Key Intellectual Property Issues in M&A Transactions – Lexology

This article is taken from GTDT Practice Guide: Japan M&A. Click here for the full guide.

Introduction

Japan ² is a scientific and technological nation, with one of the most important markets and the third-largest GDP in the world. The number of annual patent prosecutions (including international patent applications) in Japan is about 288,000,³ which is the third-largest in the world. Japan is home to many global companies with highly technological and innovative skills and capabilities. Japan also has a suitable business and legal environment for companies; for instance, there is a very low crime rate, a highly educated workforce and a reliable judicial system, especially regarding intellectual property-related cases. The Tokyo and Osaka District Courts have specialised divisions for intellectual property (IP) and Tokyo is also home to the Intellectual Property High Court. The average number of months needed for courts to resolve IP-related cases at the first instance is only around 12 to 15 months.⁴

IP and intellectual property rights (IPRs) are important assets that are key to Japanese companies’ core value and the keys for the success of these companies in business. The important value of IPRs is the ability to exploit them economically. These include defensive abilities, for instance, preventing competitors from using a patented invention and making infringers pay damages. In addition, positive effects regarding external communication,⁵ for instance, branding corporate products and services, are also included. Legal due diligence on IP is therefore a vital part of any preparation for an M&A transaction. One of the keys for the success of M&A transactions is to spot IPR issues properly and to take reasonable measures to deal with the issues. It is especially important for a buyer to ensure that key target company IP used before the M&A transaction will be continuously available to the buyer side (the target company or target business).⁶

Collecting IP-related information of the target company before an M&A transaction in light of the characteristics of the Japanese IP system is therefore important. Examples of information to be collected include:⁷ ⁸

lists of important IPRs owned by the target company;⁹
lists of IP licences granted to the target company¹⁰ (not only from third parties but also from group companies of the target company), and licence agreements thereof;
lists of IP licences the target company grants to third parties (including group companies of the target company), and licence agreements thereof;
other IP-related agreements (including joint research and development agreements) other than licence agreements;
IP-related agreements (including software licence agreements), materials on software used by the target company, how they are developed, third parties involved in the development or owning rights in the software (other than licensor, if any);
material on the overview of the department that deals with and manages IP matters;
internal rules of the target company to deal with or manage IP (including but not limited to internal rules on employee inventions), material on how the rules are implemented, etc; and
material on IP-related disputes (including potential disputes) in which the target company or the IP used by the target company is involved (in addition, it is better to include information on any grounds for invalidation¹¹ of the important IP).

Intellectual property rights

Identification of IPRs

As stated, it is very important for a buyer to ensure that important IP of the target company used before the M&A transaction can be continuously available to the buyer after the transaction. Identification of the IPRs relevant for the intended M&A transaction, as well as analysis, description and appropriate listing thereof, are the important starting points of the deal process and essential for the success of the transaction. Thus the buyer must try to obtain from the seller comprehensive lists of important IPRs, including licences relevant to the M&A transaction. To check and supplement the lists, the buyer can check registered information at the Japan Patent Office (JPO) for patent, utility model, trademark and design rights (together, industrial property rights). However, there are certain limitations to this.¹² In addition, with regards to unregistered IPRs, such as copyrights, it is more difficult to check the comprehensiveness of the lists provided by the seller side based on public information. Therefore, in addition to appropriate efforts to collect information from the seller, it is important, for instance, to establish representation and warranty clauses stating that the target company legally and validly owns or is granted the IPRs that it uses or utilises to conduct its current business and that the said IPRs do not have any encumbrances that have an adverse effect on or inhibit the use of such IPRs.¹³

Points to note in schemes of M&A transactions

As stated under ‘Licence’, the schemes of M&A transactions mainly include share acquisition, comprehensive succession (eg,merger, company split) or a specific succession scheme (eg, business transfer). However, regardless of the schemes intended, identification of the relevant important IPRs is vital.

In a share acquisition, ownership of IPRs does not change directly, but checking the following points is important. First, the transaction may have an impact on licences granted to the target company since licence agreements often contain a change of control clause that might lead to termination of such licence agreements. Second, some of the relevant important IPRs may not be owned by the target company (but by a group company of the seller or third parties outside the group). In such cases, the buyer would need an arrangement to sell (transfer) the said IPRs to the buyer or to secure a licence (the latter option might be more feasible). Third, the seller may want to keep certain IPRs for continued use.¹⁴

In a scheme using comprehensive succession, in principle, IPRs are automatically transferred without any individual succession procedures.¹⁵ However, the same issues stated in the share acquisition part also apply.

In a scheme using a specific succession scheme, the assets, liabilities and agreements that the parties agree to transfer are transferred individually. The buyer must ensure that the necessary IPRs are properly identified and allocated.¹⁶ In addition, the buyer has to make sure that the counterparties agree that the said agreements are transferred properly.¹⁷ The second and third points addressed above also apply.

Registered IPRs

As stated, the buyer can find registered information regarding industrial property rights in the JPO IP register¹⁸ (such as ownership of the right and change of the ownership, etc), including patent, utility model, trademark and design rights.¹⁹ ²⁰ However, it should be noted that there are certain limitations on the information registered at the JPO. For instance, with regard to licences, registrations of patents, utility models, trademarks and designs only contain information on exclusive licences (senyo jissiken or shiyoken).²¹ Non-exclusive licences²² ²³ are not registered at each register. In addition, though the registration of a pledge is required for it to take effect,²⁴ the pledge is not always properly registered.

Therefore it is important to collect information from the target company on whether proper registrations have been made and whether there are any encumbrances. Proper arrangements should be made for conditions precedent, covenants, and/or representation and warranty clauses to deal with registration and encumbrance issues (including, but not limited to, pledges²⁵ and licences) that may have an adverse effect on or inhibit the use of IPRs.

In addition to the core IPRs mentioned above, checking the company name as well as domain names is also important:

Domain names are not considered traditional IPRs, but they can be significant in relation to branding, for instance – domain name registration can be checked using a Whois search.
Company name registration is a requirement to establish a company – company name registrations can be checked online through the Registry Information service. The scope of protection provided by a trademark right is different from that of a company name (in principle, the latter is limited).

Unregistered IPRs

It is more difficult to identify and inventory important copyrights²⁶ that the target company actually owns or utilises. Under the principle of the creator doctrine, the copyright and moral right of an author vest automatically in the author who creates a work.²⁷ Unlike industrial property rights, no registration is required for copyrights and transferring copyrights. It is true that a registration system for copyrights is available (for instance, registration of transferring copyright and registration of establishment of a pledge are regarded as a requirement for a transferee (or a pledgee) to assert its rights against third parties).²⁸ However, the items within the scope of the registration systems are limited²⁹ and the registration system is not widely used. Thus identifying the owner of copyrights, checking the change history for ownership and checking the existence of encumbrances are not easy.³⁰ In addition, if a work is created cooperatively by multiple people, it makes issues more complicated.³¹ Thus, efforts to carefully collect information from the target company or the seller are important.

Other IP

Trade secrets³² and shared data with limited access under the Unfair Competition Prevention Act (UCPA) are also considered important.³³ They are not registered at a public office. In addition, there are lots of cases where the target companies do not develop lists thereof internally to manage them. Thus efforts to carefully collect information from the target company or the seller are important.

Trade secrets

As one of the important requirements, a trade secret must be kept secret. Generally speaking, it is not easy to satisfy this requirement. It is not sufficient that the owner of the information in issue recognises that it is secret. Instead, it is required that employees or customers easily recognise the owner’s intention to keep the information in issue confidential by clearly presenting such intention through an economically reasonable measure with respect to confidential compliance, depending on the specific situation. Thus it is important to collect information on how trade secrets are managed in the target company.

Shared data with limited access

In 2019, in order to protect and use big data, a new amendment to the UCPA was passed that makes shared data with limited access protected under the UCPA. The term ‘shared data with limited access’ as used in the UCPA (article 2(7)) means technical or business information that is accumulated in a reasonable amount by electronic or magnetic means as information provided to specific persons on a regular basis and that is managed (excluding information that is kept secret).³⁴ Since this system was introduced recently, there may be many cases where the target companies do not manage such data systematically or develop the relevant lists.

The buyer has to rely on the information for unregistered IPRs from the target company and it is important to consider,for instance, effectively establishing representation and warranty clauses in an M&A agreement.

Licence

Types of licence

Industrial property rights

With regards to Industrial property rights, under the related laws, the types of licence are divided mainly into exclusive licence (senyo jissiken)³⁵ and non-exclusive licence (tsujo jissiken).³⁶ A non-exclusive licence is, as a contractual arrangement, divided mainly into monopolistic non-exclusive licence³⁷ (dokusenteki tsujo jissiken) and non-monopolistic non-exclusive licence (hi dokusenteki tsujo jissiken).

Registration is required for an exclusive licence to take effect. Once an exclusive licence is established, for instance, even the patentee is not allowed to work the patented invention. Considering these points, exclusive licences are not widely used. In addition, an exclusive licensee (senyo jissikenjya) has the right to seek an injunction and damages, within the scope of the licence agreement, in its own name with respect to an infringement by an unauthorised third party.

For a non-exclusive licence to be established, registration is not required.³⁸ A non-monopolistic non-exclusive licensee does not have the right to seek an injunction or damages in its own name. A monopolistic non-exclusive licensees is considered to have the right to seek damages in its own name; however, whether it has the right to seek an injunction is not necessarily clear.³⁹

Copyrights40

The Copyright Act provides only for non-exclusive licences.⁴¹ Thus variations in the characteristics of licences are provided by contractual arrangements. Whether a non-exclusive licensee has the right to seek an injunction, damages, or both can be considered the same as in an industrial property right licence.⁴²

Issues related to the scheme of M&A transactions including change of control and similar issues

It is necessary to check whether there are any matters that have an adverse effect on the continuity of the use of the licensed IP.⁴³ One of the important points when checking licence agreements relating to the target company is to see whether the licences are properly succeeded (the licences granted are continuously available) through the M&A transaction. Whether and how the licences are properly succeeded depends on the type of scheme of the M&A transaction.

Buyer side’s acquisition of shares issued by target company (share acquisition)44

In principle, theoretically, consents from licensors are not required to maintain licences. This is because the legal character of the target company does not change even after the M&A transaction, so the licensee does not change. However, it is not unusual for licence agreements to include a clause that allows licensors to terminate their licence agreement when a substantial change occurs in the controlling power of the licensee, for instance, a substantial change to a licensee’s shareholders or officers⁴⁵ (change of control clause – COC clause). If a licence agreement that can be terminated based on a COC clause is essential to the target company, the purpose of the M&A transaction cannot be achieved without the licence. Then, for instance, one of the measures to be considered is to cause the seller to obtain the consent of the licensor as a condition precedent to closing the M&A transaction. If the licence agreement is important (but not essential) to the target company and certain negative effects are expected on the business of the target company, one of the measures to be considered is to have the seller owe the obligation to obtain the consent of the licensor in issue as a covenant.⁴⁶

In relation, or similar, to the said COC clause issue, the following are some circumstances where checking the continuous availability of licences is important:

If an important licence is granted by a group company of the target company or the seller, then it is necessary to check whether it is possible to make an arrangement⁴⁷ wherein the target company is granted the licence continuously.⁴⁸
If the licensor of an important licence is a pure third party that is not a group company of the target company and the licence is granted to a group company of the target company and the reason why the target company is entitled to use the IP related to the licence is because the target company is under the umbrella of the group company, it is necessary to check whether it is possible to make an arrangement wherein the target company is granted the licence continuously. Compared with (1), there is often more difficultly in achieving such arrangement.⁴⁹

It is also useful to consider the measures outlined in the section discussing the COC clause issue.

Comprehensive succession scheme

The effect of a merger scheme and company split scheme is that, in principle, all or part of the assets, rights and obligations of the target company (or the target business) are comprehensively and automatically transferred. Thus, in principle, consents from the licensors are not required to transfer the licences. However, if a licence agreement includes a COC clause, it is useful to consider the measures stated above in the section on share acquisition.

With regards to patent licences, the Patent Act article 77(3) states ‘an exclusive licence may be transferred only where the business involving the working of the relevant invention is also transferred’ or ‘where the transfer occurs as a result of general succession’. The Patent Act article 94(1) also states that ‘a non-exclusive licence may be transferred only where the business involving the working of the relevant invention is also transferred’ or ‘where the transfer occurs as a result of general succession’.⁵⁰ It is considered that the circumstances described in these two articles includes merger schemes and company split schemes. However, whether these articles are compulsory is not necessarily clear⁵¹ and such issue is debated among scholars and practitioners. Thus, from the buyer’s viewpoint, it is safer to consider taking the measures described in ‘Buyer side’s acquisition of shares’ on the premise that these articles are not compulsory and could be displaced by a mutual agreement (ie, a COC clause could terminate the licence agreement even under a merger or company split scheme). In addition, considering the issues around checking the continuous availability of licences outlined in (1) and (2) above is also important.

Specific succession scheme

During a business transfer scheme, specific assets, liabilities and agreements, etc of the target company are identified and transferred individually. Thus, in principle, consent from the licensors is required to transfer the licences. However, a business transfer scheme is considered to meet the requirement of ‘where the business involving the working of the relevant invention is also transferred’ (Patent Act articles 77(3) and 94(1)).⁵²

Nonetheless, as stated above, from the buyer’s viewpoint it is safer to consider taking measures on the premise that a COC clause could terminate the licence agreement even under a business transfer scheme.

Perfection of non-exclusive licence without registration

With regards to patents, utility models, designs and trademarks, for an exclusive licence to take effect registration is required, which enables the exclusive licensee to duly assert its rights against a third party.

On the other hand, with regards to patents, utility models and designs, a non-exclusive licensee is able to duly assert its non-exclusive licence against third parties (including the new owner of an IPR) without registration. In addition, on or after 1 October 2020, without any registration, copyright licensees⁵³ are now able to duly assert rights against any third party who obtains copyrights from the owner.⁵⁴ ⁵⁵ However, a non-exclusive licensee of a trademark is required to register it to duly assert its rights against third parties.

When checking the existence of encumbrances on IPRs to be transferred by an M&A transaction, the buyer should consider the points outlined above.⁵⁶

Software and computer programs

Software and computer programs sometimes act not only as an important lifeline for the target company to continue its business but also as an important source of revenue. Hence understanding protection under Japanese law and the relevant issues is important for the success of the M&A transaction.

Like other IPRs, it is important to check, for instance, whether there is any issue of ownership of the rights to software and computer programs, as well as the continuity of the licence granted, infringement of third parties’ rights and other encumbrances that would have an adverse effect on the use of such IPRs and to consider measures including proper establishment of representations and warranties.⁵⁷

Protection under the Copyright Act, Patent Act and UCPA

Computer programs⁵⁸ can be protected under the Copyright Act if the expression of such computer program has originality, though the protection does not extend to the programming language, coding conventions or algorithms.

In addition, under certain conditions, inventions related to computer software⁵⁹ can be protected by the Patent Act. An invention protected under the Patent Act should be a ‘creation of a technical idea utilising the laws of nature’.⁶⁰ ⁶¹ Under the Examination Guidelines for Patent and Utility Model (the Examination Guidelines),⁶² inventions utilising computer software in the following examples are considered to meet this requirement:⁶³

those concretely performing control of an apparatus or processing with respect to control; or
those concretely performing information-processing based on the technical properties such as physical, chemical, biological or electrical properties of an object.

In addition, it is considered that those utilising computer software meet this requirement if ‘information processing by the software is concretely realised by using hardware resources’⁶⁴ (even in those cases not constituting (1) or (2)).

Not only the boundary of whether computer programs are protected under the Copyright Act, but also the boundary of whether they are protected under the Patent Act is not necessarily clear. In addition, the Copyright Act protects only the expressions of computer programs. Thus, if the software in issue uses source code with different expressions from the original work, it does not constitute an infringement of copyright. On the other hand, even if the expression of source code is not the same as the original work, the right of a patented invention can be asserted if the software in issue achieves the same function and characteristic of the patented invention.

Further, there might be some cases where software provided as ‘software as a service’ can be protected under the UCPA, since users would not be able to access the object codes of the software and the codes might meet requirements to be protected as trade secrets.

Other points to note for computer programs

If a computer program used by the target company is provided by a third party through a licence, checking the contents of the licence agreement is important to ensure the continuous availability to the target company (see section on change of control issues).

If the computer program that is used was developed by a third-party vendor cosigned by the target company, it is also important to check the agreement for software development to find any restriction on the use of the software and other issues.⁶⁵ ⁶⁶ ⁶⁷

In addition, there might be some cases where the developed computer program uses open source software. In this case it is important to check the terms and conditions of the relevant open source software licence to see whether there is any restriction on the developed software, such as an obligation to disclose improved source code, etc. Considering these points, collecting information on software licence agreements, agreements on software development and material on the development history is important.

Antitrust law perspective

A detailed explanation from an antitrust perspective in the context of IP is not within the scope of this chapter.⁶⁸

In Japan, the Anti-Monopoly Act (AMA) sets forth the relationship between antitrust and IP law. Specifically, article 21 of the AMA sets forth that: ‘The provisions of this Act shall not apply to such acts recognisable as the exercise of rights under the Copyright Act, Patent Act, Utility Model Act, Design Act, or Trademark Act.’ Based on this provision, the Japan Fair Trade Commission (JFTC) has published Guidelines for the Use of Intellectual Property under the Antimonopoly Act to deal with various issues involving such relationship, including licence-related issues, etc. The JFTC has also issued Guidelines on Standardisation and Patent Pool Arrangements on antitrust issues in relation to standardisation.

In addition, the JFTC has also issued Guidelines to the Application of the Antimonopoly Act Concerning Review of Business Combination (Guidelines for Review of Business Combination) to provide general guidance for M&A transactions from the viewpoint of the effect of restraint on competition. In principle, this does not set out different analytical methods to evaluate the effect of business combinations just because the business combination in issue is related to IP. However, considering, for example, the importance of potential competitiveness derived from data or IPRs, in December 2019, some parts of the Guidelines for Review of Business Combination were amended in relation to evaluating whether restraining competition in a particular field of trade occurs or not by a business combination of parties with important IPRs or data.⁶⁹

Ownership issues in relation to IPRs

Group company issues

See sections on ‘Points to note of schemes of M&A transactions’ and ‘Issues related to the scheme of M&A transactions including change of control and similar issues’, as well as ‘Buyer side’s acquisition of shares issued by target company (share acquisition)’.

Joint ownership of IPRs

Patent, utility model, design and trademark rights

Joint ownership of an industrial property right creates several encumbrances. For instance, where a patent right is jointly owned (except for general succession) a joint owner shall obtain the consent of all the other joint owners in order to assign its own share of the ownership. In addition, to establish a right of pledge on its own share of the ownership, the said consent is also required (Patent Act article 73(1)). Further, a joint owner shall obtain the consent of all the other joint owners in order to grant a licence to third parties (Patent Act article 73(3)). Thus, if the buyer identifies the joint ownership of a patent right and specific succession scheme is used as an M&A scheme, the consents of all other joint owners are required to obtain the relevant share. In addition, if the buyer identifies the joint ownership of important relevant patent right, the buyer has to keep in mind the said encumbrances with regard to utilising the patent rights.⁷⁰ On the other hand, unless otherwise agreed, each joint owner may work the patented invention without the consent of the other joint owners (Patent Act article 73(2)).⁷¹

It should be noted that the Patent Act article 73 shall apply mutatis mutandis to utility model rights, trademark rights and design rights.⁷²

In principle, to assign its own share of the ownership of a jointly owned copyright, to establish a right of pledge on it and to grant a licence, the consent of all the other joint owners is required (Copyright Act article 65(1)(2)). Unlike industrial property rights, for a joint owner to exercise the copyright, the said consent is also required.⁷³ ⁷⁴ However, the other joint owners may not, without justifiable grounds, refuse the said consent (Copyright Act article 65(3)).

Joint research and development agreement

Checking joint research and development agreements (joint R&D agreements) is also important. Joint R&D agreements usually stipulate important clauses dealing with newly obtained IPRs such as, for instance, who owns the newly obtained IPRs, how the IPRs may be exercised, whether any restriction on the use of the IPRs exists, how the parties deal with improvement of the IP, who should maintain the IPRs, and whether there is any restriction on research on the deliverables.

One of the important points to check is whether the target company properly receives (or is vested properly with) the important IPRs from its employees or the other parties participating in the joint R&D. Theoretically, it is ideal to include the employees and the third parties working on joint R&D in an M&A agreement as parties. However, in general, this is not practical.⁷⁵

Thus, after collecting the relevant information and checking these issues, it is beneficial to consider,for example, establishing representation and warranty clauses in an M&A transaction agreement to ensure, for instance, that all important IPRs obtained through joint R&D are properly transferred to (or vested in) the target company⁷⁶.

Employee inventions (Patent Act) and work for hire (Copyright Act)

Employee inventions (Patent Act)

With regard to inventions, the inventor must be a natural person and in principle the person who originally made the invention has the right to obtain a patent. However, with regard to employee inventions,⁷⁷ if an employer makes certain arrangements, such as preparing internal rules for employee inventions before an invention is made,⁷⁸ the employer is entitled to be vested with the right from the beginning or receive the right to obtain a patent. On the other hand, the employer has to provide ‘reasonable benefit’ to the employee. This is called the employee invention system.

Thus it is important for the buyer to check whether the target company has internal rules for employee inventions with the proper content and arrangement. In addition, it is also important to check whether the reasonable benefit has been given to the relevant employee properly. If the reasonable benefit is not paid, there is a risk that the employee will claim compensation from the target company. In order to ascertain such risk, it is important to collect information on the contents and operation of the related internal rules, whether there is any dispute between the target and an employee, whether there is any patent right that produces a large amount in licence fees, whether there is any patent right that is used in the target company’s products with a large sales volume, whether there is any patent right used in cross-licensing widely used by competitors, etc.

In addition, it is beneficial to include representation and warranty clauses in an M&A transaction agreement stating, for instance, that employee inventions are properly vested in or transferred to the target company and reasonable benefits have been properly provided.⁷⁹

Work for hire (Copyright Act)

With regard to copyright, in principle the person who creates a work obtains the copyright and moral rights of the work (ie, the principle of the creator doctrine). However, with regard to a work for hire,⁸⁰ an employer is automatically vested with the copyright and moral rights of the work from the beginning. In addition, unlike the employee invention system, internal rules for the employer to obtain a work for hire are not required. Further, the employer does not have to provide reasonable benefit to an employee.

IP-related legal disputes

Cases where a target company is sued based on alleged infringement of a third party’s IPRs

It is very important to evaluate legal risks where a target company is (or can be) sued by a third party based on infringement of the IPRs of a third party. An example is the situation where a third party sues a target company, demanding that it suspends sales of products with a large sales volume, claiming a large amount of compensation, or both.

However, during legal due diligence, in general it is not practicable to comprehensively collect and evaluate information on potential legal disputes of this kind. What a buyer mainly can do is to collect information on cases where a target company has already been sued by a third party based on the IPRs of such third party or cases where a target company has actually received a warning letter regarding potential infringement.⁸¹

Cases where a target company sues a third party infringing IPRs of the target company

As above, it is not practicable to comprehensively collect the relevant information with respect to whether a target company can sue a third party infringing its IPRs. What is practically possible is to collect information on cases where the target company has already sued a third party and potential disputes regarding which the target company has actually considered, for instance, whether to send a warning letter.

In general, the risk derived from cases where a target company is sued based on alleged infringement of a third party’s IPRs is more serious than those described here. Nonetheless, the risks should not be underestimated. For instance, consider the circumstance where the target company has been able to achieve a competitive position in a market because of the ownership of a patent right of a certain patented invention and the target company sues a competitor based on an infringement of the patent right. If the target company loses the case because of, for example, invalidity of the patent, the negative impact on the target company will be substantial.

Administrative disputes at the JPO and litigation to cancel a trial decision

Checking, for instance, material on opposition to the grant of patents, trials for patent invalidation at the JPO and litigation rescinding the trial decision is important, especially if they are related to the important relevant patents that are a source of competitiveness in a market. This is because they provide important information on the validity of the said patent.

Representations and warranties

It is, in general, difficult to collect information on the validity of the relevant IPRs and the target company’s non-infringement of third parties’ IPRs and evaluate the risks thereof. It is important for the buyer to consider, for instance, establishing adequate representations and warranties to cover the risks derived from such matters,⁸² which is often a topic of dispute between the seller and buyer since even the seller has difficulty in comprehensively evaluating such risks.

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