The discussions around intellectual property risks have become increasingly important in the M&A context, in particular surrounding software issues. Whilst the challenges of the last two years have had a negative impact on M&A activities, companies with business models heavily focused on software, were amongst the winners of the crisis.1
The insurability of IP risks most commonly becomes practically relevant in the context of corporate transactions, especially in relation to the insurability of the warranties within a company purchase agreement. This raises the question of under which conditions and through which insurance products IP risks can be insured.
2. Differentiation of various IP Risks and insurance solutions
2.1 W&I Insurance
Warranty and Indemnity Insurances (W&I) only cover unidentified risks arising from a breach of warranties within company purchase agreements. In the first instance, warranties typically incorporated in company purchase agreements include warranties that certain intellectual property rights are owned by the target company and that there are no existing restrictions in this respect.
Schedule 1 contains a list of all registered and unregistered inventions, patents, utility models, trademarks, service marks, design rights, domain names, copyrights including rights in software developed or acquired by the company and its source code, rights in databases, know-how, in each case and as applicable including registrations and applications for registration, and similar forms of protection anywhere in the world, owned by the company or to which the company has exclusive, perpetual worldwide, unrestricted rights of use for any purpose (the “Owned IP Rights”). The company owns all rights, title and interest in and to its Owned IP Rights free and clear of any third-party rights and of any and all encumbrances. Other than non-exclusive licences granted to customers in the ordinary course of business, no licences or other rights of use have been granted with respect to the Owned IP Rights and there are no obligations to encumber or grant licence or other right of use in and to the Owned IP Rights. The group companies are free to operate their business as currently conducted using the Owned IP Rights and to dispose of the Owned IP Rights at their own discretion without owing payment of any royalties or similar fees to any third party.
In the context of registered IP rights, it is often guaranteed that the required registration fees have been paid and that further measures to maintain rights have been taken. This warranty is flanked by the promise of confidential treatment of IP rights as a whole, which is of decisive importance for non-registered IP rights.
The typical warranties that IP rights of the company are not infringed by third parties and that the company will not infringe upon IP rights of third parties are of decisive importance for W&I insurance from a liability point of view. From the seller’s perspective, it is usually not possible to make a final judgment on whether these declarations are true and therefore, almost without exception, these warranties can only be made to the best knowledge of the seller. Depending on the agreed standard of best knowledge, the buyer must therefore demonstrate and prove that the seller had a positive knowledge of or was grossly negligent regarding the incorrectness of this warranty in the case of a dispute.
Additionally, there are often further warranties with regard to licenced IP rights and the permission to use them. For companies heavily focused on software, particular importance is attached to the warranty for the use of open-source software (“OSS”). The seller guarantees that the relevant licence agreements have been complied with and that there is no disclosure obligation or obligation to provide rights of use free of charge.
The use of any software or other material that is distributed as “freeware”, “free software”, “open-source software” or under a similar licensing or distribution model in the development of or incorporated into or combined with the Owned IP Rights complies with the applicable licensing terms. The company’s products or services do not use or incorporate any open-source software or materials that are subject to licence terms which provide for any obligation for the company (i) to disclose or distribute any of its intellectual property in source code form to third parties, (ii) to licence any of its intellectual property for the purpose of making derivative works or (iii) to distribute any of its intellectual property without a charge.
2.2 M&A Insurance for identified risks
Whilst identified risks are excluded from insurance cover in W&I insurance policies, under certain circumstances individual M&A insurance policies also offer coverage for identified risks.
An extremely low probability that the legal risk will occur is a prerequisite for the insurability of identified risks. This may for example be the case with pending IP litigation in which both the lawyers of the target company and the insurer’s external advisors consider the prospects of legal success to far outweigh the prospects of failure. Purely factual issues such as the likelihood of a certain IP related claim stemming from an identified area of risk, cannot be covered by this type of insurance product. Of course, the interplay between legal and actual risk is complex and can ultimately only be evaluated by means of a concrete examination in each individual case.
2.3 Standalone IP Insurance solutions
The insurance industry is developing an increasing number of products for the insurance of IP risks independent of the field of corporate transactions. These are insurance policies that cover the costs of defence in the case of an alleged infringement of IP rights by third parties and also pay compensation in the case of justified claims, therefore ultimately offering a type of specialised legal protection policy. On the other hand, they also cover the area of IP ownership, for example in connection with cancellation or invalidity proceedings. This may be particularly relevant in connection with contractual obligations of the company towards third parties.