Connect with us
< All Topics
Print

Due Diligence

Due diligence – is a process conducted during investments and M&A transactions before a deal is closed (see Venture Capital and M&A). It is a large-scale appraisal of each aspect of a company, aiming to confirm its value and assess whether there are any risks to executing the deal. It can be conducted both by an investor or buyer (buyer-side DD) and by a seller or offeror (seller-side DD). Due diligence in a merger or acquisition enables a buyer to appropriately value its target, prohibiting inflated sales prices, but also to ensure that the transaction is strategically sensible and that there are no major obstacles or unwanted surprises regarding the deal. Many deals are called off due to new information arising during due diligence; conversely, deals that go forward after conducting robust due diligence have a higher likelihood of creating value for all parties involved. Similarly, due diligence is valuable for investors because it allows an assessment of the strength of the investment. It is also an important tool for divestments, the sale of parts of a company, to enable the divesting entity to set an appropriate price and communicate effectively with potential buyers.

Due diligence encompasses all company operations. This includes areas such as finances, commercial, tax and legal. Financial due diligence encompasses the company’s assets and liabilities, net debt and working capital. It aims to provide a complete overview of its financial metrics and assess projected performance. Commercial due diligence covers the business model and operations, the relevant markets, supply chain, customers and competitors. Tax due diligence clarifies companies’ tax obligations such as income tax and VAT. It also identifies tax-related risks and potential transfer taxes depending on the structure of the deal. Legal due diligence includes current litigation the company is involved in, potential liabilities, incorporation and corporate governance, commercial and employment contracts, ownership and assets such as commercial property rights or real estate. It also includes compliance and regulatory concerns such as data protection, competition and antitrust law (see Competition Law and Antitrust Law).

For video game companies as media-based companies, Intellectual Property (IP) plays a prominent role during due diligence. IP is the base of the product that video game companies sell. If they do not (fully) own the IP rights to the products in their portfolio or are unable to transfer them during a change in company ownership, this will significantly negatively impact and often kill a deal. Further, IP rights may vary in different jurisdictions, which is relevant particularly in international transactions. IP rights include trademarks, copyrights, patents, trade secrets and domain names. They are vested in many aspects of a video game, including, but not limited to, the name of the game, characters, game art, music, source and object code, user interfaces, and the company name and logo.[1]

Companies licensing IP from third parties to create games (such as in video games based on movies, book franchises or characters such as Disney Dreamlight Valley, Star Wars and Marvel’s Spider-Man games) will have signed licensing agreements detailing under which circumstances they are able to develop video games using the licensed IP. These contracts may include provisions detailing a termination or adjustment in case of a change in company ownership.[2]

Similarly, there may be regional differences in IP ownership. An American company purchasing a European developer may assume that the developer owns all copyrights in the IP made by company employees under the work-made-for-hire doctrine. In Europe, however, this doctrine does not apply. Rather, copyright must be transferred contractually from the employee to the company. In addition, moral rights will remain with the employee and cannot be transferred.[3] Similar considerations take effect when working with freelancers, or using IP that has been developed by the company’s founders instead of by employees.

Advertisement

Indie developers in particular may also often rely on open-source code to aid the software development process. Open-source licenses will detail the terms under which this code may be used. These can include copyleft clauses, which provide that any work produced using the code will have to be made available under the same licensing terms (i.e., to the public for free).[4] Identifying these clauses and understanding their consequences is important to ensure the company’s ability to monetize their game. Similarly, it is important to understand IP ownership when using engines, middleware or third-party asset packs in video game development.[5]

In a worst-case scenario, a company may even have refrained from licensing the rights to legally use an IP or have produced a clone, infringing third-party IP rights. This can lead not only to high damages claims, but can even have consequences in criminal law.

In sum, conducting due diligence, especially regarding intellectual property, ensures that the main product of a video game company, the video game itself, remains fully useable after a change in company ownership.


[1] Case C-355/12 Nintendo v PC Box [2014] ECLI:EU:C:2014:25. See also Andy Ramos et al., The Legal Status of Video Games (WIPO 2013) 8; Dan Nabel, Bill Chang, Video Game Law in a Nutshell (2nd edn, West Academic 2023) 10.

[2] Dan Nabel, Bill Chang, Video Game Law in a Nutshell (2nd edn, West Academic 2023) 246, 261.

Advertisement

[3] For a comparison of German, Colombian and US laws on copyright and moral rights in the employment context, see Jose Roberto Herrera Diaz, ‘Ownership of Copyright in Works Created in Employment Relationships’, 14 [2010] Revista la Propiedad Inmaterial 97, 113.

[4] See, e.g., the CC BY-SA 4.0 license (https://creativecommons.org/licenses/by-sa/4.0/).

[5] For more detail on middleware licensing terms, see Gregory Boyd, Brian Pyne, Sean Kane, Video Game Law (Taylor & Francis 2019) 89.

Author

  • Jasmin Dolling

    Jasmin Dolling, LL.B., Dipl.-Jur. is a German legal scholar from Hamburg. She is currently working on her doctoral thesis concerning media rights in esports and has published a number of German- and English-language academic papers and articles on questions of video game and esports law. She has also founded the ‘Student Group for Video Game and Esports Law’ at her home university. View all posts

Table of Contents