In Credit Index v. Riskwise Int'l.,4 the New York Supreme Court found Credit Index satisfactorily alleged a cause of action for breach of contract against Riskwise's acquiror Reed Elsevier. In that case, Reed Elsevier had purchased the shares of Riskwise, which, along with its affiliates, was restricted from selling certain products to direct marketing customers pursuant to an agreement between Riskwise and Credit Index.
The court noted that "a number of cases support [Credit Index]'s contention that a nonsignatory entity may, by virtue of its subsequent creation or acquisition of a signatory to an agreement, be considered an 'affiliate' within the meaning of the agreement, and be bound by the noncompetitive provisions therein."5
Buyer Beware
When a target's contracts purport to bind its affiliates or subsidiaries, the ramifications of an acquisition of or substantial investment in the target may be significant. Put simply, license provisions that apply to affiliates and subsidiaries may "infect" a buyer's businesses. Buyer may find that its—and its affiliated entities'—intellectual property is unexpectedly subject to an outgoing license grant on terms it did not negotiate with a party to whom it may not want to be a licensor. Among other things, such a license can weaken a buyer's defensive position in industries where large patent portfolios keep litigation in check through the application of "mutually assured destruction" principles.
When identified during the due diligence process, such forced license provisions also may dampen buyer's interest in, and the economics of, the potential acquisition or investment. A buyer must consider not only the present effect on its businesses, but also whether these provisions may impact its interest in other potential target companies (who would become "Affiliates" of the target) and hamper its ability to eventually divest the signatory to the license agreement (or even buyer's other affiliated entities) at an attractive price.
Protection in Agreement
It is a truism that there is no such thing as perfect due diligence. Whether as a result of imperfect information, target's failure to disclose, or the mistaken belief that a particular agreement was not material, it is always possible that buyer does not identify broad licenses before the consummation of the contemplated transaction. Accordingly, a prudent buyer should consider including in the purchase or merger agreement a representation by the target—backed, in the case of a private company acquisition, by an indemnification obligation—that offers some measure of protection against the adverse impacts of the target's contracts on the buyer.
Increasingly, buyers include a variation of the following representation in acquisition agreements:
Effect on Purchaser. Neither the consummation of the Transactions nor the negotiation, execution, delivery or performance of the Transaction Documents will result in any of the following pursuant to the terms of any Contract to which Company or a Subsidiary is a party or by which their properties or assets are bound: (i) the grant, license or assignment to any Person of any interest in or to, the modification or loss of any rights with respect to, or the creation of any Lien on, any Company Intellectual Property or any Intellectual Property owned by or licensed to Purchaser or its Affiliates prior to Closing, (ii) Purchaser or its Affiliates, or the Company or the Subsidiaries, being (A) bound by or subject to any noncompete or licensing obligation, covenant not to sue, or other restriction on or modification of the current or contemplated operation or scope of its business, which that Person was not bound by or subject to prior to Closing, or (B) obligated to (1) pay any royalties, honoraria, fees or other payments to any Person in excess of those payable prior to Closing, or (2) provide or offer any discounts or other reduced payment obligations to any Person in excess of those provided to that Person prior to Closing.
While indemnification may be useful in the context of a private acquisition, it may not provide all the protection a buyer may need. Additionally, indemnification is generally not available in public acquisitions. Therefore, in addition to including, for indemnification purposes, a representation like the one noted above, a buyer should focus on closing conditions applicable to the accuracy of this type of representation. In most acquisition transactions, closing conditions regarding the accuracy of representations tend to exclude inaccuracies that are not material to the target as a whole. However, for a representation of this type to be a meaningful closing condition, it would need to be accurate as written and not subject to any broad materiality qualifiers.
Daniel Glazer is a partner and co-head of the technology transactions group and David Shine is a partner and co-head of the M&A group at Fried, Frank, Harris, Shriver & Jacobson. Jason Greenberg, a corporate associate at the firm, assisted in the preparation of the article.
Endnotes:
1. 586 F.3d 980 (Fed. Cir. 2009).
2. Some courts have found that after-acquired affiliates are covered by such a license grant even absent a temporal reference in the definition of "Affiliate"; see, e.g., IP Co. v. Cellnet Technology, 600 F.Supp.2d 1351 (N.D. Ga. 2009).
3. Id. at 991.
4. 192 Misc.2d 755 (2002)
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