Merging Intellectual Properties among Equals

When medtech companies of similar size merge, company executives need to work extra hard to identify and balance potential IP risks.

Merging Intellectual Properties among Equals


(click to enlarge) Photo by ISTOCK

In today's medical device industry, many deals involve the merger of similar-sized companies or the acquisition of one company by another of similar size. Often an exit for the investors and management teams that created and built the merging companies, such mergers and acquisitions (M&A) can raise important issues related to companies' intellectual property (IP) holdings.

Because of the comparable sizes of the companies, such mergers and acquisitions are fundamentally different from those involving a large medtech company that merges with or acquires a start-up or a smaller medtech company. A thorough understanding of the sources from which intellectual property issues may arise in such transactions can enable medtech executives to identify methods of sharing IP-related risks and ensure that the deal can be completed.

Identifying the Risks

Two goals of any IP due-diligence process are to identify risks associated with the patent rights to be acquired and to identify risks associated with any third-party patent rights. Although these goals apply to all M&A transactions regardless of company size, the types of records most likely to reveal IP risks can differ according to the size of the companies involved in the transaction.

For risks associated with the patent rights to be acquired in a medical device transaction, the seller's patent portfolio and agreements with third parties are among the most fertile areas. For risks associated with a third party's patent rights, the areas most likely to prove fertile include the seller's product development process, opinion letters from the seller's counsel, and any cease-and-desist letters received by the seller.

Seller's Patent Portfolio

Any medtech company larger than a start-up generally has at least a modest-sized patent portfolio. Prior to any potential merger or acquisition, it is essential that the seller's portfolio be scrutinized. First, the overall portfolio should be analyzed to determine its general strength and scope. This generally involves determining the areas in which the company holds patents and analyzing the collective claims of those patents to determine their relative strength and scope.

Next, the examiners should conduct a similar strength and scope analysis for each of the seller's key patents on an individual basis. The patents selected for examination should include all those that cover key products manufactured or sold by the company, and those that prevent or limit others from practicing a certain technology. In particular, the examiners should review and analyze the prosecution histories of these key patents—including the company's communications with the patent office—to determine whether the arguments made to obtain allowance of the patent claims place any limitations on the scope of the protection offered by the patent.

Although sometimes overlooked, pending patent applications are another source of possible risk. Of particular concern are any positions being taken with respect to prior art (which could include the buyer's intellectual property) that would make it more difficult to integrate the buyer's and seller's patent portfolios once the merger or acquisition is complete.

At the time of a merger or acquisition, for example, it is likely that both the buyer and seller have pending patent applications in the same technology areas. But during the prosecution of their respective patent applications, each party may have taken a different position with respect to the same prior art. Upon completion of the merger or acquisition, these positions could prove to be problematic now that the buyer and seller are the same company. In such a situation, one solution might be for the newly merged company to forgo the claims of one patent in favor of the other.

Agreements with Third Parties

In most instances of medtech M&A activity, it's a fair bet that the seller's business is more sophisticated than that of a start-up company. As a result, it is likely that, over time, the seller has entered into a number of agreements with third parties that could limit the transfer of its patent rights or inhibit the buyer from utilizing those rights. Such agreements may describe a wide range of activities, and might include financing agreements, joint-development agreements, licensing agreements, comarketing agreements, and so on.

When considering a merger or acquisition, the buyer should analyze any financing agreements the seller may have entered into with multiple third parties, in order to determine the scope of any patent rights that might have been granted to the investing entities. Similarly, the buyer should analyze the intellectual property ownership and transfer provisions of any joint-development or distribution agreements, in order to determine their impact on the transfer or utilization of patent rights.

Agreements in which the selling party of an M&A deal has licensed the IP of a third party pose significant risks on multiple fronts, any of which could serve as barriers to the deal. To begin with, such agreements may impose long-term financial obligations on the buying company in the form of royalties or other payments. Such obligations must be taken into account when the overall value of the company being acquired is being determined.

Another concern is that the assignment provisions of the seller's licensing agreements may determine the extent to which the rights granted by the license can be transferred to another party as part of a merger or acquisition. Of special importance are any agreements in which the seller has licensed a third party's intellectual property rights, thereby allowing the seller to manufacture or sell a key product. Unless the terms of the agreement permit the license to be transferred as part of a merger or acquisition, the buyer could ultimately be foreclosed from manufacturing or selling the key product in question. In such instances, one possible solution is to make the M&A deal contingent on the buyer negotiating a new license agreement with the third party. When this approach is adopted, the cost of negotiating and obtaining the new licensing agreement can be factored into the deal agreement in the form of set-asides.

Conversely, the buyer should also examine any agreements in which the seller's intellectual property has been licensed to third parties, in order to determine the scope of rights granted and the ability to transfer those rights in the context of a merger or acquisition. It is essential to determine whether intellectual property has been licensed to any of the buyer's key competitors. When the company being acquired is a start-up, such an agreement could pose significant barriers to completing the deal, because the IP licensed to the third party may be the only such properties involved in the deal. By contrast, when an M&A deal involves two companies of similar size, it is likely that the deal spans a variety of different product lines and markets. In this context, the buyer may find it easier to accept the fact that a key competitor holds a license relating to a product or market, especially if they are not considered essential.

Product Development Process

When a medtech M&A transaction involves companies of size and sophistication beyond the level of start-up companies, it is likely that they have incorporated some form of screening process for third-party patents into their product development processes. The use of such a screening process for third-party patents is typically carried out early in the product development process, long before a new medical device ever approaches its commercial launch. The goal of such a process is to identify third-party patents that could pose a risk to a product under commercial development.

During the due diligence conducted as part of an M&A transaction, the buyer should be made aware of any potentially disruptive third-party patents previously uncovered during the seller's patent screening process. To ensure that such knowledge is transferred fully, and that the risks of any previously identified third-party patents are weighed appropriately, it is essential that the buyer understand the format and structure of the seller's patent screening process.

For example, some companies utilize their engineers to conduct an initial search for relevant third-party patents. Any relevant third-party patents requiring further review are then forwarded to the company's IP counsel for a more complete evaluation. Other companies may forgo the use of their engineers, preferring to outsource the entire process to outside IP counsel.

In any case, the buyer should always conduct an independent review of the risks associated with third-party patents through a product clearance or freedom-to-practice analysis. Such an analysis involves identifying the products to be cleared, searching issued patents and published applications, and assessing the risk that any of the products may infringe any relevant patents.

Identifying any potentially disruptive third-party patents uncovered during the earlier patent-screening process is essential. This step enables the buyer to gain an understanding of any positions developed by the seller with respect to the identified third-party patents, and whether any of those positions have been memorialized. Such memorialized characterizations of third-party patents not protected by the attorney-client privilege or work-product immunity could pose problems in subsequent lawsuits involving the identified third-party patents.

For example, e-mails exchanged between two of the seller's engineers on the subject of whether the seller's product falls within the scope of the third party's patent could serve as the basis for a willful infringement claim, thereby trebling the damages awarded in a patent infringement lawsuit. In some instances such positions or characterizations may be memorialized in an opinion of counsel, a subject that is addressed more fully below.

Opinions of Counsel and Cease-and-Desist Letters

It is also essential that the buyer review and analyze any opinions rendered by the seller's attorneys regarding potentially disruptive third-party patents. The buyer's analysis of these opinions should focus on two areas. First, the analysis should focus on the third-party patents identified and the strength of the positions set forth in the opinions. Second, the analysis should review the opinions to determine whether the positions set forth with respect to the third-party patents differ from those taken by the buyer in its own opinions of counsel. Such differences could become an issue in a later patent infringement action when determining whether to waive opinions of counsel in response to a charge of willful infringement.

In the same way, the buyer must obtain and study any correspondence with third parties regarding potential patent infringement by the seller. The correspondence should be reviewed to identify the nature of the third party's claims, the seller's responses to those claims, and any potentially damaging statements made by the seller.

Sharing the Risks

The dynamics of a deal involving two medtech companies of similar sizes are inherently different from a deal involving a large medtech company acquiring or merging with a smaller or start-up company. For example, it is easy to understand how a large medtech company could enjoy certain leverage over a smaller medtech company or start-up company. In a deal involving two medtech companies of similar size, however, it is not always clear which company has the greatest leverage. In fact, it is likely that neither party maintains a strong upper hand.

Such dynamics can affect the selection and employment of mechanisms that are designed to share IP risks identified during the due-diligence process. The mechanisms utilized to share IP risks typically include patent holdbacks, special indemnifications, and freedom-to-practice holdbacks. While remaining viable options for a deal involving companies of similar size, these mechanisms need to be tailored in light of such similarities.

Patent Holdbacks

A patent holdback is generally created by a provision in the M&A agreement that holds back a certain amount of the purchase price to address any future patent claim brought by a third party against a product involved in the deal. Normally, the buyer releases a portion of this patent holdback on certain anniversaries of the product's commercial release date, unless a third party brings a patent claim against which the funds need to be applied.

Because a deal between two medtech companies of similar size may include a large number of products that are already commercially available, the traditional application of a patent holdback may need to be modified. Instead of tying the release of monies to the anniversaries of commercial release dates, for instance, the release of monies could be tied to the anniversary of the deal.

By contrast with deals involving a very large company and a significantly smaller company, in many deals between companies of similar size it is likely that the amount of the holdback may be smaller and the length of time the money is held may be shorter. This reflects the fact that some time may already have passed since the commercial release of the products involved in the deal, so the relevant third parties have already had an opportunity to consider whether any of the products infringe their patent rights.

Freedom-to-Practice Holdbacks

If a significant period is expected to intervene between the closing of the deal and the commercial release of a product involved in the deal, the agreement may include another key provision to address newly discovered patents. Within a certain amount of time after approval of a product for commercial release, the buyer conducts a freedom-to-practice analysis on patents or patent publications issued after the completion of its initial due diligence. If the buyer identifies a freedom-to-practice issue, it consults with the seller regarding any remedial action to be taken.

If the only products involved in the M&A deal are already commercially available, it may not be desirable or necessary to employ freedom-to-practice holdbacks. But if not-yet-released products are part of the deal, the agreement may provide that the seller is responsible for a certain percentage of the costs and expenses related to any remedial action.

When a large company is acquiring a start-up or smaller company, it typically has enough leverage to insist that the smaller company cover the majority of the costs and expenses related to any remedial action. When the companies involved in an M&A transaction are closer to the same size, however, the seller may be able to argue that the two companies are equally sophisticated and capable of bearing the inherent risks associated with any deal. Consequently, the seller may be able to negotiate something more like an even split of the potential costs and expenses.

Likewise, the agreement may further provide that the amount paid by the seller for any remedial action would be capped as a percentage of the purchase price. It is likely that the seller would use the same rationale described above with respect to coverage of costs and expenses to argue for a cap at a smaller percentage of the purchase price.

Special Indemnification for Attorneys' Fees

In the course of an M&A transaction, due diligence may uncover a potential risk associated with a third-party patent, or an ownership issue that could permit a third party to assert an interest in the seller's intellectual property. In a deal involving two medtech companies of similar size, the best option for sharing such risks may be through special indemnification.

For instance, the agreement may note that the seller will be responsible for a certain amount of attorneys' fees incurred by the buyer when defending any such claim up to a certain amount, and then also be responsible for a lesser proportion of the attorneys' fees up to a total capped amount.

A special indemnification helps to balance the risk because it places the burden of uncovering potential issues on the buyer. Thus, identifying all the issues that may fall under a special indemnification requires very thorough due diligence. Otherwise, the buyer may be left financially responsible for failing to identify an issue.


Successfully identifying and mitigating IP risks in a deal involving two companies of similar size requires an understanding of how the dynamics of such a deal are different from those in which a large medtech company acquires or merges with a smaller or start-up company. The ultimate goal of the due-diligence process remains the same: to identify risks associated with the seller's patent rights and any third-party patent rights. But the types of records that can reveal such risks are different, and largely linked to the size of the companies.

Understanding the likely sources of IP risks enables medtech company executives to plan an effective due-diligence process. Consideration of any mechanisms for sharing IP risks requires the executives of both medtech companies to frame the resolution in the context of a deal where both companies are of a similar size--and mutually beneficial cooperation rather than leverage is likely to be the dominant force.

Gregory J. Vogler is a cofounder and shareholder, and Robert A. Surrette is a shareholder, in the law firm of McAndrews, Held & Malloy Ltd. (Chicago).

Copyright ©2008 MX

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