Analyzing Selected Provisions Of A Complex Technology Agreement

Editor: Large, global companies often want licenses to include their affiliated companies. How do you handle the definition of affiliates?

Holmes: While the definition of "affiliate" often encompasses a 50 percent common ownership, I've seen it as low as 5 percent and as high as 95 percent. A company with a lot of sister companies, subsidiaries and other affiliates may want to license the whole family. It depends on the circumstances and requires some investigation.

I like to add a parenthetical requirement of direct or indirect control by the licensing party. Sometimes a drafter will incorporate an SEC or other statutory definition of control. But, what happens if the statute changes or is abolished? To avoid future ambiguity, you can include language referencing the statute as defined today or you can include the definition into your agreement.

When a transaction involves foreign affiliates, drafters often include references to shared managing directors and a shared board instead of references to percentages of ownership.

Editor: What are some common strategies for negotiating a "best efforts" clause?

Holmes: Rather than requiring "best efforts," I prefer requiring the parties to engage in normal commercial practices that can be measured against what other players in the industry are doing.

You'll find some agreements defining "best efforts" in terms of a specified expenditure, such as $500,000 in a single instance, or $2 million over the aggregate. The definition of expenditures can be expansive - including such costs as attorneys', engineers', scientists', consultants', and accountants' fees and expenses - or it can be restricted to include only R&D costs directly related to the patent.

Using a specific figure during negotiations gives you a sense of the perspective of the other party. If you throw out a number like $2 million and the other side says that it expects you to spend $20 million, you have an idea of each other's expectations before you sign the agreement.

Editor: How do you recommend addressing royalty issues?

Holmes: Many licensing agreements provide that the obligation to pay royalties ends when a patent expires or is invalidated. If the patent being licensed is nearing expiration, some licensors will negotiate a substantial upfront royalty.

Some licensees see a provision for a non-refundable upfront royalty as just another business term and believe they can get a prorated portion of the upfront royalty refunded, through arbitration or litigation if necessary, if the patent is later held invalid. To strengthen their ability to get their money back if the patent is invalidated, licensees may negotiate such language as "any upfront royalty shall represent a credit against future royalty obligations." If the language does not explain how far into the future the royalty credit extends, the parties may encounter contention about what prorated portion is refundable.

Some patent holders don't want language in the agreement that may hint of the patent's possible invalidity as this may raise issues in any future discovery if the patent is disputed. Unless the royalty payment and credit provisions are clear, the ground is fertile for future arbitration or litigation.

Editor: How can a licensor ensure payment of the royalties?

Holmes: As a patent owner, you need some degree of trust with the licensee. Let's say you are licensing medical devices and were told that the licensee sold 1 million devices, but they manufactured 2 million. You would want to know where those extra devices went. Some may have been defective or if the licensee has been giving away samples, you may want to ask for royalties on those samples.

An audit performed by third party auditors may raise questions of confidentiality. In addition, unhappiness can be expected when the licensee learns that it may owe additional royalties.

Timing of audits can be limited to a period of time, such as three years, but an underpayment can trigger a right to a yearly audit and shift the costs of the audit to the licensee.

The provision can be structured so that the auditor can inform the licensor whether royalties have been fully paid but cannot disclose sales figures or other information. The patent owner may also require certification from a corporate officer of the licensee.

If royalties have been underreported over a period of time by a certain percentage, the licensor may want to terminate the license, which may not be possible depending on the agreement's termination provisions. Both parties should be wary of automatic termination provisions. As situations change, a party may no longer want the other party to have a termination right.

Editor: Do you often see arbitration provisions in complex technology licenses?

Holmes: Small inventors may want arbitration because it can be less expensive if they contractually limit discovery; of course, they forgo juror sympathies for the underdog or if foreign infringers are involved. Another advantage of arbitration is confidentiality of the results.

A provision can also be included for informal dispute resolution. It might provide, for example, that controversies be escalated to the attention of both party's general counsel if there is no resolution within 14 days; and onward to the CEO's if there is no resolution by the general counsel.

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