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License Agreements

A brief review of the types of negotiated license agreements, applicable law, and the parts of agreements

by Steve Ritchey

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A License Agreement is a Unique Business Arrangement Memorializes Evolving Business Relationship Defines Immediate Rights & Obligations

Business peoples’ primary concerns Conveys Parties’ Intentions as to Future Events

Technology becomes obsolete Merger or acquisition Changes in law or market power Lawyers’ primary concerns dealing with remedies

associated with possible future events People that negotiated the agreement will probably

not be around when a problem arises

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General Rules

Try to avoid ambiguities Resolved against the drafter

Use terminology consistently Strive for completeness and clarity

Overemphasizing brevity and simplicity often leads to ambiguity and disputes

Negotiated ambiguity is to be tolerated Use boilerplate with care

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Transfer of Patent Rights

Patent is a Right to Exclude Make, Use, Sell, Offer for Sale,

Import May license each separately

Transfer of Right to Exclude is an Assignment

Waiver of Right to Exclude is a License

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Assignment or LicenseSubstance over Form

Contract terms, not title, controls Exclusive license may be an assignment

“All substantial rights transferred” such as to a specific geographic part of the U.S. or the entire U.S., or an undivided share of the patent.

Assignment may be found despite conditions subsequent Payment of royalties Best efforts Other conditions outside control of assignor

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Assignment or LicenseWhy is it important? Tax Liability

License – ordinary income Assignment – capital gains and depreciation Transfer of all substantial rights is assignment for tax

purposes Standing to Sue for Infringement

Patent owner or exclusive licensee alone or joining licensor “all substantial rights” standard is different for tax and

standing to sue for infringement Very fact specific; granting unqualified right to sue tends

to be dispositive; but qualified right to sue not effective (e.g., licensee has first right to sue but if declined licensor has right)

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Agreements to Assign Applies to any arrangement in which

Inventions are expected Consulting Contracts, development agreements Employment contracts; don’t rely on implied right

to own Agreement to assign vs. present assignment

Equitable title vs. Legal title Equitable remedies vs. Damages

Assignment of Right, Title, and Interest does not convey right to sue for past infringement; must be separately granted

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Joint Ownership General rule in US - an owner may license

without permission from or accounting to other owner(s) Contract provisions will control May grant immunity from suit by other owner Need not share license royalties

May not grant exclusive license but may grant exclusive right to that owner’s interest

All Owners Needed for Suit Owners may not be compelled unless in a

contract

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Primary Types of Negotiated Licenses

Express Licenses Exclusive Licenses Nonexclusive Licenses

Covenant not to sue Field of Use Licenses Cross Licenses Grantback Licenses Sublicenses

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Express Licenses

Written or oral Written contract Exchange of correspondence Oral if terms provable

Partial performance Acceptance of payment

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Exclusive Licenses May be an Assignment - rare Agreement not to grant further licenses

May be preexisting nonexclusive licenses Agreement not to practice under patent

Reservation of right May be limited in time, territory, and field Exclusive Licensee may sue for infringement

Can compel joinder of Licensor Though implied, it is advisable to specify terms

such as control of litigation, sharing of costs and recovery

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Exclusive Licenses (cont.)

Implied Obligation to Exploit “Best Efforts” or “Due Diligence”

provisions can be vague Advisable to expressly agree on what

constituted best efforts or due diligence Alternatively, set minimum annual

royalties with termination or conversion to nonexclusive license

Disclaimer of obligation possible but may bring the “consideration” in question

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Possible concerns associated with Exclusive Licenses If total value of agreement is over $50M it may be

an Asset Transfer requiring Hart-Scott-Rodino Filing

Possible Antitrust Consequences - fact specific; inconsistent enforcement Exclusive rights are “assets” and their acquisition in

certain circumstances can violate Section 7 of Clayton Act (a holding company used to promote monopoly)

Failure to grant sublicensing rights may imply or expressly require illicit interaction between licensee and licensor in granting or withholding further licenses

Exclusive licenses for particular fields can be evidence of illegal allocation and segregation of those fields

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Nonexclusive Licenses

Simply a promise not to sue for patent infringement

Licensee gets no protection from unlicensed competition Absent contract provision for abating third

party infringement Licensor may grant other licenses

Nonexclusive licensee may seek most favored licensee protection (often difficult to arrive at terms, contentious)

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Covenant Not to Sue A personal promise – not a transferable license May not run with patent only particular identified

product (patent may cover multiple products) Likely considered to cover covenantee and its

customers if covenantor knew covenantee will continue making and selling patented products

Advisable that agreement granting covenant not to sue expressly address scope Patentee reserves right to sue covenantee’s

customers Patent-based scope vs. product-based scope

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Field of Use License Where a patented invention has different uses,

such uses may be separately licensed Can maximize the use of the technology and

thereby revenue Practice outside of licensed field is an infringement Divisions can be by, e.g., market, size, uses,

applications The key is the definition of the field May be exclusive or nonexclusive May have antitrust consequences (intentional

restraint of normal competition)

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Cross License Parties exchange technologies

Blocking patent(s) Can be patents on different technologies

“Consideration” may be more than the license (e.g., money, litigation settlement)

May have antitrust consequences Parties agree to consult before granting further licenses Patent pools combining most of the relevant

technologies; normally not a problem so long as each member can license someone outside the pool; in the past Justice Dept tended not to view patent pools favorably but that has changed significantly over the past couple of decades

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Grantback Licenses

A license directed to “improvements,” which are typically defined as inventions made by the licensee that cannot be practiced without infringing the licensed patent(s)

“Consideration” in the license agreement includes the grantback

Can be exclusive, nonexclusive, limited to field, etc.

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Sublicenses Structure: Patent Owner → Licensee →

Sublicensee Purpose: to allow for broad dissemination of

technology Different from “have made” right, which is implied

unless expressly restricted; right to sell typically includes “have sold” unless expressly addressed

Unless specified in license agreement, a licensee is generally not responsible for actions of the sublicensee

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Sublicenses (cont.) Authority to grant sublicenses

The right to grant sublicenses must be expressly set for in license agreement

Scope of licensee’s authority to grant sublicenses is determined by the terms of the license agreement Sublicense cannot be less restrictive than license (e.g.,

can’t have a lower royalty rate or to a larger territory) Advisable to specify terms for sublicenses in license

agreement (e.g., can sublicensees grant sublicenses, up-front payments, minimum payments, etc.)

Advisable to require that licensee notify licensor of sublicensees to avoid accidental suits

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Sublicenses (cont.) An authorized sublicense is, in effect, an agreement

between the licensor and the sublicensee Unless specified otherwise, a sublicense usually continues

despite early termination of the license agreement; sublicensee will then render payments and other obligations to the licensor

Caution: sublicensing involves agency law Possibility for revocation of authority to grant

sublicenses; possible protection from revocability if licensee obtains a property interest in the patent

Licensor may be estopped from denying sublicensee’s right — detrimental reliance of sublicensee; possibly require licensor review and approval of sublicenses or require licensee to allow sublicensee to review license

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Parts of a License Agreement Preamble – identifies the parties and usually the

effective date Recitals – described background relationship of the

parties Definitions – probably the most difficult and time

consuming portion of an agreement to negotiate and draft; Avoids ambiguity from inaccurate repetition; where parties

use different words it is presumed different meanings were intended

Aids in achieving conciseness and clarity Specify omissions and inclusions Special meanings to terms

Caution – avoid circularity in definitions

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Definitions (cont.) Licensed Patents

Identify specific existing patents and applications Consider whether continuations, continuations-in-

part, divisionals, corresponding foreign patents, utility models, design patents, inventor’s certificates, reissues, patents of additions, extensions, etc. are to be included

Inventions made for a specified period of time Licensed Products

May serve to limit scope of license if defined as less than scope of patents; field of use may also serve this purpose

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Grant Clause – licensor grants to licensee

Agrees to grant for future (e.g., an option agreement

Subsidiaries, affiliates, controlled companies - usually addressed in definitions Consider change of control clauses (e.g.,

licensed subsidiary could retain license after it is sold).

Consider whether performance obligations must be met by each individual subsidiary

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Grant Clause (cont.) Can include combinations of exclusive,

nonexclusive, field of use, grantbacks, cross licenses, etc.

Expressly include right to grant sublicenses Under what

Licensed patents Know-how, technical information

To do what Make, use, sell, offer for sale, import, export,

otherwise dispose of, etc. Should expressly exclude implied rights to “have

made” or “have sold”, if intended

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Grant Clause (cont.) Geographic scope – U.S., its territories, and

possessions, other specified countries, worldwide; can be defined as “Licensed Territory”

Term of the Grant – unless agreed otherwise the term of the grant is usually presumed to be for the life of the patents.

Reservations – explicit provisions inconsistent with license grant such as licensor reserving right to practice patent when granting an exclusive license or prior licenses

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Money – usually the most significant part of the “consideration”

Sum certain payments — paid-up license, pay over time, or a combination

Milestone payments — can be milestones for both parties (e.g., licensee reaching a development stage or licensor having a patent issue)

Royalties — payments based in some manner on sales or use of Licensed Products or licensed methods; may be based on patents, know-how, or a combination

Reimbursement of patent prosecution costs

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Royalties Arrive at a Royalty Base then a Royalty Rate

Ideally royalty base should (a) relate directly to the licensee’s use of the licensed rights and (b) be amenable to reliable accounting and auditing

Thus, it will vary with the licensed technology. Consider patent claim scope

Products to be sold Processes to be used Base can be broader than claim if voluntary or

negotiated (e.g., patented product is seatbelt but royalty is based on cost of auto)– can possibly implicate antitrust concerns

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Royalties (cont.) Examples for a royalty base when licensed

process or product is not sold Volume of raw material used (often appropriate for

process license) or production volume (often used where product is intermediate or subcomponent) Not inflation sensitive, without escalation provision

Example of royalty base when licensed process or product is sold Net or gross sales price often used

Records routinely kept Directly related to use of technology Automatically adjusts for inflation and competition

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Royalties (cont.) “Reach-through” license – tie royalties to sales of identified

products not manufactured directly through use of patented product or method Typically used for biotech technologies where use is difficult to

police (e.g., research tools) Can be beneficial to both parties

Allows licensees to use technology and defer payments until use yields commercial results

Allows licensors to have potential for enhanced royalty income based on larger payoff from sales of downstream products rather than certain, but smaller, upfront fees

Can result in royalty payments being made after patent expiration; not patent misuse if structured properly For example, royalty paid on the sales of products discovered with

research tool for life of patent on discovered product or if not patented for x years from first sale

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Royalties (cont.)

Other factors that may impact royalty base and royalty rates Different levels of value added may affect

royalty base and royalty rate Sales to Related Companies / non-arms

length transactions Other dispositions – leases, given away,

use by licensee Patent applications vs. issued patents,

trade secrets

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Royalties as Incentives Minimum annual royalties – to maintain

license or exclusivity Advance minimum royalty payments Possibly increasing over time to encourage

effort Variable Royalties

Typically rate is inverse to production volume Vary royalty rate with profit margin; if

competition decreases prices, royalty rate is automatically decreased but if efficiency increases both parties earn more

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Royalty Reporting & Accounting Licensee is usually expressly required to

keep sufficient records to determine the royalties due licensor

Licensor usually has right to audit records of licensee, normally at licensor’s expense unless discrepancy exceeds a threshold

The content of reports is negotiable but should be specified along with reporting period(s) and timing of payments

Post-termination report is typical

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Indemnification from torts

Primarily for limiting the liability of licensor for damages arising from sale or use of licensed products and processes

Typically includes duty to defend and indemnify

Licensee may be required to maintain liability insurance listing licensor as additional named insured

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Representations & Warranties Usual for Licensors

Power to grant license No inconsistent actions have been nor will be

taken Title to patent Licensor will not practice under the patent, if

exclusive license with no reservation Disclaim (a) validity or scope of patent, (b)

noninfringement of third party patents, (c) merchantability, (d) license under other patents, and (e) use of licensor’s name.

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Succession or Assignment of Rights and Obligations Determine whether one or both of the parties

can assign their rights and obligations under the agreement to third parties and to what extent

Advisable to require assignee to expressly agree to be bound to the terms of the agreement

Ability to assign allows for flexibility in spinning off, mergers, sale of relevant business assets, etc.

Assignment to competitors can be a concern

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Bankruptcy Treatment of license agreements provided for in

bankruptcy code A license agreement is an asset of a licensee A clause terminating a license upon filing for bankruptcy

is not illegal but may not be enforceable; could be helpful if bankruptcy petition is rejected

Most licenses are considered “executory contracts” and may be rejected or assigned by bankruptcy trustee

Consider requiring notice of acts that may signal impending bankruptcy (e.g., pledging of assets or making late payments) or obtaining a security interest in license

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Abating Infringement by Third Party Nonexclusive licensee may be harmed by a

tolerated infringer – absent contract provisions, no right to bring suit

Exclusive licensee may bring suit and join licensor

Licensor agrees to abate infringement Establish criteria – how much infringement, how

much proof of infringement, notice Other conditions – possibly limit to one suit at a time

Possible remedies for Licensor’s failure to abate Termination, suspension or reduction of royalties,

licensee having right to sue in name of licensor

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Term and Termination Absent specified term it is typically

presumed to be for life of patents Termination on “Material Breach”

Usually notice and cure provisions Acts considered to be material may be defined

Termination without cause – usually only appropriate for nonexclusive licensees

Termination for failing to pay minimum annual amounts

Termination because of financial problems

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Term and Termination (cont.)

Specify effects of termination Accrued royalties, reporting, auditing Disposition of existing products Confidentiality Sublicenses Right to use know-how/trade secrets

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Dispute Resolution Alternative Dispute Resolution – arbitration,

mediation Choice of law, specify rules, panel size and

qualifications, location, language, time limits, etc.

Court proceedings even if ADR is applicable to compel arbitration or appealing an award Jurisdiction, venue, choice of law

International choices of law – US courts likely to enforce

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Challenges to Validity of Licensed Patents by Licensee Public policy reasons for allowing challenges –

strong public interest in free competition and in ideas in the public domain; licensee may have the greatest economic incentive to change validity Cannot enforce a promise not to challenge But may be able to terminate in the event of a challenge

MedImmune – US Supreme Court (2007) case held that licensee can file Declaratory Judgment action alleging invalidity without repudiating license (continuing to meet its obligations such as paying royalties)

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Other Provisions Patent marking – required for licensor to recover damages;

recent case law may result in a trend of increased false marking lawsuits based on expired patents

Force majeure – excuses performance prevented by cause outside of control of party

Severability – any provision held to be illegal is severed from the agreement so long as it does not go to the heart of the agreement

Amendment – usually required to be in writing and agreed to by both parties

Waiver – waiving a breach does not waive subsequent breaches Integration – this is the entire agreement and supersedes all

other prior agreements or understandings Government approvals – for example, U.S. export control, USDA,

etc.

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Conclusion The law around licensing is fact specific,

complex, and sometimes contradictory. This presentation focused on the general rules; exceptions apply to nearly all of the general rules.

Therefore, consult an attorney to obtain legal advice for your particular situation.

Disclaimer: This presentation is intended for information only and should not be considered legal advice.