6

Handling of Intellectual Property Rights in M&A

M&A (business reorganization) is an option for one company to buy the business of another company,
with other company’s patent and other intellectual property rights included, as a means to keep growing its
own business while saving temporal cost. Japan has finished legislation of relevant laws such as
Companies Act, and is entering the age of M&A. The purpose of this surveillance study is to research andanalyze intellectual property related issues that are problematic in M&A to provide a baseline fordiscussing the handling of patent and other intellectual property rights in business reorganization. In thisreport, M&A transaction methods permitted in our country (Japan), the United States, and the United
Kingdom are explained, first. Subsequently legal issues pertaining to the Industrial Property Rights Act
and related acts, for instance, a reasonable remuneration pertaining to employee’s inventions, treatment oflicense agreements etc. are gathered up by each M&A transaction method. In addition, issues and pointsof concern pertaining to M&A transaction and due diligence are analyzed. Furthermore the way of thevaluation of intangible assets, accounting issues and tax treatments are mentioned. Finally the result of
this surveillance study is analyzed with the cooperation of experts.

This research study was conducted, as partof the Japan Patent Office’s research project on
issues concerning the industrial property rights
system, to study the treatment of patent rights
and other issues in relation to businessreorganization.

Ⅰ Business reorganizationtransactions)(M&A

In Japan, permitted methods of businessreorganization include mergers, company splits,
business transfers and acceptances, shareacquisition methods such as share exchanges,
share transfers and share assignments, andcontributions in kind. When looking at businessreorganizations from the viewpoint of intellectual
assets, an important point is whether rights andduties are transferred from the extinct, split, ortransferring
company,tothesurviving,
succeeding, or accepting company, in acomprehensive manner as a result of the businessreorganization. The intellectual assets mentioned
above include not only intellectual property rights
such as patent rights, trademark rights andcopyrights, but also intellectual property such asbrands, trade secrets and knowhow, as well as
intellectual assets such as human organizations
and organizational strength.
In the case of a merger, the rights and dutiesof the extinct company are succeeded by thesurviving company in a comprehensive manner. In
the case of a company split, the rights and duties
described in the split agreement (or split
program) are succeeded by the succeedingcompany in a comprehensive manner. In the case

IIP Bulletin 2009of a business transfer, the specified assets andliabilities are transferred from the transferring
company to the accepting company individually. In
the case of share acquisitions, such as shareexchanges, rights and duties of the target
company are not transferred to the buyer since
there is no change to the juridical personality ofthe target company.
Outside Japan, in the United States, mergers,
asset transfers and share transfers are permitted
as methods of business reorganization. In the
United Kingdom, in addition to asset transfers
and share transfers, there is a procedure
involving the court called the Scheme of
Arrangement.

Ⅱ Legal issues and points ofconcern
pertaining
totheIndustrial Property Rights Act
and related acts
1

Issues pertaining to employee’s inventions

Regarding business reorganizations inrelation to employee’s inventions, different
problems are conceivable depending on whether
or not patent rights and duties to pay a reasonable
remuneration
pertaining
toemployee’s
inventions will be transferred in a comprehensive
manner as a result of the business reorganization,and to which company the patent rights, duties to
pay a reasonable remuneration, and the inventor
belong following the business reorganization.
In the case of a merger, patent rights andduties to pay a reasonable remuneration held by
the extinct company are transferred to the● 42 ●

surviving company following the merger in a
general succession, and the inventor istransferred to the surviving company. Here, theissues in relation to employee’s inventions are, if
sales increased as a result of the merger, whether
the sales increase should be reflected in the
profits to be obtained by the company, as well as
issues pertaining to the unification of employee’s
invention rules.
In the case of a company split, the situation
is more complicated compared to a merger, since
the split company will survive following thebusiness reorganization. Cases in which patentrights and duties to pay a reasonable
remuneration are both succeeded by the
succeeding company in a comprehensive manner
can be considered in the same way as a merger.
However, in cases where patent rights aretransferred to the succeeding company and duties
to pay a reasonable remuneration are retained by
the split company, the patent rights and duties to
pay a reasonable remuneration would belong todifferent actors, and the method of calculating thereasonable remuneration would become an issue.
Additionally, in cases where the inventor istransferred to the succeeding company and duties
to pay a reasonable remuneration are retained by
the split company, or in cases where patent rights
and duties to pay a reasonable remuneration are
succeeded by the succeeding company and theinventor stays in the split company, duties to pay
a reasonable remuneration and the inventor
would belong to different companies. In thesecases, the inventor would demand compensation
to a company to which s/he does not belong, andthe method of calculating the reasonable
remuneration would become a problem. In
addition, with regard to employee’s invention
rules, when the split or succeeding company
newly establishes or revises employee’s
invention rules, it is necessary to establish amethod of calculating the remuneration value
with the assumption of cases where patent rights,
duties to pay a reasonable remuneration and theinventor are owned by or belong to different
companies. Furthermore, in the case of acompany split, there is also the issue pertaining
to creditor protection procedures; specifically,
whether the inventor qualifies as a known
creditor.
In the case of a business transfer, rights andduties are transferred in a specified succession. Itshould be noted that the consent of the inventor
is required if duties to pay a reasonable
remuneration are to be transferred to theaccepting company.
2Issues pertaining to license agreements

In the cases of mergers and company splits,
the statuses of licensor and licensee in a license
agreement are transferred to the surviving or
succeeding company in a comprehensive manner.
Therefore, there are no problems regarding theownership of the statuses of licensor and licensee
in a license agreement. There is a problem,
however, if the license agreement contains a
specialprovisionthatbansbusinessreorganizations (provision banning mergers, etc.)
or a COC (Change of Control) provision.
Furthermore, in cases where, at the time when
the license agreement was concluded, it was notenvisaged that the licensee or licensor would
become party to business reorganization, aprovision banning mergers, etc. or a COC
provision are often not provided. In such cases,
there is a possibility that the counterparty of thelicense agreement might incur unexpecteddisadvantages, which would become an issue.
If the licensee conducted a company split,
there would be cases where both the split
company and the succeeding company would
require licenses, which would pose a problem.
Furthermore, if the license agreement is acomprehensive license agreement, the patentrights subject to the license are not specified bypatent number, etc. Then, if the licensor side
underwent business reorganization, would thatsignify an expansion of the patent rights subject
to the comprehensive license agreement?
Regarding business transfers, there are two
problems. The first problem is, in cases where
the licensee undergoes a business transfer,whether the status of holder of non-exclusive
registered right to work is transferred with thebusiness, pursuant to the provision of Patent Act
Article 94, paragraph 1. The second problem is, incases where the licensor transfers patent rights
in line with a business transfer, whether
unregistered holders of non-exclusive registeredright to work can counter the new patentee.
3

Points of concern
transactions

regarding

M&A

In M&A transaction agreements, in order tomove the deal to the next step, provisions such as
representation
andwarranty,
pledge,compensation and condition precedent areprovided for issues that could not be uncovered● 43 ●IIP Bulletin 2009

by due diligence, or were uncovered but could not
be resolved, due to restrictions with respect tothe time and personnel spent on due diligence.
Notably, the role of the representation andwarranty provision is important as it specifies thepatent rights owned by the target company andrepresents and warrants that the rights areregistered, etc. However, it should be noted thatthe party making the representation and warranty
would bear a significant risk if it made excessive
representation and warranty, such as “noinfringement on a third party’s patent rights.”
In addition, in M&A transaction agreements,
security provisions are commonly taken in order
to secure payment of damages or compensation incase one of the parties breaches an agreement.
These provisions include a two-stage payment
method, compensation by the parent company
upon representation and warranty, and using
escrow accounts.
4

Points ofdiligence

concernregardingdue

Due diligence is conducted in order to findrisks in an M&A transaction. Due diligencespecifies and confirms intellectual property rights
owned by the target company, examines theagreements concluded by the target company,
confirms the validity of rights and grasps
contingent liabilities such as risks regarding
infringements of intellectual property rights ofthird parties and risks regarding employee’s
inventions.
In
confirming
agreements,
licenseagreements and joint development agreements
are mainly evaluated, focusing on whether aso-called COC provision exists and, if it does, on
its content. The judgment of the risks ofinfringing intellectual property rights of third
parties is extremely important from thestandpoint of business continuity following the
M&A transaction. However, as this requires
high-level and specialized knowledge, and isdifficult to judge in a short period, due diligencein reality is conducted only with the minimum
necessary examination and judgment is avoided
through representation and warranty, pledge, etc.
In some cases of due diligence, the target
company discloses confidential information to thebuyer. The method of confidential information
disclosure and the treatment of disclosed
confidential information require particular care
and attention.

IIP Bulletin 2009

Ⅲ Issues and points of concern
regardingvalue,
valuation,accounting and tax
1

Value and valuation

In M&A transactions, the value of the target
enterprise (or business) is appraised in order todecide the purchase price. Usually, whenappraising the target enterprise (or business), it
is rare to appraise separately the intangible
assets owned by the target enterprise (orbusiness) concerned. However, in cases where
the purpose of the M&A transaction lies inacquiring intangible assets, or where thetransaction involves buying a research anddevelopment-oriented enterprise, it becomes
necessary to appraise the industrial property
rights, technologies, trade secrets, knowhow,human assets, etc. of the enterprise concerned.
Since valuation for deciding the purchase price isdifferent from valuation for accounting purposes,
it is meaningless to allocate value to individual
intangible assets. The subject of valuation is to be
decided depending on the purpose of the M&Atransaction.
There are several ways of appraisingintangible assets, which are classified into a cost
approach, market approach or income approach.
Each has its advantages and disadvantages. The
optimal method should be chosen in light of the
purpose of the M&A transaction. The income
approach calculates the enterprise value andvalue of intangible assets based on the future
profit to be generated by the enterprise. Since thepurpose of M&A transactions lies in improving
the enterprise value, it is desirable to appraiseintangible assets using the income approach.
2

Possibility of leaks of technology, etc.

In
M&A
transactions,confidential
information of the target enterprise is disclosed
to the buyer for purposes such as deciding thepurchase price. However, M&A transactions are
not always successful. In cases where the deal iscancelled halfway through, the target enterprisewould end up having disclosed confidential
information to a third party without gaining
anything from it, resulting in a substantial loss.
Additionally, given that the higher theconfidentiality of the information, the greater its
impact on the purchase price, the enterprise
disclosing information is typically caught in adilemma between the purchase price and● 44 ●

maintaining confidentiality. While there is no
absolute measure to prevent leaks of confidential
information, one possible way is to limit thedisclosure to a third-party valuation body.

research and development expenses need tobe reported as costs. Goodwill is notamortized but, instead, is subject toimpairment tests each term and reported as aloss if impairment has been confirmed.

3

In the United Kingdom, listed enterprises are
required to conduct accounting procedures inaccordance with IFRS (International Financial
Reporting Standards). Under IFRS 3 and IAS 32,
accounting procedures for business combinations
are to follow the purchase method (the pooling ofinterest method is banned), and reporting
intangible assets is compulsory if certain
conditions are met. If in-process research anddevelopment have been acquired, development
costs that meet the requirements set by IFRS are
required to be reported as assets.
As explained above, accounting proceduresfor business combinations differ by country.
However, given that investment activities aretranscending borders, Japanese and U.S.
accounting standards are increasingly converging
with IFRS, and a direct adoption of IFRS is also
underconsideration.
The
aforementioned
revision of Japan’s business combinationaccounting standards took place amid the current
trend of accounting standard convergence.

Accounting valuations and reporting
methods of patent rights, etc.

In Japan, accounting standards pertaining tobusiness combinations have been established andare in operation. Under the accounting standards,
accounting procedures for business combinations,in principle, use the purchase method, while theapplication of the pooling of interest method ispermitted
asanexception.
Accounting
procedures using the purchase method involve
goodwill, which is amortized over a period of up
to 20 years. In addition, patent rights etc.
acquired in M&A transactions can be treated andreported as intangible assets. However, since theaccounting standards merely approve of reportingthem as assets, it is rare for patent rights etc.
obtained in M&A transactions to be actuallyreported as assets. In cases where in-process
research and development have been acquired,research and development expenses are to bereported as costs.
The business combination accounting
standards were revised in December 2008 andnew accounting standards will be applied tobusiness combinations starting from April 1, 2010.
Under the new accounting standards, accounting
procedures using the pooling of interest method
will be banned in business combinations. In
addition, in cases where the purpose of the M&Atransaction lies in acquiring intangible assets, theintangible assets in question are required to bereported as assets on the condition that theirvalue can be measured accurately. Research anddevelopment expenses for in-process researchand development acquired in M&A transactions
are also required to be reported as assets if theymeet certain conditions. Under the revised
accounting standards, an enterprise’s intangible
assets that are expected to become a future
profit-making source will become reflected infinancial statements more than ever.
In the United States, SFAS 141 provides foraccounting procedures for business combinations
and SFAS 142 provides for the treatment ofintangible assets. Accounting procedures forbusiness combinations are to use the purchasemethod (the pooling of interest method is banned),and reporting intangible assets is compulsory if

certainconditions

are

met.

4

Tax treatment

When business reorganization is conductedby means of a merger, company split, shareexchange, share transfer, etc., an organizational
restructuring tax system is applied. If thebusiness reorganization is recognized as aqualifiedorganizational
restructuring,arescheduling of asset transfer gains or losses isallowed and taxation does not take place. On theother hand, if it is recognized as a non-qualified
organizational restructuring, asset transfer gains
or losses are subject to taxation. Since intangible
assets are often unreported, if the businessreorganization is recognized as a non-qualified
organizational restructuring, the value of thetransferred intangible assets must be appraised
and taxes must be paid. There are no provisions
in the Corporation Tax Act regarding thevaluation method of intangible assets. For
practical purposes, intangible assets are appraisedby making calculations based on basic
instructions for property valuation used whencalculating inheritance tax and transfer tax, or inaccordance with the excess profits act.

In-process● 45 ●IIP Bulletin 2009

Ⅳ Analysis of research results
Based on the outcomes of domestic andforeign literature research, overseas research anddomestic interview research, legal and otherissues regarding the treatment of patent rights
etc. in relation to business reorganization werebrought together and analyzed with thecooperation of experts.
Regarding the legal issues pertaining to theIndustrial Property Rights Act and related acts,
two attorneys analyze and discuss the topics of“problems arising in each stage of an M&A
transaction and practical responses” and“problems with intellectual property laws in
relation to M&A transactions that need beresolved” from the standpoints of practitioner andlegal expert.
With respect to issues and points of concern
regarding value, valuation, accounting and tax, acertified public accountant analyzes and discusses,
based on his business experience, the following
five issues: (i) Valuation method selection, (ii)
Computational elements of the discounted cash
flow (DCF) method, (iii) Valuation result
discounting, (iv) Brand value appraisal, and (v)Effect of differences in accounting and taxation
procedures.
(Senior Researcher: Kazuaki WATANABE)

IIP Bulletin 2009

● 46 ●