Pitfalls in Asian IP Acquisition Deals

By Alan Adcock and Nicholas Redfearn (Rouse & Co. International)
Excerpt from a recent article in WorldTrade Executive's
Global Intellectual Property Asset Management Report

Merger and acquisition deals in Asia are taking on an increasingly significant IP component. But for a foreign company interested in an Asian target, are there any particularly tricky steps which deserve more attention than you might normally pay? This article identifies 10 major pitfalls, including the following:

The Non Disclosure Agreement – an important first step in deal planning or an over zealous over reaching attempt to look strong?

Obligations of non-disclosure and confidentiality are important for any type of deal touching on IP, not only for technology, IP and trade secret matters which may be the target of the purchase, but also for business strategies, new product ideas and financial and accounting information which are likely useful to decide whether a deal will go forward.

Non-disclosure and confidentiality undertakings are enforceable in Asia provided they be reasonable and fair and not do violate the public interest. Normal western style confidentiality undertakings setting out the agreed terms of what constitutes the “confidential information” and what does not, acknowledgement of proprietary interest in the confidential information and penalties for unauthorized disclosure, etc are also common in Asia.

However, sometimes your Asian counterpart may feel uncomfortable with your standard NDA. He may feel that you are taking too formal of an approach to a relationship he believes should be built on trust rather than legally enforceable rights. This is usually the reaction if the NDA and its obligations are one-sided. While non-reciprocal NDAs may be achievable in terms of a licensor/licensee relationship, a buyer-seller relationship is different and the necessary (and expected) disclosure of information needed to decide whether the deal progresses should be explained to your Asian counterpart. If this still cannot be agreed, then a prudent buyer will ask himself why uncertainty remains and whether this particular target is appropriate.

Sometimes, the non-disclosure undertaking you seek may not be directly with the target, but rather with employees or other third parties connected to the target or to the target IP. If you are not in a position to enter into a NDA directly with those people who know of the confidential information, you can ask your seller counterpart to add its own confidentiality restrictions (as riders to existing or in new agreements) to its own agreements with its employees, agents, etc and you should request copies of these. This is common and we would certainly advise it.

Disclosure Statement – what is the minimum expected and how much can/should you ask for?

The attractiveness of acquiring a business in Asia is not only the prospect of an instant market for goods or services the target already sells or manufactures, but also the ability to acquire valuable IP rights or to source materials at prices often more competitive than in other countries. Having a business here also makes for easy distribution within the Asia Pacific Region. However, when acquiring a business in Asia, it is imperative that you get the seller to identify defects in the IP, in the market and in the business which may effect your purchase price or which will need to be corrected (possibly with the help of the seller). Representations and warranties from the seller should be expressly set out in the acquisition agreement and the Disclosure Statement serves to limit these (save for fraudulent misrepresentation on the part of the seller) by identifying such problems and putting the buyer on notice that they exist. This should be explained carefully to your Asian seller so that he understands that this serves to protect him against future claims you may make for breach of warranties and representations.

Many times, sellers may not be able to answer all of the buyer’s questions on existing IP portfolio defects, disputes or business concerns. This is particularly true if the IP has not been carefully maintained (which occurs frequently in Asia with local domestic counsel and registries themselves making mistakes). There may be disputes over the IP both in Asian IP registries as well as on the ground with infringers or with others who claim that the IP you wish to buy infringes their rights. Sometimes, a seller’s business is stong in some countries, but not in others. You should be wary of any seller who paints only a rosy picture and fails to disclose any problems. In many Asian jurisdictions, the time and costs of litigating representations and warranties can be extremely high and will likely take years to resolve (if at all). This, of course, may delay rollout of your business plans. More

Dealing (and Dealmaking) with Mexican Grupos

Excerpt from
North American Free Trade & Investment Report
published by WorldTrade Executive, Inc.
by Alyssa A. Grikscheit and Javier Fierro
(Goodwin Procter LLP)


Grupos are the large family conglomerates that dominate the Mexican economy. If you are a strategic or private equity investor attracted to the increasing opportunities in Mexico what kind of structural issues are you going to encounter if you invest with Grupos?

In Mexico, Grupos have impeded competition, keeping near-monopolies in certain industries. For instance, there are only two beer companies, two major food processors, two television networks and six radio chains in the country.Some Grupos have successfully expanded outside of outside of Mexico.

There are three main common characteristics found in a Mexican Grupo. First, the Grupo will typically run several businesses, and often these businesses will operate within various industries. Second, the Grupo will generally be composed of more than one family, but their connections run deep. And third, the organizational structure is predominantly based on kinship.

Dealing with Grupos can be a thorny issue, especially when trying to exit the investment Some Grupos may not want to exit their investment because they want to pass down the business to their offspring. Other less scrupulous Grupos may use
their political and economic muscle to shift assets to other investments within the
Grupo.

On the other hand, a Grupo on an investor’s side can
be a significant ally in an emerging market. By integrating with
a Grupo, an investor will gain political power, acquire local
knowledge of the country, and avoid contractual problems
with other local firms, all while avoiding expensive search
costs. The question therefore arises: how to find a suitable
Grupo? As with any other investment opportunity, finding a Grupo will inevitably require the investor to do its homework.


Due Diligence
First and foremost, the investor needs to perform a background check on the family. The investor needs to identify red flags such as young and inexperienced family members in key management positions within the company. In addition, the investor needs to review their resumes. Are they educated professionals or are they simply in their positions because of their family name? A strong kinship bond within the Grupos sometimes displaces sound business judgment and good corporate governance.

The investor should also identify the family patriarch within the Grupo. Sometimes knowing who holds the power within the family may not be readily apparent because of the complexity of the Grupo network. Understanding the family organizational hierarchy will prove invaluable when a conflict arises. The investor should also verify whether the Grupo has the political and economic muscle they claim to have; sometimes it may just be pure bravado.

In addition, the investor should check to see if the Grupo has commitments with other foreign firms. Such commitments may mean a Grupo has already been required to keep family assets and company assets separate and to meet certain corporate governance standards. It may also mean the Grupo’s reputation will be affected by a major fallout with a foreign investor. While checking the Grupo’s commitments, the investor should also check for potential conflicts of interest that may arise from the transaction.

It is critical to identify the keyplayers in the Grupo. This is particularly important in the negotiation process. Negotiating with a family member with insufficient authority may mean that concessions made by the Grupo are later reversed, effectively giving the Grupo two bites at the apple.

It is also critical to build a relationship based on mutual trust. Although many Grupos have been successful in jurisdictions outside of Mexico where deals may go to the highest bidder regardless of emotional or other connections, they still tend to rely on building relationships before crafting and executing deals. Finally, it is crucial to note the long-term memory of most Grupos. Because of their family connections, management is typically not very fluid. The investor’s management team may change several times, while the Grupo’s team remains more or less intact. Perceived injustices by the investor will not be easily forgotten, and may impact future dealings with the Grupo.

Setting a Price
Earnouts can be a powerful tool in dealmaking with Grupos. They ensure that performance incentives are aligned and serve as both “sticks” and “carrots”. The stick is essentially the investor’s bargaining power in the event of future disputes, and the carrot, quite simply, is cash, which may be in short supply in Grupos that do not include a captive bank.

There are other possible leverage points as well. Sometimes a private equity investor will try to position itself as the information gatekeeper. The investor may try to hold certain valuable information or intellectual property separately from the portfolio company. Holding such information or intellectual property directly may allow the investor to exert external pressure on the Grupo without having to rely on weak institutions for enforcement. However, this approach may not be practical in Grupos where the management (and members of the Grupo) has an inherent information advantage. More

Pensions Issues in European Mergers and Acquisitions

Excerpt from a recent issue of International Finance & Treasury
By Rosalind J. Connor, Daniel C. Hagen, Emmanuelle Rivez-Domont, Georg Mikes, Friederike Göbbels, Carla Calcagnile, and Chantal Biernaux, of Jones Day

Pensions-related issues have long been a major concern in M&A transactions in the United States. Issues relating to funding can color the attractiveness of a transaction, and liabilities relating to multi-employer plans and to postretirement medical expenses can have a significant effect on the economic viability of the transaction.

Pension obligations continue to cause problems, particularly given growing longevity, which gives rise to significantly increased costs. The growing global trend towards more disclosure of pension liabilities in company accounts has also moved pensions further up the agenda in corporate transactions.

These matters are of growing concern across Europe, which is experiencing both increased longevity and enhanced disclosure requirements. However, the particular issues are very much country-specific, and it is important to be aware of what particular issues may arise in any specified jurisdiction on an international M&A transaction. The latest issue of International Finance & Treasury, published by WorldTrade Executive, reviews the pension provisions in a number of European jurisdictions and the issues to be alert to in a transaction involving pensions plans. Among the findings:

United Kingdom. The United Kingdom is most like the United States in terms of benefit provision. As in the U.S., businesses in the U.K. that provide pensions usually do so through a trust held separate from the company's assets and, as in the U.S., the company has obligations to ensure the pension plan is properly funded following regular plan valuations, which in the U.K. are carried out every three years.

The U.K. Parliament has closely followed ERISA in its recent reform of pension funding and, in particular, established a Pensions Regulator and a Pension Protection Fund, which have between them powers very similar to those of the Pension Benefit Guaranty Corporation. However, some of the powers are significantly more expansive, as the U.K. is eager to avoid the deficits that the PBGC is presently facing.

Any acquisition of a U.K. company with a defined-benefit pension plan may raise significant issues. It is worth obtaining local actuarial advice as to the funding level of the plan, as the plan valuations may not be accurate. This is not only because the valuation is triennial and therefore may be very out of date, but because the basis for agreeing valuations changed in 2005 and is significantly more onerous and less predictable as a result.

In addition, the U.K. Pensions Regulator has the power in a number of circumstances, including where it believes the plan sponsor is insufficiently resourced to meet its pension liabilities, to bring a direction against any group company requiring it to fund the pension plan. Group companies and shareholders that may be subject to this requirement include non-U.K. companies and, in fact, the Pensions Regulator is in the process of issuing one such direction against Sea Containers Ltd., a Bermudan company that is presently in chapter 11 bankruptcy proceedings in the United States.

In order to limit the risks from the Pensions Regulator, it is common practice for the purchaser to seek clearance from the Pensions Regulator as a condition of closing.

France. In France, most pension contributions are made by way of mandatory contribution to a national social security system that also covers health care and welfare benefits. The contributions are very significant but are a standard cost of employing staff in France and should be reflected in cash flow. Due diligence is important to ensure these costs are understood.

The major concern in France will relate to senior employees, who are often provided with a top-up pension. These benefits can be very generous, although they are tax-advantageous. Appropriate due diligence is necessary to understand the extent of these liabilities and costs.
More

Issues to Consider When Outsourcing to India

With the outsourcing boom of the last decade, more than half of the Fortune 500 companies have become IT clients of Indian IT firms. Overall, India is home to approximately seventy percent of the global offshore IT services market. In addition to IT functions, US companies, recognizing the benefits of favorable tax treatment and a relatively inexpensive labor market, have increased the level of their outsourced business processes and functions to India as well.

In a special report, published by WorldTrade Executive, Inc., James Steinberg, Sunjay Sood, and William Helmstetter of Kilpatrick Stockton LLP, examine some of the vital export issues, commercial disputes, IP and data protection which corporate counsel should consider if their client or company is outsourcing to India. The following are excerpts from the report:

Export Issues

The outsourcing of services to a service provider in a foreign country will likely require you to determine if any software or technology being transferred to the service provider constitutes an export and is thus subject to the export controls of the U.S. For instance, if a call center application currently utilized by your employees in the U.S. will be transferred to contractors in India, that software may require an export license.

Commercial Disputes

A significant risk for U.S. companies doing business with Indian outsourcing vendors is the possibility of being forced into litigation in the Indian court system. Litigating in India can often be a protracted process taking numerous years for cases to be resolved or even heard by the Indian courts. Indian courts are severely backlogged and, as of 2005, lower courts in India had over twenty-five million pending cases and the higher courts had over three million pending cases. This tremendous backlog, coupled with an insufficient number of judges available to hear cases, has lead to significant delays in the Indian judicial process and Indian courts are unlikely to be of much help to U.S. companies involved in commercial disputes.

As a result, many U.S. companies would prefer to sue in U.S. courts and have these decisions enforced in India. India, however, only enforces judgments from countries that have a reciprocal relationship with it. The U.S. does not currently have a reciprocal relationship with India and it is, therefore, unlikely that U.S. judgments would be enforced in India. Consequently, U.S. companies doing business in India generally prefer to make use of an alternative dispute resolution process to settle commercial disputes.

Protection of Intellectual Property

Copyright

A significant area of legal risk for U.S. companies engaged in outsourcing transactions in India is the protection of intellectual property. In India, a copyright assignment is enforceable only if signed in writing by the party assigning such copyright interest. Unless a contract specifically provides otherwise, the term of a copyright assignment defaults to a term of five years and the territorial breadth of such assignment is limited solely to India. Additionally, if the rights assigned are not utilized by the assignee in the first year of an assignment not specified in writing, the assignment will lapse.

As a result, U.S. companies engaged with an Indian Vendor should require that assignment of copyright agreements are in writing and specify a fixed term of years and territory in order to ensure the largest grant of rights possible under Indian law. Additionally, U.S. companies must be aware that the Indian “works made for hire” doctrine applies solely to employees within the scope of employment and does not include com-missioned works or works created by an independent contractor. As a result, U.S. companies should be sure to receive supplemental protections, such as an intellectual property assignment clause within the MSA, and ensure that the Indian Vendor executes agreements containing intellectual property assignment provisions with each of its employees or contractors involved in providing the outsourced services.

Patent Protection
Historically, patent protection in India has been far weaker than patent protection offered in the U.S. Prior to 1970, Indian law provided for a compulsory license system for patents with a low royalty ceiling, short patent terms (as low as three years for certain types of patents), as well as many exclusions of certain inventions from patentability. Procedural delays associated with patent registration in India create a minimum six year patent examination period. Since 1994, when India joined the WTO, it has strengthened protection for foreign and domestic patent holders and has passed three amendments to its Patents Act of 1970 (the “Patents Act”) to bring its patent laws into compliance with TRIPS.

American companies, however, should remain vigilant of certain loopholes in the Indian patent system. India’s patent laws do not recognize patents on computer programs, per se. While this appears to be an absolute bar on the patentability of a computer program, patents are available for computer programs if a party can demonstrate additional technical applications related to such program. U.S. companies should remain aware of these additional barriers to patentability of computer programs in India. More

Negotiating Insurance Protection for China Imports

Recalls of Chinese-made products have proliferated this year, eroding importers’ profits, threatening their market share and damaging brands. According to Ryan S. Smethurst, of McDermott Will & Emery, writing in WorldTrade Executive's Practical China Tax & Finance Strategies, faced with these risks and potential liability, counsel to importers of Chinese goods should proactively assess the scope of their insurance programs and carefully negotiate insurance-related provisions in their contracts with Chinese suppliers. The following are some of Mr. Smethurst recommendations, excerpted from the WTE articles:

Most importers purchase liability insurance with products coverage. Such policies typically cover claims arising out of product-related damage to third-party property or injuries to consumers and the costs of defending a product liability lawsuit. Consequently, product liability coverage is essential “front line” protection for any importer of Chinese goods.

In light of recent revelations concerning manufacturing defects and quality control issues in China, importers should re-evaluate their existing product liability coverage to assess its scope, the sufficiency of its limits, the effect of defense costs on limits, and who has the right to control the importer’s defense and settlement decisions in litigation. Importers also should assess the financial strength of their product liability underwriter and its claims handling reputation, as well as any endorsements or other policy provisions specific to the importer’s business.

But liability policies with products coverage do not offer complete protection. Such policies do not cover product recall and other costs in addition to, or in the absence of, actual or alleged injury to third parties. Product liability coverage also will not apply to the extent that property damage or bodily injury was caused by sales of products that the importer had recalled or otherwise knew were defective.

Many importers, therefore, should consider adding product recall coverage to their insurance portfolios. Unlike product liability coverage, product recall policies apply in the event that a product on the market is likely to cause damage or injury to third parties; no actual or alleged damage or injury is required for the policy to respond. Thus, product recall coverage is triggered where an importer incurs costs proactively to prevent injury or damage. It also typically covers the costs of communicating a recall to consumers, of replacing unsaleable products and of mitigating damage to the corporate brand through public relations and crisis management initiatives. These costs can be devastating. The unfortunate case of Foreign Tire Sales is a case in point. FTS, a family-owned tire import business, was forced to recall 450,000 defective Chinese-made tires at a projected cost of $90 million. In addition, product recall policies may cover lost profits occasioned by the negative publicity and lost sales that often result from a recall. Product recall coverage, however, often comes at a hefty price. Importers should confer with their insurance brokers to discuss pricing and the effect of the Chinese products scandal on the breadth of product recall policies currently on the market.

Chinese Suppliers’ Liability Insurance

Importers also should evaluate whether their Chinese suppliers maintain liability insurance and, if so, whether it is adequate and accessible from the importer’s perspective. An importer faced with a product liability lawsuit in the United States, for example, may be entitled to make a claim against a Chinese manufacturer’s liability insurer if that insurer has conferred additional insured status to the importer or has included in its policy a provision extending coverage to entities contracting with the named insured. Although such rights can offer an importer protection in addition to its own insurance, an importer must carefully negotiate these terms and ensure their conscientious implementation by the supplier and its affected insurers. More