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Creating a Win- Win Situation: IP Licensing Negotiation Strategies Transcript of Video Leadership Seminar By, Gary W. Smith Posternak, Blankstein & Lund LLP Executive Seminars

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Creating a Win-Win Situation: IP Licensing Negotiation Strategies

Transcript of Video Leadership Seminar By,

Gary W. Smith Posternak, Blankstein & Lund LLP

Executive Seminars

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Creating a Win-Win Situation: IP Licensing Negotiation Strategies

Introduction The primary focus of my Intellectual Property (IP) practice involves licensing in all areas of IP, including patents, copyrights, trademarks, trade secrets, and branding for food products and biotechnology products. I always try to achieve a win-win situation for both the licensor and the licensee, because once the agreement is finalized the parties will have to live with each other for many years to come; therefore, you need to arrange a licensing deal that works well for both sides. Creating a Win-Win Situation The initial approach that I will take in an IP licensing deal will often vary, depending upon the type of IP being licensed and the side of the deal that I am on. For example, when working on a trademark license deal, it is important to keep in mind that the goodwill or the image that the trademark conveys is very important to both sides of the deal. When negotiating a patent license for a certain form of technology or a potential product or process, there is, more often than not, a good deal of development that still needs to go into the technology before it goes to market; therefore, it important to learn what each side needs and expects out of the deal, and what their long-term business objectives are. Next, I need to talk to both parties about how we are going to translate those objectives into a workable relationship and license document; some of the broad brush areas that need to be scoped out in that process include the extent of the license with respect to term, field of use, and territory. Finally, I must negotiate on behalf of the client in order to obtain a license that gives them as much flexibility, rights, and opportunities as possible.

Video Leadership Seminar by Gary W. Smith Most importantly, I believe that you should never view license arrangement negotiations as an adversarial process; rather, I think that license negotiations should always be viewed as the beginning of a long-term business relationship. All too often, attorneys do not focus on the business objectives of the licensing deal, or on the fact that there is going to be a business relationship between the parties going forward; and this is a mistake, because once the deal is finalized the parties have a mutual interest in the ongoing success of the licensing arrangement. In my opinion, success in the license structuring process is based on coming to a workable agreement that gives each party a chance to succeed within the licensing relationship. Step by Step Analyzing the IP When beginning work on an IP licensing project, the first thing that I need to know is what the IP consists of, whether it is a patent for some form of technology; a trademark for a specific product; or a copyright, which could include a design, character, or content on a website. It is important to understand what form of IP is being licensed; the background of that IP; and the potential uses for that IP. Next, I need to know how developed the IP is—is it a well-known brand name that is being extended to another product, or some breakthrough technology that does not have a market as of yet? You need to put the IP and its development stage into the context of the potential business relationship between the licensing parties, and the product’s potential success in the marketplace. For example, it is especially important to ensure that I understand the client’s and the other party’s business objectives and corporate issues. It is also helpful to research the size of their companies and the extent of their capital, so that I can

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

understand how the relationship between the two parties is likely to develop. Market Applications, Scope of the Deal, and Business Models Next, I need to understand the market for the application that the client wants to make of their IP; and I would need to consider that market from either the licensor’s or licensee’s viewpoint, depending on which side of the deal I am on. Some other factors that would come into play at this point would be the experience of the parties in the marketplace; the competition the client would be facing; and the growth potential of the licensed product/technology. Another important business factor that I would need to understand is the scope of the deal, including the scope of the rights that the licensor is expecting to give and the licensee is expecting to receive with respect to field of use, territory, and product applications. I need to understand all of those factors in order to successfully assist the client and get them the best possible result. However, the most important overall factor that an IP attorney needs to understand when working on a licensing deal is what business model the licensor and the licensee expect to work with. It is important to ensure that both sides are on the same page with respect to their expectations regarding what is going to happen after the license is finalized and the business applications take place. There are many legal issues that must be considered in this process that are likely to bore your client, such as representations, warranties, indemnification clauses, and assignment rights; however, while the client may be reluctant to focus on these issues at the time that the deal is being worked on, those issues are likely to become very important three to five years

Video Leadership Seminar by Gary W. Smith down the road. Therefore, it is essential for them to be addressed at the outset by a skilled IP attorney. Negotiation & Settlements The Role of the Attorney My role on behalf of the client in IP licensing negotiations is threefold: 1) to act as an advocate; 2) to be a facilitator; and 3) to be an advisor. My personal negotiation strategy in terms of structuring an IP license deal is to focus on understanding my client’s needs and objectives; and then I try to understand the needs and objectives of the other party. I believe that it is important to structure the deal in such a way that my client’s objectives can be met; however, I also try to ensure that the deal is acceptable, within limits, to the other party. Simply put, I do not view the negotiation process as an adversarial, contentious scenario; rather, I strive to come to a reasonable position that satisfies both parties’ needs. Negotiating License Rights The most often negotiated items in an IP licensing deal typically include the scope of the license rights; the monetary terms with respect to how the payment is structured; ownership and improvements issues; indemnification, including representations and warranties; and who has enforcement rights. While the scope of the license rights is an important issue in many respects, what I am trying to achieve typically depends upon whether I am representing the licensor or the licensee. For example, it is generally in the interest of the licensee is to get as big a bundle of rights as possible—a technology or patent licensee would like to have full use of the rights in all potential areas or applications, as well as broad territorial rights; and as much exclusivity as possible. However, the licensor may not be

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

willing to grant such expansive rights; they may want to retain certain fields of use, applications, and product extensions, either for itself or to license again to some other party for an additional revenue stream; and they may want to grant only limited territorial rights. Negotiating Deal Terms Another important issue is the term of the rights that are being licensed—the licensee generally wants a long term, and the licensor often prefers a shorter term. Therefore, when negotiating the monetary terms your strategy is going to depend on which side of the deal your client is on. Of course the licensor wants to maximize the amount of revenue that the license produces, and the licensee is going to want to minimize that amount; however, the process is generally not as simple as merely negotiating a specific royalty rate. There are a number of other issues that need to be considered, such as whether there is going to be an upfront payment when the licensee gets signed; and whether there will be minimum royalties or a minimum sales volume that sets a floor for the deal. Certain incentives may also be structured into the deal. For example, the licensor may want to incentivize the licensee to maximize its market potential and sell more products by reducing the royalty rate at a higher volume of sales. Concessions may also be built into the deal—i.e., the licensee may be given a ramp-up time to either plot the development of the technology to fund the marketing process, or just to create a demand for the product. Dealing with Conflicting Interests: The Importance of Flexibility In many cases, the interests of the licensee and licensor will differ. For example, in a patent licensing deal in which a

Video Leadership Seminar by Gary W. Smith certain broad biotech application is being licensed, the licensor may go on to refine the application in question by developing a new process that modifies the protein that forms the basis for the drug. The licensee, having created a market for the product, would typically like to have the rights to that improvement; however, the licensor may not want to be stuck with the same licensee on what it sees as a breakthrough product. Therefore, there is always an inherent tension in the negotiating process with respect to who gets what rights from any improvements that are made in the course of product development; and this conflict of interests applies not only in the context of a patent deal. For example, in the trademark area this conflict could relate to a brand extension into a different market or product line; and on the copyright side, conflicts could arise with respect to a new version of a software product, or a replacement product to existing licensed software. Indeed, license deals most often break down over legal issues such as consignment, change of control, and scope of use issues. Therefore, it never makes sense for the client to sign an agreement that they are not completely happy with, because if they do not think that the agreement is workable at the beginning of the licensing relationship, it is not going to get any better going forward. It never makes sense to sign a license agreement when the parties are in a contentious relationship; if the parties are butting heads just trying to get the agreement signed, then chances are that business relationship is not going to work very well at any point in the future. Therefore, my favorite piece of advice to clients who are going into IP licensing negotiations is to always be flexible and creative in structuring the license agreement. It is extremely important to try to think of an alternative strategy

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

that will meet the objectives of both parties, so that they can be equally accepting of the resulting license terms. To that end, there are three key qualities that every IP lawyer must possess in order to negotiate successful licensing deals for their clients: 1) A willingness to ask questions and to understand their client’s objectives; 2) A willingness to understand the client’s business objectives; and 3) A willingness to understand what the other party’s business objectives and needs consist of. Laws behind the Situation Federal and State IP Laws Most intellectual property is a creation of federal law; and the most important federal statutes related to IP are the Federal Patent Statute; the Lanham Act, which is the trademark statute; and the Copyright Act. Patents trace their roots back to early English law; and there are patent laws in our Constitution. The Patent Act is a federal statute that elaborates on the power that the federal government has to grant patents under the Constitution. Trademarks, on the other hand, have a common law origin. You can have trademark rights independent of any statutory creation; therefore, trademark law often ends up being a mix of both state and federal law. However, the federal Lanham Act statute gives trademark holders the most rights. Copyrights, like patents, trace their roots to the Constitution; and the Copyright Act is a federal statute that preempts any state statute or state rights in this area. Therefore, copyrights differ from trademarks in that they are a creation of federal, statutory and constitutional law, and not common law.

Video Leadership Seminar by Gary W. Smith One of the most important ways that I help my clients is by helping them to understand the many statutes related to IP law, including the provisions of those statutes and the scope of the rights that go with each individual form of IP. I also help to keep my clients abreast of recent court decisions that have led to new developments in IP case law. I help them to understand the many different interpretations of the statutory provisions; and I help them to keep track of any amendments and changes to the statutes of IP law, including any proposed changes that are currently before Congress. Indeed, IP has become so important in today’s economy, and there is so much tension between competing groups with competing rights, that there are constant revisions being made to the existing statutes in this area, as well as proposed revisions which, even if they are not enacted today, could affect the client’s rights during the term of their licensing agreement. Recent Trends in IP Law: Meeting the Challenge of International IP There has been a trend in recent years towards harmonization in IP laws, both within the United States and in the international trade arena. For example, TRIPPS, the treaty that is associated with the World Trade Organization (WTO), requires countries that join the WTO to harmonize their IP laws within certain parameters. Therefore, the IP laws and statutory rights that are now being granted and developed in many different countries are increasingly the same in many respects. However, what often differs markedly is the level of enforcement. It is one thing to enact a statute in your country in order to gain admission to the WTO, but that does not always translate into enforcement. The advantage of increased harmonization in the IP area is that it makes it easier to have a license that works not only in the U.S. or the European Union (EU) but also—at least with

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

respect to statutory rights—in developing countries and markets such as China and Latin America. Therefore, the main challenge that IP attorneys must deal with over the next five years pertains not so much to any changes in the realm of international law, but to the manner in which countries in emerging markets such as China, India, or Russia go about enforcing the laws that they have recently passed. Indeed, there must be increasing levels of enforcement in order for those countries to encourage internal investment, as well as investment by foreign companies and businesses. In essence, the most important thing to keep in mind when looking at international licensing opportunities is to try and structure your agreements in a way that maximizes your potential for enforcement. For example, if the license is being granted in another country, or if your client’s products are being made in another country, then you may want to have a choice of law provision, or a forms selection clause that stipulates that any disputes be arbitrated or any litigation be held in the U.S. or in an EU country where the enforcement rights are strong. Case Study A Trademark License Case One of the most interesting licensing agreements that I have ever worked on was a trademark licensing agreement that involved a brand name associated with a famous entertainment personality. The brand name was so closely tied to the image of that entertainment personality that it was especially important for the licensor to be comfortable with the licensee in this situation; in fact, it was essential for the licensor to view the license as a form of stewardship of the entertainer’s brand name.

Video Leadership Seminar by Gary W. Smith My client, the licensee, was involved in a food processing business, and their current market was primarily institutional and wholesale sales. However, my client was looking for an opportunity to extend their market reach into a branded consumer product, and the license of this brand name gave them an opportunity to enter the consumer market with a significant head start—i.e., they would be coming into the market with an already well-known, well-liked brand. The client’s motivation to get into the consumer-branded end of the market was to increase their margins in the prepared food market to a much higher level than they could achieve with their institutional sales base; and this proposed agreement provided them with a major business opportunity to extend a successful licensing program that had been initiated some years before. Significant Issues The primary challenge in this deal was to make sure that the licensor was comfortable that their brand was going to be well taken care of; that the quality of the product would remain high and be well-presented; that there would be minimal risk associated with the deal; and that the ultimate licensed product and the licensee’s marketing efforts would increase and enhance the goodwill associated with the brand, not impair it. The biggest issue in this deal pertained to the scope of the license, in terms of what products would be licensed and what territory would be granted. The next important issue was product quality and control—which side had what degree of control. Both parties wanted the quality of the products to be high; but naturally the licensee wanted to have flexibility in what it did with the license, and the licensor wanted to have assurances that they would be happy with the result. Finally, we needed to ensure that the licensee

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

would have sufficient marketing and distribution muscle to make sure that the resulting sales would satisfy both parties. Negotiating the License and Structuring the Agreement In order to address these issues successfully, we granted the licensee the right to license a limited number of products in a limited territory; however, if those products were successful in that license territory, the licensee had the option, subject to review by the licensor, to increase the number of products that carried the license brand, and to extend the distribution use of the mark in other countries. In order to allay the licensor’s concerns about product quality, a quality assurance program was negotiated and included as a schedule to the agreement, as well as a review process in which the product formulations would be reviewed and subject to reasonable approval on the part of the licensor. We were also able to get the entertainment personality to agree to taste the product and approve its quality; therefore, the negotiating process involved both legal issues and practical assurances. On the legal side, we structured the arrangement so that there were some minimum sales volumes and royalties, as well as other milestones that had to be met during the course of the agreement; and these milestones were put in place over a period of years. Fortunately, we were able to negotiate those sales points in a way that was satisfactory to both sides, in that both parties felt comfortable that they were in fact achievable.

Video Leadership Seminar by Gary W. Smith The Financials Explaining License Provisions The legal fees with respect to a license deal can vary wildly, depending on how complicated the license is and whether it is part of a larger transaction. Generally speaking, however, it can cost anywhere from $10,000 - $100,000 to negotiate and document a license. There are many important provisions and terms that must be considered in a typical IP licensing agreement. For example, the license should contain a reasonable definition of the scope of what is being licensed—i.e., the technology or the trademark. There should also be a clear description of what rights are being granted with respect to that IP—the territory; the field of use; the duration; whether or not there is a right to sub-license; and options to expand that grant. Another important issue is the payment schedule and how the payment is structured. In addition to stipulating a percentage rate for royalties, the agreement may also specify a ramp-up period; milestones; and a step-up or step-down in the royalty rate, depending on other factors. Therefore, the payment structure of a licensing agreement can become quite complicated, depending upon how the deal is structured and what incentives each side wants the other side to have. An IP licensing agreement will also include terms related to the ownership of improvements to the IP; the rights that are involved with those improvements; and the rights to any derivative works—for example, if a licensee is licensing the patent rights to a certain process they may think of a way to improve upon the process that is being licensed; and in that case, the licensor may want to have some rights in those improvements as well.

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

Other significant issues are forum selection—i.e., how and where license rights are going to be enforced; and the termination provision—i.e., on what basis the license can be terminated. From the licensee’s perspective, they are investing a lot of time and money in developing and marketing this IP asset and they do not want to be at risk of losing their rights. From the licensor’s perspective, if the licensee is not performing, the licensor would like to have the opportunity to take back their IP rights and license them out to someone else that will perform. Dealing with Risk: Explaining Exposure Both sides to a licensing agreement are typically looking for a financial upside—they both have an interest in increasing their sales as substantially and rapidly as possible. At the same time, both parties are typically looking to control their potential exposure to lawsuits and product recalls by making sure that the licensed product is of high quality and meets required standards. In addition, neither side wants to be in a position where there is adverse publicity associated with the brand, because that would also provide financial risk to both parties. Therefore, during IP licensing negotiations it is important to minimize any quality control issues by ensuring that there is substantial insurance coverage for both parties; and if you are representing the licensee, it is important to minimize how much risk your client assumes from the licensor in terms of indemnifications, representations, and warranties. Indeed, the allocation of liability and risk are extremely important issues in an IP licensing agreement, particularly if the product that is being licensed is very important to one of the parties because of its connection to their overall business. In such a case, it is especially important to include terms related to the quality control of the end product and

Video Leadership Seminar by Gary W. Smith the enforcement of the client’s IP rights against third parties. For example, I recently represented the licensor in a copyright license negotiation, and neither party to the deal asked for or negotiated any provisions with respect to duty on the party of the licensor to in effect police the marketplace. After the deal was signed, the licensee wanted the licensor to sue a third party that they considered to be an infringer; however, the licensor viewed the situation differently and did not think that there was any infringement involved or any basis for bringing a suit against the other party—and under the terms of the license agreement, they did not have a duty to enforce infringement. Indeed, although representations and warranties are often viewed as legalese by business people, if an issue in this area should arise at some point during the term of the licensing relationship, those provisions can become very important, because they govern risk exposure and allocation—areas which are important to any business. However, it can be quite difficult to evaluate and explain exposure when you are negotiating a licensing agreement, especially if your client is the licensee, because both sides are generally quite optimistic at the outset of the negotiation process. Indeed, whenever I start talking about indemnification provisions, enforcement of rights against infringers, and warranties for non-infringement with respect to third parties’ rights, I have often found that the client’s eyes will tend to glaze over. Therefore, I always try to present the client with various scenarios—i.e., what will happen if you are sued by another company three years from now because they claim that your use of this licensed product is infringing on their patent? If the client does not have proper coverage against such claims in the form of indemnifications and warranties to the effect that the rights that they have licensed do not infringe against other parties’ patents, then they could be risking the future of their entire business.

Creating a Win-Win Situation: IP Licensing Negotiation Strategies

Simply put, the best way to explain risk is not to focus on the language and the legal provisions that are involved in warranties and indemnifications; rather, I try to help the client think through various scenarios that could arise two to three years after the license has been signed—after they have invested a lot of time and money to develop and market the licensed product. Successful Licensing A successful licensing agreement is one that includes terms that make your client, especially if they are the licensee, feel motivated to succeed; you always want to negotiate a license agreement that provides your client with a good business opportunity and the potential to make good money. From the licensor’s perspective the definition of success is very similar—the licensor wants the licensee to succeed because if they do not, then the licensor will not get the maximum revenue potential out of their IP asset. That being said, when you start to allocate risk in the licensing agreement there is typically a divergence of interest between the two parties; and what I generally want to do whether I am representing the licensor or the licensee is to minimize the downside risk and maximize the upside potential. For example, if I am representing the licensor, I want some assurance that the intellectual property asset is going to be developed; that it is going to be successful in the marketplace; and that I am going to get a good revenue stream—and if I do not get those results, I want to be able to get out of the deal so I can license the asset to someone else. If I am representing the licensee, I want to be given enough time for my client to successfully develop the product and the marketplace; and I do not want my client to have too much of a burden placed on them too early in the license term, because that will impair their ability to succeed.

Video Leadership Seminar by Gary W. Smith Concluding Remarks The Advantages of Licensing: Two Perspectives From a licensor’s perspective, IP licensing is an opportunity to make money from an asset that has some intrinsic value that is not currently being realized, either because the development of that asset requires capital that the licensor does not have; or because it requires a business model or plan that the licensor is not interested in developing, does not have the capital to develop, or which does not fit in with their core business. Simply stated, licensing is an opportunity for the licensor to increase its revenues and maximize the value of an existing asset without taking on a lot of extra risk, or without having to divert a lot of time or capital from their business. From the licensee’s perspective, licensing is an opportunity to acquire the rights to an asset that the licensee sees as having business and revenue potential, without having to independently develop that asset, and without necessarily having to put a lot of capital into acquiring that asset before they have begun earning revenues. From the licensee’s perspective, acquiring an IP license is also an opportunity to get into the marketplace with a brand or a copyright for a product or technology asset that is at least partially developed, because someone else has invested the money and capital that was needed to get it to the point where it can be brought to market.

About the Seminar Leader Gary W. Smith

Gary is a partner at Posternak Blankstein & Lund LLP in Boston, MA, where he leads its Intellectual Property and Technology Practice Group. His practice includes protecting and licensing intellectual property, negotiating and drafting Internet related agreements, counseling clients on technology and e-commerce matters, franchising, and general corporate representation. He also handles complex litigation, including patent infringement, trademark and copyright actions. Representative Transactions:

• Represented a medical publisher licensing content to a medical information website.

• Represented a global food processor licensing a well-known brand name.

• Negotiated distribution and license agreements with national retailers on behalf of a client offering on-line learning courses.

• Developed an international franchise program for an on-line software distributor.

Gary writes and speaks frequently on topics related to intellectual property, technology and Internet law. Gary was named Massachusetts Super Lawyer in 2004 in Boston Magazine.

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