Analysis of Key Points in Patent Verification During Legal Due Diligence for Corporate Equity Investment
Patents related to core technologies are important assets of an enterprise and must be fully protected. For investors of the enterprise, by gaining a detailed understanding of basic information about the target company’s patents—such as ownership status, legal status, and application status—they can identify, analyze, and evaluate the actual value of the target company’s patents as well as potential obstacles to future business activities or legal risks. This helps avoid transaction risks or reduce additional transaction costs. In the legal due diligence for corporate equity investment, verifying the value of the target company’s patents and assessing related risks is a core task. Combining relevant legal provisions and cases, this article discusses the key points of patent due diligence as follows:
Shanghai Top NC Technology Co., Ltd. (hereinafter referred to as "Shanghai Top") applied for listing on the STAR Market twice. During the IPO review process, since the core technical personnel of Shanghai Top had part-time positions at universities, the company’s intellectual property rights attracted key attention from the China Securities Regulatory Commission (CSRC). Shanghai Top was repeatedly questioned about issues such as joint intellectual property rights, service inventions, and patent ownership. Eventually, Shanghai Top terminated its second listing review in January 2021, and neither of its two listing applications was approved.
The ownership of patents is the primary focus in the due diligence of an enterprise’s patents. Uncertainty regarding patent ownership may affect the enterprise’s ability to use and implement patents and may give rise to infringement risks. Generally, enterprises obtain patent rights mainly through independent R&D, cooperative R&D, or assignment. Based on different methods of obtaining patent rights, the content to be focused on during due diligence is as follows:
For patents obtained by the target company through independent R&D, the first step is to focus on the inventors of the patents—for example, verifying their educational and work backgrounds and employment status at the company to confirm whether they are core technical personnel of the company. Secondly, it is necessary to understand the R&D process of the patents to determine whether they qualify as service inventions of the inventors.
According to the relevant provisions of the Implementation Rules of the Patent Law of the People’s Republic of China, if an inventor applies for a patent at a new employer within one year of leaving their original unit, the original unit of the inventor may claim such patents as its service inventions. This may lead to disputes among parties regarding patent ownership and profit distribution.
Therefore, in the verification of patents obtained by the target company through independent R&D, the following specific verifications should be conducted regarding the status of service inventions:
Verify labor contracts to confirm whether any inventor has left their original unit within one year;
For inventors who left their original unit within one year, further verify their resignation certificates, labor contracts signed with the original employer, confidentiality agreements (if any), non-compete agreements (if any), and check whether the inventor used the original unit’s technical achievements in the process of creating the patent;
Verify whether the inventor has signed an agreement on the ownership of intellectual property rights for service inventions with the target company. If such an agreement exists, pay attention to the clauses regarding the ownership of service inventions.
For patents formed through technical cooperation or commissioned development, the exercise of rights and profit distribution shall be based on the explicit agreements of the parties in the relevant technical cooperation or commissioned development agreements. If there is no agreement or the agreement is unclear, according to the Patent Law and relevant judicial interpretations, the right to apply for a patent shall belong to the R&D personnel (i.e., the trustee), while the client may implement the patent free of charge. For technical secrets generated during the development process, both parties have the right to use and transfer them. Therefore, in such cases, there is considerable uncertainty and potential for disputes regarding issues such as the manner in which each right holder independently implements or licenses others to implement the patent (or technical secret) and the distribution of proceeds therefrom.
Therefore, when verifying patents obtained by the target company through technical cooperation or commissioned development, the following matters should be noted:
Verify all technical cooperation and commissioned development contracts of the company, focusing on key clauses such as the ownership of technical achievements, profit-sharing methods, patent holders, and patent applicants. Check whether the relevant agreements include situations that may adversely affect the rights obtained by the target company under the contract—such as licensing third parties to use and implement the patent and obtain relevant proceeds;
If there is no technical cooperation or commissioned development contract, or if the contract does not clearly stipulate the above issues, obtain confirmation documents and other relevant materials from the cooperative parties to verify the ownership of the patent rights, as well as the rules for use and profit distribution;
For cases where the target company conducts technical R&D in cooperation with universities, verify the ownership of intellectual property rights in accordance with the specific university’s management regulations on technical achievements and relevant contract agreements. If core technical personnel are university faculty members working at the company, also verify whether such personnel comply with the university’s policies on external part-time work and the university’s employment regulations.
If the target company’s patents are acquired by assignment from other parties, key verification items include whether the assignor has the qualification to assign, whether the assignment by the parties is legally valid, and whether the patent rights have been transferred in accordance with legal provisions. For patents obtained by assignment, the following points should be noted during specific verification:
Verify the assignment agreement, focusing on clauses such as patent ownership, assignment time, and specific content of the assigned patent;
Check the payment vouchers for the assignment price to confirm that both parties have fulfilled all their obligations under the assignment agreement;
Verify information about the patent through public channels, including details of the previous right holder and inventor. In addition, verify the assignment registration certificate, patent recordal change certificate, and change announcement to ensure the legality and validity of the assignment.
If a target company intends to apply for listing on the STAR Market, its "scientific and technological attributes" will be a key focus of the Shanghai Stock Exchange (SSE). The scientific and technological attributes also include clear requirements for the number of invention patents that form the company’s core technologies and main business income. The Guidelines for the Evaluation of Scientific and Technological Attributes (for Trial Implementation) stipulates:
"1. Enterprises in relevant industrial fields specified in the STAR Market positioning that meet all of the following 4 indicators are supported and encouraged to apply for listing on the STAR Market: ... (3) Having 5 or more invention patents that generate main business income;
2. Enterprises in relevant industrial fields specified in the STAR Market positioning that do not meet the aforementioned indicators but meet one of the following conditions are supported and encouraged to apply for listing on the STAR Market: ... (5) Having a total of 50 or more invention patents (including national defense patents) that form core technologies and main business income."
The quantity of patents and their technical advancement reflect the core competitiveness of technology-based enterprises. Generally, there is a certain correlation between the number of patents an enterprise applies for its core technologies and its market competitiveness. Additionally, if the target enterprise intends to list on the STAR Market, it must meet the patent quantity indicators specified in the scientific and technological attribute requirements. Therefore, during patent due diligence, it is also necessary to understand the number of patents corresponding to the core technologies.
In the patent verification process, it is first necessary to classify the patents involved in the target company’s main business products and focus on key ones. Furthermore, to gain an in-depth understanding of the patent content, relevant patent specifications and claims can be reviewed. The investment team can make judgments based on industry research; if necessary, industry experts or external consultants can be engaged to identify whether the relevant technologies are advanced, assisting investors in evaluating the market value of the target company’s core technologies.
Yifang Bio-Technology (Shanghai) Co., Ltd. (hereinafter referred to as "Yifang Bio") was officially registered and listed on the STAR Market on April 6, 2022. However, according to public information, Yifang Bio’s listing review was suspended by the STAR Market Listing Committee in December 2021. The main reason for the suspension was disputes over the patents it applied for—the Listing Committee expressed concern about whether the disputes would affect the patent rights of Yifang Bio’s authorized products or have a material adverse impact on the company’s subsequent operations and R&D.
The specific details of the dispute are as follows: In December 2020, Shanghai Bei’erda Pharmaceutical Co., Ltd. (hereinafter referred to as "Shanghai Bei’erda") filed a lawsuit against Yifang Bio and Betta Pharmaceuticals Co., Ltd. with the Shanghai Intellectual Property Court regarding the ownership of patent application rights. Shanghai Bei’erda claimed that Yifang Bio and Betta Pharmaceuticals improperly obtained its technologies through illegal means and arbitrarily submitted an invention patent application to the National Intellectual Property Administration with application number 201910491253.6 and title "Pyrimidine or Pyridine Compounds, Their Preparation Methods and Pharmaceutical Uses". Shanghai Bei’erda requested confirmation that the subject patent application and the subsequent invention patent (after authorization) belong to it, and demanded that Yifang Bio and Betta Pharmaceuticals cooperate in handling the registration or ownership change procedures for the patent application right or patent right.
After Yifang Bio’s listing application resumed review, the STAR Market Listing Committee asked Yifang Bio: "Please explain the relationship between the issuer’s invention patent application (CN201910491253.6), Bei’erda USA’s under-development product BPI-7711, and the issuer’s externally authorized product BPI-D0316. In the ‘Key Matters to Note’ and ‘Risk Disclosure’ sections, supplement the disclosure of whether the aforementioned patents, patent applications, BPI-7711 compounds, and trade secret disputes will have a material adverse impact on the patent rights of the issuer’s BPI-D0316 product and the issuer’s subsequent operations and R&D."
Yifang Bio replied: "The subject compound (BPI-7711) only involves one candidate compound of the issuer that was designed and developed based on the EGFR target but not clinically developed. The issuer’s invention patent application CN201910491253.6 is a defensive patent that covers the subject compound (BPI-7711). Disputes between Bei’erda USA and Shanghai Bei’erda do not involve the issuer’s BPI-D0316 compound or related patents (ZL201510152615.0; US10,179,784 B2), and will not have a material adverse impact on the patent rights of the issuer’s BPI-D0316 product or the issuer’s subsequent operations and R&D."
Based on Yifang Bio’s response to the issues involved, since the product related to the patent dispute was no longer part of Yifang Bio’s R&D pipeline, and the dispute had no impact on the patents of authorized products or the company’s subsequent operations and R&D, Yifang Bio subsequently passed the inquiry of the STAR Market Listing Committee.
From the above case, it can be seen that after obtaining patent authorization, the target company still needs to guard against patent infringement risks and maintain the validity of patents. Additionally, in certain cases, patents may face challenges and be declared invalid even after authorization. Therefore, during due diligence, the following aspects should be focused on regarding the validity of the target company’s patents and infringement risks:
Whether patent fees have been paid in full and on time;
Search for public information to check whether the target company is involved in patent infringement lawsuits. If so, gain a detailed understanding of the case and assess the impact of the lawsuit on the target company;
For the target company’s core patents, if necessary, further conduct Freedom to Operate (FTO) due diligence to determine whether there are infringement risks in the regions where the business operates.
Freedom to Operate (FTO) due diligence is a type of legal due diligence conducted to assess the risk that a particular technology or product may be prohibited from being implemented due to infringing on others’ patent rights. The specific steps of FTO are as follows:
Determine the technical solution: The technical solution of the target company’s patent is the basis for patent verification. Only by gaining an in-depth understanding of the technical solution can the core points of the technology and search keywords be identified, thereby comparing different technical solutions and judging whether there are infringement risks.
Determine the search region and database, and conduct a comprehensive search: According to the geographical requirements for patent protection, first determine the regions where the patent will be used and protected, and search the corresponding databases. Common search databases include the official website of the National Intellectual Property Administration, various intellectual property judgment document query websites, and commercial patent databases such as Thomson Innovation, Total Patent, or Pat Base.
Infringement comparison and analysis: Conduct an analysis of infringement risks based on principles such as the "doctrine of complete coverage", "doctrine of equivalents", and "doctrine of prosecution history estoppel" to determine whether the target technology falls within the protection scope of the patent. In addition, since patent protection laws vary by region, specific analysis of infringement risks must be conducted in accordance with the patent infringement regulations of the relevant region.
During investment due diligence, investigators should conduct a comprehensive analysis and risk assessment of the target company’s patent status. Based on the due diligence results, they should conduct targeted business negotiations with the target company and adjust and improve the design of transaction document clauses to protect the investor’s rights and interests. The scope of patent verification should be adjusted according to the investor’s business needs. Considering the complexity and professionalism of different industries and technologies, professional intellectual property lawyers may be engaged when necessary to conduct a comprehensive intellectual property survey, stability survey, authorization prospect survey, and FTO analysis of the target company to meet the actual needs of the project investment.
Cover image and illustrations source: Visual China
