Intellectual Property Audits

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Intellectual Property Audits

Intellectual property is essential to a business for at least two reasons. First, intellectual property is used to execute the business plan. Capturing a share of the market, for example, will certainly require that the brand (represented by a trademark) be advertised, recognized, and protected from infringement. Second, a company's intellectual property often has independent value derived from licensing or sale. In fact, it may be the most valuable asset a company owns. Outside investors or lenders often make funding decisions based on the strength of a company's intellectual property.

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A licensor of intellectual property must be able to warrant that it is the sole owner of the property and that it is free from the claims of third parties. Perhaps more importantly, should an owner wish to sell a company or assets the prospective buyer will determine independently whether the company owns what it says it does. Any questions regarding ownership in or claims of others to, the intellectual property will be resolved in favor of a reduction in purchase price or a dead deal. We've seen this over and over again. Weak intellectual property, not capable of protection, will also diminish value.

The time to remedy any problems associated with intellectual property is long before the company enters into sales or licensing negotiations or before funding or lending is sought. Otherwise, disclosure of problems can kill a sale or dry up a funding opportunity.

A timely audit can avoid problems, or at least make resolution of intellectual property ownership issues easier to resolve. Take, for example, a software developer who recently failed to obtain transfer of ownership agreements from independent contractors who helped write the software. As difficult as this situation may be to rectify, it becomes far harder ten years later when the contractors can't be located, or worse, the company has to negotiate with their estates.

An audit can also disclose to a company forgotten intellectual property assets that may still retain value. For example, a trademark that hasn't been used for a while might still have value if the company knows not to abandon that mark. An audit can also disclose the need for certain government filings or registrations before it is too late.

The audit should also disclose whether the company's use of intellectual property infringes the rights of third parties and exposes the company to a crippling lawsuit. Advance knowledge will allow a wise company to establish alternative action plans, including obtaining any necessary licenses or developing its own intellectual property.

The audit should be conducted by an attorney who really understands the intricacies of intellectual property and can read and understand a license agreement. This person must be given complete access to the company's records. Often, the company's financial records provide clues that intellectual property has been created as will discussions with marketing, engineering, and other development employees as well as the company's strategic thinkers. Finally, the auditor must understand the company's business and its industry.

Licenses

Licensing agreements must be carefully reviewed. The company, if the licensor, should own all intellectual property created by the licensee that is derived from the licensed asset. Critical to the retention of trademark rights is the right of the licensor to satisfy itself that the licensee is producing goods under a license that are true in quality to the original.

Registrations

Registrations will be particularly helpful to the auditor. They include all trademark, copyright, and patent registrations, renewals, and other associated filings. A review of trademark filings, for example, may reveal that the company has failed to file a Section 8 affidavit that can still be remedied. Even if too late, better to take proactive remedial action than to be blindsided later.

Trade Secrets

A careful auditor will ascertain exactly what trade secrets the company owns. The auditor should help the company document the development of these trade secrets in order to fend off a subsequent claim that trade secrets were stolen and not independently developed. If a company has to sue to protect its trade secrets, documentation of independent development is crucial to success. It is critical that the auditor determine whether and how the company keeps its trade secrets secret. Because failure to maintain secrecy will result in loss of trade secret status, the auditor must be prepared to help the company establish a procedure to safeguard these secrets. For example, are trade secrets kept under lock and key with restricted access? Can the existence of that procedure be later documented? Is the procedure always followed? How close is the photocopy machine to where the trade secrets are kept? If Coca Cola allowed all its employees access to its formula for Coke, that formula would no longer be a trade secret.

Trademarks

Trademarks can be registered or unregistered. An audit of unregistered marks may suggest it is time for registration. A review of how trademarks are actually used by the company may suggest changes in practice. For example, using marks in a print size no larger than the body copy in advertising may cause the mark to cease functioning as a trademark, as could use of a mark as a noun or a verb. It is no accident that Levis refers to its jeans as "Levi brand jeans". Proper use of symbols designating the proprietary nature of the marks should be ensured. A program to monitor the use by others of similar marks is essential if the company is going to police its assets. A knowing auditor will bring these issues and many more to the attention of the company.

Inventions

Are the company's employees establishing evidence and chronology of the development of inventions in a log? Have other company personnel signed off on this? When was the invention first offered for sale? All crucial questions.

A carefully conducted audit may result in a determination that the company's use of its intellectual property violates the rights of a third party. But it is better to learn of this and bring it to the attention of upper management than be sued without warning. Advance warning of infringement allows the company to cease infringing activities, obtain a license or at the least, evaluate its liabilities and defenses. The audit, however, may also put upper management on notice of the possible infringement, and if the infringement continues, allow for larger damages in a subsequent suit.

Like any other auditor, the intellectual property auditor will work from a carefully crafted and detailed checklist, modified for the nature of the company's business. A publisher, software developer, and bio-tech company will each have different and similar issues. While the auditor should work from a checklist, novel issues will appear in almost every audit. The auditor must have the training to be prepared.

Finally, an audit should be conducted at least annually. After the initial audit, the follow-ups become easy. The cost of an audit is easily justified. First, the results form the starting point of a buyer's or investor's due diligence and show that the company takes seriously its intellectual property responsibilities. Second, the audit may also capture some valuable intellectual property that is in danger of escaping the company's ownership. Finally, an audit may disclose infringement of third-party rights by the company in a timely fashion so as to allow the company to be proactive.

Employment Contracts

A review of employment agreements is also critical. The auditor should ascertain whether the employee is obligated to disclose and transfer discoveries and inventions to the company. These agreements must also restrict the employees' right to disclose or use proprietary information, a carefully chosen term that falls short of trade secrets protected by statute. Finally, buyers and investors crave restrictions on post-employment competition, narrowly drawn so as to be enforceable. Even when they exist, employment agreements are often put away and forgotten. A review will require that they be read and may suggest important changes.

Employee Handbooks

Employee handbooks should also be reviewed and amended where necessary. The handbook should instruct employees to always protect the company's trade secrets and proprietary material. It should explain to employees just how valuable trade secrets are to the company. Proper use of trademarks should be described. Finally, the handbook must remind employees of their obligation to disclose and transfer to the company inventions and ideas relating to their employment, which obligations should also be set out in the employment agreement. Many employers and human resource professionals think employee handbooks are only labor law-related, but clearly, they can be very helpful tools to protect the company's intellectual property.

Independent Contractors

Independent contractor agreements are a rich source of trouble and must be carefully reviewed for the transfer of ownership of the property created by the contractor. In lieu of a transfer of ownership, the auditor must ascertain whether a grant of a perpetual, paid-up license has occurred. Otherwise, the company may be basing its business on property owned by others.

Training

Even procedures that appear unrelated to intellectual property should be reviewed. Training programs, for example, should include material related to intellectual property. Definitions, use, importance, and protection of intellectual property should all be discussed. If the training materials are devoid of material related to intellectual property, the auditor should provide it; if it's included, it must be carefully reviewed.

 

To learn more about conducting an IP audit at your organization, contact Jim Astrachan (jastrachan@gdldlaw.com), Donna Thomas (dthomas@gdldlaw.com), or Kaitlin Corey (kcorey@gdldlaw.com).

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