An article in Chinese by Chang Wenfen, General Manager of Shenzhen Jiaqin IPR Service and Chief Legal Officer of JW Insights. Editing in English by David Du
Acquiring foreign IP through overseas mergers and acquisitions (M&A) has become a common way for Chinese companies to accelerate their business growth and quickly improve competitiveness in the global market. Often IP issues are complex and could be risky if not handled properly.
In the past, M&A activity's primary focus was to obtain control over a business. That focus has now shifted to intellectual property (IP). With the rapid advancement in science and technology, intangible assets, such as IP, become key to business success. International laws and treaties, such as the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS), have provided a better environment for IP protection. As a result, 2018 saw a twofold increase in IP-based M&A transactions worldwide compared to ten years ago. For example, 53% of the M&A deals with German carmakers in China over the past decade involve 100 or more foreign patents.
In 2004, Lenovo, a Chinese personal computer (PC) maker, bought IBM’s global PC and laptop business in a $1.25 billion deal. Under their agreement, Lenovo was given the right to use the IBM brand and integrate with its operations. This allowed Lenovo to scale up its global reach while exploring world-class technology and better business strategies.
IP issues in M&A are inherently complex. They involve, among other things, transferring, realigning, using, and commercializing IP assets. IP issues can be risky and give rise to unexpected results if not handled properly.
In 2001, Holley Group, a Chinese electric meter producer, acquired the code-division multiple access (CDMA)-related operations of Netherland’s Philips Electronics. According to their agreement, Philips would transfer all its CDMA-related R&D results, equipment, assets, and IP to Holley Group. Its CDMA staff would move to Holley Group’s U.S.-based company, Holley Communications USA. However, Philips was bound by a separate cross-licensing agreement with Qualcomm before the acquisition. Under the agreement, IP transfers would not affect Philips’ undertaking of their cross-licensing arrangement. Consequently, Holley Group had to pay Qualcomm royalties for implementing its CDMA-related patents cross-licensed to Philips.
In another example, TCL, a Chinese electronics company, and Thomson SA, a French electronics company, reached a deal in 2003 to form a joint venture called TCL-Thomson Electronics Corporation (TTE). Before the merger, Thomson had more than 34,000 patents related to TV and DVD sets, the second-largest global patent holder, contributing around a 400-million-euro ($486 million) royalty each year. Besides patents, it was also the owner of several well-recognized brands, including Thomson and RCA. TCL planned to take advantage of Thomson’s patent strength for its global expansion. However, under their agreement, Thomson’s contributions did not include its TV-related patents or trademarks, nor did TTE have the ownership or right to use those patents or trademarks. TTE had to sign separate licensing agreements with Thomson to pay royalties to use Thomson’s proprietary IP. However, it is only possible if TTE could meet the minimum sales targets set out in their agreement.
It is not uncommon that neglecting IP issues leads to adverse consequences or even failures in Chinese companies’ overseas M&A deals. To rule out IP-related risks, Chinese companies could take the following four steps.
Step 1: IP due diligence. It is an exhaustive investigation of a target company’s IP assets, including:
Ownership,
Validity,
Expiration Date,
Licensing status,
Whether there is any pledge or encumbrance to the title, and
Whether there are any IP claims or threats.
IP due diligence is the most important among the four steps, which is decisive in making a successful deal. It helps to reveal IP issues that are detrimental to a deal or susceptible to claims. Companies should also examine any prior agreements or contracts entered into by the target company.
Step 2: IP valuation. It is the process to determine the value of an IP asset, which can be measured by future economic returns to its owner or authorized user. IP is not only rights vested by law or contracts but intangible assets. It can bring significant benefits to a business and be traded as commodities. Typically, three methods are used for IP valuation: The replacement cost method, the market method, and the income method.
According to a World Intellectual Property Organization (WIPO) document:
“Cost method is based on the intention of establishing the value of an IP asset by calculating the cost of developing a similar (or exact) IP asset either internally or externally... Replacement cost contemplates the cost to recreate the functionality or utility of the subject IP, but in a form or appearance that may be quite different from the subject IP.”
“The market method is based on... the actual price paid for a similar IP asset under comparable circumstances.”
“The income method values the IP asset on... [the] economic income that the IP asset is expected to generate...”
Step 3: IP execution. It deals with negotiations and the subsequent agreement for IP transfer. The process involves identifying transactional types, developing the right licensing and purchasing contracts, and drafting and communicating specific IP terms. The agreement should contain the target company’s representation and warranties regarding its IP assets, such as the IP scope. It should also specify how to carry out the transfer, including but not limited to filing, registration, and any changes to ownership.
Step 4: IP integration. Due to their different IP strategies, the acquiring and target companies may have IP assets in different fields or types. As such, the acquiring company needs to realign its IP strategy and business considerations to maximize the value of the target company’s IP addition.
It is crucial to take IP issues seriously throughout the M&A process. Chinese companies looking to go global should develop a strategic IP plan containing due diligence, valuation, execution, and integration. For better or worse, the lessons they learned the hard way may help them strike better deals in the future.
