Advanced Issues In Licensing - Just A Bunch Of BS

Tuesday, August 1, 2006 - 00:00

With the ever-growing use of technology and intellectual property ("IP") in the corporate world, licensing has become what I like to call "mainstreamed" in recent years for the in-house practitioner. Indeed, you would be hard-pressed not to find some element of licensing in a majority of commercial transactions that occur in today's technological/Internet driven economy. Familiarity with critical licensing issues (and pitfalls) has thus become even more important for the in-house practitioner as such attorneys are often managing some of their company's most valued assets.

This article is not intended to serve as a primer on licensing, but rather strives to help identify and highlight certain critical issues that are often overlooked but regularly crop up in the licensing context and which can significantly impact your clients and their businesses. Indeed, most of the concepts discussed herein can be boiled down to a simple concept, that is, - "BS" - not the colloquially used term , but rather: - BE SPECIFIC. This will be the common theme in this article and one to which all licensing practitioners should take heed. As the old adage goes, the devil is in the details, and never more so when licensing potentially critical business assets. One drafting error can be extremely costly. So let's break this down.

(1) Draft Separate Clauses For Technology And IP.

Technology and IP are oftentimes misused concepts in the licensing context, frequently combined or confused leading to detrimental results. Technology is a tangible object or thing, while IP is a legal right. A typical technology license may, for example, include language that grants a license to use the technology, which term is in turn defined to include all related IP rights. The intent of the clause is to license the technology for licensee's use. However, as written, the license grant presumably licenses everything covered by the respective IP, including any and all inventions and material covered by such IP, even if portions of such material were not intended to be conveyed by the license, and even if originating from someone other than the licensor. At best this leads to an ambiguity . . . and at worst, we have inadvertently licensed away broader rights than intended or rights we may never have had the authority to license at all.

The solution is a relatively simple one. Include separate licensing clauses for the technology and, if applicable, the IP rights, so each can be specifically limited as intended. Remember, if you are only licensing technology, for example, as part of a finished product, like a media player, there is generally an implied license for use of all necessary IP in order to exploit the technology as intended, so IP need not be separately licensed. Thus, whether you are licensing technology only, IP only, or a combination of both, it is important to BS (i.e., BE SPECIFIC) about each of the licensed technology and IP and do so in separate clauses as the situation dictates.

(2) Take A Little R&R - Reserve Those Rights You Do Not Intend To Convey.

Make sure to retain any rights your client may wish to keep and BS - BE SPECIFIC - about anything that is NOT included in the grant. If, for example, a licensor enters into an exclusive distribution arrangement for its new media player, but also intends to distribute the players itself, it should so specify in the license or it may inadvertently restrict its own ability to distribute its product. Similarly, if the license is intended only to cover use of the technology for beta testing purposes, for example, you should specify that mass commercial distribution is not included in the license.

(3) Exclusivity Issues.

There are a number of additional inadvertent mistakes that can crop up in the exclusive license situation. First, beware of the situation where a licensee enters into an exclusive license for the purposes of burying the technology. You want to ensure there are well defined performance obligations AND remedies for failure to comply with the same. From a licensee's perspective, while no performance requirements are theoretically ideal, in practice both parties should agree on reasonable performance parameters to help ensure both parties receive the full benefit of their bargain. If a licensee is unwilling to do this, be wary

Second, you will also want to think about other restrictions for an exclusive license, such as time periods for exclusivity, and geographical and/or field of use restrictions - including automatic sunsets. Third-party issues arising in connection with affiliates and sub-licensees are also critical (see below) and must be addressed in the agreement.

(4) Special Considerations with Third-Parties - Specify Rights and Remedies.

A number of issues come up with respect to third-parties, most notably affiliates and sub-licensees. It is critical that you gain a thorough understanding of the licensee's business model, business structure, and geographic scope. These factors can play a critical role in how third-parties may come into the picture. You must also work closely with your client on assessing the benefits and risks of bringing third-parties into the transaction. On the one hand, it can result in a quicker and more thorough distribution of product. On the other, it means a certain amount of control over the technology or IP will be sacrificed.

With respect to affiliates specifically, first agree on what types of entities are going to qualify as affiliates and then craft a clear definition which is static (that is, frozen in time). It is not always clear what companies will actually qualify as affiliates. These may include entities where the licensee owns significantly less than 50%, e.g., for tax or other purposes. The key issue is whether the licensee is effectively able to direct the activities of the affiliate. This can be determined based on whether the affiliate operates under the parent brand, the parent exercises direct or indirect control, affiliate employees deem themselves employed by the licensee, etc. Also be cognizant not to simply reference a third-party definition of affiliate, which may be subject to later revision, or you may risk inadvertently having your license expanded beyond the parties' expectations some time in the future. Whatever the ultimate solution - make sure to agree on a set of parameters and specify them in the agreement.

With respect to sub-licensees, you will also want to consider additional restrictions, including, e.g., requiring licensor consent to each sub-license (again with reasonable time, geographic or field of use limitations no broader than the original license), and/or that each sub-licensee sign an acknowledgement to the master license agreement, binding it to the same. Licensees, of course, will want to try to negotiate greater flexibility and should also plan for survival of sub-licenses to ultimate end-users, post-agreement termination, if the situation dictates.

Finally, whenever a third-party is involved, specify explicit remedies governing such third-parties' behavior. Unless each third-party is a named signatory to the agreement (not likely to happen), the licensor will likely be putting its IP at risk as it will not necessarily have direct enforcement rights against each third-party. This can be addressed in the agreement in several ways, including reps and warranties, indemnification, and covenants covering the licensee's actions vis--vis such third-parties. Nothing, however, is a substitute for thorough due diligence!

(5) Joint Owners Beware - Assign Ownership Of Jointly Developed Technology To Only One Party Or A Third-Party - Then License Back.

Probably one of the most common errors in licensing involves multiple-party collaboration or jointly developed IP. In most agreements you will see, one party owns what they develop, the other owns what they develop, and they both own what they both develop. Sounds logical, right? Maybe, but such an arrangement can actually be fraught with unintended pitfalls.

A common scenario arises when a third-party infringer plays each joint owner off the other to negotiate a below-market-price for the technology. Using a jointly owned patent for example, an infringement suit against a potential infringer is foreclosed if one of the joint owners does not want to bring suit. Also, there is no duty of royalty accounting among joint patent owners if one joint owner enters into a license. Thus, if one owner does not want to sue, then the only option is for each joint owner to attempt to independently license the patented technology, which a sophisticated third-party can leverage to negotiate a below-market price. This scenario becomes more complicated in the case of multiple IP types with differing, often contradictory, legal obligations, like, for example, copyright, which does require an accounting of royalties amongst joint owners. Messy stuff.

The solution? Avoid joint ownership altogether, and assign all IP rights to either one party or a third-party entity (e.g., a joint venture) and have that entity license the rights to the other party or parties as the case may be. While on its face, this solution may be greeted with some resistance at the negotiating table due to one or both parties foregoing ownership rights, the rights granted to each party will effectively be the same as in the joint ownership scenario, without the potential ambiguities and conflicts that can result.

(6) Compensation Issues.

Methods of calculating compensation are only limited by the parties' imaginations. Common performance royalty arrangements include those earned on, for example, profits, gross receipts, net receipts, or units sold. Other compensation arrangements are independent of performance and may include up-front fees and progress payments. Key points to remember in any compensation arrangement include: (i) ensuring the definitions included in the calculation metrics are clear (try to stay away from any potentially ambiguous metrics, such as profits as such concept is easily manipulated); (ii) clearly identifying payment timing and triggers, including, e.g., when royalties are technically earned and due (e.g., at the time of contract, the time of shipping or receipt of product, upon collection of payment, etc.); and (iii) crafting provisions limiting the amount of bad debt and returns that can reasonably affect the royalty payment.

Specifically, with respect to sub-licensees, you also want to be alert to clever licensees' attempts to avoid their royalty obligations by using licensor's technology as a loss leader to win other business from prospective sub-licensees. In order to protect against this scenario, require all royalty payments for sub-licensed product to be based not on the licensee's compensation, but directly on the sub-licensee's gross receipts or percent of sales, etc., as the case may be. This forecloses a licensee's ability to avoid royalties and ensure a licensor gets the full benefit of its bargain.

Finally, all compensation mechanisms should include a combination of record-keeping and officer certification requirements, audit rights, and remedies for failure to accurately report royalty information. Certain back-up records may not necessarily be kept in the licensee's ordinary course of business, so additional record-keeping requirements may be necessary. Officer certification ensures the company has knowledge of any royalty payment deficiencies, and audit rights provide independent verification of payment accuracy and should include remedies for mis-reporting, including audit fee shifting and, in the case of repeated violations, termination of the license.

As you can see, the issues that can arise when drafting license agreements are complex and peppered with potential pitfalls. This article only scratches the surface of the many issues that can arise in a licensing transaction. The key is to thoroughly understand the transaction, the respective parties' business operations and intentions, and adjust as the facts demand. The rest is just BS!

Jason R. Karp is Special Counsel in the Vienna, Virginia office of Kelly Drye Collier Shannon.

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