Changes in Corporate Structure Can Destroy Key IP Rights

What happens to a company’s IP portfolio when it merges with another company or otherwise reorganizes?  Say that Company A merges into Company B.  Shouldn’t someone, presumably company B, do an IP audit?  An IP audit identifies and evaluates a company’s IP assets, such as patents, copyrights and licenses.  An IP audit should identify the licenses that are important to the day to day operations of Company A.  For each such license, the IP audit should identify whether the license contains terms restricting its transfer or assignment.  Perhaps this is an obvious aspect of due diligence, but it sometimes gets overlooked, leading to a loss of value of or even the inability to enforce rights regarding a particular IP asset.

Owen J. McKeon describes a recent example of the failure to account for a patent during a corporate reorganization in Corporate Reorganization Absent Assignment or License of Patent Rights Results in Preclusion of Patentee’s Lost Profits Damages.  The plaintiff patentee is a company that sued another company for patent infringement.  The plaintiff patentee’s operations were transferred to a parent corporation in a stock acquisition and operations restructuring.  The parent corporation was not a party to the litigation.  The plaintiff patentee did not assign or license the patent to the non-party parent.  The patentee continued to operate as a business, but the non-party parent conducted all operations regarding the subject patent.  The court ruled that the patentee could not collect lost profits damages for any time after the reorganization date, as the non-party parent, not the patentee, incurred the business expenses and losses and enjoyed the profits associated with the patent after that date.  The plaintiff patentee could not enforce the patent after the reorganization date, but neither could the non-party parent, as no patent rights were transferred or licensed to it.  The upshot is that no entity on the plaintiff’s side of the suit could enforce the patent after the reorganization date.

Federal common law causes this licensing problem.  The U.S. Supreme Court declared in Erie R.R. v. Tompkins, “[t]here is no federal general common law.”  Undeterred by this pronouncement, the 6th Circuit proclaimed, “[f]ederal common law governs questions with respect to the assignability of a patent [or copyright] license.”  The 6th Circuit stated that despite the declaration in Erie that there is no federal general common law, “there are limited situations where there is a significant conflict between some federal policy or interest and the use of state law that require judicial creation of a special federal rule of common law.”  The court indicated that such a special rule is clearly justified in the area of intellectual property, because the reward of the exclusive right acts as an incentive to invent and create.

In Cincom Systems, Inc. v. Novelis, Corp, the case discussed immediately above, Cincom developed, licensed and serviced software for corporations.  It licensed some software to Alcan Ohio for use in a particular facility.  The license was non-exclusive and non-transferable.  Alcon Ohio underwent a series of reorganizations and name changes, eventually becoming Novelis.  Apparently the name changes did not affect operations and Cincom’s software continued to be used in the facility for which it was licensed.  Cincom learned of the corporate changes and sued Novelis, alleging violation of the software licensing agreement.  The district court entered summary judgment in favor of Cincom and the 6th Circuit affirmed.  The name changes violated the license and caused Novelis to infringe Cincom’s copyright.

In PPG Industries v. Guardian Industries Corp. the plaintiff PPG and Permaglass, Inc. developed similar processes for fabricating glass.  The two companies licensed their respective patents to each other.  PPG licensed two patents to Permaglass on a non-exclusive, non-transferable basis.  Permaglass granted an exclusive license in nine patents to PPG, reserving to itself a non-exclusive, non-transferable, royalty-free license.  PPG could assign to any successor of its entire flat glass business, but otherwise could not assign without the previous written consent of Permaglass.  The license granted to Permaglass was personal to Permaglass and was non-assignable except with the previous written consent of PPG.  A termination clause provided that if a majority of the voting stock of Permaglass became owned or controlled by an automobile manufacturer or a glass manufacturer or glass fabricator other than the present owners, the license granted to Permaglass would terminate. Permaglass subsequently merged into Guardian, the defendant.  Guardian’s primary business was fabricating and distributing automobile and truck windshields.  When PPG discovered the merger, it filed suit against Guardian for patent infringement.  PPG claimed that Guardian infringed all eleven patents, the two PPG patents and the nine Permaglass patents.  The district court ruled that there was not a transfer or assignment under Ohio and Delaware merger statutes.  The 6th Circuit reversed, stating that “[q]uestions with respect to the assignability of a patent license are controlled by federal law.  It has long been held by federal courts that agreements granting patent licenses are personal and not assignable unless expressly made so.”

The result in PPG highlights the need to include a thorough IP audit in the due diligence process.  It is not enough for the potential target to provide an attachment with copies of the patents, as Permaglass did for Guardian.   The acquiring company must examine the licensing documents itself.