Due Diligence in Acquiring American Patent Portfolios

DUE DILIGENCE IN ACQUIRING AMERICAN PATENT PORTFOLIOS by John L. Cooper

TABLE OF CONTENTS

I. Need for due diligence in acquiring intellectual property..................................................... 1

III. Basic questions ...................................................................................................................... 2

III. Is the patent valid?................................................................................................................. 2

A. Why a patent may not be valid.. ................................................................................ 2

1. Prior Art......................................................................................................... 2

2.

3.

Failures of specification................................................................................ 3

Prior use or sale ............................................................................................. 4

4.

5.

Earlier-filed foreign counterpart.................................................................... 4

Examples could be multiplied ....................................................................... 5

B. Reasons why an otherwise valid patent might lapse. ................................................ 5

1.

2.

Expiration of term ......................................................................................... 5

Failure to pay maintenance fees .................................................................... 5

3.

4.

Re-examination ............................................................................................. 5

Unenforceability due to inequitable conduct ................................................ 5

C. Presumption of validity............................................................................................. 7

IV. Does the proposed seller have good title to the patent? ........................................................ 7

A. Is ownership concentrated exclusively in the seller? ................................................ 7

B. Has the patent been assigned? ................................................................................... 8

C. Have IP rights been pledged or mortgaged? ............................................................. 8

Copyright © 2005 by John L. Cooper; Farella Braun + Martel LLP. All rights reserved.

D. Are any rights disputed?............................................................................................ 9

V. Are there limitations on the rights the patents extend? ......................................................... 9

A. Licenses ..................................................................................................................... 9

B. Prosecution history estoppel...................................................................................... 10

C. Other limits on freedom to operate or exclude.......................................................... 11

D. In what jurisdictions is the invention protected?....................................................... 11

VI. Are any of these problems correctible? ................................................................................. 12

VII. How to check for problems ................................................................................................... 13

A. Collect representations, disclosures and warranties by the seller ............................. 13

B. Examine the patents .................................................................................................. 14

C. Examine carefully the seller’s representations, disclosures and warranties.............. 15

D. Talk to the seller’s lawyers and technical people as well as its business people ...... 15

E. "Trust, but verify." .................................................................................................... 16

F. Public sources............................................................................................................ 17

G. Examine yo ur own portfolio. .................................................................................... 20

VIII. Other due diligence issues ..................................................................................................... 21

A. Cost-benefit analysis ................................................................................................. 21

B. Take your time .......................................................................................................... 21

C. What are you buying? ............................................................................................... 21

D. Valuation................................................................................................................... 22

IX. Conclusion............................................................................................................................. 23


DUE DILIGENCE IN ACQUIRING AMERICAN PATENT PORTFOLIOS by John L. Cooper

*

“Always look before you leap.” – American folk saying

I.

Need for due diligence in acquiring intellectual property.

A.

“Due diligence” in the present context means verifying that the representations and warranties made by the seller in a proposed corporate transaction, and the assumptions and understandings of the buyer, are accurate and reflect a correct understanding of the intellectual property and relevant market conditions.

B.

Due diligence is an important step, whether a whole company is being acquired or just a single patent. It applies to other IP elements such as copyrights, trademarks and trade secrets, and of course has a wider application to all aspects of a targeted company’s operation, not just its IP portfolio. This presentation will focus on due diligence in assessing the patent portfolio of an American corporation, but the other aspects of due diligence should not be neglected.

C.

If things are not as they seem, it is obviously of vital importance to discover this before the proposed transaction is consummated rather than afterward.

1.

If things are not as they seem, this does not necessarily mean that the sellers have acted dishonestly. For example, a possible claimant to inventorship may have been inadvertently omitted from the documentation. Though inadvertent, the omission may still lead to serious complications later on.

2.

Similarly, the appearance in the market of a superior competing product, or a new method, or a legitimate means of working around the seller’s patent, may sharply diminish the value of the seller’s intellectual property without any misrepresentation having been made, or the seller even having been aware of the damaging development.

D.

“In these times of market volatility, technology due diligence is a concept of potentially critical importance. Companies desperate for additional sources of financing need a way to convince investors that their projects have real value. Venture capitalists and other potential investors need a way to investigate such claims. Businesses seeking potential merger partners must be able to evaluate the underlying value of the target company.

Lawyers and other professionals involved in these deals have disclosure and other obligations which require them to be able to make good faith estimates about the nature of these companies’ businesses.” Carol R. Goforth & Ronald R. Goforth, “Technology

Due Diligence – The Need for and Benefits of Technology Assessment in Connection with Investment in High-Tech Companies,” 27 Rutgers Computer and Technology Law

Journal 165, 166-167 (2001).

*

John L. Cooper is a senior litigation partner in the San Francisco law firm of Farella Braun +

Martel

LLP

, specializing in trial of intellectual property cases. He holds university degrees in engineering, law, and law & economics. John Cooper is a Regent and Fellow of the American

College of Trial Lawyers. His practice also includes concentrations in technology and antitrust litigation. He can be reached at 415-954-4410, and at jcooper@fbm.com

.


1

II.

Basic questions. Three basic questions concern any patent sought to be acquired, whether by buying the patent-holding corporation or otherwise.

Is the patent valid? A.

B.

C.

Does the seller have sufficient ownership to pass complete title to the buyer?

Are there limitations on the rights the patents extend, either to practice the invention or to exclude others from doing so?

III.

Is the patent valid?

A.

Why a patent may not be valid. There are many reasons why a patent, even though issued in proper form by the U.S. Patent Office, might actually not be valid. The following are examples only and by no means exhaust the field.

1.

Prior Art a.

Patent protection is only available for new inventions. A patent is invalid if it was anticipated by, or was obvious from, the prior art. i.

ii.

“‘Prior art’ is a term commonly used to collectively denote all earlier devices, compositions, or processes that can be used to attack the validity of a patent on the grounds that the claimed invention is not new or would have been obvious. To be early enough to qualify as an item of prior art, it must precede the date on which the inventor named on a patent made his invention, or be more than a year before the patent filing date.” Lawrence

Pretty, P ATENT L ITIGATION , § 1:2.3, p. 1-22 (2003).

“According to 35 U.S.C. § 102(f), a person is not entitled to a patent if he did not himself invent the subject matter sought to be patented. To prove derivation under § 102(f), the party asserting invalidity must prove both prior conception of the invention by another and communication of that conception to the patentee by clear and convincing evidence. The communication must be sufficient to enable one of ordinary skill in the art to make the patented invention.” Eaton Corp. v. Rockwell International

Corp ., 323 F.3d 1332, 1344 (Fed. Cir. 2003) (citations and internals quotation marks omitted). iii.

“A patent is invalid for anticipation if a single prior art reference discloses each and every limitation of the claimed invention.

Moreover, a prior art reference may anticipate without disclosing a feature of the claimed invention if that missing characteristic is necessarily present, or inherent, in the single anticipating reference.” Schering Corp. v. Geneva Pharmaceuticals , 339

F.3d 1373, 1377 (Fed. Cir. 2003) (citations omitted). iv.

v.

For a relatively simple case illustration where a claim was rejected because it was anticipated by prior art, see In re

Cruciferous Sprout Litigation , 301 F.3d 1343 (Fed. Cir. 2002).

For a relatively simple case illustration where a claim was rejected because of obviousness from prior art, see In re Huston ,

308 F.3d 1267 (Fed. Cir. 2002).


2

2.

b.

In 2004 Congress passed an important new law, the Cooperative

Research and Technology Enhancement (CREATE) Act, now 35 U.S.C.

§ 103(c)(2). i.

The CREATE Act was intended to promote cooperative research involving universities, government and private enterprises.

Under existing law a prior invention could not be used to block another patent as obvious if both inventions were by a common owner. The amendment extends this protection to inventions of joint research collaborators under a research agreement entered into before the new invention was made, when the parties are named in the patent application. c.

ii.

It was a legislative response to a 1997 Federal Circuit case,

OddzOn Products, Inc. v. Just Toys, Inc ., 122 F.3d 1396, which held that “in the case of an inventive collaboration that involved researchers from more than one organization, the sharing of confidential information by members of a research team could render an invention ‘obvious’ … and therefore unpatentable if the researchers did not have an obligation to assign their rights to the invention to a single entity in advance of making the invention.” H.Rep. Report 108-425, at *4.

A search for prior art without a specific starting place is labor-intensive and the costs need to be balanced against the likely benefits. i.

The most likely representation by the seller is that it is not actually aware of any prior art that would invalidate or limit the scope of the patents being acquired. Whether this is good enough, or whether further investigation is warranted, depends on circumstances. ii.

Web resources for checking prior art are given in Part VII.F below.

Failures of specification a.

The statute 35 U.S.C. § 112 requires that an application for a patent

“shall contain a written description of the invention, and of the manner and process of making and using it, in such full, clear, concise, and exact terms as to enable any person skilled in the art to which it pertains, or with which it is most nearly connected, to make and use the same, and shall set forth the best mode contemplated by the inventor of carrying out his invention.” (Emphasis added.) i.

ii.

A specification which does not describe the invention adequately under this requirement, or a specification which does not set forth the best mode of carrying it out, is vulnerable to an attack on its validity.

“A best mode violation requires that the inventor knew of and concealed a better mode than was disclosed for making and using the claimed invention.” Cardiac Pacemakers, Inc. v. St.

Jude Medical, Inc.

, 381 F.3d 1371, 1378 (Fed. Cir. 2004).


3

3.

4.

Prior use or sale a.

A patent is invalid if the application was not filed within one year after the invention, ready for patenting, was first commercially offered for sale. See 35 U.S.C. § 102(b); Pfaff v. Wells Electronics , Inc.

, 525 U.S.

55 (1998). i.

This rule exists to require an inventor to choose between secrecy and commercial explo itation – permitting both would allow an inventor to extend his monopoly beyond the statutory term. b.

(A) “Subject matter that is not part of the invention that is claimed need not be included in the specification, and thus is not subject to the best mode requirement.” Id.

at

1379. iii.

“The best mode requirement differs from the enablement requirement, for failure to enable an invention will produce invalidity whether or not the omission was deliberate …” Id.

at

1378.

(A) Enablement cases typically turn on “evidence that the trial and error required to practice the claimed invention would be unduly laborious or beyond the reach of one of ordinary skill in the art.” Koito Mfg. Co., Ltd. v. Turn

Key Tech, LLC , 381 F.3d 1142, 1155 (Fed. Cir. 2004).

Like best mode, this is essentially a factual question. c.

A patent is likewise invalid if the invention was used within the year before the patent was applied for, whether sold or not, or offered for sale commercially within this period, whether used or not.

Experimental use does not count – if there is “adequate proof that a device was sold primarily for experimentation,” the on-sale bar does not apply. Allen Engineering Corp. v. Bartell Industries, Inc ., 299 F.3d

1336, 1353 (Fed. Cir. 2002) (listing 13 criteria for determining experimental use).

Earlier-filed foreign counterpart. a.

A patent may not be granted if “the invention was first patented or caused to be patented … by the applicant or his legal representatives or assigns in a foreign country prior to the date of the application for patent in this country on an application for patent … filed more than twelve months before the filing of the application in the United States” 35

U.S.C. § 102(d). b.

“Three things must occur for a patent to be invalid under section 102(d).

First, the applicant must file an application on the invention in another country. Then, more than twelve months later, the applicant must file for a patent on the same invention in this country. Third, the foreign patent must issue before the applicant filed the U.S. patent application. If all three occur, then the U.S. patent is invalid under section 102(d).” Bayer

AG v. Schein Pharmaceuticals, Inc ., 301 F.3d 1306, 1312 (Fed. Cir.

2002).


4

B.

5.

Examples could be multiplied.

Reasons why an otherwise valid patent might lapse. Here too the examples are illustrative but not exhaustive .

1.

Expiration of term a.

Ordinarily a patent is subject to a fixed 20-year term, beginning either at the time of application or at the time of an earlier referenced application.

See 35 U.S.C. § 154(a)(2). At the end of the term the patent expires. b.

In some cases the patent term is extended by another statute – the main example being the Drug Price Competition and Patent Term Restoration

Act (the Hatch-Waxman Act), 35 U.S.C. § 155-156. This Act permits a patentee to obtain an extension of the patent term if marketing of the patented product was delayed due to federal regulatory review. i.

The requirements for this extension are quite technical and not all drugs or devices qualify even if they were subject to regulatory review; see, e.g., Arnold Partnership v. Dudas , 362

F.3d 1338 (Fed. Cir. 2004) (upholding denial of term extension for combination of known drugs, even though regulatory approval for use in combination was required, where both components had previously been approved and sold). c.

Successor patents may be in force to give continued protection to the current version of a technology even if the original patents have expired.

2.

Failure to pay maintenance fees a.

b.

Fees are due to maintain patents in force at three periods during a patent term – 3½, 7½ and 11½ years after the grant. If the fees, which range from $830 to $2910, are not paid within a 6-month grace period after the due date, the patent will lapse. See 35 U.S.C. § 41(b).

Reduced fees are available for “small entities.” See 37 C.F.R. § 1.27.

3.

Re-examination a.

Any person may request that a patent be re-examined in light of prior art, see 35 U.S.C. § 302, and the Patent Office will re-examine it if there is a

“substantial new question of patentability affecting any claim of the patent concerned,” 35 U.S.C. § 303. b.

Following a re-examination the Director of the PTO “will issue and publish a certificate canceling any claim of the patent finally determined to be unpatentable, confirming any claim of the patent determined to be patentable, and incorporating in the patent any proposed amended or new claim determined to be patentable.” 35 U.S.C. § 307(a).

4.

Unenforceability due to inequitable conduct a.

One important type of inequitable conduct leading to unenforceability is

“fraud on patent office.” This typically involves false statements in the patent application. i.

“[I]nequitable conduct rendering a patent unenforceable arises when there is ‘evidence of affirmative misrepresentation of a material fact, failure to disclose material information, or


5

b.

ii.

submission of false material information, coupled with an intent to deceive.’” Ulead Systems, Inc. v. Lex Computer &

Management Corp ., 351 F.3d 1139, 1144 (Fed. Cir. 2003).

For example, in Unitherm Food Systems, Inc. v. Swift Eckrich,

Inc ., 375 F.3d 1341, 1361 (Fed. Cir. 2004), the applicant represented to the Patent Office that he invented the disputed process, and that it had not been offered for sale within the year before the application, while knowing that actually someone else invented the process and did offer it for sale within that period.

The resulting patent was thus fraudulently obtained and unenforceable. iii.

“Misleading statements by patent applicants, if intentionally made and material to patentability, can produce unenforceability, not invalidity.” Norian Corp. v. Stryker Corp ., 363 F.3d 1321,

1329 (Fed. Cir. 2004). iv.

Moreover, a patent is a licensed monopoly. If the license for the monopoly is unenforceable, monopolistic practices – such as excluding others from the market – which had been sheltered under the patent can become antitrust violations. See Walker

Process Equipment, Inc. v. Food Machinery & Chemical Corp .,

382 U.S. 172 (1965).

Another type of misconduct leading to unenforceability is “patent misuse.” The policy of the patent misuse doctrine is “to prevent a patentee from using the patent to obtain market benefit beyond that which inheres in the statutory patent right.” Mallinckrodt, Inc. v.

Medipart, Inc ., 976 F.2d 700, 704 (Fed. Cir. 1992). “Therefore, in evaluating a patent-misuse defense, the key inquiry is whether, by imposing conditions that derive their force from the patent, the patentee has impermissibly broadened the scope of the patent grant with anticompetitive effect.” Monsanto Co. v. McFarling , 363 F.3d 1336,

1341 (Fed. Cir. 2004) (citations and quotation apparatus omitted). i.

(A) In such a case what had seemed like an asset can become a liability. ii.

Examples of patent misuse include exacting royalties after the expiration of the patent term and asserting rights under a patent knowing it to be invalid. For a classic example see Morton Salt

Co. v. G. S. Suppiger Co ., 314 U.S. 488, 491 (1942) (tying license for patented salt dispenser to use of company’s unpatented salt tablets).

“[T]he patent laws preclude the patentee of an expired patent and all others including petitioner from recapturing any part of the former patent monopoly; for those laws dedicate to all the public the ideas and inventions embodied in an expired patent. They do not contemplate that anyone by contract or any form of private arrangement may withhold from the public the use of an invention for which the public has paid by its grant of a monopoly and which has been appropriated to the use of all.


6

C.

The rights in the invention are then no longer subject to private barter, sale, or waiver.” Scott Paper Co. v. Marcalus Mfg. Co .,

326 U.S. 249, 256-7 (1945). iii.

“[A] holding of misuse renders the patent unenforceable until the misuse is purged; it does not, of itself, invalidate the patent.”

C.R. Bard, Inc. v. M3 Systems, Inc ., 157 F.3d 1340, 1372 (Fed.

Cir. 1998). iv.

“All that a successful defense of patent misuse means is that a court of equity will not lend its support to enforcement of a misuser’s patent.” Senza-Gel Corp. v. Seiffhart , 803 F.2d 661, 668

(Fed. Cir. 1986).

Presumption of validity

1.

As to matters such as these there is a statutory presumption of validity, based on the presumed competence of the patent examiners not to issue a patent if the invention is not new or is anticipated by prior art. See 35 U.S.C. § 282.

2.

3.

The presumption is rebuttable, but “[t]he burden is on the party asserting invalidity to prove it with facts supported by clear and convincing evidence.”

Bausch & Lomb, Inc. v. Barnes-Hind/Hydrocurve, Inc ., 796 F.2d 443, 446 (Fed.

Cir. 1986). This is a higher standard than applies in ordinary civil actions.

Despite this heavy burden of proof, a great many patent cases are brought to litigate validity; invalidity is also a defense to infringement.

IV.

Does the proposed seller have good title to the patent?

A.

Is ownership concentrated exclusively in the seller?

1.

For example, the IP may have joint owners, by contract or because of the circumstances under which the patent was developed.

2.

Or the rights of the actual inventors may not have been merged into the seller’s ownership. a.

For example, a company may not be issued a patent in the first instance – an applicant does not qualify if “he did not himself invent the subject matter sought to be patented.” 35 U.S.C. § 102(f).

3.

b.

Therefore it is customary in industry to require actual inventors on a company’s staff, through their employment contracts, to assign their patents to the company (perhaps for additional compensation). Similar requirements are imposed on university researchers, often reserving some participation to the researcher. c.

However, although a staff scientist who worked on the project may have been under an obligation to assign her rights, she may for some reason not have done so, or this obligation may negligently not have been imposed, or some rights as to future participation or reversion may have been reserved.

Or perhaps the project was developed under a research and development grant, or a work-for-hire arrangement, which reserved some participation or imposed restrictions on transfer of resulting patents.


7

B.

C.

4.

Variations are numberless. a.

b.

Representations, disclosures and warranties by the seller are necessary to begin due diligence on this topic , and all arrangements discovered, reviewed and documented.

“Moreover, determine whether the inventors assigned their rights to later-filed improvements, divisional, continuation, continuation-in-part, and reissue applications. For pending applications, determine whether the inventors agreed to assist in prosecution.” Esther H. Lim, “Valuation of Patent Assets in a Global Economy: The Requisite Due Diligence,”

803 PLI/Pat 137, at 148 (2004).

Has the patent been assigned, either by the targeted company or to it?

1.

“Applications for patent, patents, or any interest therein, shall be assignable in law by an instrument in writing. The applicant, patentee, or his assigns or legal representatives may in like manner grant and convey an exclusive right under his application for patent, or patents, to the whole or any specified part of the United

States.” 35 U.S.C. § 261. a.

Obviously a buyer cannot acquire a patent which has been assigned until either the seller or the buyer recaptures the assigned interest.

2.

However, “[a]n assignment, grant or conveyance shall be void as against any subsequent purchaser or mortgagee for a valuable consideration, without notice, unless it is recorded in the Patent and Trademark Office within three months from its date or prior to the date of such subsequent purchase or mortgage.” Ibid.

a.

“That statute is by its terms limited to situations in which the patent owner makes inconsistent assignments, grants, or conveyances to two entities, and the question is whether the later assignee should prevail.

Section 261 provides that a later bona fide purchaser for value without notice (a later assignee) prevails if the earlier assignment was not timely recorded in the patent office.” Rhone Poulenc Agro, S.A. v. DeKalb

Genetics Corp ., 284 F.3d 1323, 1327 (Fed. Cir. 2002).

3.

4.

Patent assignments can be checked on line – see the resources mentioned in Part

VII.F below.

Representations, disclosures and warrantie s by the seller are necessary to begin due diligence on this topic .

Have IP rights been pledged or mortgaged, or otherwise subjected to a security interest?

1.

The Ninth Circuit has held that the statute requiring recording of a patent assignment with the USPTO does not apply to a lien or security interest secured by the patent, and that perfection of the lien is accomplished by recording it with state authorities under Title 9 of the Uniform Commercial Code. See In re

Cybernetic Services, Inc ., 252 F.3d 1039, 1044 (9th Cir. 2001).

2.

a.

This suggests yet another place to search when investigating title to an invention.

Are the IP interests in question providing security for any obligations of the company and if so how will they be treated in the acquisition of the company or the IP rights?


8

V.

D.

3.

Are any rights disputed?

1.

The most likely dispute would be about infringement – either by another company claiming the seller’s patents or processes infringes their patents, or by the seller itself, claiming infringement by others.

2.

Here again, representations, disclosures and warranties by the seller are necessary for due diligence.

Both have potential to damage to value of the patents. a.

If the seller’s patents infringe then they are worthless, or worthless without modification which may or may not be possible, and may indeed be a liability because of the possibility of litigation and an eventual judgment for damages. b.

If the actions of another appear to infringe the seller’s patents, that reduces their commercial value and indeed threatens their continuing viability. i.

Vindication of the seller’s patent may require litigation, which can be expensive, protracted and unpredictable. ii.

There is also a risk that the alleged infringer might succeed on a defense of invalidity, which would extinguish the patent.

3.

It is therefore an important element of due diligence to identify any dispute about infringement, whether or not it has proceeded to litigation. The buyer should request disclosure of all known litigation, cease-and-desist letters (either in or out), and any other claims by anyone affecting the targeted technology. a.

The seller should have notice of all lit igation directed to it, but if there are doubts about its candor or completeness an on-line search may be needed – see Part VII.F below.

4.

Infringement is not the only possible subject of dispute. Others include claims by employees or other participants to a share in the invention, disputed title , and liability for past acts (such as product liability claims). a.

The new CREATE Act, mentioned above, may spawn novel disputes about the nature of a particular joint research agreement, whether a particular agreement qualifies under the Act to bar a finding of obviousness, and whether others may have claims under the agreement.

There are as yet no binding precedents – this is an area to watch.

Are there limitations on the rights the patents extend?

A.

Licenses

1.

Have any been issued?

a.

Do they contain market, fie ld of use, or geographic limits? b.

Are they exclusive or non-exclusive? This can make a huge difference economically. c.

d.

i.

Are “most favored licensee” provisions in force?

Have there been requested or compulsory licenses?

Are grantback licenses in force?


9

B.

e.

f.

i.

“A grantback clause requires the licensee to grant back to the licensor patent rights which the licensee may develop or acquire.

There are two types of grantback licenses: one requires licensees to grantback exclusive licenses for improvement; the other requires licensees to grantback nonexclusive licenses for improvements.” Toshiko Takenaka, “Extending the New Patent

Misuse Limitation to Copyright,” 5 Software Law Journal 739,

770, 767 n. 136 (1992).

Do customers have any continuing rights, such as rights to renew royalty agreements or to use upgrades? i.

Government contracts sometimes include some user rights in source code.

“Only assignments need be in writing under 35 U.S.C. § 261. Licenses may be oral.” Waymark Corp. v. Porta Systems Corp ., 334 F.3d 1358,

1364 (Fed. Cir. 2003).

2.

Prosecution history estoppel

1.

2.

“The doctrine of prosecution history estoppel bars a patentee from asserting as an equivalent subject matter surrendered during prosecution of the patent application.” Eagle Comtronics, Inc. v. Arrow Communication Laboratories,

Inc ., 305 F.3d 1303, 1316 (Fed. Cir. 2002).

Thus when an applicant narrows a claim to satisfy Patent Office objections, he is presumed to have surrendered that part of the claim and is estopped from reviving it. The older term file wrapper estoppel means the same thing.

3.

Has the seller obtained licenses or other interests in patents of others? a.

Are there joint development agreements, or cross-licenses? b.

c.

Are any licenses transferable at the seller’s option, or must they be renegotiated?

To what extent are these third-party licenses necessary to the operation of the seller’s own technology?

“There are two distinct theories … of prosecution history estoppel – amendmentbased estoppel and argument-based estoppel. In general, prosecution history estoppel, under either theory, requires that patent claims be interpreted in light of the proceedings before the PTO.” Deering Precision Instruments, L.L.C. v.

Vector Distribution Systems, Inc ., 347 F.3d 1314, 1324-5 (Fed. Cir. 2003)

(citations and quotation apparatus omitted). a.

“With respect to amendment-based estoppel, a narrowing amendment made to satisfy any requirement of the Patent Act may give rise to an estoppel. A patentee’s decision to narrow his claims may be presumed to be a general disclaimer of the territory between the original claim and the amended claim.” Id. at 1325 (citations and quotation apparatus omitted) .

b.

“To invoke argument-based estoppel, the prosecution history must evince a clear and unmistakable surrender of subject matter.” Id.

at 1326

(citation omitted).


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C.

E.

D.

c.

Prosecution history estoppel can be deduced only from the correspondence between the applicant and the Patent Office as they negotiate what claims will be accepted for patent protection. i.

ii.

This is why is it necessary to examine this correspondence as well as the final issued patent.

This correspondence is available on line – see Part VII.F below.

Other reasons why a patent may not extend as much freedom to operate or exclude as appears on its face.

1.

Blocking patents a.

“The most common example is a pioneering patent that broadly covers a general process or product and an improvement patent that builds upon the original patent. Both patents are presumed valid, but the improvement patent cannot be put to use without infringing upon the pioneering patent. Hence, in the absence of a license, the pioneering patent effectively blocks the implementation or commercialization of the improvement patent.” Ian Simmons et al.

, “I Know It When I See It:

Defining and Demonstrating ‘Blocking Patents,’” Antitrust (Summer

2002) at 48 (footnotes omitted). b.

Blocking patents also have antitrust implications which are beyond the scope of this presentation.

2.

a.

A patent is a wasting asset, and unless supplementary patents are devised which effectively keep the company master of the technology, the term of the patent will mark the limit of its owner’s ability to exclude others from the practice of the art.

3.

There are many other possibilities.

In what jurisdictions is the invention protected?

1.

2.

Imminent expiry date

An American patent only carries patent rights in America.

Due diligence requires a search for patents for every significant invention or process be done in every relevant market. a.

Even though some jurisdictions aggregate patent protection, the costs of a truly worldwide search can easily outweigh the benefits – a triage is called for, separating out for searching only the most valuable patents and the most important markets. i.

Links to all major (including transnational) and many minor foreign patent office websites can be found collected at www.uspto.gov/web/menu/other.html

. ii.

The Derwent system offered at www.delphion.com

allows simultaneous searching of multiple foreign patent office records.

Note that deficiencies in none of these areas necessarily kill a deal – they just affect its value.


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VI.

Are any of these problems correctible?

A.

Some are. For example:

1.

2.

3.

4.

Unpaid maintenance fees can be paid if within the grace period.

Abandoned claims can be revived

Claims by joint inventors can be disclaimed or extinguished

Potential interests by customers in upgrades or source code can be disclaimed or extinguished – or knowingly accepted.

5.

6.

7.

Patent misuse can be purged.

Actual or potential litigation can be settled.

Patent protection can be obtained for unprotected foreign markets.

B.

8.

Competitive processes can be acquired. But antitrust issues must be considered if this is attempted.

9.

Examples could be multiplied.

Some are not. For example:

1.

2.

An expired patent cannot be revived, or extended absent some specific authorization such as the Hatch-Waxman Act mentioned above.

An invalid patent cannot be validated, although it can in certain restricted circumstances be reissued. See 35 U.S.C. § 251.

C.

D.

Distinguish problems curable by representations or warranties by the seller.

1.

As noted, much information may be too costly to obtain in the due diligence process. If the buyer cannot obtain satisfaction in his due diligence, he will often require a representation or warranty that a fact is true or that it is disclaimed. The selling company would not typically make the representation if the whole company were being bought, but the individuals who would obtain value from the purchase might make it. If the whole company were being sold , a portion of the purchase price could be retained for a while to see if any of the warranties prove to be unfounded.

Insurance against patent problems.

1.

While it is theoretically possible to obtain first-party commercial insurance against an acquired patent turning out to be invalid or otherwise valueless, it is generally impractical to do so. Such a policy would have to be individually underwritten and would almost certainly be prohibitively expensive.

2.

3.

Obtaining a commercial surety bond presents many of the same problems, and so it too is not a practical way to protect against this risk.

An alternate route to compensation for a deliberate or negligent misrepresentation by the seller as to the status or value of an acquired patent would be to proceed against the seller’s directors and officers, which could make available the company’s “D&O” insurance policy for their wrongful acts. a.

If the selling company is itself acquired and dissolved, its D&O coverage will ordinarily lapse, and as coverage is typically limited to claims made while the policy is in force the buyer’s claim may come too late.


12

b.

c.

b.

VII.

How to check for problems

A.

Collect representations , disclosures and warranties by the seller.

1.

Begin by asking the seller for an inventory of its patent portfolio, with particular attention to the possible problems noted in Parts III-VI above. a.

But because it is to the advantage of both buyer and seller companies to keep D&O insurance active, sometimes one or the other arranges for it to continue in force, or for “extended reporting” or “tail” coverage to be added to cover later-made claims.

Discovering the status of the target company’s D&O coverage is an important item in the buyer’s due diligence.

This would begin with a list of all patents the seller believes it owns or has some legal interest in.

Although these materials concern only patents, in practice the seller would be asked about its entire IP portfolio and many other aspects of its business.

2.

3.

Ask the seller for representations and warranties about the state of each patent with regard to the three categories mentioned above. a.

Are they valid? b.

c.

Is title complete?

Are there limitations in force?

Ask for disclosure of all documentation and correspondence relating to the development or acquisition of the patent, and subsequent history both of the patent and of the technology. a.

Check documentation of employee, consultant, and independent contractor agreements to determine ownership of the invention. b.

c.

Check documents bearing on encumbrances on the patent, such as the rights of other inventors, or licenses or contracts.

Check documents bearing on limitations on its scope, such as prosecution history estoppel. See Part V.B above. d.

Check documents bearing on maintenance issues, such as fee receipts, paperwork for small entity fee reductions, etc. i.

For an example of a patent imperiled because of doubts about the good faith use of the small entity fee reduction, see Ulead

Systems, Inc. v. Lex Computer & Management Corp ., 351 F.3d

1139 (Fed. Cir. 2003).

4.

5.

Check all papers transferring any IP interest to or from the seller. a.

This includes ownership and acquisition documents, chain of title, contracts and transfer documents with supporting papers and side letters if any, assignments and their recording in the Patent Office, records and threats of litigation, etc.

Ask for disclosure of any clouds on the company’s ability under the patent to practice the art and exclude other from doing so.


13

B.

6.

7.

a.

b.

c.

For example, has there been litigation concerning any patent?

Have there been cease-and-desist letters claiming infringement of the patents of others? Or has the seller issued such letters to protect its own patents?

An underfunded suit by an individual with no real case can have a very different impact on valuation than a serious suit by a major company with some right on its side. The same is true of an infringement claim.

Ask for disclosure of any other difficulties (or advantages) the seller knows to attend the use of the patent for business – for example competition in the market, expected technical developments, protection of lack of it in other markets.

Ask for the seller’s written policies for protection of patents (and in practice all intellectual property) and documentation that the policies have been followed. a.

Don’t be surprised if these are defective – companies often neglect their patent protection policies – but checking this is a necessary part of due diligence, and defective protection policies may suggest problem areas to investigate.

Examine the patents

1.

What do the patents actually claim? a.

“It is a bedrock principle of patent law that the claims of a patent define the invention to which the patentee is entitled the right to exclude. The claims made in the patent are the sole measure of the grant.”

Innova/Pure Water, Inc. v. Safari Water Filtration Systems, Inc ., 381

F.3d 1111, 1115 (Fed Cir. 2004) (citations and quotation apparatus omitted). b.

Sometimes it not obvious just what the clams cover, and even the patent holder may be mistaken about the extent of his rights. Check the scope of the patent claims against any representations, formal or informal, as to the scope of patent protection.

2.

What are the effective dates? a.

These can not only determine expiration date, but also disclose statutory problems such as the on-sale bar.

3.

4.

Are any patents vulnerable for faulty disclosure or other errors?

Include in your examination all applications and supporting correspondence and documentation you can locate. a.

For example, as noted it is the correspondence rather than the final patent that determines prosecution history estoppel. b.

Perhaps abandoned claims may be discovered which could be revived. i.

“Upon failure of the applicant to prosecute the application within six months after any action therein …, the application shall be regarded as abandoned by the parties thereto, unless it be shown to the satisfaction of the Director [of the Patent Office] that such delay was unavoidable.” 35 U.S.C. § 133.


14

C.

D.

5.

c.

Entire patent files, including applications and correspondence, can be viewed on line – see Part VII.F below.

The buyer will likely have knowledge of the technology relating to the acquired company. That should be compared with what the seller represents he is selling.

The buyer may be aware of invalidating prior art which could affect the selling price of the IP.

Examine carefully the seller’s representations, disclosures and warranties.

1.

A careful review of these representations (and supporting documentation) lawyer is essential to reveal hidden or potential defects. by a a.

The lawyer could be the buyer’s in-house counsel, or counsel retained for this task, or specialized patent counsel, or some combination. b.

Skimping on legal review of the seller’s IP inventory and supporting documentation is a false economy. One problem undiscovered could cost many times more than the lawyers were paid to discover it.

Talk to the seller’s lawyers and technical people as well as its business people .

1.

Talk to the lawyers a.

b.

This includes the lawyers who prepared the patent applications, and other patent counsel if any.

Review all IP opinion letters, including auditor opinions, relating to technology of interest in this transaction. c.

d.

Where litigation has been discovered or threatened, for example over alleged infringement, speak to the lawyers responsible for those matters as well, to get a realistic view of the circumstances.

This may be problematic for the seller, as disclosing to the buyer the legal advice it has received from counsel will waive attorney-client privilege and leave otherwise protected information vulnerable to discovery by its opponents. i.

This is a problem if the disclosure is made but the sale does not go through. If the sale does go through, and the parties enter into a joint interest agreement prior to the disclosure, the privilege may be preserved. Sellers in this situation should consult counsel before making any disclosure, as there may be farreaching consequences to sacrificing privilege.

2.

3.

Talk to the technical people , including inventors and engineers a.

What can they tell you about the technology and its development and potential? b.

What relevant research is ongoing? Ask for disclosure, subject to a confidentiality agreement to merge in the eventual deal if there is one.

Talk to the business people a.

Document their sales, royalty and revenue figures. i.

ii.

Who are their competitors, customers, and suppliers?

Are the sales genuine?


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E.

4.

iii.

Is the accounting sound?

(A) For example, is revenue prematurely booked before actually realized? iv.

What is their business plan for the targeted technology?

(A) They might have ideas you haven’t thought of, or you may know reasons why their plan is unrealistic. v.

vi.

What are the business trends for the targeted technology?

Involve an accountant if necessary to make sure the figures are accurate and reliable.

Document all these conversations a.

If possible offer the informants the chance to see your version of their comments – your perception of their views might not be accurate. This requires an analysis of the protection of privileged information – on the one hand you may lose the privilege, but on the other you may learn you are harboring false impressions.

5.

“Trust, but verify.”

1.

Ronald Reagan made this adage famous in his 1987 arms control summit with

Mikhail Gorbachev – it actually translates a Russian proverb.

2.

Does the view you have formed by your investigation match that of the seller’s people? Even allowing for biases, any divergence should be taken seriously – even after your investigation the seller’s people know their business better than you do. a.

This is a good reason to circulate your tentative conclusions in writing for comment by the seller’s personnel.

The phrase has become an international byword because it sums up two basic related truths about the need of decision-makers to verify their information. The need to verify does not necessarily imply distrust of the informant, and trust of the informant, however profound, does not diminish the need to verify. The representations and warranties of the seller should not be taken entirely at face value no matter what the circumstances. a.

There may be deliberate deception, although this is rarer than might be expected. b.

c.

d.

What is more likely is that the inventor or patent owner has a belief or wish that her patents are broader than they really are. This is common among patentees, who often think they have a pioneer patent that is broader than it actually is.

There may also be an element of negligence, such as items honestly but inadvertently omitted from the representations, or warranties made after insufficient investigation.

Even without negligence or deliberate deception, you must expect that the properties will be presented in their most attractive light, and that they might not look quite as good under pitiless daylight.


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F.

3.

If documentation, and verification, and interviews with the seller’s personnel, do not appear open and straightforward, if access is unreasonably delayed or trickles in irregularly, this is a danger signal that something may be wrong and that perhaps the seller is not being candid. This can be at least as strong a disincentive to proceed as negative information forthrightly disclosed.

Public sources. When all the seller has to say and offer has been absorbed, and maybe even sooner, begin to check from public sources.

1.

U.S. Patent & Trademark Office a.

The official U.S. Patent & Trademark Office website www.uspto.gov contains many sophisticated search tools for locating information about particular patents according to many search categories. i.

For example, given a patent number it can identify, exhibit, and transmit the patent and supporting documentation, including drawings and prosecution history. ii.

It can identify all the patents of a particular patentholder, by inventor or by owner, and subsequent assignments. iii.

It can identify sets of patents, independently of ownership, which correspond to classifications of invention, using the PTO classification system or descriptive terms. This is one vehicle for searching for prior art. iv.

v.

(A) Searching patents (or patents applied for) by subject, type, or classification, through on-line resources, can identify products not yet marketed.

The website also identifies by patent number the prior art referenced in the patent and later patents referencing the patent searched for. This is another vehicle for searching for prior art, as well as for later art which may affect the patentholder’s IP interests.

It will disclose the status of patents in progress, the maintenance fee status of patents already issued, contact information for an attorney or agent, and much more. vi.

(A) There are also an elaborate glossary, and a thorough, alphabetically arranged site index.

(B) Patents are archived on the site back to 1790, but search methods and available information grow narrower the further back one searches.

However efficient and versatile it may be, however, it takes some expertise to make the best use of the features of the

USPTO website, especially the classification system.

(A) But it is the premier free site where the answers to many of the necessary questions in the IP analysis are to be found.


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2.

Other on-line resources. a.

A number of on-line services offer, for a price, more streamlined access to patent information. i.

(B) There are explanations built into the site, and a help line.

Seven basic steps for a search strategy are identified at www.uspto.gov/web/offices/ac/ido/ptdl/step7.htm

The Delphion Research Intellectual Property Network has a subscription website at www.delphion.com

that offers an impressive and graphically sophisticated array of information on patents.

(A) Delphion includes access to the Derwent World Patent

Index, useful for searching for foreign patents in

English. b.

(B) It is worth taking the “free tour” offered on the website to see what it can do – see www.delphion.com/research/quicktour ii.

i.

Other services include Derwent (as noted also available through

Delphion), Reedfax, Nerac, and many others.

The PACER [Public Access to Court Electronic Records] system, maintained by the U.S. judiciary, can identify all filed federal litigation involving a particular party.

As all American patent litigation is in the federal system, a

PACER search will capture all patent cases involving any particular company. ii.

PACER breaks down cases by subject, so applying “nature of suit” code 830 separates out patent cases. iii.

PACER can will provide at the least a full and current listing of cases with districts and docket numbers, and for each a list of parties and counsel, a full-text docket, and sometimes other information. iv.

(A) PACER is useful for checking whether the target company has been complete in its disclosure of all pending patent cases, and in leading to copies of the original documents if further details are required.

In recent years some courts have accepted documents by electronic filing, and in such cases images of actual pages may also be available on PACER. v.

PACER is on the web at www.pacer.psc.uscourts.gov

. An overview is available on line. Costs are negligible.

(A) Courtlink, a private system now run by Lexis/Nexis at www.courtlink.com

, provides essentially the same services at a higher cost, but has some additional search features and is more efficient for retrieving documents, especially from multiple districts.


18

3.

4.

5.

6.

Other public information about the seller. a.

The seller’s website is a treasure chest of information – it is designed to be bullish on the company, and this very bias may reveal information which might otherwise not surface as a pre-sale disclosure. i.

For example, if the website boasts of government contracts, that may alert you to the possibility of contractual encumbrances on

IP which could impede its absolute alienation. b.

c.

The seller’s public securities filings – not only annual reports but many others required by the U.S. Securities and Exchange Commission in all sorts of circumstances – are available for full-text review on the

Commission’s website at www.sec.gov/edgar.shtml

. The site contains an on-line tutorial.

The trade and financial press, available through a Westlaw or Lexis-

Nexis search, can reveal much information about the seller’s business and business problems. d.

i.

Similarly the trade and financial press tracks technical or business developments in the field which might impact on a patent’s commercial usefulness. i.

Perhaps the targeted property has been offered be fore, but the deal did not go through. It is worth finding out why not.

However much a new patent improved a typewriter ribbon, it would not be worth much on today’s market.

A business intelligence service can provide a wealth of information not only about the target company but about competitors and market conditions in the industry. Kroll, for example, offers a good service and operates internationally – see their website at www.krollworldwide.com

. a.

For example, what are the alternatives to the targeted technology and who if anyone controls them? i.

An industry search can identify existing (or discontinued) commercial products. ii.

As noted, searching patents (or patents applied for) by subject, type, or classification can identify products not yet marketed.

How hard would it be to design a work-around for the targeted technology? a.

Consult your technical staff and that of the seller (even though the seller’s staff may have a bias). b.

Is a non-infringing product already in use by a competitor?

Foreign patent office databases a.

As noted a national patent generally offers protection only within the issuing country, and protection in other markets requires independent patenting elsewhere. b.

“Currently national patents protect property rights to new technologies but are only enforceable within the borders of the nation granting the patent. When a single competitor infringes the same patent in different


19

G.

H.

c.

d.

countries, the patent holder must sue for each infringement in each individual nation where the patent has allegedly been infringed.” John

Gladstone Mills III, “A Transnational Patent Convention for the

Acquisition and Enforcement of International Rights,” 84 Journal of the

Patent and Trademark Office Society 83, 84 (2002).

In some places, notably but not exclusively Europe, this is changing, and one registration can have transnational effect. The details of this development are beyond the scope of this presentation.

In some circumstances registration in a foreign patent office can defeat

American patent eligibility – see 35 U.S.C. § 102(d). e.

It requires a cost-benefit analysis how many foreign patent jurisdictions it is worthwhile to research, and for which properties.

Examine your own portfolio. The buyer needs to examine its own portfolio too, with almost as skeptical a viewpoint as it examine the seller’s.

1.

The buyer’s properties, and the condition they are in, will determine what is attractive (or not) about the seller’s IP portfolio, and what it (or parts of it) might be worth to the buyer. a.

b.

The buyer should have a thoroughly researched and verified analysis of its own IP portfolio on hand as a matter of sound business practice.

Weaknesses in either party’s portfolio can be compensated for by strengths in the other’s.

2.

Developing an inventory for one’s own company will make it easier to frame categories and develop a matrix for demanding and evaluating representations, disclosures and warranties from the seller, and easier to evaluate whether the seller’s properties are a good fit with your own, and how much they might be worth to you.

The final report

1.

The last step is to issue a comprehensive report the buyer’s decision-makers can weigh and analyze to decide if the possible gain is worth the risk according to their business values.

2.

“You should generate meaningful final reports that summarize findings and conclusions, rather than succumbing to the temptation to offer a simple go or nogo decision. Your final IP due diligence reports should specify the information basis of the report, sources and reliability of the data, findings, potential issues, such as risks, costs, obligations, that should be considered when deciding whether to complete the transaction or acquisition, potential issues that do not apply to the proposed transaction, and remedial actions that will improve the transaction, as well as possible assignment of responsibility for such actions. IP due diligence data are perhaps best organized first by category of asset and then by each individual IP asset within each category.” Michael P. Lachuck and

James R. Myers, “IP Due Diligence in Business Transactions: Develop Your

Plan Now,” 21 ACCA [American Corporate Counsel Association] Docket No.1, at 44, 57 (2003).


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3.

VIII.

Other due diligence issues

A.

Cost-benefit analysis: how deeply to inquire?

1.

2.

Due diligence on IP properties is a complex task.

3.

Getting the basic information about a named patent is relatively easy, but tracking down external circumstances affecting the patent, such as prior art, prior use or sale, undiscovered co-inventors, incomplete title, potential challenges to validity, potentially competitive technology, protection in foreign markets, and the like, can be labor-intensive and almost by definition is never absolutely completed.

Therefore, as noted, a cost-benefit analysis and a kind of triage are necessary, in which the investigation focuses on key IP properties and their protection in key markets, and on comparatively likely and potentially dangerous problems.

4.

Circulate the report to the buyer’s personnel, and insofar as possible (perhaps redacting parts pertaining to the buyer’s objectives) to the seller’s side also, as suggested, to discover inaccuracies.

5.

You will almost never be able to inquire about every aspect of the seller’s portfolio in the depth that would satisfy a careful accountant. Concentrate on what matters, and on those risks you can explore and quantify.

Discount the value of the portfolio by your horseback estimate of the unexplored risks, and make explicit all such risks and unverified assumptions so they can be factored into the final valuation. Failure to identify what you do not know can blindside your principals.

B.

Take your time

1.

Often opportunities require swift action, but swift action sometimes means superficial investigation.

2.

The tradeoff between these two values will always be a compromise. But it is a good rule of thumb never to be pressured into acting faster than feels right. It may be better to let an opportunity pass than to move before being reasonably satisfied that it is in the best interest of your company and its shareholders.

C.

3.

How fast events move, and how deep an investigation time allows for, may not always be under your control. At the very least, though, try to warn of the risks and identify outstanding questions. Some might be met with warranties which, if things turn bad, may afford your company a right of rescission or at least a cause of action.

What are you buying?

1.

Are you contemplating acquiring the entire company, or just interests in IP properties? If you are after the whole company, many other factors are relevant beyond the IP portfolio.

2.

The factors involved in valuing an entire company are of course beyond the scope of this presentation. It requires the help of skilled financial, accounting, legal and business professionals to do this correctly.


21

D.

Valuation

1.

How to value a company, or an IP portfolio, is primarily a business rather than a legal decision. a.

b.

But you have to have accurate legal analysis before valuation can be realistic .

Valuation is not absolute – a property is worth different amounts to different companies, depending on what they already have and what they think they need, which in turn depends on wider market conditions and on what other companies have or are thought to have (or have coming).

2.

How does the seller’s portfolio fit in with the buyer’s portfolio or needs? a.

b.

Valuation means value to the buyer portfolio as well as the seller’s.

– this requires analysis of the buyer’s

Use the buyer’s acquisition goals as yardstick – what are you after? i.

ii.

Is the technology an important marketing feature?

Can exclusion of others from the technology materially help the buyer’s own competitive position? c.

What is the value of the targeted properties: i.

to augment existing market position, or ii.

to complement existing IP holdings, or iii.

to expand the company’s position into other areas, or

3.

d.

iv.

v.

to block others from expanding theirs?

Or would some of these aims be redundant?

Independent analysis of importance of the seller’s patents i.

From industry sources, product reviews, business intelligence services, Internet, etc. ii.

Other IP components (trademarks, copyrights, trade secrets). iii.

The seller’s prospective patents – proprietary works in progress. iv.

Subsequent improvements – these could lessen or increase demand depending on market conditions. v.

The seller’s business plan – without acquisition would the seller be either an obstacle or a competitor?

Licensing royalties – are they profitable? a.

Are they still profitable after discounting for purchase price, but factoring in the expiration schedule and planned strategic expansion if any? b.

Their value might be different if the buyer aims at exclusion from practice (for example as a blocking patent), or at a licensing strategy, than if it aims at practicing the patents itself.


22

4.

Impediments exterior to the patent (some have been mentioned) a.

b.

c.

d.

e.

f.

Blocking patents or design-around capacity

Regulatory problems

Market problems

Antitrust problems

Lawsuits such as product liability actions not related to the patent itself

Licensing rights already given to existing patents

IX.

Conclusion

A.

Due diligence is only as good as the effort, time and money that is invested in it. It is costly and time consuming, but it is probably the only way to avoid buying something that is not worth what you paid for it.

January 2005

07345\754368.3


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Due Diligence in Acquiring American Patent Portfolios

DUE DILIGENCE IN ACQUIRING AMERICAN PATENT PORTFOLIOS by John L. Cooper

TABLE OF CONTENTS