Written by: Marcus Wolter, Takahiro Miyazaki, Bianca Lindau, and Elizabeth Bestwick

One of our core tenets at Caldwell is that we do NOT take a lacklustre approach when it comes to the financial and strategic value of intellectual property (IP). Intangible assets accounted for 90% of the S&P 500’s total assets in 2020, an increase from 17% in 1975, and similarly, they accounted for 74% of the S&P Europe 350’s assets in 2020.[1] Global intangible assets held by companies worldwide are worth USD 61.9 trillion in 2023, an 8 percent increase since 2022.[2]

Yet, in their professional past, many of our team members have worked with clients that are seemingly disregarding the importance of intangible assets in terms of, for example, financial value, for becoming a gate keeper in a new sector, to defend themselves against infringement claims, or simply to create a moat around their business. They do not have strategic IP policies in place and due diligence is often limited to a “tick-the-box” exercise without regard for the alignment of registered IP and the business model of a target for example.

This article focuses on why this disregard is dangerous for directors specifically with examples from Delaware, Japan and Germany. It is not only in the company’s best interest to protect IP assets, it is also a director’s duty to protect them.

It is not surprising that the fiduciary duties of corporate directors extend to their company’s IP assets. In Delaware, Germany, and Japan for example, courts treat IP assets the same as any other corporate assets, especially within tech companies where IP assets have a high value relative to the company’s total value. Accordingly, there can be significant implications when directors do not fulfill their responsibilities to protect the company’s IP assets or conduct proper IP due diligence in an M&A scenario.

To adhere to these responsibilities, whether in the US, Germany, or Japan, directors and their companies should implement policies and procedures to regularly (i) familiarize directors and officers with the company’s IP portfolio; (ii) review the related IP strategy; (iii) review industry practices and (iv) develop and document internal IP controls.

Delaware

Delaware is the leading incorporation jurisdiction, with well-established fiduciary duties that are widely followed in other states in the US. Fiduciary duties were and continue to be developed at common law, and are partially codified in the Delaware General Corporation Law (DGCL). Directors have fiduciary duties of care and loyalty that also apply to the management of a corporation’s IP assets. 

The duty of care requires directors to act with the care that an ordinary and prudent person in similar circumstances would act with in making business decisions. This includes being knowledgeable about the corporation, its business, industry, corporate affairs, relevant risks, and engaging in deliberation about issues the corporation faces. As applies to IP management, directors should be familiar with the corporation’s IP portfolio and especially the key IP assets, including patents, trademarks, copyrights, and trade secrets. Particularly where a company mainly operates utilizing trade secrets, directors should thoroughly understand the measures in place to protect the company’s trade secrets, whether these are sufficient or could be improved and whether these trade secrets are better protected by patents. Before approving transactions, directors should ensure that thorough IP due diligence is conducted. This includes verifying the ownership and validity of IP assets, checking for any potential infringement issues, and assessing how the IP aligns with the corporation’s business model. Directors should evaluate IP risks, such as of potential litigation, the expiration of key patents, or any reliance on third-party IP. Decisions should be made based on a clear understanding of these risks. When a director breaches this duty and is sued, courts typically apply the business judgment rule, which presumes that independent and disinterested directors made an informed decision in good faith and in the best interest of the corporation. If a director (or the majority of the board) makes an uninformed decision regarding the protection of IP or IP due diligence, acts in bad faith, and their belief that the action or transaction was in the corporation’s best interest is held to be unreasonable, courts could override this rule and hold the director liable. If the presumption is not rebutted, a finding of a breach of the duty of care requires gross negligence on the part of the director.

The duty of loyalty requires directors to act in good faith and in the best interest of the corporation and its shareholders and not in their own personal interest or the interest of a director, officer, or controlling shareholder. Consequently, in the IP management context, directors should not engage in transactions with the corporation where they or their affiliates stand to benefit from the corporation’s IP assets at the expense of shareholders. When approving transactions involving IP, the disinterested directors should ensure that there is a fair valuation of the IP, such that the assets are neither undervalued nor overvalued, which could harm shareholder interests. A breach of this duty is implicated if there is a conflict of interest and bad faith. Courts may also apply the business judgment rule in the case of a breach of this duty. A director may risk a shareholder derivative suit as a result of approving a transaction that either values the IP assets too low or too high, as this is not in the best interest of the corporation and its shareholders. This requires careful strategic consideration of the IP assets, especially in the process of IP due diligence.

As a subset of the foregoing duties, directors have a duty of oversight. This requires directors to stay informed and oversee and monitor the corporation’s business operations, exposure to risk, compliance with laws, and requires that good faith efforts are made to implement a system to report information and compliance risks to directors in a timely and accurate manner and actually monitor and oversee its obligations. A failure of oversight may be found where directors make no effort to put such a system in place or consciously fail to monitor or oversee the corporation’s operations and exposure to risk. Directors could be held liable for inaction or lack of oversight regarding the corporation’s IP assets. Consequently, directors should ensure there are robust systems in place to report IP-related information and risks to the board. Directors should further monitor the corporation’s compliance with IP laws and regulations, ensuring that all filings, such as patent applications, are accurate and timely. It should be noted that Delaware courts focus on legal compliance risk, not business risks, and Delaware courts have not expanded liability for failure of oversight to include monitoring business risk. For most companies, directors are not, nor are they expected to be, IP experts, so proper oversight may require that directors hire IP counsel to assist them in IP strategy and management. A director can delegate this management because it is a duty that does not lie at the heart of the management of the corporation, although that may depend on the particular corporation. 

As part of both the duty of care and the duty of loyalty, directors have a responsibility to ensure that all of the corporation’s IP assets are utilized effectively. Directors should periodically review the corporation’s portfolio for dormant IP assets, i.e. IP assets that are not currently being used, but might still have potential for commercialization, licensing, or sale. Directors should assess whether dormant patents, trademarks, or other IP assets could be leveraged in new markets, licensed to third parties, or integrated into new products or services, in particular since unused IP can still generate costs, e.g. patent maintenance fees, trademark maintenance fees and costs of maintaining trade secrets. If the corporation lacks the capacity or interest in commercializing dormant IP, directors should consider whether selling or licensing these assets could provide value to shareholders, involving a strategic evaluation of potential partnerships, licensing opportunities, or outright sales. Monetization requires due diligence as well. At Caldwell, we work closely together with large client corporations to identify and foster monetization strategies. Before pursuing commercialization or sale, directors should ensure that a thorough market analysis is conducted to determine the potential value of the dormant IP and the best avenues for monetization. Fair valuation of dormant IP is essential to avoid undervaluing or overvaluing the assets during negotiations. Directors should ensure that any transaction involving dormant IP is in the best interest of the corporation and its shareholders.

Germany

Germany has entities that are similar to Delaware corporations and limited liability companies, namely the Aktiengesellschaft (AG) and the Gesellschaft mit beschränkter Haftung (GmbH) respectively. While a Delaware corporation typically only has a board of directors and shareholders, the German AG is composed of three corporate bodies, namely the management board (Vorstand), which is equivalent to the board of directors, a supervisory board (Aufsichtsrat) and the shareholders’ meeting (Hauptversammlung). The Vorstand independently manages an AG and is responsible for the day-to-day business of the company, whereas the Aufsichtsrat appoints, supervises and advises the Vorstand, but has no power to make executive decisions or formally order the Vorstand to do or not do something. The GmbH is structured similarly to most Delaware LLCs, having members (Gesellschafter) and a manager/managing member (Geschäftsführer). The AG is governed by the German Stock Corporation Act (Aktiengesetz) (AktG) and the GmbH by the German Limited Liabilities Company Act (Gesetz betreffend die Gesellschaften mit beschränkter Haftung) (GmbHG).

The AktG imposes duties of care and loyalty in relation to the company on the Vorstand, including the duty to comply with applicable law. Further, Section 93 para. 1, sentence 3 of the AktG expressly imposes a duty on members of the management board to keep confidential and not disclose confidential information and company secrets, particularly trade secrets and other company secrets, of which they have become aware of through its activities as part of the management Board. Furthermore, Section 88 para. 1 prohibits members of the Vorstand from carrying on trade or pursuing any business in the company’s line of business without the consent of the supervisory board. The standard of care is that of a diligent and prudent businessman. In addition, under Section 93 para. 1 sentence 2 of the AktG the business judgment rule applies, under which there is no breach of duty by a member of the management board if in making a business decision the member could reasonably assume that they were acting in the best interests of the company on the basis of appropriate information. As such, the management board generally has discretion when it comes to business decisions, including whether and to what extent to protect, strategically use, and monetize IP assets and conduct proper IP due diligence, although what is reasonable may depend on the specific company and the M&A scenario. A breach of these duties leads to personal and joint liability of the members of the Vorstand towards the AG, but not individual shareholders or third parties. The US business judgment rule has, with Section 93 para. 1 sentence 2 of the AktG, been codified in Germany.  Directors should be more cautious and thoroughly document their decision-making process, provide proof of accurate due diligence, make decisions objectively in the best interest of the corporation, and consider all available information. Additionally, the burden of proof shifts from being on the plaintiff and favoring the directors in the US, to being on the directors in Germany. In summary, while both Delaware and German law protect directors from liability for business decisions made in good faith, the standards and level of scrutiny applied differ. Delaware’s business judgment rule provides a broad presumption of protection, focusing on the procedural aspects of decision-making. In contrast, German law requires a higher degree of diligence and may involve more stringent judicial review of directors’ decisions. As such, members of the management board need to be thorough in the IP management context. They should ensure that they have a thorough understanding of the AG’s IP portfolio, thoroughly document their decisions regarding IP and the company’s IP strategy, ensure that thorough IP due diligence is conducted (similar to Delaware) in the transactional context and work with IP specialists where the members do not have sufficient knowledge and understanding of IP, associated risks and monetization strategies.

The Aufsichtsrat has, among others, the right and duty to request a report from the management board regarding affairs of the company and can determine certain matters that require its consent (for example, material acquisitions and divestments). As such, the consent of the supervisory board may be required if IP assets are sold, in particular where they represent a substantial portion of the AG’s assets. If the supervisory board refuses to provide its consent, the management board may demand that the shareholder meeting provide consent instead.

The GmbHG imposes upon Geschäftsführer duties of legality, oversight, loyalty, care and a duty of confidentiality to their companies. Section 43 of the GmbHG covers directors’ liability, requiring that (i) directors shall conduct the company’s affairs with the due diligence of a prudent businessman; (ii) directors who breach the duties incumbent upon them shall be jointly and severally liable to the company for damages; (iii) directors shall be obligated to compensate for prohibited payments made from company assets; and (iv) any claims based on these provisions shall be statute-barred after five years.

Although not specifically required under the AktG and the GmbHG, managing board members and managing directors should ensure their IP assets are protected, which may include securing patents, trademarks, or copyrights, or keeping them as trade secrets. In particular, they are subject to duties of confidentiality and must protect business secrets and generally cannot compete with the businesses they manage. As a best practice, they should manage the company’s IP portfolio, disclose any potential conflicts of interest related to the IP assets, develop IP strategies for the company, and ensure compliance with IP-related laws (the UrhG, MarkenG, and PatG).

Japan

1. Overview of Directors’ Fiduciary Duties in Japan:

Article 330 and 355 of the Companies Act (Act No. 86 of 2005) impose a fiduciary duty of care upon directors, which requires directors to act with the due care of a prudent manager when performing their functions.

In contrast to the DGCL, Japanese law does not strictly distinguish between the duty of care, the duty of loyalty, or oversight of the company’s business. Court precedents implicate that, under Japanese law, the duty of loyalty or oversight should be a part of the duty of care.

Directors should understand that this is unfavorable compared to the fiduciary duties under many US state statutes, including the DGCL. For example, while section 102(b)(7) of the DGCL could eliminate or limit the monetary liability of directors for breaches of solely the duty of care, Japanese law does not provide for such a mitigation of damages benefitting the directors. Because Japanese law does not distinguish between the duty of care and other duties, it does not provide for a situation where directors only breach the duty of care.

2. Trends of the IP Due Diligence in Japan:

Historically, IP matters were not recognized as an independent area of legal due diligence but were addressed separately when disputes concerning assets, contracts, or disputes arose. However, the importance of IP strategy in business has grown significantly, resulting in unique and severe risks associated with intellectual property.

This dynamic trend is reflected in the increased number of IP litigation cases. Since the Intellectual Property High Courts was set up in 2005, the number of IP litigation cases in Japan has nearly doubled from 311 in 1991 to 600 in 2022, while the average trial period has significantly shortened from 31.1 months to 14.9 months. These improvements have encouraged the industry to resolve disputes through court proceedings.

Given this noticeable uptick of IP-related risks, the government released the Guidance and Commentary for the Standard Practice of IP Due Diligence (IP DD Guidance) in 2018[3]. To conduct proper IP due diligence in Japan, directors should be familiar with and understand this IP DD Guidance.

3. Proper IP Due Diligence in Japan:

In Japan, it is extremely difficult to draw a line for best practices for IP due diligence in terms of the directors’ duties to protect IP.

As mentioned above, it is essential to tailor the approach to the characteristics of each target company and its business when considering the procedures and scope of IP due diligence. For example, the IP DD Guidance suggests that, for startups in fields like drug discovery or materials, where the value of specific technologies is closely tied to business value and future performance, thorough review of the company’s intellectual property rights is essentially mandatory. Conversely, in sectors like information and communication technology, where individual intellectual property rights are less critical, or where the speed of a business launch is more important than a detailed investigation, it may be practical to limit the scope of the investigation or even skip it altogether. In IP due diligence, it is crucial to understand the business content at the initial stage, narrow down the investigation targets, and consider the necessity and difficulty of the investigation to request efficient document provision and conduct hearings effectively.

In addition, it is crucial to be acutely aware of the limitations inherent to diligence conducted within a short timeframe. For example, many IP rights that once seemed firmly established could later be invalidated through procedures like invalidation proceedings at the patent office or litigation for the revocation of allowances at court. According to 2021 statistics from the patent office, for patents, 57 requests for invalidation proceedings were rejected, while 17 were accepted. For trademark rights, 62 requests for invalidation proceedings were rejected, while 27 were accepted. This demonstrates that, in terms of stability, IP rights significantly differ from ownership rights concerning tangible assets like real estate. It is common for new invalidation grounds to emerge for patents that serve as the basis for claims during infringement lawsuits.

As indicated above, the intricacies of Japanese IP due diligence demand specialized knowledge about Japanese law and IP industries. It is crucial to carry out IP due diligence with the help of attorneys who possess strong expertise in the IP industry.

4. Duty and Importance of Protecting IP Assets in Japan:

As explained, the Companies Act imposes a fiduciary duty of care upon directors. The core of their duties is to maximize shareholder benefits, which is measured by the company’s value, including its IP assets. Subject to the business judgment rule, the directors will be held liable for damages if they do not pay enough care to protect the company’s IP assets.

Additionally, beyond fiduciary duties, it is, in many cases, undoubtedly crucial for a company’s growth to maximize the value of IP assets value. Given the importance of IP assets in Japan, the Japanese government released various guidelines. For example, the Ministry of Economy, Trade and Industry (METI) released standard documents and practical notes commonly used in IP related transactions, including model non-disclosure and joint-development agreements[4]. Directors should take these standard documents into consideration because these include the terms which, from the government’s viewpoint, best reflect unique Japanese commercial practices. For example, in one of the latest guidelines, issued July 31, 2024[5], METI specifically addresses the issues arising when transferring the responsibility and burden of IP disputes, such as IP infringement, to subcontractors and provides model clauses. Although this kind of clause might be common in some jurisdictions, and in view of the fact that currently there are no court precedents related to breaches of this guidance, the guidance indicates that conduct that contradicts this guidance might raise the risk of violating the Japanese competition law or subcontract law.

To maximize the value of a company’s IP assets, it is essential to take into consideration the factors that are unique to the Japanese market.

This publication is distributed with the understanding that the author, publisher, and distributor of this publication and/or any linked publication are not rendering legal, accounting, or other professional advice or opinions on specific facts or matters and, accordingly, assume no liability whatsoever in connection with its use. Pursuant to applicable rules of professional conduct, portions of this publication may constitute Attorney Advertising.

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[1] Ocean Tomo, a Part of J.S. Held, Intangible Asset Market Value Study, www.oceantomo.com (Jul. 2020), https://oceantomo.com/intangible-asset-market-value-study.

[2] Brown, Annie et. al, Corporate Intangible Assets Grew to USD 61.9 trillion in 2023, www.wipo.int (Feb. 28, 2024), https://www.wipo.int/global_innovation_index/en/gii-insights-blog/2024/corporate-intangible-assets.html.

[3] Japan Patent Office, the guidance and commentary for the standard practice of IP due diligence, (Mar. 2018), https://www.jpo.go.jp/support/startup/document/index/2017_06_kaisetsu.pdf (last visited Aug. 5, 2024).

[4] The Ministry of Economy, Trade and Industry, Guidelines and Model Agreements for Intellectual Property Transactions, meti.go.jp, https://www.chusho.meti.go.jp/keiei/torihiki/chizai_guideline.html (last visited Aug. 10, 2024).

[5] The Ministry of Economy, Trade and Industry, Response to the act of shifting the responsibility and burden of disputes concerning intellectual property rights to subcontractors, meti.go.jp (July 31, 2024), https://www.meti.go.jp/press/2024/07/20240731001/20240731001.html.