Technology Team Newsletter: Licensing: The Simplest Form of Collaboration Is Not So SimpleJune 9, 2010
Previously, I've written about what I called the "collaboration continuum" (see "Collaboration Bridges the Gap"), which can be used to organize the ways in which businesses collaborate with each other, ranging from "licensing" on the simple end of the continuum to the acquisition of a company on the complex end. Between these two extremes are various kinds of agreements that parties use to collaborate, each of which has its own characteristics.
This article will address the simplest form of collaboration: licensing.
Generally, licenses are contracts that allow a person or entity (the "licensee") to use the property of another (the "licensor"). Licenses often involve intellectual property, and, when they do, their characteristics include the following:
a limited right to use the intellectual property;
little access to the knowledge source (i.e., the licensor); and
the application of a "packaged solution," rather than a customized one.
In deciding whether to enter into a licensing arrangement, the parties should weigh the advantages of using licensing as a means of collaboration over the disadvantages and then use that analysis to compare licensing with the other ways the parties could collaborate. Obviously, a party's perspective affects that analysis. In particular, the advantages and disadvantages the licensee experiences will be different from those experienced by the licensor.
THE LICENSEE'S PERSPECTIVE
For licensees, the principal advantage of a license (typically referred to as a "license-in") is that it allows the licensee to use proven technology in its business in exchange for paying the license fee, rather than incurring the full cost of developing and maintaining the technology. If the licensee's business is relatively complex and involves a variety of different technologies, which would be difficult and costly for the licensee to develop on its own, then the licensee will probably need a number of "licenses-in."
The principal disadvantage of licenses-in is that they can cause the licensee to become technologically dependent on the licensor, which could lead to a variety of problems when the time comes to renew the license. The licensor could use its leverage to negotiate better terms. Or, if another party has offered the licensor more money in exchange for an exclusive license, then the licensor might refuse to license the technology to the licensee. Even if the license-in is a perpetual license, which does not need to be renewed, the licensee is still at risk. The licensor could license the same technology to one or more of the licensee's competitors, thereby giving them the same competitive advantage that the technology provides to the licensee. In addition, the licensor could fail to maintain or update the technology, thereby diminishing its value.
THE LICENSOR'S PERSPECTIVE
From the licensor's perspective, a license is referred to as a "license-out." The principal advantage of a license-out is that it allows the licensor to realize a return on its technology without incurring the expense involved in actually manufacturing, marketing, distributing, and selling a product. If a licensor has technology that is unrelated to its core business, then it can use a license-out to realize some value from the technology, without being distracted from its core business. Licenses-out can also be employed with technologies that have little value by themselves and must be combined with other proprietary technologies in order to create a complete product.
The disadvantages of licenses-out depend upon how they are being used. If the licensor is licensing the technology in exchange for receiving a royalty based on sales of the products that incorporate its technology, then the licensor is, to some extent, dependent upon the licensee to make the sales and to be honest in reporting the sales revenue. To protect itself, the licensor can establish certain sales goals that the licensee must meet in order to keep the license and can include special audit rights in the license agreement to ensure that the licensee is accurately reporting its sales revenue. The licensor is also dependent upon the licensee to make quality products with its technology. To the extent the public knows that the licensor's technology is in a product, the licensor will want to ensure that the licensee adheres to certain quality standards so that the licensor's reputation is not damaged.
TYPICAL TERMS FOUND IN A LICENSE AGREEMENT
Parties to the License Agreement
It is important to identify the parties to the license agreement and to be clear concerning whether the licensee may allow its affiliates to use the technology being licensed.
Scope of the License Grant
The granting clause is the most important, because it defines the basic parameters of the license agreement. The granting clause identifies the licensed intellectual property and describes where, and in what manner, the licensee may practice the rights granted. Typical terms specified in the granting clause include the following:
- the type of rights being licensed;
- the type of license (i.e., exclusive or nonexclusive);
- the territorial scope;
- the field of use;
- improvements/developments; and
- the right to sublicense.
Rights Licensed. The rights licensed depend on the type of intellectual property involved. The chart below sets forth the rights that a licensor can grant with respect to the basic forms of intellectual property.
TYPE OF INTELLECTUAL PROPERTY
TYPE OF RIGHTS LICENSED
The right to make, use, and sell the patented subject matter
The right to sell goods or services under a particular mark
The right to copy and distribute copyrighted subject matter, including the right to make derivative works
The right to use and/or disclose the subject matter covered by the trade secret
Type of License. An exclusive license prevents the licensor from granting the rights to others. From the licensee's perspective, an exclusive license prevents its competitors from using the intellectual property being licensed. From the licensor's perspective, however, an exclusive license entails greater risk, because the licensor is depending on only one licensee to fully exploit the licensed intellectual property. Accordingly, the terms of an exclusive license will typically include certain protections for the licensor. For example, an exclusive license will usually include minimum royalty payments and will require the licensee to employ reasonable or best efforts to exploit the licensed property commercially. Exclusive licenses also typically include a termination provision or a provision to convert the license to a nonexclusive license, in the event the licensee fails to meet the requirements of the license agreement.
A licensor that is being pressed to grant an exclusive license might want to suggest a middle ground between total exclusivity and non-exclusivity, such as a license that is exclusive only
- within a specific geographic territory;
- within a given field of expertise; or
- for a set period of time that is less than the entire
term of the license agreement.
If an exclusive license of any sort is being considered, the licensor should ensure that the license agreement unambiguously addresses whether the licensor itself would be precluded from using the intellectual property for its own internal purposes.
Territorial Scope. Unless an express territorial limitation is included in the license agreement, the license grant is assumed to be geographically coextensive with the territorial scope of the intellectual property involved, although the rules with patent licenses are a bit different. For example, if a license refers to a U.S. patent, then the geographic scope of the license might not be limited to the United States. Some courts have held that a reference to a particular patent relates to the nature of the products covered by the claims, not the geographic scope of the agreement. Consequently, the license would include foreign countries in which patent protection has been obtained, unless the license agreement included specific language to the contrary.
Field of Use. A field-of-use limitation places a restriction on a licensee with regard to the uses that the licensee is permitted to make of the licensed intellectual property. A licensor might use the field-of-use limitation to exercise control over the class of customers to whom the licensee is permitted to sell. For example, in the area of patents, the field-of-use limitation might be utilized to restrict a licensee to using the patented subject matter only for manufacturing and selling certain products, which would normally be specified in the license agreement.
Improvements/Developments. It is extremely important for the license agreement to address whether the licensee may make improvements or developments based on the licensed intellectual property. If the licensee is entitled to make improvements and developments, then the license agreement should also specify who owns the improvements or developments. Although the focus of a particular license agreement is usually on the intellectual property involved, the improvements and developments to that property might prove, over time, to be more important than the underlying intellectual property. Addressing the issue of ownership is further complicated by the manner in which the law addresses improvements and developments of various types of intellectual property.
Under copyright law, the creator enjoys an exclusive right to "prepare derivative works based on the copyrighted work." In other words, the creator may change or improve the copyrighted work in a non-trivial way and secure a copyright on that improved work. In addition, the original copyright holder has the sole right to give permission and/or to grant a license to another to make a derivative work on which a copyright can adhere. Without such permission by the original creator, any improvement to the copyrighted work by another party is an infringement of the original holder's copyright.
In contrast to copyright law, patent law does not vest in the original patent holder any right to improvements or derivative inventions. A patent only gives the holder the right to exclude others from the patented invention. Consequently, a new and separate patent can issue for an improvement to an invention. If the patent holder licenses a patent but fails to address the issue of improvements and developments, then the licensee could design around the original patent, or substantially improve the invention, and secure a new patent on the improvement. In many cases, such improvement patents are "blocked" by the original patent holder—that is, the improvement cannot be exercised without a license from the original patent holder whose technology has been incorporated into the improved patent. At the same time, however, the original patent holder is blocked by the licensee's improved patent from taking advantage of the improvement. The possibility of mutual patent blocking is one of the reasons that a patent licensing agreement should address the issue of improvements.
Right to Sublicense. The right to sublicense allows the licensee to grant outsiders a license to the intellectual property. Nevertheless, even if the licensor agrees to allow the licensee to sublicense the intellectual property to outsiders, the licensor will probably want to qualify the right in some way, such as limiting the sublicensing to a specific geographic territory. The licensee should be aware that, even if it has the right to sublicense, it can sublicense only the rights it has been granted and nothing more.
The license agreement will either be perpetual or set forth the period that it is effective—that is, the "term." For various reasons, however, one of the parties might want the right to exit from the relationship before the term has expired. This right—the right of termination—comes in several forms.
License agreements typically state that a "material breach" of the license agreement by one party gives the other party the right to terminate. What constitutes a material breach is fact-specific. Consequently, if a party is particularly concerned about a specific risk that could be present in the relationship, it should specify that concern as an event of constituting a material breach. For example, a licensor might want to state that the licensee's failure to pay fees or royalties on a timely basis constitutes the licensee's material breach of the agreement.
The right of termination "for convenience" enables a party to terminate the license agreement for any reason or no reason, without having to prove that a breach has occurred. Termination for convenience provisions will normally apply only where there is an ongoing payment obligation by the licensee. The license agreement will usually require a couple of months between the time of the terminating party's notice and the effective date of such a termination. Agreements containing termination for convenience clauses often provide for a payment to the non-terminating party if a termination takes place. The size of such a payment will vary based on when the termination took place, and it will decline in proportion to the amount of time remaining in the term of the agreement.
Aside from "convenience" and "material breach," several other occurrences might be considered as a constituting an occasion for termination, such as the non-terminating party's insolvency.
It is impossible to address all of the important issues involved in preparing an appropriate licensing agreement. Nevertheless, I hope that the discussion above has given you some useful information to apply to your next encounter with the simplest form of collaboration, which—as you can see from the discussion above—is not so simple.
Date Change: On June 16, 2010, Michelle Capezza will present a webinar entitled "Contemporary Issues in Employee Benefits & Compensation in a Recovering Economy" as part of the UBS Corporate Employee Financial Services (CEFS) Speaker Series. For more information, contact Michelle at [email protected].
The Technology Team is now a proud Member of the New Jersey Technology Council.
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