All corporate transactions involving intellectual property (IP) assets – e.g., mergers, acquisitions, public or private offerings, licenses, and partnering/development/distribution agreements – require IP-specific due diligence. The party conducting the diligence varies – e.g., licensee, partner, investor, or underwriter – but the task is always to ascertain the scope and strength of the Target's IP, as well as to understand risks, rewards, and costs of the underlying business transaction. IP due diligence can be expensive and time-consuming and is typically viewed as part of the overall transaction cost. While successful completion of IP diligence is typically a condition of closing, it should be conducted early enough to allow for any necessary course correction. Given invariable budget and time constraints, the following are five essential questions when conducting IP due diligence:

1. Identify all owned and/or licensed IP, along with their status and correspondence to products.

Targets generally hold an assortment of IP rights. Comparing publically available records (e.g., at the Patent and Trademark Office) with Target-provided listings is a good first step. However, diligence should also identify the properties most relevant to commercial products. These properties should be a focus in diligence because they usually have the greatest value. In some cases, the answer will be clear – for example, the “Orange Book” patents for an FDA-approved pharmaceutical or the registered trademark name of a commercial product. Other answers may be more difficult to evaluate, for example regarding trade secrets or manufacturing processes.

2. Are you aware of any information that might make your IP invalid or unenforceable?

Diligence includes evaluating the strength of Target's IP. For example, a granted patent might turn out to be invalid because of previously undiscovered prior art such as public disclosure of an invention before a patent application was filed or omission of key, enabling steps from the patent application. Additionally, given the flux in US law regarding what subject matter is patent-eligible, what once was thought squarely eligible may now be ineligible because it is too close to a “naturally occurring” phenomenon or a mere “abstract idea.” Inequitable conduct is another issue to consider: fraud or intentional withholding of material information from the US Patent Office could render Target's patents unenforceable. While outright fraud is rare, problematic situations raising questions of enforceability are not uncommon. The Target refusing to affirm that it is not aware of any information that their IP is unpatentable, invalid, or unenforceable is a red flag.

3. Provide documentation of ownership or licensed rights.

Trust, but verify. Patent assignments are typically recorded at the USPTO. When missing, they should be obtained and recorded. Licenses, however, are generally not public and are therefore more challenging to track. For public companies, SEC filings may contain redacted versions of significant licenses. For private companies, and undisclosed licenses, ask the Target for copies of the relevant documents. Determine the scope of the rights granted. Exclusive rights are generally worth more than non-exclusive rights. Also, check if the rights are assignable in the course of the anticipated transaction and are sublicensable in the future. Many licenses contain restrictions that are easily overlooked. Non-license documents can also be important to understanding the big picture. For example, employment and consulting agreements can be as important as assignments and licenses in understanding ownership.

4. What is your “freedom to operate?” Are you aware of any third party IP that may be infringed, and have you received notice from a third-party or obtained a formal or informal opinion from counsel in the past?

Diligence should anticipate and mitigate litigation risk. After all, the ultimate barrier to the transaction may be third-party IP. While patents provide a right to exclude others, they don't guarantee that others won't have the right to exclude you. That's why it is important to determine not only whether the Target has IP protection for its business, but also whether it has “freedom to operate” (FTO) over any third party IP. Target should be able to identify and summarize their position with respect to any relevant third party IP – sophisticated companies usually monitor the patent landscape, but an independent FTO analysis is sometimes necessary. Target should also disclose any third party threats such as “cease-and-desist” letters. Targets are generally reluctant to disclose opinions of counsel (e.g., with respect to potential infringement of a third party patent) due to the risk of waiving attorney-client privilege. A common interest agreement may allow sharing while minimizing the risk, but the more common approach is to gather the underlying facts and form your own opinion.

5. Have you been involved in, or do you anticipate, any IP-related disputes?

Beware of “buying a lawsuit.” Legal disputes are costly, time-consuming, and create uncertainty. Litigants tend to be more aggressive when they have the most leverage, e.g., right before Target files for an IPO or enters into a business-critical agreement with another party. Even a hint of possible litigation should be scrutinized.

Moving the Transaction Forward

These questions are just a start – additional questions will be necessary based upon the objectives of the parties and the nature of the transaction and underlying IP. Once all questions have been addressed and the answers analyzed, will the transaction go forward and on what terms?

The impact of IP due diligence can be tremendous. Fraud, infringement, lack of freedom to operate or IP ownership can kill a deal. More often, the consequences include price and term adjustments, special indemnities for breach of representations and warranties, patent infringement insurance, or deal earn-outs. Indemnifications, representations, and warranties are often viewed as “boilerplate” and their distinctions are overlooked – be careful not to fall into that trap. These provisions are critical because they can allocate risks and resolve specific issues.

Finally, many problems uncovered during IP due diligence are resolvable. Common remedial actions, which can occur post-closing or be a condition of closing, include: executing and recording assignments, amending and updating licenses, and filing and adapting IP applications. Changing IP counsel is often a part of moving forward, especially when developing and implementing a new IP strategy, or new legal and technical expertise, is indicated.

Konstantin M. Linnik, Ph.D., is a partner at Nutter McClennen & Fish LLP. He works with biotechnology and pharmaceutical companies on various matters involving intellectual property. He is a former Senior Corporate Counsel at Pfizer.

Isaac A. Hubner, Ph.D., is a former associate at Nutter McClennen & Fish LLP, and is currently an in-house patent counsel at a global biopharmaceutical company.