Author: Andrew Clay
Licensing your IP rights can be a great way of accessing new markets where you may not have a presence and/or increasing your rate of market penetration by partnering with a player with a much bigger market footprint and access to more capital than you. For licensees too there are benefits to licensing: access to new technology, new ways of doing business and new products.
However getting licensing wrong can threaten a business’ very survival. A large licensee may walk off with a start-up’s technology without paying for it or simply sit on it and fail to exploit it, sometimes in preference to its own “invented here” technology. A licensee may overpay for the licence and/or accept onerous exploitation obligations, which prove uneconomic in practice.
How to get your licensing deal right
The starting point is to understand what the commercial risks are for both licensor and licensee.
The licensor is potentially limiting its commercialisation options for an important asset (its IP) for the duration of the licence in the territory covered by the licence. If the licensee does not perform and the licence granted to it is exclusive then the licensor may get a very limited or indeed no return from its IP during the term of the licence.
The licensee is potentially going to forego other opportunities to invest in the commercialisation of the licensor’s IP. For that investment to pay off, the commercial opportunity the licensor’s IP represents must stack up.
Numerous factors have to be considered when weighing up these and other risks, including the characteristics of the licensee (including in particular its available resources), the market demand for the licensor’s IP and its robustness, the likely impact of other competing technologies, the resources required to properly commercialise the IP and the projected return on investment etc.
Some of these variables will be relatively easy to ascertain but others will be almost impossible to predict with any meaningful accuracy. Licensing agreements that are overly rigid and don’t factor in these uncertainties risk causing problems down the line. The best and most stable deals are win win for both parties. In practice this will often mean regular reviews of what each party is putting into and getting out of the deal and a mechanism for reasonable adjustments to be made, factoring in changing market conditions.
10 Rules to get the Right IP licensing deal
So are there any rules that would be licensors and licensees can follow to minimise the risks of getting the wrong deal. Having drafted many hundreds of licensing agreements and been involved in numerous licensing disputes over a 35+ year legal career, these are my ten top tips:-
Rule 1: Do your homework on your prospective bed fellow
No pre-nup, however well-drafted, is as good as being married to the right person.
So it is with licensing.
Don’t rush to the altar.
Find out as much as you can about your prospective licensing partner whilst you are still dating. It is amazing what a google search or talking to people in the industry can sometimes reveal.
Rule 2: Agree heads of terms before drafting the licence agreement
Using solicitors to negotiate the basic commercial terms of a licence can be both costly and inefficient. It is often much better and cheaper to agree with the other party the key commercial terms at least in outline first. These can be recorded in a non-binding Heads of Terms type document, which can then be passed to the lawyers to use to draft the licence. Attempting to nail down key commercial terms early on will also help identify any deal killer road block points before spending a lot of money on legals.
Rule 3: Define the scope of the licensed rights with real precision
Parties to licences often subsequently disagree about what precisely has been licensed and what has not. Unregistered IP rights such as know-how, copyrights in software and unregistered design rights can be hard to define. Definitions can be very important here and they should all be stress tested. Does the definition cover this thing or activity or not?
Improvements are another area that often give rise to difficulty: are they included in the licence automatically, does the licensee have to take a licence of them and does it have to pay extra for them? What are the licensee’s obligations to license back to the licensor its own improvements.
Arguments can also arise as to what a licensee can do with the licensed IP. Can the licensee sell licensed products to customers based outside the territory in response to enquiries received via a website? Can the licensee improve the licensed IP or is it stuck with what was licensed? What precisely is permitted and what is not needs spelling out with care.
It is important to lock out the licensee from activities that may compete with the licensor to the greatest extent the law allows: for example the licensee should not be able to export licensed product to countries reserved to the licensor or to another exclusive licensee.
Finally it is important to state clearly if the licence is exclusive (one licensee only), sole (one licensee and licensor only) or non-exclusive (many licensees and the licensor).
Rule 4: Be clear about royalty terms
The other major area of dispute in licence agreements is royalties. Numerous aspects of royalty payment provisions can give rise to disagreements. Is a “patented product” one that falls within at least one of the claims of one of the licensed patents or does the term refer to something broader? Is a product still a “patented product” once the patents have all expired? Does the licensee still have to pay to use know-how even if it is now all in the public domain? Are there minimum royalty payment obligations and if so what is the sanction if the licensee does not hit them? What precisely does the obligation to pay royalties bite on – what costs can be deducted from the net selling price? Can the licensee pay much lower royalties by selling the licensed products to a connected third party at an undervalue?
From the licensor’s perspective a right to audit the licensee’s performance can be very important in practice: a well drafted licence will give the licensor the right to inspect the licensee’s accounting and other records so as to ensure that all royalties properly payable have in fact been paid.
Rule 5: Think through what happens if it goes wrong
Hope for the best but plan for the worst.
How can you ameliorate the risks of the licensee taking your technology and not paying for it? Perhaps ask for an advanced payment of royalties up front? Perhaps the licensor can supply a key element of the licensed products to the licensee so that the licensee remains locked in to good performance.
Particular risks arise when transferring know-how to overseas licensees: the costs of suing a third party based in for example the US, India or China may well make such a course of action uneconomic.
Rule 6: What happens on termination
The issue of what happens when the licence terminates is often overlooked and not properly provided for. Can the licensee dispose of existing stocks of licensed products or does it have to destroy them? If the licensee has spent millions on production equipment can it continue to use it on termination and if so on what basis? Do different reasons for termination lead to different consequences.
Rule 7: Particular care required when licensing in the US
George Bernard Shaw was not wrong when he said that “England and America are two countries separated by a common language”.
US business culture is markedly different to that in the UK. Litigation is regarded much more as a tool to be routinely used to achieve a business objective than is the case in the UK.
The costs of litigation in the US are also generally very much higher than for the UK and there is, in most cases, no presumption that the losing party will pay the winner’s costs.
It is generally fairly easy for a US based entity to circumvent exclusive UK jurisdiction clauses in licence agreements and commence litigation in the US against a UK contracting party.
In short there can be a big upside in licensing in the US but there are also material risks, which licensors should familiarise themselves with.
Rule 8: Don’t forget Patent Box
With the main rate of corporation tax being 25%, the benefits of patent box relief shouldn’t be forgotten. Patent Box relief is an allowable deduction from a company’s relevant income, which reduces the effective rate of corporation tax on that income down to 10%. It applies to a licensor’s income generated from licensing its patents. It also applies to the income generated by an exclusive licensee from its sale of patent products or the use of a patented process. It does not apply to the income of a non-exclusive licensee. Even an exclusive licensee has to have contributed to the further development of the licensed technology incorporating the patent. The patent box upside for a licensee can greatly reduce or even eradicate the effect of paying royalties.
Rule 9: Manage the relationship
All business relationships have their ups and downs and conflicts. The trick is to manage them effectively. Appointing relationship managers, having regular review meetings and a graduated dispute resolution procedure can all help keep the show on the road.
Rule 10: Find an experienced Commercial Solicitor to help you navigate the maze
Many solicitors can bash out a credible looking IP licence agreement for you, especially with the help of Chat GPT. However to get the best deal, which will stand the test of time, what you really need is a solicitor who is focused on and really understand the commercials and has been through enough licensing deals so that there won’t be any surprises down the line either for him or her or for you.
What Sonder & Clay can do for you?
Sonder & Clay’s accomplished IP Solicitors will help you exploit and enforce your IP rights to maximise their value. Our team enjoy years of IP experience and will devise a licensing or exploitation strategy to help deliver a return on your research and development investment. Please get in touch to book a consultation.
