In the last edition, I highlighted some due diligence considerations for a business wanting to acquire a technology venture. In this article, I will focus on some important factors to keep in mind regarding the actual acquisition transaction. Although the interaction between oil and gas and technology is nothing new, there is an increase in the crossover between ICT (information and communications technology) and the oil and gas industry, with a significant rise in interest by production and service companies in new technology.
The factors to keep in mind in an intellectual property (IP) acquisition are often the same whether the transaction is structured as an asset purchase, share purchase, or a merger. One of the first points to look at is the jurisdiction of the buyer. Recent changes in the tax regimes of some countries can make it desirable to purchase the IP into a corporation that is set up in a tax-friendly jurisdiction, especially if the IP is intended for international exploitation. These countries allow a preferential tax rate for royalty and licensing income gained from IP, from where it can license and sell its IP to subsidiaries or other customers worldwide. Keep in mind that many governments also provide incentive programs for further IP development, which can be especially handy if the IP is not complete, is further developed or improved, as is often the case with technology.
If the buyer first purchases the IP in one company and then wants to transfer it to a holding company in a tax-friendly jurisdiction, there may be further tax consequences. An outright sale of IP can trigger a capital gains tax on the disposition, and a long-term arms-length licensing arrangement to the foreign entity may be better in larger transactions. On the other hand, if the IP is undervalued, the sale to the holding company with the lower capital gains tax may be better.
The sale and purchase agreement contains the bulk of the terms, including representations and warranties that are required to make the transaction successful. Often the sale and purchase agreement is accompanied by ancillary agreements, such as contracts for key person employment, non-competition and licensing, or assignment contracts. The terms of the sale and purchase agreement are not only important on closing, but also very important for a period after the closing to ensure a smooth handoff. Because of the abstract nature of IP, special provisions come into play in a technology purchase and must be properly addressed to minimize problems after closing of the transaction.
The objective of the purchase is to obtain all the IP necessary to conduct the business immediately after closing. Infringement of intellectual property rights is an important factor in the sale. There must be representations that the IP sold is authentic, does not infringe on the intellectual property rights of others, and is owned outright by the seller without any claim by a third party. Related to this is the representation that there is no actual or threatened claim by third parties that may impact on the utility or value of the IP sold. For example, if a patent process is pending with a significant risk of a claim or objection by another patent holder, the value of the IP can decrease dramatically, and the use thereof may be suspended if an actual claim is filed after the purchase. If the scope of the possible liability cannot be ascertained at closing, a separate continuing indemnity may be a good idea.
The seller may want to keep certain other IP to continue its business in different divisions that are not in competition with the buyer’s purchased business. The description of different IP can be confusingly close to each other. For this reason, the parties should clearly describe the IP sold and the IP excluded from the sale, to avoid problems with the interpretation of non-competition provisions after the sale. If parts of the IP has to be licensed or assigned to the buyer separately, these will have to be identified and the ancillary agreements drawn up.
The covenants are determined by the unique nature of each transaction. The most common of the seller’s covenants are to correct any technical problems with the IP and other problems that are revealed in the due diligence, to complete certain necessary developments and technical adjustments to make the IP usable to the buyer, and to get the necessary consents and authorizations to allow the buyer to use the IP uninterruptedly. Another important covenant, in the case of a lengthy handover, is that the seller must maintain the IP and the business throughout the handover period to avoid interruptions in service. If part of the sold business is to service customers, there should be a proper protocol to hand off customer and supplier accounts through closing, and often for some period thereafter.
IP is often a work in progress and continuing development and improvement is part of the package. Depending on the nature of the technology and competition, static IP can be obsolete within a few years, if not a few months, if improvements to the IP are not included. It is very important that the description of the IP bought does not only include the current IP, but also includes all future developments of the product. If the buyer does not have the skills internally to maintain ongoing development and improvement, it will have to make a contractual provision to retain key employees from the seller’s business, alternatively to have a compulsory service agreement with the seller, and in any event at least include all future developments as part of what is bought.
The value of IP is often very much connected with the principals and key employees of the seller. A separate contract to deal with this issue is a critical part of the success of the transaction. For example, a key developer and principal may have a depth of knowledge and understanding of the IP and its business that the buyer will not be able to reproduce or find internally. This often leads to a separate employment or service contract with the key employees to have them as part of the buyer’s business for a few years after the sale. This is beneficial not only from a product development point, but also from a client liaison and handover perspective. The buyer may negotiate a holdback on the purchase price or a balloon payment at the end of the required employment period to ensure that the key persons stay for the duration. The key person’s knowledge of the business may also be a risk to the buyer, because the unscrupulous seller may use the knowledge to start up a competing business after the sale. To avoid this, the key person agreement will usually have strict provisions of non-competition, non-solicitation, and non-circumvention, to deter the key person from soliciting supplier’s clients or employees away from the seller.
The business of technology and IP is ever becoming more complicated, involving more and more different parties in a single transaction. There is no doubt that the legal transactions will follow suit, and also become more complex to keep up with these challenges. However, it is nonetheless an exciting and fast-developing area that participants in the oil and gas technology industry will have to keep up with.
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