Minefields in patent due diligence for high-tech financing

By Tang Huadong and Zhong Yueping, Merits & Tree Law Offices
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Patents are usually the cornerstone of high-tech enterprises and an important guarantee for maintaining their competitive advantages. In recent years, patents have received more and more attention during IP due diligence for high-tech enterprise investment and financing. In due diligence, it is often found that some patent minefields too dangerous to be ignored are not being taken seriously. This article introduces three major patent minefields in due diligence.

Who owns the patents applied for by a startup jointly established by a professor?

patent
Tang Huadong
Partner
Merits & Tree Law Offices

Professor A is a well-known expert who has made great achievements in his research field, and has his own laboratory and research team in a prestigious university. In recent years, his laboratory has yielded some research findings with commercial potential.

Professor A happened to meet businessman B, a senior figure in industry, who believed in the bright market prospects of professor A’s research findings and encouraged him to resign and start a business, and turn the research findings into marketable products.

Professor A had had the same intention for a long time, so they jointly founded a company and filed several patent applications in the name of the company. Based on his business networking, businessman B advised fund C to invest in professor A’s company.

Fund C found in due diligence that professor A was the inventor of all the patents applied for by professor’s A company, but the named applicant was professor A’s company alone, excluding the university that employed professor A.

patent
Zhong Yueping
Partner
Merits & Tree Law Offices

Further investigation showed that professor A’s company was a newly established startup without any laboratory or researcher, so most of the work on the patents had been done at the university that professor A had worked for.

Fund C stopped the investment immediately. Professor A did not understand why, arguing that the patents were applied for in the name of his company and had nothing to do with the university.

Here it is necessary to mention the term, “service invention”. Article 6 of the Patent Law stipulates that “an invention-creation, made by a person in execution of the tasks of the entity to which he or she belongs, or made by him or her by mainly using the material and technical means of the entity, is a service invention-creation”.

According to this provision, service invention is not an issue that can be shunned simply by changing the applicant. Since professor A was a former employee of the university, the patents he, as an inventor, applied for should be service inventions made by professor A at the university he worked for.

Thus, the patent applicant or the patentee should be the university. If the university finds in the future that professor A’s company filed patent applications without the consent of the university, and did not name the university as the applicant, the university will be entitled to claim the ownership of these patents.

If these patents are the company’s main source of technology, there will be great uncertainty for the operations of the company. Fund C would, if investing in professor A’s company, be at risk of loss. Of course, service invention can be precluded via an agreement. Prior to investment, professor A still has the opportunity to solve the issue of patent ownership with the university.

Can the risk of infringement be eliminated through a patent application?

Mr Zhang registered a startup back in China after 20 years of overseas service for a famous multinational company. Due to his many years of experience in such a large foreign company, Mr Zhang had made many innovations and filed patent applications in China, some of which had been granted patents.

His company had recently planned to seek financing for its expansion and overseas presence. However, the institutional investor found in due diligence that many of Mr Zhang’s core technologies were suspected of infringing existing patents. Mr Zhang did not understand: “How could it be an infringement since I have filed patent applications for all my technologies?”

This is what would confuse many people. It is necessary to clarify here that a patent application itself will not constitute an infringement upon any patents of other patentees, but infringement may occur if the patented technology is implemented.

Many innovative technologies represent further progress made based on prior research findings. Of course, the innovative content of such technologies can be filed for patents, but if the innovative technology is implemented on the premise of implementing prior research findings, infringement may occur.

Will a patent application guarantee the success of a product?

Mr Wang is a senior investor. Recently, one of his friends introduced to him a company boasting bright prospects. The company has many products and has filed a number of patent applications. Of course, no patents have been granted as the examination process is still underway.

Mr Wang is worried about these pending patents, so he engages a patent lawyer to conduct due diligence on these patent applications. The lawyer conducts an analysis from the perspective of the prospects for patent grant and the scope of patent protection, only to find that many of these pending patents were existing technologies.

In other words, most of these pending patents had been made publicly available in prior patents or publications, so they are lacking in novelty or creativity and are unlikely to be granted.

In addition, the patent applications regarding the company’s products claimed a very narrow scope of protection, which would hardly cover its existing products. That means the company has no proprietary core technology or patented products of its own. The current boom may be no more than a flash in the pan, so Mr Wang suspends the investment in time.

Thus it can be seen that patent application is not a panacea. Sometimes it may be used by enterprises as “window dressing”, and it is only when we see through the surface that we can protect our investment from risks. In the investment or financing process, one should sharpen one’s focus and make clear who owns the patent rights, whether there is any infringement upon patent rights of others, and whether an investment can truly enjoy the patent rights.

Tang Huadong and Zhong Yueping are partners at Merits & Tree Law Offices

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