IP Due Diligence In Canadian Business Transactions: Key Considerations

In today’s competitive marketplace, intellectual property (IP) and the IP rights that protect them are often among the most valuable assets a company possesses. Whether you are buying or selling a business (through a share purchase, asset acquisition or other transaction), a thorough understanding of the target’s IP portfolio is essential.

Due diligence is the investigation and analysis that a party undertakes before completing a transaction. It involves reviewing legal, financial, operational and other relevant information to assess the risks and opportunities associated with the deal. In the IP context, due diligence focuses on evaluating the target’s IP assets to confirm proper ownership, use and protection, and to identify any issues that could diminish the value of those assets. The scope and focus of IP due diligence will vary depending on the relevant IP and how the transaction is structured. This article highlights certain key considerations but is not intended to be a comprehensive list of all issues that may arise in the course of IP due diligence. Please contact the authors if you require assistance with a specific matter.

Confirming ownership and chain of title

One of the most important steps in IP due diligence is verifying that the seller owns, or otherwise has the right to use, the IP being used in the business. Depending on the type of IP involved, key considerations may include whether persons who created the IP properly assigned their IP rights to the target and whether there are any existing agreements that could affect post-closing use of the IP. Buyers should request and review relevant agreements (such as employment agreements, independent contractor agreements, R&D agreements, IP assignment agreements and any other agreements involving in-bound or out-bound licensing of IP) to confirm ownership, and trace the chain of title from the original creator(s) of the IP to the target.

In Canada, the distinction between employees and independent contractors is critical: while employers generally own IP created by employees in the course of employment, the same is not true for independent contractors, who retain ownership of their work absent a written assignment.

Buyers should also consider ownership issues arising from content generated by artificial intelligence (AI). Currently, Canadian copyright law is generally understood to require human authorship, and we can expect more discourse on this topic as the use of AI continues to grow.

Reviewing registered and common-law IP rights

A comprehensive review of the target’s registered and common law IP rights is essential. This includes searching the Canadian trademark, patent, industrial design and copyright databases,¹ as well as any foreign databases if the target operates internationally. Key considerations include the jurisdiction (e.g. Canada) and status (e.g. pending, registered or expired) of each registration, the scope of protection afforded by each right, whether any required maintenance fees have been paid, and if there are any outstanding examiner’s reports, office actions or other material correspondence from the applicable IP office.

For trademarks specifically, buyers should confirm that the target’s trademarks are being used in association with the relevant goods and services. In Canada, trademark registrations are generally valid for an initial period of 10 years and may be renewed indefinitely for successive 10-year periods, provided the mark remains in use.

For patents, buyers should note that Canadian patents have a term of 20 years from the filing date, subject to payment of annual maintenance fees.

For industrial designs, the term of protection in Canada ends on the later of 10 years after the registration date and 15 years after the filing date, subject to payment of a maintenance fee.

For copyrights, buyers should be aware that, in Canada, copyright lasts for the life of the author, the remainder of the calendar year in which the author dies, and for 70 years following the end of that calendar year.

Assessing IP agreements and encumbrances

IP assets are frequently subject to licenses, security interests and other encumbrances or rights that can affect their value, use or transferability (some of which may be recorded at the relevant IP office). Buyers should request and review all IP-related agreements, including without limitation any assignment agreements, inbound or outbound license agreements, joint development agreements, research and development agreements, distribution agreements, material transfer agreements, employee/independent contractor invention agreements, co-existence agreements, and security agreements. Issues to consider will depend on the type of IP and IP agreement. Examples include:

• The term of the agreement (e.g., is it perpetual, renewable or set to expire?)
• The type of license (e.g., is it exclusive, non-exclusive or sole?)
• Whether any sub-licensing is permitted or has occurred
• Any limitations on how the IP can be used in certain industries, territories or applications
• Any ongoing royalty commitments, revenue-sharing arrangements, or other payment obligations
• Whether any IP assets have been pledged as collateral or are subject to security interests that would need to be released or would survive the transaction, and whether there are any liens or other encumbrances recorded against the IP that could restrict transfer
• Whether the agreement survives a change of control of the target or whether there are any restrictions on assignment
• Whether the target has obtained waivers of moral rights from authors, as moral rights (including the right of attribution and the right of integrity) cannot be assigned under Canadian law and may restrict how copyrighted works can be used or modified
• Whether adequate measures are in place at the target company to protect trade secrets and prevent unauthorized disclosure of confidential information

For technology companies in particular, buyers should conduct an audit of the target’s use of open-source software. Open-source licenses may vary widely in their terms, and certain “copyleft” licenses require that derivative works (i.e., new creations that are based upon or incorporate elements of one or more pre-existing copyrighted works) be made available under the same open-source terms. This can have significant implications for proprietary software assets.

Assessing sufficiency

Buyers should assess whether the target’s IP portfolio is sufficient for the business as currently conducted. This means confirming that the IP rights cover the products, services, technologies and markets that are core to the business. Gaps in IP protection can affect the value of the transaction and the risk associated with the target’s business, and may require pre- or post-closing action to address.

Identifying disputes

IP due diligence should also assess the target’s exposure to IP disputes. This includes reviewing any litigation (including without limitation any opposition or section 45 proceedings under the Trademarks Act (Canada)), cease-and-desist letters and clearance search results or freedom to operate analyses. Buyers should consider whether the target’s products or services may infringe upon, pass off, misappropriate or otherwise violate the IP rights of third parties, which could result in future claims. On the flip side, buyers should also evaluate whether the target has been adequately enforcing its own IP rights against third parties that may be infringing upon, passing off, misappropriating or otherwise violating the target’s IP rights. A failure to police trademark rights, for example, could weaken the distinctiveness and value of the trademarks over time.

Practical steps for transaction success

Sellers can expedite the due diligence process, facilitate a smoother transaction and reduce the risk of post-closing disputes by organizing their IP portfolio well in advance of a sale and by engaging IP counsel early in the process. This includes ensuring that any and all IP assignments are properly documented, applications are filed, registrations are up to date and agreements are readily accessible.

Buyers should similarly engage IP counsel early in the due diligence process and should not rely solely on representations and warranties in the purchase agreement. While contractual protections such as representations, warranties and indemnities are important, they are not a substitute for a thorough understanding of the IP portfolio before closing. Identifying IP issues early may allow the parties to address them before closing, for example, by having the seller remedy defects, by adjusting the purchase price or by negotiating specific indemnities. In some cases, significant IP deficiencies (such as a fundamental ownership dispute or material infringement exposure) may be deal-breakers that cause the buyer to walk away from the transaction entirely.

Footnote

1. These are the most common types of registerable IP in Canada. However, registered IP rights in Canada also include plant breeders' rights under the Plant Breeders' Rights Act (Canada) and integrated circuit topography rights under the Integrated Circuit Topography Act (Canada), which may be relevant depending on the transaction. ↩