buyer immediately puts the potential transaction on hold to evaluate the risk of proceeding.
This article discusses how to identify during the diligence process provisions such as the one described above that can "infect" a company and its affiliated entities, how courts have viewed those provisions, the potential ramifications on buyer and its affiliated entities, and specific protections to include in purchase agreements to guard against the adverse impact of those provisions.
Pre-acquisition legal due diligence on target's commercial contracts (such as property leases, customer agreements and vendor contracts) typically focuses on several common topics, e.g., fees and pricing; change of control and assignment; term and termination; noncompetition and exclusivity restrictions; indemnification; and warranties.
IP licenses warrant additional inquiries, including identifying the licensed IP, the scope of the license grant, and who is granting and receiving the license. Thorough diligence on IP licenses requires an understanding not only of the business deal reflected on the face of these provisions, but also the impact of any embedded references to defined terms such as "Affiliates" and "Subsidiaries." In the context of an IP license, those seemingly innocuous definitions may broaden the scope of licensors and licensees far beyond the agreement's signatories and expand the license grant to encompass additional intellectual property as third parties subsequently enter into transactions with those signatories.
Failure to appreciate the sometimes-nuanced impact of these definitions can lead to overlooking material aspects of the IP agreement. For example, a common grant of patent license reads as follows:
Company hereby grants Licensee a license under the Licensed Patents to make, have made, use, import, offer to sell, and sell products.
Understanding the scope of the licensed IP then requires a review of the definition of "Licensed Patents," which might include "all patents owned, and patent applications filed, by Company and its Affiliates" that cover inventions in a certain specified field of technology.
If "Affiliates" are referenced in such a manner so as to include their patents and patent applications within the subject matter of the license, it is crucial to study the definition of "Affiliate" to determine whether the patents and patent applications of after-acquired affiliates are included. Particular attention should be paid to definitions of "Affiliate" and "Subsidiary" that expressly encompass entities that fall within the scope of the applicable definition only after the effective date of the license agreement.
The Judicial View
In several reported decisions, courts have held obligations to be enforceable against a signatory's affiliates and subsidiaries, including subsequent buyers.
For example, in Imation v. Koninklijke Philips Electronics,1 the U.S. Court of Appeals for the Federal Circuit (applying New York law) held that Philips' grant of a license to Imation and its subsidiaries extended to two subsidiaries that Imation acquired only after termination of the license agreement. In that agreement, "Subsidiaries" was defined to include subsidiaries "now or hereafter owned" by a party.2 The Imation court noted that under New York law, a court must read the plain language of a contract to give full meaning to its material provisions, interpreted as a whole, and to give effect to its general purpose, mindful not to render language superfluous. In this case, giving effect to the plain language led the Federal Circuit to hold that Imation's after-acquired subsidiaries were licensed to use Philips' patents and immune from suit by Philips for patent infringement.
The Imation court observed that parties may draft license agreements in an intentionally expansive manner to "enable the parties to operate in a given area of technology, free of the risk that the other party would threaten infringement." To make this possible in the context of the transaction described in Imation, "the parties constructed licenses with a fluid scope that grew with the acquisition of additional patent rights and a fluid membership that changed as the partiessophisticated corporations operating throughout the worldchanged their corporate structures."3
Similar reasoning underlies the rationale for courts' enforcement of noncompetition provisions against a buyer pursuant to an agreement "inherited" from a target during an acquisition, such that buyer and its affiliated entities are prohibited from engaging in certain competitive activities in which target "and its Affiliates" previously agreed not to engage.