In recent years, intellectual property issues encountered by pre-IPO (i.e., initial have been increasing. Many enterprises have been stuck or even fallen on the way of IPO due to intellectual property issues.) Intellectual property risk has almost become a nightmare for pre-IPO enterprises.
I. Relevant Law and Regulation and Risk Source
The laws, regulations and departmental regulations involved in enterprise’s IPO activities mainly include the Securities Law, Administrative Measures for Initial Public Offerings and Listing of Stocks, Interim Measures on Administration of Initial Public Offerings and Listings on the Growth Enterprise Board, Principles of Due Diligence Practice for Sponsor, Standards for the Contents and Formats of Information Disclosure by Companies Offering Securities to the Public No. 1— Prospectus, etc.
Judging from specific content of the above laws and regulations, provisions related to IP issues mainly include two aspects, i.e., the sources of IP risks in the enterprise IPO process can be generally summarized into two categories. The first aspect is the risk of information disclosure authenticity, of which common causes are the disclosure of invalid IP rights and unclear ownership. The second aspect is the risk of sustained profitability, which is commonly caused by IP disputes.
II、IP Risk Type and Prevention & Control Measure Involved in IPO Enterprise
In 2019, China Securities Regulatory Commission for the Issuance Examination Committee (hereinafter referred to as the “Examination Committee”) published a total of 16 enterprises that are asked about intellectual property issues in the announcement of examination results, according to intellectual property categories, there are 8 enterprises involving patent issue, 1 involving copyright issue and 5 involving trademark issue. Many trade secrets issues coincide with patent issues, and there are 2 enterprises only involving trade secrets. It can be seen that patent issues have been the focus of IP issues in IPO enterprises.
Based on the analysis of relevant cases in previous years, the types of intellectual property risks of enterprises in the IPO process can be divided into two categories: non-litigation and litigation. Non-litigation risk mainly refers to the issue triggered by the issuer itself, such as untruthful information disclosure, non-standard intellectual property transaction, etc. Therefore, its main prevention and control measures are to strengthen the basic management of intellectual property rights. Litigation risks mainly come from infringement litigation, some of which involve trade secrets, ownership of rights and other issues. Therefore, targeted identification and prevention of infringement risks should be carried out before IPO, and the core is FTO retrieval of key products and technologies.
III、 Basic Management of Intellectual Property
Basic management of intellectual property covers a wide range of topics, including the creation, use, protection and management of intellectual property. For common risk scenarios, at least the following should be done.
1. Routine Maintenance of Intellectual Property
Routine maintenance of intellectual property is the basis of intellectual property management, of which the most basic content is to pay the annual fee normally, and regularly check the legal status, such as whether there is pledge, assignment, licensing, invalidation, termination, etc.
In 2010, five patents disclosed in the IP prospectus of Suzhou Goldengreen Technologies Ltd. were terminated due to unpaid annual fee, which led to the emergency stoppage by the regulatory authorities on the eve of the listing due to untruthful information disclosure.
2. Intellectual Property Investigation of Core Technology/Product
In 2016, Examination Committee found that a formal patent license agreement wasn’t entered into by and between Xidian Pharmaceutical Ltd. and the patentee in regard to key patents for the core products. The use of the patent had significant adverse changes, which may affect the continued profitability. As a result, the IPO was not approved.
It can be seen that for core products and technologies of enterprise, from the beginning of R&D or introduction, the intellectual property protection should be systematically planned, scientific protection strategy should be adopted, patent application and relevant procedures for patents should be handled in time. In addition, relevant intellectual property should be regularly checked and gaps in current protection strategies should be filled in time.
3. Record Keeping of R&D Activity
R&D capability is an important support for sustained profitability. In addition to examining whether the issuer has relevant patents, Examination Committee will conduct in-depth inquiries. For example, in 2019, Hangzhou Tianyuan Pet Products Co., Ltd. was asked by the Examination Committee to explain the R&D model, R&D team, R&D expenditures, etc., to prove that “research and development” is one of its core competitive advantages. 3Shenzhen Defang Nano Technology Co., Ltd. was required to explain the conditions of R&D, facilities and personnel required for relevant patents to prove that those patents disclosed by the issuer originated from independent research and development.
None of these problems don't require enterprises to properly keep records of the “current year” R&D activities, such as project approval reports, R&D plans, experimental records, drawings, R&D meeting minutes, and results acceptance reports.
4. Intellectual Property Background Survey of Core Team Member
In 2019, in the announcement of audit results of Zhongjian Technology Co., Ltd. and Yunnan Zhenan Shock Absorption Technology Co., Ltd., Examination Committee proposed that the actual controller of the issuer, shareholders and some core technical personnel had served in peer enterprise of the same industry, and some of the core technologies were acquired from peer enterprise. Therefore, it is required to explain the source of the core technology, the ownership of technical achievements of the relevant technical personnel during the employment of previous peer enterprise, and whether there are violations of non-competition obligations.
Both of these are typical examples of people and technology coming from peer enterprises which are questioned about IP dispute. In order to avoid the emergence of these risks, it is necessary to fully investigate the intellectual property background when introducing core personnel, especially core technicians and personnel with relevant technical achievements, such as whether there is a non-competition agreement, a non-disclosure agreement, ownership of the technical achievements carried, etc.
5. Standardization of Patent Transaction
In 2015, Jiangsu Zhuosheng purchased the patent rights from its affiliate enterprise, Zhuosheng Shanghai, at a price of 6.5 million yuan. In 2019, Examination Committee requested Jiangsu Zhuosheng to explain specific content of the aforementioned patent rights transfer, the patent evaluation methods adopted, key assumptions and important parameters, and whether there is any impairment after the purchase of patent rights.
This case reminds us that when the amount of patent transactions is relatively large, especially involving transaction with affiliate enterprises, it is necessary to standardize the transaction flow, especially to carry out independent, real and scientific patent evaluation to avoid being challenged to carry out profit transfer or other illegal activities through patent transaction.
IV、Identification and Prevention of Infringement Risk
Infringement litigation is another kind of great risk for pre-IPO enterprise, which is often triggered by competitors with more unpredictability. For example, Yonganxing Co., known as “first stock of shared bicycle” in 2017, was sued for infringement on the eve of the release, resulting in the suspension of IPO road show7. In 2019, Xinli Optoelectronics Co., Ltd. and Honghe Technology Co., Ltd. were all inquired by Examination Committee about the patent disputes involved. 8、9
Patent infringement litigation has the largest number, the greatest threat, and is the most complicated type to be handled in all kinds of infringement litigation. Therefore, for pre-IPO enterprises, the most effective prevention and control measures for infringement risks are to conduct freedom-to-operate analysis for core products and technologies in advance, i.e., FTO search and analysis. On the one hand, it is necessary to assess the risk level, on the other hand, it is necessary to understand the specific risk points, prepare in advance, collect invalid evidence of risk patents, and make response plans for risk patentees.
Exposure of risks and emergence of crises often occur when formally entering into the pre-IPO process. The most common is infringement litigation along with negative news and reports. In 2019, Honghe Technology Co., Ltd. was approved for IPO though it was in patent litigation disputes, which attracted widespread attention. It can be seen from the announcement of the audit results of Honghe Technology Co., Ltd. that Honghe Technology quickly proposed the invalidation request for patents involved, and proposed that the involved patent is not related to their core technology which has been protected in the form of technical secrets.
Honghe’s success “going ashore” indicates that when the pre-IPO enterprises encounter patent litigation in the IPO, Examination Committee no longer judges based on the rule of “one size fits all”, but will analyze in depth whether it will affect the issuer’s continued profitability. For pre-IPO enterprises, when facing litigation crisis, the response core is to reduce the negative impact on the sustainable profitability. The key is to respond quickly with positive measures. If the infringement possibility is low, it may take the means of invalidating the patent and proving non-core technology infringement; if the infringement fact is clear, it should seek quick resolution through active negotiation; and for malicious litigation, we can resist and fight back through counterclaims and non-infringement actions. At the same time, it is needed to make rapid response to negative news and reports through timely and sufficient information disclosure to reduce negative impacts.
IPO is a key link for enterprises to obtain more abundant funds and broader development space. Today, intellectual property as an important means of market competition, intellectual property issues in IPOs are becoming increasingly prominent and complex. In order to better avoid and cope with the intellectual property risks in the IPO, the enterprises to be listed must start from IP routine management, and enrich their own strengths such as patent portfolio and conduct FTO search and analysis before the IPO, and take this basis to make plans so that enterprises could respond appropriately when facing crisis risk.