The Deal Maker's Minefield

The urge to merge shouldn't blind firms to intellectual property problems

3 min read

Illustration: Mick Wiggins

When deal makers at companies like Comcast and Cingular consider tomorrow's headline merger, it's a pretty good bet they're focused on grand strategies and big numbers. Meanwhile their lawyers lose sleep as they count intellectual property (IP) land mines rather than sheep. IP problems have a way of erupting unexpectedly, often just before a big deal closes.

Anyone doubting the dread inspired by IP issues in legal circles might consider the epic precautions taken by Synopsys Inc., an electronic design automation company, in its 2002 acquisition of another electronic design firm, Avant! Corp.

Avant!'s CEO and several other executives had recently pleaded no contest to theft of trade secrets from their previous employer, Cadence Design Systems Inc., Synopsys's main rival. Forewarned, Synopsys paid a whopping US $335 million for a litigation insurance policy against any potentially ruinous financial penalties resulting from the civil suits filed in response to the thefts. The lesson is clear: particularly for technology companies, IP concerns can cast a large shadow over deal making--and this can happen even without charges of outright theft.

One reason for this, of course, is that IP can turn insignificant competitors into potent threats. Eolas Technologies Inc., a company with just one employee, claims patents on how all browsers use external applications such as media players to view Web content. It recently stunned Microsoft Corp. with a lawsuit that resulted in a $521 million patent-infringement verdict.

What's really worrying is the elusive nature of many IP rights. Problems can arise from knowledge gained in past employment or seemingly innocuous contract clauses; they can lurk in the corners of unknown patents and obscure licensing deals and open-source obligations. And they tend to surface when the stakes are highest--on the eve of a merger, for example, when IP owners find sudden motivation to investigate and assert their rights.

Just who these IP owners are can also be a surprise. Savvy technology companies screen job candidates for obligations to current and past employers. But what about ties to their alma maters? Few companies bother to investigate whether projects proposed by recent graduates have roots in their student days, but stringent invention policies have become widespread in universities. Graduate students and postdocs may not own the innovations they created in academia. Learning of a university's prior and superior rights in a technology that a company has paid its employees to develop can come as quite an unwelcome shock--particularly if the university has already licensed such rights to the employer's competitor.

Technology firms, of course, routinely require employees to sign comprehensive invention-assignment agreements (even if they can't imagine universities doing this). But often companies let their guards down when it comes to consultants. They assume that because they're paying the consultant to perform a task, they own all rights to the resulting work. The truth is just the opposite. Pay an artist for a painting and you get the painting itself, but not the artist's copyright in the painting.

Similarly, without an express agreement assigning copyright, a software consultant may owe the client no more than a copy of the program. The consultant retains the exclusive right to sell the program to others. (A related trap is thinking an agreement calling the program a "work for hire" is sufficient to transfer copyright, which frequently it is not.)

Anticipating IP challenges is complicated by the confidential nature of most proprietary information. Yet even patents, the most public of all IP rights, can hide unforeseeable problems. To identify patents of possible relevance to their businesses, companies typically search by keyword and by classification. A competent search can reveal most--but never all--patents of concern, because technical vocabularies evolve and classifications become outmoded.

In 1976 British Telecommunications PLC (then part of the British Post Office) filed a patent for a system that allows users to access text-based information via a telephone network. BT claimed in 2000 that this patent covered hyperlinking and tried to enforce it against Prodigy Communications Corp., an Internet service provider. At the time the system was patented, none of the inventors used the term "hyperlink." But 25 years later, with the Internet ascendant and hyperlinking ubiquitous, the temptation toward creative patent reinterpretation was enormous. Certainly no search for "hyperlinking" would have turned up the BT patent.

The point is that some IP rights resist all efforts to unearth them. But that doesn't mean prospective acquirers and merger partners shouldn't dig.

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