A Sponsor's Due Diligence on the Risk of Intellectual Property Infringement by the Listing Applicant

The SFC’s 2024-25 enforcement priorities, published in its Annual Report 2024, explicitly identify intellectual property (IP) rights due diligence as a heightened area of focus in IPO sponsor work. This shift follows a series of listing applications where material IP infringement risks were either undisclosed or inadequately investigated, leading to suspension of trading and investor losses. For a sponsor holding a Type 6 (advising on corporate finance) or Type 6A (sponsorship) licence under the Securities and Futures Ordinance (Cap. 571), the consequences of deficient IP due diligence are severe: the SFC can impose fines, suspend licences, or refer cases to the Market Misconduct Tribunal. The Listing Rules of The Stock Exchange of Hong Kong Limited (HKEX) under Chapter 9A require sponsors to exercise “reasonable skill and care” in verifying a listing applicant’s business model, which directly encompasses the legal ownership, validity, and freedom-to-operate of its IP portfolio. This article examines the specific regulatory expectations, common pitfalls, and actionable frameworks for sponsors conducting IP infringement risk assessments, drawing on recent SFC disciplinary actions and HKEX listing decisions.

The Regulatory Framework for IP Due Diligence

HKEX Listing Rules and the Sponsor’s Statutory Duty

The sponsor’s obligation to investigate IP infringement risks originates from HKEX Listing Rule 9A.03, which requires a sponsor to conduct “reasonable due diligence” to ensure the listing applicant’s prospectus contains no materially false or misleading statements. This duty is further codified in the SFC’s Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (the Code of Conduct), specifically paragraphs 17.1 to 17.8, which set out the sponsor’s responsibilities in the listing process. Paragraph 17.6(b) explicitly requires the sponsor to “take reasonable steps to satisfy itself that the listing applicant has title to, or a valid right to use, all material intellectual property rights.”

A 2023 SFC disciplinary action against a sponsor for failing to verify a biotechnology applicant’s patent assignments illustrates the standard. The SFC found the sponsor had relied on a single legal opinion from PRC counsel without independently confirming the chain of title for three core patents. The sponsor was fined HKD 12 million and its licence conditions were tightened for 18 months. The decision emphasised that “reasonable steps” include reviewing original assignment agreements, confirming recordal with the relevant patent office (e.g., CNIPA), and verifying that all inventors have executed valid assignments.

The Listing Committee’s Scrutiny of IP Risk in Practice

The HKEX Listing Committee has increasingly questioned applicants on IP infringement exposure during the vetting process. In a 2024 listing decision (LD 142-2024), the Committee refused to approve a Main Board application from a PRC-based consumer electronics manufacturer because the sponsor had failed to address a pending patent infringement lawsuit in the Shenzhen Intermediate People’s Court. The sponsor’s due diligence report noted the lawsuit but dismissed it as “immaterial” without quantifying the potential damages. The Committee required the sponsor to commission a PRC patent litigation specialist to assess the probability of an adverse judgment and the financial impact, which was estimated at HKD 85 million—representing 12% of the applicant’s net profit for the most recent financial year. The application was withdrawn.

This case reinforces that HKEX expects sponsors to treat IP litigation as a material risk factor unless the sponsor can demonstrate, with expert evidence, that the claim has no merit or the quantum is de minimis (defined by HKEX guidance as below 5% of net profit).

Key Areas of IP Infringement Risk for Listing Applicants

Patent Infringement in Technology-Intensive Sectors

For applicants in the biotechnology, semiconductor, and advanced manufacturing sectors, patent infringement risk is the most common and financially material IP issue. The sponsor must verify that the applicant’s core products or processes do not infringe valid third-party patents. This requires a freedom-to-operate (FTO) analysis, typically commissioned from a qualified patent attorney in the relevant jurisdiction (PRC, US, or EU).

The SFC’s 2022 Consultation Conclusions on the Regulation of Sponsors stated that a sponsor cannot discharge its duty by simply accepting management’s representation that no infringement exists. The sponsor must obtain a written FTO opinion from external counsel, covering at least the applicant’s top three revenue-generating products. The opinion should identify any blocking patents, assess their validity, and evaluate the risk of an injunction or damages claim.

A common deficiency is the sponsor’s failure to update the FTO analysis when the applicant changes its product design or manufacturing process during the listing process. In one 2023 case, a medical device applicant modified its core product’s software algorithm after the initial FTO report was issued, but the sponsor did not commission an updated analysis. The SFC imposed a reprimand and a HKD 8 million fine.

Trademark and Trade Dress Infringement in Consumer Goods

For consumer goods and retail applicants, trademark infringement is the dominant risk. The sponsor must verify that the applicant’s brand names, logos, and product packaging do not infringe registered trademarks of third parties. This involves conducting trademark clearance searches in all jurisdictions where the applicant operates or intends to operate, as disclosed in the prospectus.

The HKEX Listing Rules require the prospectus to disclose any material intellectual property rights that are “the subject of any litigation or other proceedings.” In practice, the Listing Committee expects the sponsor to identify potential infringement even before litigation is filed. A 2024 HKEX guidance letter (GL 112-24) advised sponsors to review the applicant’s marketing materials, product catalogues, and domain names for any signs of intentional or inadvertent infringement.

A recurring issue is the applicant’s use of a third-party trademark as a keyword in online advertising, which can constitute infringement under PRC Trademark Law (Article 57). The sponsor should obtain a legal opinion on the applicant’s online advertising practices in key markets, particularly on Alibaba’s Tmall and JD.com.

Copyright and Trade Secret Infringement in Software and Content

For software, gaming, and content-driven applicants, copyright infringement and trade secret misappropriation are material risks. The sponsor must verify that the applicant’s software code, graphics, music, and other content are either original or properly licensed.

The SFC’s 2023 Thematic Inspection Report on Sponsor Due Diligence for Technology Companies highlighted that sponsors often fail to verify the provenance of open-source code used in the applicant’s products. The report cited a case where an applicant’s core software contained GNU General Public License (GPL) code, but the applicant had not complied with the license’s requirement to release its own code under the same license. The sponsor had not identified this issue, and the SFC required the applicant to restructure its software architecture before listing.

Trade secret risk is particularly acute for applicants that have hired key personnel from competitors. The sponsor should review employment agreements and non-disclosure agreements of senior technical staff to ensure they are not using confidential information from previous employers. A 2024 PRC court decision in the Shenzhen Huada v. Former Employees case awarded damages of RMB 150 million for trade secret misappropriation, demonstrating the financial magnitude of this risk.

Practical Due Diligence Framework for Sponsors

Phase 1: Scoping and Engagement of Expert Advisors

The sponsor should engage a qualified IP law firm at the outset of the due diligence process. The engagement letter should specify the scope of work, including:

• Patent FTO analysis for the applicant’s core products (defined as products contributing more than 10% of revenue).
• Trademark clearance searches in all material jurisdictions (PRC, Hong Kong, US, EU, and any other jurisdiction with more than 5% of revenue).
• Copyright ownership verification for all material software and content.
• Trade secret risk assessment for key technical personnel.

The sponsor should ensure the IP law firm is independent of the applicant and has no conflicts of interest. The SFC’s Code of Conduct paragraph 17.7 requires the sponsor to “take reasonable steps to ensure that any expert engaged by the sponsor is independent and has the requisite expertise.”

Phase 2: Document Review and Verification

The sponsor must review and verify the following documents:

• Patent and trademark registration certificates, with confirmation of current status from the relevant patent office (e.g., CNIPA, USPTO, EPO).
• Assignment agreements for all patents and trademarks, confirming that the applicant is the legal owner.
• License agreements for any IP used but not owned by the applicant, including royalty rates and termination provisions.
• Employment agreements for all inventors and creators, confirming that IP created during employment is assigned to the applicant.
• Non-disclosure agreements and non-compete clauses for senior technical staff.
• Litigation and opposition records for all material IP rights.

The sponsor should also conduct interviews with the applicant’s IP management team and external counsel to identify any unregistered IP or pending applications that may not appear in standard searches.

Phase 3: Risk Assessment and Disclosure

The sponsor must assess the materiality of any identified IP infringement risks. The assessment should consider:

• The probability of an adverse outcome (low, medium, high).
• The potential financial impact, including damages, legal costs, and loss of revenue from an injunction.
• The impact on the applicant’s business model and growth prospects.

Where the risk is material, the sponsor must ensure the prospectus contains clear and prominent disclosure. The disclosure should include:

• A description of the infringement claim or risk.
• The amount of damages claimed or estimated.
• The applicant’s defence strategy.
• The potential impact on the applicant’s financial condition and operations.

The SFC’s 2024 enforcement action against a sponsor for inadequate disclosure of a patent dispute in a pharmaceutical applicant’s prospectus resulted in a HKD 15 million fine. The SFC found that the sponsor had disclosed the existence of the dispute but had not quantified the potential damages or explained the applicant’s contingency plans.

Recent Enforcement Trends and Market Practice

SFC’s Heightened Scrutiny of IP Due Diligence

The SFC’s Enforcement Division has increased its focus on IP due diligence deficiencies. In the 2024-25 enforcement cycle, the SFC has brought three actions against sponsors for IP-related failures, compared to one in the previous cycle. The SFC’s Director of Enforcement stated in a November 2024 speech that “sponsors must treat IP due diligence with the same rigour as financial due diligence. A failure to identify material IP risks is a failure of the sponsor’s core duty.”

The SFC has also issued a guidance note (GN 2024-07) on IP due diligence for sponsors, which provides detailed expectations for FTO analysis, trademark searches, and copyright verification. The guidance emphasises that sponsors should not rely solely on management representations or standard online searches, but should engage qualified experts and conduct independent verification.

HKEX’s Enhanced Vetting of IP Disclosures

The HKEX Listing Division has implemented a new IP disclosure checklist for Main Board applicants, effective 1 January 2025. The checklist requires applicants to disclose:

• A summary of the applicant’s IP portfolio, including the number of patents, trademarks, and copyrights, and their jurisdictions.
• Any pending or threatened IP litigation, with details of the parties, claims, and estimated damages.
• The applicant’s IP management policies and procedures.
• The results of any FTO analysis or trademark clearance searches.

The Listing Division has the authority to request the sponsor to provide the underlying due diligence reports and expert opinions for review. In 2024, the Division requested such documents in 12 cases, and in 3 cases, it required the sponsor to supplement its due diligence before proceeding with the listing hearing.

Actionable Takeaways for Sponsors

1. Engage a qualified IP law firm at the start of the due diligence process, with a written scope of work that covers patent FTO analysis, trademark clearance searches, copyright ownership verification, and trade secret risk assessment for all material jurisdictions.

2. Do not rely on management representations or standard online searches; independently verify the chain of title for all material patents and trademarks by reviewing original assignment agreements and confirming recordal with the relevant patent office.

3. Update the FTO analysis whenever the applicant modifies its core products or manufacturing processes during the listing process, and document the basis for any conclusion that the change is not material.

4. Quantify the potential financial impact of any identified IP infringement risk in the prospectus disclosure, using expert evidence on the probability of an adverse outcome and the range of potential damages.

5. Maintain a complete and indexed due diligence file for all IP-related work, including engagement letters, expert opinions, verification notes, and correspondence with the applicant, to demonstrate compliance with the SFC’s Code of Conduct and HKEX Listing Rules in the event of an SFC inspection or enforcement action.