Legal update: Is an IP audit worth US$154 Million?

Mention ‘IP audit’ and many managers wonder if their company needs one. Is it really necessary? How much will an audit cost? Will it tie up human and financial resources? What benefits will I gain from it? A recent news article illustrates the importance of IP audits.

A Chinese operator of a popular online game abruptly cancelled its initial public offering a few days before it was to begin trading. It would have been the first Chinese company to trade on the Osaka exchange in Japan. The company wanted to raise US$100 million and was surprised when it received subscriptions for US$154 million, 50% more than its targeted goal. So what caused them to drop the IPO?

A week before the planned listing, the game’s developer announced that it will sue the company over inadequate royalty payment and that it will not renew the game’s licence when it expires next year. Indeed, it may terminate the licence already because of the game operator’s breach of the licence agreement. The game in question brought in 60% of the company’s 2006 revenue so losing the licence will seriously jeopardise the operator’s ability to continue its business.

The underlying dispute may be more complicated than as reported and its details were not disclosed in a news article. What is clear is that the relationship between licensor and licensee seems to have broken down and a lawsuit involving royalty payment and non-renewal of the licence was serious enough to kill the US$154 million IPO.

Is this a story of a greedy game developer, a cheating licensee or an underwriter trying to ram through a listing with shoddy due diligence investigation? Perhaps the developer only realized that it was being shortchanged upon review of the financial statements in the offering prospectus. Whatever the reason, the dispute should be a reminder that licensing involves a long-term working relationship, so trust, communication and cooperation are vital to the success of the relationship.

A good IP audit might have helped spot the licensing problem earlier and perhaps help avert the embarrassment of the last-minute derailment of the listing. An IP audit is intended to help a company take stock of its intangible assets, devise ways to protect the assets better and determine means to realise more revenue from such assets. It also provides management with vital data for strategic business planning.

In this case, during the course of an IP audit, this key licensing agreement would have been reviewed and analyzed. Issues such as royalty calculation and payment would have been checked and irregularities would have been spotted and brought to management’s attention.

During a post-audit review, the fact that 60% of revenue comes from a single source would have been considered because it represents a potential vulnerability. Findings from the audit would have warned management of the fragility of the company’s most valuable asset being a licence agreement of limited duration without an absolute right of extension. If the licence is not renewed or if royalty rates under its renewal are too expensive, its viability may be compromised. The company’s future success rests on the game developer’s willingness to renew the licence and is beyond the company’s direct control. The lack of control threatens the company’s competitiveness. In the post-audit review, this glaring danger should have pushed management into taking steps to reduce its reliance on a single source of revenue, consider acquisition of the asset or otherwise strengthen its licensing right and develop other sources of revenue. An IP audit would have spawned changes to the company’s business plan to strengthen its intangible assets before its preparation to list its shares on a publicly traded exchange.

This is one important reason for going through an IP audit. An audit is really a useful management tool to help a company with its planning. Who knows, it could have helped the gaming operator put the US$154 million in its coffers.

For further information, please contact:
Eddie Look
Partner | Email

Tim Drew
Partner | Email

Edmond Leung
Partner | Email

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.