In the feature article below, Holly K. Towle, Partner, Kirkpatrick & Lockhart Preston Gates Ellis, focuses on issues arising from doing business electronically and information that tends not to enjoy intellectual property protection.

Holly K. Towle's practice focuses on technology, intellectual property, and electronics in commerce. She is the author of “The Law of Electronic Transactions,“ an information-rich treatise explaining the legal landscape of commercial law when electronics or electronic settings (such as the Internet) are used.

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TouchStar Software Corp. Has Acquired Sigmaworx, Inc.

FOCUS initiated negotiations and acted as financial advisor to Sigmaworx, Inc., a CRM solutions and telemarketing software producer. In the company’s twenty-year history, over 2,000 contact centers have deployed a Sigmaworx system, supporting over 30,000 contact center agents. Established in 1985, Sigmaworx, Inc. provides best-of-breed call center software, predictive dialer applications, CRM solutions, and telemarketing software. Established in 1996, TouchStar Software Corp. provides robust predictive dialing and blended inbound/outbound, ACD, and IVR features previously affordable to only large companies. Read more...

The Importance of M&A Due Diligence in the E-Information Age

A fundamental commerce shift from bricks-and-mortar to clicks-without-borders has changed the rules of due diligence. As our economy has moved from "goods" to intellectual property and information, due diligence has changed to include reviews for open-source software and its potential "viral" effect.

Yet, while intellectual property matters dominate the headlines, "Non-IP/Electronic" due diligence, or E-DD, focuses on issues arising from doing business electronically and information that tends not to enjoy intellectual property protection.

The importance of due diligence reviews is no secret. An investigation may reveal risks that lurk below the surface, and only the foolhardy acquirer skips this step. When computer information is created, collected, held, used or discarded, E-DD is essential. Here are a few key considerations for due diligence in the e-information age.

Updating the Agreement

Most agreements focus on tangible "property" concepts, yet items important in an information economy are not tangible. Some are not even "property."

As intellectual property rights became as or more important than brick-and-mortar assets, wording of acquisition agreements shifted from focusing on tangible property—"sales," "ownership," and "title"—to dealing with "licenses" and intangible intellectual property rights.

But another shift beyond intangible property rights is necessary. If a target entertainment company is sending computer "robots" to gather ticket prices from Internet auction sites, the gathered facts are not protected by copyright, so getting an assurance that the target is not "infringing" misses the mark. The target could be "trespassing," however, and E-DD would have used language to capture that kind of difference.

New Laws

Assume a buyer wants to send e-mail promotions to post-merger customers. This makes the target's customer list a valuable asset in the deal. These days, having customers is not the same as being able to send marketing e-mails to them. If E-DD ignores this, the buyer may end up paying for something it is not really getting, specifically the ability to send e-mails to the full list.

In another example, new state laws require customer notice upon breach of information security. ChoicePoint Inc. made news in February 2005 when the company provided notice that it had been duped into selling the personal information of almost 145,000 people. ChoicePoint made this disclosure under a 2003 California law (recently followed by about 20 states) more than eight months after the breach occurred.

Had ChoicePoint been an acquisition target during that period, asking during E-DD whether it had suffered any security breaches might have elicited important information.

Let's put the potential acquisition risks into perspective: ChoicePoint stock lost 1.3 percent the day after the announcement, fell nearly 14 percent the next week and, as of June 2005, was still down more than 12 percent from the day of disclosure, according to The Wall Street Journal.

No. Many of the new laws do not require anything, so they cannot be violated—they simply create material consequences if the law is ignored. Thus, a target could accurately represent that it is not in violation of law while still being at risk under those laws.

To illustrate, assume the target has a Web site where customers make contracts. Those contracts are electronic records and several state and federal laws will affect them simply because they are electronic (that is, these laws do not exist for paper records).

For example, under federal law, e-records may be denied legal effect, validity or enforceability if they do not meet certain federal rules. There is no "violation" of law if the rules are not met—the records simply become susceptible to challenge. Worst case, the target might not have the enforceable or valid contracts that it thinks it has—instead, it may have contracts and records that are subject to challenge because that is a consequence of, but not a requirement of, not meeting the new e-rules.

Had the acquirer sought a specific representation regarding electronic records and done some E-DD regarding them, it might have paid less for the contracts or added "fix e-records and procedures" to its post-merger to-do list.

Due Diligence

E-DD liabilities and issues tend to create an affirmative need to investigate instead of relying on representations in acquisition agreements. In modern practice, a mismatch between privacy policy text and practice may present greater liability or reputational risk and business disruption than many issues examined in traditional due diligence. Review is necessary, not mere assurances.

E-DD is a "tip of the iceberg" issue, and addressing every new law and concept would be prohibitive. But E-DD commensurate with the circumstances, risks and the target company's business is a new necessity. This includes updating acquisition agreements and taking another look at the focus of existing due diligence.

This article, written by Holly K. Towle, Partner, Kirkpatrick & Lockhart Preston Gates Ellis LLP, originally appeared in The Deal, January 2006.

RECOMMENDED READING:
What Sarbox Wrought

In the April 7-8, 2007 issue of The Wall Street Journal, Jonathan Macey, deputy dean of Yale Law School, writes in an article, “What Sarbox Wrought,” about how avoiding US capital markets used to attract suspicion, but not anymore.

“…We are in the midst of the greatest natural experiment in the history of finance. The three great pools of liquidity—Hong Kong, London, and New York—all have modern trading systems. Under the thumb of the SEC, New York is competing along the vector of providing the ‘best,’ or at least the most, regulation; London lies in the middle; and Hong Kong does little in the way of actual enforcement. My guess is that the middle road will win.