Unrestricted Ownership

The typical starting point of the reps & warranties catalogue is the seller’s representation that the schedules contain a correct and complete list of all (registered) trademarks owned by the target company (in the case of a share deal) or the seller (in the case of an asset deal). Buyers will reasonably expect the seller to further represent that it/the company is the unrestricted legal and beneficial owner of such trademarks, is free to dispose of them, and that the trademarks are free of encumbrances. It is advisable to clarify that the term “encumbrances” only includes pledges, usufructs, and other security interests and liens, but not licenses granted to third parties (as licenses are usually dealt with separately).

Granted Licenses

Buyers insist in general on a representation that no licenses under the company’s/seller’s trademarks have been granted to third parties (other than those disclosed in the schedules). Such a representation is important, considering that under most jurisdictions licenses continue to be valid (and potentially devalue the trademark), even after a change in ownership of the company (in the case of a share deal) or an assignment of the trademarks to the buyer (in the case of an asset deal). In some cases, however, it may be necessary to narrow down the clause in order to avoid misrepresentations: For instance, many distribution contracts concluded between a trademark owner and resellers of the branded goods contain a right of the reseller to use the trademarks in advertising and at the point of sale.

Licenses as Encumbrances and as Assets

As many of these clauses go beyond the fair use right resellers enjoy under the applicable law, they qualify, strictly speaking, as a license agreement and therefore are excluded from the representation in most cases. Another example is intra-group licenses which are, in many groups, granted for all IP rights owned by the group companies. The seller may have a legitimate interest not to disclose all such intra-group licenses, at least as long as the seller warrants that those licenses will terminate as of the closing date of the transaction.

Obtained Licenses

If the company has obtained trademark licenses which are significant for the company’s business, the buyer (in the case of a share deal) will want to make sure that the licenses are in force and will continue even after the transaction has been closed. A standard representation would be that the licenses have been validly granted and have not been terminated, and that to the seller’s best knowledge the respective licenses cannot be terminated by the respective licensors for cause. This would be a customary rep at least if limited to the situation which exists at the signing date or closing date. That representation typically excludes the question as to whether the licenses can be terminated by the licensors because of the contemplated transaction under change of control clauses.

»Usually, it is a good compromise to focus representations on any litigation threatened or pending within a certain time frame before the signing date, and on the seller’s best knowledge in relation to other (potential) infringements.« Dr. Benjamin Koch

It is the buyer’s homework during the due diligence phase to review the agreements for change of control clauses. The seller may under certain circumstances agree to refund part of the purchase price or rescind the transaction if important license agreements are terminated, but the seller should not give a warranty that the license agreement cannot be terminated if they include change of control clauses. In asset deals, if a trademark license forms part of the assets sold and assigned, a similar issue arises in relation to the assignability of the license.

No Infringements

The buyer’s preference will always be to obtain a hard representation that the company, or respectively the company’s trademarks, are not infringing any third party’s trademarks, and that no third parties are infringing company’s trademarks. But for the seller this is difficult to accept, particularly considering that the similarity between trademarks is hardly a clear-cut assessment and that court and office decisions are difficult to predict. Usually, it is a good compromise to focus representations on any litigation threatened or pending within a certain time frame before the signing date, and on the seller’s best knowledge in relation to other (potential) infringements.

Valid and Enforceable Trademarks

A rep & warranty that all of a company’s trademarks are valid and enforceable sounds reasonable, but in fact is hardly acceptable for seller: In many cases trademarks are registered for goods and services for which they are not used. They may be at least partly vulnerable to cancellation on non-use grounds (after the grace period has expired, dependent on the applicable law). Furthermore, unless a company’s trademarks have already been used for many years, it will be difficult to exclude the existence of third party trademarks which could be asserted against any of that company’s trademarks. Representing that the trademarks exist validly at the signing date, have been properly maintained and that the seller has no knowledge of any third party trademarks which could be asserted against the validity usually sounds like an acceptable compromise.

Indemnification

If the buyer has come across red flag issues during the due diligence it may decide to request an indemnification – at least in more severe cases such as trademark disputes with a higher potential of damage claims or rebranding costs. Negotiating indemnification clauses and conditions can be burdensome, given that both parties talk about the sharing of risks and the liabilities in worst case scenarios. A focus in such negotiations usually lies in the period for which the indemnification is granted, the definition of claims and damages subject to indemnification (direct/indirect damages, loss of profits etc.) and formal and procedural aspects (e.g. notification periods and requirements, determination of the party having control over defense and settlements, and the obligations of the parties to assist each other). Negotiating indemnities in many transactions is one of the last major issues, and if the parties have agreed on them, they will all usually hope that the dark scenarios they have discussed for days and nights, will never occur in practice.

Identifying the Relevant IP Subject Matter

It is important to consider the buyer’s commercial motive and, in the light of that motive, identify the IP subject matter relevant to the transaction. The brands of a target company may be a part of what the buyer is interested in. In this case the target’s portfolio of registered trademarks would deserve great attention and any gaps could be a deal breaker or at least a good reason to push the price. If the buyer intends to integrate the target company or its assets under the buyer’s name and trademarks, the target’s trademarks are of little concern to the buyer. Typically, the buyer would need to use them during a brief transitional period after the acquisition only. Any gaps in the trademark portfolio then would be, in principle, less cause for alarm.

Trademark Portfolio and Desired Use

From the buyer’s perspective, the key question of a trademark due diligence review is whether the target company’s assets include registered trademarks that cover the desired brands and the goods or services the buyer wants to use these brands for in the respective territory. The comparison between desired use and the trademark register is rather straightforward, but some knowledge about how class headings and descriptions of goods and services are construed (see ECJ IP Translator) certainly helps.

Ownership

What complicates that comparison is the fact that registration as the owner does not necessarily mean that the registered owner actually holds title to the trademark registration. So, just like a machine standing in the target’s production hall may belong to someone else, somebody else may own a registration that is registered in the target’s name. The target company may, for example, have agreed to a retention of title in a trademark purchase contract or the target company may have transferred trademarks by way of security. Any hints at such irregularities require a closer look at the chain of title.

Scattered Registrations

Sometimes, the portfolio management of a group of companies is a mess. Trademarks are often registered in the names of current or – worse – former principals of the target. Self-respecting managing directors of subsidiaries sometimes decide to register a trademark in the name of their entity instead of, or in addition to, registering it in the name of the parent or the IP holding of the group. The day-to-day business has often left little room for consolidating such scattered registrations. In the due diligence review, the buyer must ensure that the targeted entity is the owner, and the only owner, of registrations for the desired brands.

This is not only an issue for the buyer: The seller must check whether, by giving away the shares of the target, registrations for brands are lost that, commercially, are not part of the deal. Such checks (which may take the form of an outright vendor’s due diligence review) may require trademarks and other IP rights to be transferred into or out of the target companies. Tax lawyers need to be involved to avoid adverse tax consequences arising from such transfers (constructive dividends, hidden contribution in kind).

Licenses

Trademark licenses granted by the current owner or any predecessors are valid without a registration in most jurisdictions. In some jurisdictions, including Germany, the acquirer of a trademark remains bound by trademark licenses granted by previous owners. If these licenses are commercially unattractive to the buyer, they constitute an encumbrance of the trademark registrations and lessen the value the registrations have for the buyer. Therefore, examining license agreements is an essential part of any trademark due diligence review.

Disputes

Presumably most red flags during the due diligence are caused by threatening or pending IP disputes. If the target is alleged of having infringed a third party trademark, or – even worse – if the target has already been sued by such third party, a potential buyer needs to get a clear picture about the dispute and potential worst-case scenarios. What are the costs of a rebranding? How much damages are due if the target loses the litigation? What are the litigation costs? How likely is it that the target indeed infringes the third party rights? These and other questions need to be reviewed and assessed before completing the due diligence review.

When the due diligence is done, the negotiation and drafting of contracts begins.