Authored by Bryan C. Diner, Thomas L. Irving, and Jill K. MacAlpine, Ph.D.
In the fast-paced world of corporate acquisitions, companies considering an acquisition must thoroughly evaluate the target company yet conduct that evaluation fast enough to offer a competitive bid. A key component in today's technology-driven deals is the value of the target company's intellectual property ("IP"). Often however, business managers engage IP lawyers only after having brokered a tentative deal, and then want the IP due-diligence investigation completed in short order—typically in a length of time that does not reflect the proportional value of the IP in the overall deal. The pressure falls on the IP attorneys to thoroughly, yet efficiently, conduct the investigation and advise their client on matters that could impact the deal, both in terms of price and structure. Organisation and experience with such matters are key to the investigation's success.
This article provides a four-phase roadmap for organising an efficient and comprehensive IP due-diligence investigation, including:
- the initial steps of the investigation;
- working with publicly available information before entering the data room;
- considering data room information and other information of the target company; and
- reporting the conclusions and recommendations to the client.
Many of the topics discussed in the article can apply to international deals, without regard to national boundaries and laws. But, where appropriate, we have provided insight into how the U.S. legal system might uniquely affect the investigation, and in some cases, have focused the discussion on the specific issues of concern to pharmaceutical companies acquiring significant assets in the United States.
Before beginning, one should consider a few important "housekeeping" matters that will help organise the team and start the investigation off in the right direction. First, initial discussions with the client should seek to establish preliminary working parameters and guidelines. Many investigations have three common components:
- freedom to use the target company's technology without infringing the IP rights of third parties;
- determination of the scope, validity, and enforceability of the IP protecting the target company's technology now and in the future; and
- clear title to that IP to avoid any later unpleasantries of unexpected future co-owners.1
Understanding the client's time constraints, budget, objectives, and priorities will determine the level of detail of the due-diligence analysis and manage expectations regarding the basic components of the investigation.
A second pre-investigation consideration is the assembly of a due-diligence team. Because the investigations must often occur rapidly, significant resources have to be marshaled in short order, preferably with team members having previous due-diligence experience and appropriate technical ability. For larger investigations, a three-way division of labour usually works well, with one team concentrating on the freedom to operate ("FTO") issues, another on the scope, validity, and enforceability of the target company's IP, and a third confirming ownership of the IP as well as the transferability of relevant IP-based agreements. Appointing team leaders to assess all parts of the investigation can assist in organising and communicating information amongst the teams and to the client.
Unless the acquiring company has already done exhaustive searches, both for validity and freedom to use, a competent and reliable patent search firm should also be engaged. Since it would be preferable to have the same search firm conduct both the freedom-to-operate and validity searches, assurances should be obtained that the firm will have the time and resources to commit once the investigation begins.
Lastly, analysing the issues of freedom to operate, scope of coverage, validity, and enforceability will generate substantial information and pose a significant data-management challenge. To effectively communicate information between members of the investigation team, particularly with large investigations, initial capture of the information in questionnaires or worksheets and subsequent loading of the critical facts into databases specifically designed to highlight the importance of those facts relative to the issues under investigation often works well.
Having taken care of the housekeeping matters, the team should be organised, focused on its objectives, and ready to undertake the investigation.
Phase I: Initial Steps of the Investigation
Once authorisation has been received to start the investigation, the first phase of the investigation entails initiating the patent and literature searches, identifying and prioritising the target company's relevant IP, commencing the ownership analysis of that IP, preparing a common-interest agreement, and drafting of a wish list of documents and information sought from the target company. This and the next phase essentially set the stage for a more involved analysis of the relevant documents and witnesses, which comes in Phase III once the target company permits access to the data room and its employees.
First, the patent search firm should initiate the freedom-to-operate search, since the team can start the validity analysis by analysing documents cited during prosecution of the target company's patents and applications. At this stage of the negotiations, the parties to the potential deal typically have a confidentiality agreement in place that permits access to basic information about the target company's technology. This information will allow the team to establish preliminary parameters for the freedom-to-operate search. Because the search can often take several weeks to complete, the search firm should provide results on a rolling basis so that review of the references can proceed concurrently with the search. Identification of third-party patents that dominate the target company's technology may seriously affect freedom to operate and hence the parties' negotiations. Uncovering such patents early in the investigation, before investing too much time in other aspects of the investigation, has obvious benefits.
Next, the target company's IP should be identified and prioritised to the extent possible. Even before the target company produces its own list of relevant IP, public databases (such as the U.S. and European patent-office websites) can be searched to assemble patents related to the target company's technology of interest. For deals focused on pharmaceuticals, the U.S. Food and Drug Association ("FDA") identifies patents covering a product approved for marketing in the United States in a publication generally known in the industry as the Orange Book. (See www.fda.gov/cder/ob). Copies of relevant patents and pending applications, including file histories, should be obtained and initially analysed. With this information, a well-directed prior-art search can be commenced. The search should also encompass patents and publications, including theses, posters, and lecture summaries, by any of the inventors of the target IP. These documents, sometimes unknown by the target company, tend to be very relevant to the validity of the IP and occasionally predate the target company's patent.
Ensuring that the target company owns all the relevant IP and can convey clear title is critical for the client, particularly when acquiring U.S. patent rights. As mentioned above, absent an agreement to the contrary, co-owners of U.S. patents have no accountability to each other and can license or assign their rights to third parties without the consent of other co-owners.2 Co-owners can even dedicate the patent to the public. Investigating ownership of the target company's IP should begin with publicly available information, including the assignment database on the U.S. Patent and Trademark Office's ("USPTO") website.3 An Internet search of the inventors' background can also provide useful information, particularly if any inventors had an affiliation with organisations (e.g., universities, government agencies, etc.) that might claim an ownership interest in the IP. Inventorship, which is the first form of ownership, needs verification for each inventor, but particularly for those non-employee inventors who may have an obligation of assignment to a third party. Under U.S. law, an inventor has equal rights as a co-owner even if he or she contributed to only one claim of a multi-claim patent.
The sub-group of the team investigating ownership usually also determines whether the target company has made timely payment of maintenance fees to keep the patents in force and whether it has paid the correct fee amounts throughout the examination and post-grant period. In the United States, organisations qualifying as small entities can obtain a 50 percent discount on all fees owed to the USPTO. 37 C.F.R. §§1.27 and 1.20(e)-(g). But paying small-entity fees when a large-entity fee was due could, under certain circumstances, raise issues affecting a patent's enforceability. Ulead Sys., Inc. v. Lex Computer & Mgmt. Corp., 351 F.3d 1139 (Fed. Cir. 2003).
Opinions of counsel and files, including patent-attorney files, relating to freedom to use and/or validity of the target's IP should be reviewed during the investigation. Since privilege claims will attach to those documents, the target company may not grant access to them without an executed common-interest agreement between the parties to ensure that the privilege claims remain intact despite the due-diligence review. In the interest of efficiency and thoroughness, this agreement should be prepared and ready to go as part of Phase I. The acquiring company can later determine whether it needs or even wants to review opinions of counsel.
Creating a preliminary list of documents to review and people to interview can also increase the efficiency and thoroughness of the investigation. Within reason, the target company may accommodate the request and, perhaps, provide notice of potential points of contention. Knowing the contentious issues beforehand could afford the team a chance to resolve them in advance of the data-room visit. A request should also be made for an inventory and an estimate of the number of documents to be placed in the data room to enable adequate planning. Finally, an arrangement should be worked out for copying relevant documents and other information during the data-room visit.
Phase II: Working with Publicly Available Information Before Access to the Data Room is Granted
A detailed review of the target company's IP should constitute a large portion of the second phase of the due-diligence investigation. It will generally flag issues for further consideration when access to the data room and employees for the target company become available. During this phase, the investigation will typically identify the claims of the patents covering the target company's technology and any issues pertaining to the validity and enforceability of those claims.
Assessing the scope of coverage starts with construing the claims of the relevant patents and applications. U.S. jurisprudence on claim construction provides that patent claims be interpreted primarily from the intrinsic record, i.e., the language of the claims themselves, the specification, and the prosecution history. Phillips v. AWH Corp., 415 F.3d 1303, cert. denied, 2006 U.S. LEXIS 1154 (Feb. 21, 2006). Any information not found in the intrinsic record constitutes extrinsic evidence and generally is not favoured when interpreting the boundaries of a claimed invention. 415 F.3d at 1318. Once construed, the claims of the target company's relevant patents should be compared to the target company's technology, and a determination whether any of those claims cover that technology should be made. This exercise will yield a list of claims to evaluate for validity and enforceability.4 It may also highlight weaknesses in one or more claims that third parties could exploit in designing non-infringing alternatives. Of course, such information could affect the value of the patents and ultimately affect the deal.
Next, the validity of the target company's relevant patents should be assessed. An assessment of the novelty and non-obviousness of the relevant claims should, as mentioned, begin with the art cited during prosecution and be supplemented and updated continuously as the prior-art search results roll in. Compliance with the formal requirements for patent specifications must also be confirmed. In the United States, 35 U.S.C. § 112, first paragraph, requires that the specification set forth a sufficient written description of the invention that enables one skilled in the art to make and use the invention as claimed. Those requirements seem common among the patent laws of many countries. But section 112 has an additional component, which is unique to the United States, requiring that the specification disclose the best mode each of the inventors knew for carrying out the invention at the time the application was filed. Id. Best-mode issues, however, typically do not surface at this stage of the investigation because best mode has a subjective element. That subjective element necessitates at least a review of internal documents and typically requires direct communication with the inventors to determine if they subjectively contemplated a best mode—activities primarily reserved for phase III when access to the data room and the inventors becomes available. In that regard, it is worth noting a few salient points: Only if the inventors contemplated a best mode does an analysis of the specification occur to determine whether it adequately discloses the best mode. Second, commercial details do not necessarily relate to the best mode.
Another validity issue receiving a lot of attention recently, especially in the pharmaceutical area, is obviousness-type double patenting. Arising out of U.S. jurisprudence, obviousness-type double patenting is used by courts in situations where, for example, the invention claimed in a patent or application constitutes an obvious variant of the claimed invention of a separate patent. See, e.g., M.P.E.P. § 804. In that instance, allowing two patents to enjoy full patent term would, according to the rationale of double-patenting jurisprudence, unfairly extend the exclusionary right conferred by patents.5 In an era where pharmaceutical companies are concerned with pharmaceutical life-cycle management, continually filing improvement patents on a basic product invention draws criticism by some for "evergreening" the product and patent portfolio.
Obviousness-type double patenting can be addressed either by showing that the patents claim patentably distinct subject matter or by filing a terminal disclaimer. See, e.g., M.P.E.P. § 804.02. A terminal disclaimer essentially causes the patents to expire on the same day and requires them to remain commonly owned throughout their term.6 With valuable and highly profitable pharmaceutical products, reducing the patent term will significantly affect the value of the IP and consequently the deal.
Questions of enforceability, such as inequitable conduct in the procurement of a patent, arise fairly often in contested matters in the United States. Inequitable conduct can occur, for example, when a patent applicant intentionally fails to submit material information to the patent examiner. Dayco Prods., Inc. v. Total Containment, Inc., 329 F.3d 1358, 1363 (Fed. Cir. 2003). Information is deemed material if an examiner would have considered it important in allowing the application to issue as a patent. Id. Not many countries, other than the United States and Australia, consider such enforceability issues for patents. In the United States, a finding of inequitable conduct is devastating. It will render an otherwise valid and infringed patent totally unenforceable. PerSeptive Biosystems, Inc. v. Pharmacia Biotech, Inc., 225 F.3d 1315, 1322 (Fed. Cir. 2000) (stating that a patent may be valid and yet be rendered unenforceable due to inequitable conduct). Unlike validity, which courts adjudicate on a claim-by-claim basis, inequitable conduct will render all claims unenforceable even if the conduct pertained only to one claim in the patent. Surfacing an enforceability issue during the due diligence process, therefore, can have a significant impact on the overall deal. These issues are primarily flagged in this phase to further consider and evaluate in the Phase III, when access to documents and key witnesses become available.
When studying the specifications and file histories of the target company's patents, the team should consider whether the patentees cited material prior art, especially from a related cases in the portfolio under investigation, and whether they cited related cases that could form the basis of a double patenting rejection. Recently, the U.S. Court of Appeals for the Federal Circuit ("CAFC")7 indicated that rejections made in office actions in a copending application containing substantially similar claims may be material and may have to be submitted to the patent examiner. See, e.g., Dayco Products, Inc. v. Total Containment, Inc. 329 F.3d 1358 (Fed. Cir. 2003) (holding that a copending application is "highly material to the prosecution of [an application, where] it could have conceivably served as the basis of a double patenting rejection," as is a contrary decision of another examiner reviewing a substantially similar claim). Accordingly, for purposes of assessing enforceability issues during a due-diligence investigation, consideration should be given to whether office actions in related cases are material.
But the duty of disclosure goes even further. Examples written in the past tense and statements regarding advantageous properties of the invention made in the specification and/or during prosecution should be highlighted at this stage for later verification of support. See, e.g., Hoffman-La Roche, Inc. v. Promega Corp., 323 F.3d 1354 (Fed. Cir. 2003) (description of a prophetic example in the past tense held to be an affirmative misrepresentation). Information from litigations in related patents, including both foreign and domestic, can also be material to the examination of an application.8 As such, the investigation seeks to identify past or pending litigations related to the portfolio under review to determine whether the existence and/or information from any uncovered litigations was or should have been submitted to the USPTO.
For some, the practical effects and consequences of the CAFC's decisions regarding inequitable conduct may seem harsh and out of touch with the realities and complexities of prosecuting patent applications. Relief may have arrived, however, in the court's recent decision in the case of Purdue Pharma L.L.P. v. Endo Pharmaceuticals, 2006 U.S. App. LEXIS 2887 (Fed. Cir. Feb. 1, 2006). In that case, the CAFC vacated its decision of unenforceability regarding a patent covering the well-known pain reliever, Oxycontin. The court confirmed that omissions of fact are typically less egregious—and less material—than an affirmative misrepresentation. 2006 U.S. App. LEXIS 2887, at *26 (citing Hoffmann-La Roche, Inc. v. Promega Corp., 323 F.3d 1354, 1367 (Fed. Cir. 2003)). In addition, the court also noted that where the materiality is low, there is less basis for inferring intent from materiality alone. Id. at *30.
In some instances, protection for the target company's technology other than that provided by patents may exist. In the pharmaceutical area, holders of a New Drug Application ("NDA") enjoy the exclusive use and protection of the data they submit to the FDA to obtain approval for their products (referred to as "data exclusivity"). Depending on the circumstances, a generic company seeking to market a generic version of an NDA holder's product may not avail itself of that data for a period of five, four, or three years. Which period of data exclusivity applies can constitute important information for evaluating the merits of the deal.
In that regard, a five-year period of data exclusivity exists for a new chemical entity ("NCE") not previously approved and not covered by a patent. A generic company cannot submit an abbreviated new drug application ("ANDA") until after the five-year period expires. On average, it takes 18 months for the FDA to approve a generic drug, effectively extending the period of exclusivity to six and a half years. When a patent exists covering the NCE, a four-year exclusivity period applies during which time a generic cannot submit an ANDA. If the generic company files the ANDA and certifies to its intention to challenge the patent, and if the patent holder sues for infringement within 45 days, the FDA cannot approve the generic drug for 30 months, subject to some exceptions. For non-NCEs, irrespective of whether patent protection exists, a three-year period of exclusivity attaches. But a generic can submit an ANDA before the expiration of that period, and the FDA can pre-approve the generic drug for launch at the end of the three-year period.
By this point in the due-diligence investigation, initial results from the freedom-to-operate search should have arrived. The FTO sub-group initially should compare the claims of patents identified during the search to the target company's technology, categorising the patents as relevant or not. Of course, varying degrees of relevancy typically arise, and some patents lying on the fringe may be eliminated from consideration after a further interpretation of the claims in light of the specification. A determination regarding other patents, however, may require ordering the file history so that a more in-depth analysis can be made. That later analysis could lead to a narrow interpretation of the claims based on arguments and/or amendments made during prosecution. See, e.g., Sandisk Corp. v. Memorex Prods., Inc., 415 F.3d 1278, 1286 (Fed. Cir. 2005) ("When the patentee makes clear and unmistakable prosecution arguments limiting the meaning of a claim term in order to overcome a rejection, the courts limit the relevant claim term to exclude the disclaimed matter."). Where it appears, based on a thorough analysis of the intrinsic record, that the claims of the third-party patent still read on the target company's technology, the team may consider assessing the validity of the relevant claims. If the analysis reaches this stage on a particular third-party patent, however, the target company should be queried about whether it knew of the patent, whether it has an opinion of counsel on the infringement and validity of the patent, and whether it has a license to practice the patented invention covering the relevant field of use.
Using information acquired in Phase II, the due-diligence team will have a focused set of issues to pursue in the data room. Before visiting the data room, the team should consider revising the original list of information sought from the target company. The team may have already obtained some of the information it sought earlier or answered some of the questions it initially had. In addition, if the first request for an inventory of the documents and information present in the data room went unanswered, the team should vigorously renew the request. Time will be limited in the data room, and usually it contains a lot of information to review. The team may be focused on the issues and the information it needs from the target company, but knowing the contents of the room and how they are organised will significantly enhance the efficiency and effectiveness of the investigation.
Phase III: Entering the Data Room with Focus and an Agenda
The sub-group considering validity and enforceability should immediately target the patent attorney's prosecution files, both foreign and domestic. Particular attention should be directed to the correspondence between the attorney and the client, looking for documents bearing on validity (e.g., opinions) or on enforceability of the target company's patents, such as failure to cite a reference or a related application. Sometimes the files will contain invention records originally submitted by the inventors in support of filing a patent application to protect the invention. Those records typically provide very valuable information about the closest prior art, whether and how the invention was previously made public, the best mode for practicing the invention, who the inventors are, etc. Even if not in the attorneys' files, those documents should always be requested and reviewed.
For additional information about inventorship, members of the validity sub-group should thoroughly comb through the inventor's notebooks and other files of the inventor relating to the patents under review. Because of the heavy technical nature of those documents, having an inventor or someone from the target company familiar with the notebooks and the record-keeping system that could guide the team through those documents will greatly facilitate the review. These documents could also provide information to assess compliance with the best mode requirement or to address enforceability issues flagged in the Phase II. For instance, the inventor's notebooks could contain the examples described in the specification of the target company's patents or support factual representations made in the specification or during the prosecution. Ideally, after reviewing these documents, the team should make arrangements to interview the inventors and patent attorneys to address any lingering questions bearing on inventorship, best mode, or any surfacing enforceability matters.
The ownership team will want to examine all employment contracts of the named inventors, confirming their obligation to assign their rights in the inventions to the target company. If no contracts exist, the team should investigate facts and information supporting a theory that the inventors were hired to invent. As such, they would be legally obligated to assign to the company inventions they conceived and discovered during company time and with company resources. Efforts should be made to identify any obligations the inventors may have had to third parties. The documentation surrounding any outside funding, collaboration (e.g., with a government agency) or joint developments should be reviewed to evaluate what rights the sponsors, collaborators, or joint development partners may have. Often, the documents will identify the relevant company person most knowledgeable about the collaborations or joint developments, and that person should be interviewed by a team member to sort out any residual matters.
Coming into the data room, the FTO sub-group will likely know at least some of the problematic third-party patents. They may, depending on privilege issues, want to review any legal opinions generated by or for the target company concerning the infringement and validity of those patents. Similarly, because no one wants to buy a lawsuit, the team should request the target company to identify any existing or threatened claims of infringement based on a third party's IP, including what action, if any, the target has taken regarding those claims. For example, the company may already have, or may contemplate acquiring, a license from the third party. The team needs to study all such agreements, making sure, among other things, that they pertain to the correct field of use and that the proposed acquisition will not impede their assignability or transferability. Similar questions arise with respect to supply agreements, which can also fall within the review responsibility of the FTO team. Sometimes, the licensing and supply agreements place restrictions on assignability or transferability, depending on the purchaser (for example, a long-standing competitor of the licensor) or on whether the acquisition is a stock or asset purchase.
If the due-diligence project involves a pharmaceutical product, the target company may have one or several patents listed in the FDA's Orange Book. Improperly listing patents in the Orange Book can raise antitrust issues. The sub-group assessing the scope of coverage of the target company's patents should examine all listing opinions and interview anyone involved in the decision to list a particular patent to determine the propriety of the listing.
Phase IV: Reporting Conclusions and Recommendations to the Client
Due diligence is education in motion. With an enormous amount of information to review in a short period of time, the team's knowledge about the facts and the corresponding legal issues is constantly evolving. For that reason, regular and frequent meetings, both among team members and with the client, reporting on the status of the investigation work best. With focus provided by the team leaders, the meetings serve to efficiently disseminate information, build consensus, and help to target the investigation on the issues that matter most to the deal. They also keep written positions on the issues to a minimum—generally a sound policy, particularly if the deal goes through. Negative comments made in writing, for example, could potentially have negative consequences in the future.
At some point, final conclusions and recommendations are reached regarding the major components of the investigation: freedom to operate, scope of coverage, validity, enforceability, and ownership of the target company's IP. Problems with any of them can have a substantial effect on the value of the deal. Usually the agreement document can be modified to minimise the risk posed by those problems. Alternative means exist, however. For validity concerns with the target company's patent, corrective procedures are available in the United States. By filing a reissue or re-examination, the claims can be narrowed to avoid prior art. 35 U.S.C. § 251 and 35 U.S.C. § 302. For insufficient coverage, the claims of the patent can be broadened by reissue if filed within two years of the patent's original grant date. See, e.g., 35 U.S.C. § 251. If pending applications exist, it may be possible to file a continuation application to expand the scope of protection.
At the end of the day, the client requires the best assessment of the risks involved in the deal, and it needs that assessment quickly. Using this four-phase approach to due diligence, the IP attorneys can thoroughly yet efficiently evaluate the risk and advise their client on matters that could affect the deal, both in terms of price and structure.
1 In the United States, no accountability is due among co-owners of a patent absent an express agreement to the contrary. 35 U.S.C. § 262. For example, a patent co-owner can non-exclusively license or assign (retroactively or prospectively) its rights to a third party without the consent of the other owners. Such a co-owner has no obligation to share any of the royalties or revenues with other co-owners. But since patent owners constitute indispensable parties to an enforcement proceeding involving the patent, all owners must consent to bringing legal action on the patent. For these reasons, identifying all owners of the target's IP and securing clear title at least to the target's U.S. patents become critical.
2 35 U.S.C. § 262 provides that "[i]n absence of any agreement to the contrary, each of the joint owners of a patent may make, use, offer to sell, or sell the patented invention within the United States, or import the patented invention into the United States without the consent of and without accounting to the other owners".
3 The official website of the USPTO is www.uspto.gov.
4 As discussed below, however, a finding of inequitable conduct will lead to the unenforceability of the entire patent and is not limited to any particular claim.
5 M.P.E.P. § 804(II)(B) (internal cites omitted) ("A rejection based on nonstatutory double patenting is based on a judicially created doctrine grounded in public policy so as to prevent the unjustified or improper timewise extension of the right to exclude granted by a patent.").
6 37 C.F.R. § 1.321(c)(3) states that "[a] terminal disclaimer, when filed to obviate judicially created double patenting in a patent application created double patenting in a patent application created double patenting in a patent application . . . must: . . . (3) Include a provision that any patent granted on that application . . . shall be enforceable only for and during such period that said patent is commonly owned with the application or patent which formed the basis for the judicially created double patenting". The common-ownership requirement of a terminal disclaimer forecloses multiple suits against a single defendant on subject matter considered patentably indistinct.
7 The U.S. Court of Appeals for the Federal Circuit is the appellate court with exclusive jurisdiction over patent matters in the United States.
8 See, e.g., M.P.E.P. § 2001.06(c), which states that "[w]here the subject matter for which a patent is being sought is or has been involved in litigation, the existence of such litigation and any other material information arising therefrom must be brought to the attention of the U.S. Patent and Trademark Office."
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