The Effect of Mergers on Licenses: Considering the Often Overlooked and Unaddressed

A key benefit arising from structuring an acquisition as a merger is the ability to avoid obtaining third-party consent to the acquisition with respect to contracts with vanilla anti-assignment clauses.

As a general rule, state merger statutes and associated court interpretations provide that, when two companies merge, contracts held by either of the merging entities do not implicate clauses that generally prohibit assignment but do not expressly require consent in connection with a merger. However, this general rule should not automatically be considered to apply in the context of intellectual property licenses.

State law generally permits the free assignability of contracts absent an express provision in the agreement to the contrary. Notwithstanding such, the assignability of patent and copyright licenses is governed by federal law which preempts applicable state law. ¹See, e.g, PPG Industries Inc. v. Guardian Industries Corp., 597 F.2d 1090, 202 USPQ 95 (6th Cir. 1979), and Cincom Systems Inc. v. Novelis Corp., 581 F.3d 431, 92 USPQ2d 1085 (6th Cir. 2009) (78 PTCJ 699, 10/9/09). On the basis that patent and copyright licenses are personal in nature, federal law provides that patent and copyright licenses are presumed to be nonassignable unless the license expressly provides otherwise. ²Id.

The U.S. Court of Appeals for the Sixth Circuit is one of the few federal courts to interpret this longstanding federal rule in the context of a merger. The Sixth Circuit has twice considered the issue in the context of forward mergers and found that “a transfer is no less a transfer because it takes place by operation of law rather than by a particular act of the parties. [A] merger [is] effected by the parties and [a] transfer [is] a result of their act of merging … .[I]n the context of a patent or copyright license, a transfer occurs any time an entity other than the one to which the license was expressly granted gains possession of the license.”

As a practical matter, these rulings from the Sixth Circuit require that, in forward mergers, consent must be obtained from licensors, or effecting the merger will result in a breach of the patent and copyright licenses purportedly transferred in a merger.

The U.S. District Court for the Northern District of California is the only federal court that has considered the effect of reverse triangular mergers on intellectual property licenses. That court ruled a license held by the surviving entity in a reverse triangle merger was improperly transferred as the licensee went through a fundamental change in its form of ownership. ³SQL Solutions Inc. v. Oracle Corp., 1991 WL 626458 (N.D. Cal. 1991).

In sum, in the only federal case on the subject, the court found the result to be the same for reverse triangular mergers as is the rule for forward mergers. Without consent from the licensor or an express provision in a license to the contrary, effecting a reverse triangular merger will result in a breach of the non-surviving entity’s licenses.

Federal case law on the effect of mergers on intellectual property licenses is admittedly sparse and unsettled, especially in the context of reverse triangular mergers, and many federal jurisdictions are yet to speak on this issue. However, all applicable decisions to date have found that mergers result in an impermissible assignment of patent and copyright licenses. Further, while courts to date have only addressed patent and copyright licenses, the rationale underlying these decisions might be reasonably applied to other forms of intellectual property, such as federal trademarks, as a court could determine that other forms of intellectual property are similarly personal to the owner.

An easy mistake in effectuating a merger is to simply apply the same rule to licenses as is generally applied to other commercial agreements, and lawyers often assume that a merger does not result in a transfer or assignment of a license that could affect the licensee’s rights or liability under the license. Conversely, experience of the author has proved that seeking consents in mergers to assign licenses with vanilla anti-assignment clauses (i) is a cumbersome process that can potentially delay the transaction, and (ii) often results in confusion among licensors who are generally uncertain how to respond to a request for such a consent, as most such licensors are generally unfamiliar with this still-developing body of law.

At a minimum, attorneys advising on intellectual property issues in mergers should be familiar with the issues presented in this article so that they might advise their clients of the same, allowing their clients to make informed decisions regarding: (i) the desirability of obtaining consent to assign intellectual property licenses in mergers; and (ii) the allocation of risk with respect to intellectual property licenses in the merger agreement.

As a practical matter, targets are often willing to accept the risk that a merger might breach an intellectual property license, as a licensor is unlikely to take action in response to the merger. However, if the target is aware that a licensor may either be interested in terminating the license or otherwise harassing a licensee, or if the licensor would likely have not granted the license to the acquirer, then the risk of the licensor taking action is undoubtedly increased and such risk is especially worthy of careful consideration.