American and Asian companies considering investments in Europe often focus on targets based in Germany, Europe’s largest national economy. Many buyers are not aware that due to the particularities of German employee invention law the patent portfolio of the target may contain considerable risks with regard to patent ownership. In the worst case, such “skeletons in the closet” may prevent the target company from using the patented technology.
On March 15, 2019, my colleague Janice Rice published a post on preparing for IP diligence by ensuring proper ownership of patents with valuable tips for investing companies. As this post was from the US perspective, we considered it useful to point out the risks involved when investing in German companies and provide some guidance on how to deal with them.
Patents often do not belong to the company for which they are registered
In Germany, like in many other jurisdictions, IP rights including patents may be transferred “on a beer mat,” or, in other words, outside the register. Therefore, it is crucial to keep in mind that the patent register does not necessarily reflect current ownership status.
A typical scenario from the German perspective is that the registered patent holder failed to comply with the requirements of the German Employee Inventions Act. German law before October 2009 required considerable organizational efforts for companies to claim the right to a patent. If the company failed to claim the invention in writing within a time limit of four months, a transfer of rights was not effective and all rights to the invention remained with the employee. The German legislature addressed this problem with an amendment of the Employee Inventions Act. The new law stipulates that the employer’s claim to the invention is deemed to be declared, if it has not expressly released the invention to the employee within a period of 4 months from receiving the invention report.
From an M&A perspective, it has to be considered that patents have a term of protection of twenty years. Patents filed before 2009, which are particularly susceptible to the ownership risk, often relate to inventions that are key for the current business operations of the target.
What are the risks involved?
Inventors having retained the right to a patent can in certain cases request the transfer of the patent and then assign or license rights in the patented technology to third parties.
The central risk in this case is that a new patent owner could have the target company legally prohibited from using the patented technology. In case of patents tailored to the core products of the company, these products can no longer be delivered and products already delivered might have to be recalled, destroyed or modified. This risk is considerably more serious for an investor, who is primarily interested in continuing the existing business operations of the target company, than for an investor, who already has a similar business operation of his own, including a patent portfolio, and may only wish to integrate parts of the target company.
From a purely financial point of view, there are additional risks with regard to the payment of damages and employee invention compensation. In the overall assessment, however, these risks are less significant than the ownership risk.
Risk mitigation strategies
Besides various other reasons why IP rights may not lie with the target (such as the absence of proper IP assignment clauses in contracts with management staff, subcontractors, research institutions and freelancers), companies investing in German technology businesses should pay particular attention as to whether the target complied with the requirements of the German Employee Inventions Act.
If the seller is not able to provide complete information, profound risk mitigation strategies targeted to the quality and/or lack of information are required. Such strategies may include a detailed analysis of the patent portfolio in order to identify patents that still fall under the former law, patents that are about to expire, key patents and patents that are not or only to a very limited extent product-relevant for the target’s current business operations. Depending on the individual case, further legal, economic and technical hedging factors may apply. This refers, for example, to statutory periods of exclusion and limitation, fiduciary duties to assign rights under German case law and the availability of work-around-solutions.
With the right strategy, in most cases at least moderate hedges can be determined for significant parts of the portfolio. Any remaining risks can be covered by warranties and indemnities to get the deal done.