Trademark Due Diligence in Corporate Transactions, Contributed by Monica Riva Talley, Sterne, Kessler, Goldstein & Fox
Businesses today are continuously evolving beasts, rapidly devouring and shedding subsidiaries and business units to take advantage of ebbs and flows in the global economy. Moreover, more so now than at any other time in history, a company’s value lies not in its physical assets, but in the more intangible intellectual property―the trademarks, patents, copyrights, and trade secrets―that distinguishes the offerings, reputation, and cache of one business from another. It is estimated that intellectual property comprises a full 80 percent of the value of most businesses today.
This article will examine how to evaluate trademark assets as part of a due diligence analysis. Like a review of a company’s financial position, the trademark evaluation should provide not only invaluable assistance in determining the value of the transferred assets, but also crucial information as to the strength of the company vis-à-vis its competitors.
The first step in undertaking a due diligence analysis is understanding the purpose of the exercise. Is the company looking to acquire a target to expand geographic market penetration? Is it looking to offer a new product line? Or is it looking to place the business or a unit thereof in the best possible position for sale, and the analysis is thus being undertaken to help valuate the business and/or cure any alleged deficiencies? Not all due diligence analysis will be conducted the same way, and understanding the purpose of the evaluation goes a long way in ensuring that the proper factors are taken into consideration.
Identifying Trademark Assets
Trademarks, defined as any source identifying indicia including names, words, images, symbols, sounds, colors, smells, product shape, packaging, and the like, are an inherent part of the goodwill transferred in any sort of business acquisition scenario. Typically when a company is being sold, the seller will provide a schedule of trademark assets, usually with some type of back-up information such as copies of registration certificates. Such information should be viewed as only the first step in identifying the trademark assets used and intended to be used by the company, owned by the company, or licensed to the company. The accuracy of such lists should be confirmed against the records found in the trademark offices of the respective countries, including a review of filings regarding change in ownership, licenses, or encumbrances.
However, while some trademark office records, such as those of the U.S. Patent and Trademark Office, provide such information online, it is often necessary to engage foreign counsel to review the records in foreign jurisdictions. In lieu of this step, it may be sufficient (depending on importance and/or value of the foreign portfolio, size of the transaction, whether the trademark office records are in a foreign language, and the like) to obtain an affidavit from the foreign counsel that handles the portfolio in that particular country, attesting to the status of the applications and registrations as of the closing date. While not a substitute for an actual review of the trademark documents, such an affidavit could make sense in certain situations.
In addition, the review should also include identifying marks that are in use, but have not yet been registered or applied for. To identify such assets, the audit should include a comprehensive review of all advertising, promotional, printed, and electronic materials in use by or on behalf of a company, such as print ads, radio ads, television ads, online ads, press releases, press clippings, annual reports, signage, uniforms, vehicles, stationery, forms, packaging, labels, tags, catalogs, brochures, annual reports, collateral merchandise (e.g., giveaways), and the like. It is also critical to review all Internet websites associated with the entity, including all sites associated with a particular product line, service line, and corporate subsidiary, along with any Facebook, LinkedIn, or other social media/networking platforms attributed to the company, either formally or informally.
Finally, if at all possible, meet with in-house advertising, marketing, and sales personnel to learn which brands are viewed as most valuable to the company. Such conversations can also uncover upcoming marketing campaigns, and provide an understanding of whether the company has current plans to discontinue any brands. It can also be helpful to meet with outside advertising agencies to determine what new campaigns and initiatives may be in the planning stages.
Use of the Trademarks
In the United States (and other common law countries that trace their legal heritage to England, such as Canada, Ireland, Australia, and others), trademark rights are acquired and maintained through actual use of a mark in commerce in a particular geographic area in connection with particular goods and services (i.e., trademarks in these countries are “common law” in nature), versus being acquired from registration. Thus, once a list of registered and applied-for trademarks has been compiled, the analysis should include a review of the company’s products, services, websites, and the like to confirm that the marks identified as registered are all still in use for the covered goods and services (or at least the goods or services most relevant to the sale or acquisition at hand), and thus should not be vulnerable to cancellation based on non-use.
Similarly, the due diligence analysis should include a review of all the products and services with which each of the marks revealed by the audit is in use, or will be used, to determine whether these products and services are covered by the company’s current trademark registrations and applications. The review should also evaluate whether any of the entity’s registrations are vulnerable to cancellation based on abandonment. With respect to the United States, non-use of a mark for three years gives rise to a presumption that the mark has been abandoned. Similarly, if the mark is not abandoned, but is used in a different form or for a different product, the company’s registrations may not cover the current use.
Finally, identify marks used under license from third parties or licensed to third parties, review the scope of the license granted, and compare this to the company’s current and anticipated use of the licensed marks. The terms of license agreements should be reviewed to make sure they are still applicable under current market conditions and/or in the event of a merger or acquisition.
Identify Countries Where Trademark Assets Should Be Protected
Because trademark protection is territorially limited, and laws vary from country to country, a company’s plans to expand into a certain jurisdiction can be waylaid by its inability to use and register a key trademark in a new market. In contrast to how trademark rights are acquired in the United States, in many foreign countries trademark rights arise from registration of a mark versus use. If trademark owners do not hold registrations for their marks in such countries, the ability to use a mark in a new market, not to mention the ability to enforce such rights through trademark infringement proceedings, will likely be limited. These jurisdictional differences in how trademark rights are acquired are referred to as “first to file” versus “first to use.”
Accordingly, consider whether key trademarks are protected in countries in which the company is rendering or selling, or is planning to render or sell, products or services itself or through subsidiaries, franchisees, licensees, distributors, partners, or sales agents. It is also critical to review future expansion plans to see whether the company is protected in countries in which it is negotiating with potential franchisees, licensees, distributors, sales agents, and/or partners or is considering establishing a new subsidiary or affiliate.
Once key trademark assets and markets have been identified, and their use analyzed, the next step in the due diligence process is to review the current portfolio of trademark registrations and applications to determine if the trademark assets are adequately protected, and to identify the strengths and weaknesses of the trademark portfolio.
The first issue to examine is whether all of the pertinent marks are the subject of registrations or pending applications, and whether all of the pertinent marks are registered in the appropriate form. In particular, consider whether marks are registered in standard characters, meaning they are protected regardless of the type and style of the font used, versus a stylized form, or as one component of a company’s logo or design mark. While it is sometimes necessary to register marks in a stylized form to overcome refusals to register based on a lack of inherent distinctiveness or a likelihood of confusion with a prior registration, standard character registrations provide greater protection and should be used whenever possible. Similarly, word marks and logo/design marks should ideally be registered separately from one another. The review should also include an analysis of current pending applications to determine whether they will likely issue as registrations, and consideration of what steps may be necessary to improve the chances of registering the company’s marks.
As to logos and designs, compare the forms of such marks as registered with the forms of such marks as currently used. Also, consider whether the entity owns copyright registrations that might enhance its ability to enforce its logos and design marks, particularly in foreign jurisdictions.
The second level of analysis is to determine whether all pertinent marks are registered or pending in connection with the services and products with which they are currently used and will be used in the future. Identify registrations that may be subject to challenge for nonuse, and consider whether it is possible to make use of the mark for such goods or services, or consider filing new applications covering the mark(s) as currently used.
The third level of analysis is to review the trademark portfolio to determine whether pertinent marks are registered or pending in the appropriate countries. Review the trademark office records of the various countries in which applications and registrations are owned, to make sure they reflect the current ownership of the marks, whether the records contain any security interests or other encumbrances recorded against the marks, and whether the address and state of incorporation information is current. Where required, review whether foreign franchisees, licensees, distributors, and/or sales agents have been recorded as registered users with the trademark office, or whether the appropriate franchise, license, distribution, and/or sales agency agreement itself or a “short form” agreement has been recorded with the trademark office or other government authorities. Finally, consider whether key marks are registered in foreign languages where appropriate (e.g., in Japan, it is may be advisable to also register marks in Katakana characters), and whether the filings reflect the approved practice in foreign jurisdictions (e.g., some foreign countries, such as Brazil, do not allow for co-ownership of trademark registrations).
The fourth level of analysis is to look at the “strength” of the trademark assets―the relative scope of protection to which the mark should be entitled vis-à-vis third parties. The strength of a mark depends on whether the mark is inherently weak (for example, because the mark is merely descriptive or is primarily merely a surname), whether the mark has become diluted through third-party use and registration of similar marks, or whether the mark is at risk of becoming generic. Such searches can also identify potential infringement liabilities and potential limitations on the ability to use and register the mark.
Finally, the portfolio should be analyzed to determine whether the assets can be transferred free of any encumbrances. Trademark counsel should work with transactional counsel to identify any security interests, liens, or other encumbrances that may transfer with the marks. The portfolio should also be evaluated in light of any recent merger and acquisition activity to determine whether the related marks were properly assigned and recorded. In particular, identify any marks that were acquired but do not appear to be in current use.
Third Party Agreements/Actions
A due diligence review of a company’s trademark assets should also include a review of all agreements relating to third-party use of the company’s marks and agreements relating to the sale of the company’s products and services―including franchise agreements, license agreements, distributorship agreements, and sales agency agreements. In particular, such agreements should be reviewed for any information regarding the ability of third parties to use and/or register the company’s trademarks.
To the extent that the entity licenses its mark(s) to third parties, the trademark analysis should include a review of the license agreements, and a review of how the licensees are using the covered mark(s). The analysis should also include a review of the company’s quality control provisions, whether the agreements allow for sublicenses, whether the agreements survive a merger or sale of the company, and a review of how the licenses generally fit within the company’s branding strategy.
The review should also necessarily include a review of all other agreements that relate to the company’s ability to use and register its own trademarks. Such documents would include consent agreements entered into so as to ensure that the company’s marks would register; coexistence agreements with third parties; settlement agreements entered into to resolve disputes; covenants not to sue; license agreements; and the like. An audit should also include a review of the company’s prior trademark and false advertising litigation, and a review of all potential, pending, and concluded trademark opposition and cancellation proceedings, to determine any possible impact on the future protectability and enforcement of the company’s trademarks.
A review of company policies should include a review of policies relating to trademark use and monitoring, and of the procedures in place for complying with the quality control provisions of trademark licenses for both marks licensed out (e.g., the company’s marks that it licenses for use by third parties), and licensed in (e.g., third party marks licensed for use by the company). Keep in mind that if a licensor fails to exercise adequate quality control over a licensee, a court may find that the license is in fact a “naked license,” and that the licensor has technically abandoned the trademark.
Given the numerous top-level and country code domain names currently available (not to mention the plethora of new top level domains that will likely be unleashed in the marketplace over the next year), it can be difficult, if not impossible, to determine whether every possible iteration of a company’s names and trademarks are registered to the company. However, the due diligence review should at least confirm that the company’s name and key marks are registered as top-level Internet domain names (e.g., “.com,” “.net,” and “.org”), and possibly whether any entity has undertaken to register key marks as an .xxx name. Depending on the company’s international activities, the audit could also include a review of registered country-specific top level domain names (e.g., “.ca” for Canada). Moreover, it is typically a good idea to investigate whether the company owns domain name registrations for any nicknames by which it is known (e.g., “FedEx”), and whether any third-party owns registrations for any of the company’s names and/or trademarks or service marks, or any variations and misspellings of the same.
Particularly when a due diligence review is performed as part of a business sale or acquisition, the review should include a search of the relevant secretary of state and other corporate registers for corporate names, trade name registrations, assumed names, and/or fictitious names registered to the company.
Done properly, a due diligence analysis of a company’s trademark assets can help a purchaser assess the strength and value of the portfolio, identify potential infringement liabilities, and uncover potential limitations on use of a mark. Conversely, prior to selling a business or business unit, an analysis of the trademark assets can help the seller identify any gaps or protections in coverage that might negatively affect the value of the asset to be sold. In either scenario, a due diligence analysis helps put the value of the trademark assets properly within the context of the transaction.
Monica Riva Talley is a Director at Washington, DC-based intellectual property specialty law firm Sterne, Kessler, Goldstein & Fox PLLC. Monica specializes in trademark prosecution, clearance, portfolio management, and client counseling. She also has significant expertise in trademark infringement and dilution litigation, Internet-related trademark disputes, and opposition and cancellation proceedings before the Trademark Trial and Appeal Board of the U.S. Patent and Trademark Office. Ms. Talley serves a broad base of international clients in the consumer products, apparel, personal care, manufacturing, telecom, biotechnology, computer, media, and entertainment fields, and has been involved with every aspect of trademark, service mark, trade name, unfair competition, false advertising, and trade dress litigation. She can be reached at firstname.lastname@example.org.
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
© 2011 Bloomberg Finance L.P. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of Bloomberg Finance L.P.