IP and M&A

M&A RISKS Your best defence against IP claims

Traditional R&W policies can fall short of providing claims protections. Here’s why a standalone IP policy is needed…

BY KRISTIAN KOLSAKER AND ANGUS MARSHALL, CFC Underwriting

Intellectual property (IP) has caused a dramatic shift in the valuation of companies. Intangible assets, including reason. The extent to which a company infringes a third party’s IP rights cannot easily be discovered through due IP, now make up anywhere from 70% to 90% of a typical company’s balance sheet. As a result, IP often plays a significant role in an acquisition.

How can buyers protect their investment against IP infringement allegations arising from past or future activities?

When an acquisition takes place, the buyer usually obtains representations and warranties (R&Ws) from the seller regarding the company or assets being acquired. Representations are essentially statements of fact at a point in time. They typically address certain historical circumstances, not future issues. Accordingly, the buyer is usually able to seek indemnity from the seller for a breach of representation only if the issue that caused the breach occurs before the representation is given, and discovered after the transaction has closed.

In most instances, R&Ws will include statements in relation to the target compadiligence; and due diligence will never eliminate infringement risk. This is primarily because of resource constraints in searching for relevant IP rights from a sample of millions; also, it’s impossible to anticipate spurious or opportunistic infringement allegations. Consequently, sellers are cautious in providing broad IP representations in respect of the target company’s infringement of third-party IP. Including qualifiers to representations such as “…to the seller’s knowledge...” and materiality qualifiers are a common way to reduce significantly the ability of the buyer to claim against the seller for a breach of representation. IP insurance offers a solution because it will respond to any allegation of IP infringement, regardless of whether the seller’s representations are limited in any way.

ny’s IP. It’s common for the seller to represent that the operations of the target’s business do not infringe, misappropriate, or violate any other party’s IP rights.

To protect against financial loss resulting from a breach of R&Ws, buyers are increasingly turning to R&W insurance. While this affords IP infringement protection, its extent varies depending on the scope of the IP R&Ws negotiated between the seller and the buyer.

Differences in bargaining positions can affect the scope and breadth of all R&Ws, including IP, which is especially relevant when acquiring a company in a competitive auction. A potential gap can exist between the protections provided under the IP representations (and consequently under the R&W insurance policy) and the exposure brought about by an IP infringement allegation made against the acquired company.

Filling the gaps IP infringement R&Ws are heavily negotiated in transactions, and for good Prospective IP infringement exposures Acquired companies are exposed to IP

infringement allegations that are linked to new business activities, just as they are exposed to allegations related to existing business activities. In what way do these exposures arise?

Often, the purpose of acquisitions is to “scale up.” Typical strategies include developing new products and services to complement or diversify those already sold by the acquired business. New products and services are not only exposed to IP infringement allegations, they’re not typically protected by R&W insurance policies due to the retrospective nature of representations covered under the policy. An R&W policy provides no protection for future IP infringement allegations, which is why a separate standalone IP infringement insurance policy may be of value.

New markets are another potential source of exposure. It’s possible to develop and sell a product or service in one country without infringing a third party’s IP. But as soon as the same product or service is offered in a new jurisdiction, a different set of IP rights and rules apply. This is because IP rights are granted nationally and managed by IP offices in their respective jurisdiction. As a new strategy pursued following the acquisition of a company (so on a prospective basis), it’s unlikely that there is any protection under the R&W insurance policy or, alternatively, that the sellers provided any representation concerning a new product or service. A standalone IP infringement insurance policy can ensure that companies have infringement protection in new territories.

Finally, there is an exposure related to new third-party IP. An allegation that an acquired business is infringing a new patent, granted after the transaction closed, is not something commonly represented, meaning that an R&W insurance policy would not afford any coverage. Fortunately, IP insurance is available to cover infringement allegations relating to new IP rights.

Looking ahead The combination of R&W insurance and IP insurance not only protects the buyer against financial loss resulting from breaches of the R&Ws made by the seller, but also against any IP infringement allegations relating to the target’s new business activities going forward. Plus, it can fill in any gaps where the R&Ws fail to provide sufficient cover in respect of third-party IP infringement allegations.

It can act as a deal facilitator, smoothing the negotiation of IP R&Ws, and provide peace of mind for both the acquisition and integration stages of a transaction.

Kristian Kolsaker is an IP underwriter and Angus Marshall is transaction liability practice leader at CFC Underwriting

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