Licensing
BUSINESS INFORMATION SERVICES
This guide was written on behalf of Invest NI by Carson McDowell Solicitors
1 What Is a Licensing Agreement?
A licensing agreement is essentially a contract conferring on someone the legal right to use intellectual property rights owned by another person. It is used when the owner of a product does not have the necessary expertise, resources, time or indeed inclination to successfully manufacture/ operate/market the particular product. The owner grants a licence to a third party who has the requisite business acumen, knowledge and experience to operate, manufacture and market the product in a certain territory on behalf of the owner of the product. Although the licensor relinquishes the direct sale or manufacture of the product, he enjoys the benefit of still owning the intellectual property, and usually retains control over the use of same. In addition, the licensor may receive continuing royalties throughout the duration of the licence, thereby fully maximising his return. Royalty figures are usually calculated based on the number of licensed products sold. It would therefore be most advantageous for the licensor to select the licensee who is likely to make the best yield on the product.
2 Choosing a Licensee
The choice of licensee should be fully investigated before any commitment is made. The licensor should find out about any other similar ventures or, if this is a first-time venture, they should ensure that the potential licensee has a sound business plan and sufficient commitment to the project. The construction of the licence should promote proactive selling and create an incentive to boost the potential of the license. be increased and vice versa. In his protection of the intellectual property, the licensor should ensure that the licensee is using the licence in the manner in which he intended by imposing limitations and conditions on its use.
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4 Are There Different Types of Licensing Agreement?
The first stage to consider, once the decision has been taken to create a licence, is the nature of the licence. It can be: • Exclusive – where only the licensee will market/ manufacture/operate the product itself. • Sole – where the licensor agrees not to grant any other licences but retains the right to market/manufacture/operate himself. • Non-exclusive – where the licensor can grant any number of licences and may market/ manufacture/operate the product himself.
3 Protecting your Intellectual Property
Just as a specific financial return is important, so too is the manner in which the products or trade mark will be utilised by the licensee. In order to maintain the integrity of the product, it is necessary to protect it. If the manner of use enhances the reputation of the product, inevitably the value and marketability of any affiliated products will also
FOR FURTHER INFORMATION: CONTACT KATHY McCONVILLE, BUSINESS INFORMATION SERVICES T: 028 9069 8127 E: kathy.mcconville@investni.com
Licensing contd.
It is obvious that the value of a licence depends on the level of exclusivity granted by the licence. A non-exclusive licence would be of lesser value than either of the other two types of agreement to a licensee. It may be more beneficial for the licensor to conduct his own business in the territory with which he is familiar, whilst simultaneously granting licences to others in order to fully exploit both the product in question and indeed the licences created. Conversely, however, where a licensor has no direct contact or knowledge of a territory, for example, another country, he may be better advised to appoint a single, large exclusive licensee who is, in turn, permitted to sub-licence. This ensures that the licensor reaps the benefits without suffering any of the aggravation and associated problems which accompany any business undertaking. The licensor may not, however, be in a position to dictate the nature of the licence agreement and it may fall to the licensee to elect the type of licence from which terms are to be agreed. If a new product or new technology were being licensed, presumably the licensee would be making an initial capital investment sum and is unlikely, in this instance, to accept anything less than an exclusive licence. • Using an organisation whose speciality is technology
transfer and identification of suitable business
partners for exploiting a new technology.
• The extent of the potential licensee’s manufacturing
capacity and distribution network, and its
strength and reputation in the local market.
7 What Form Should a Licensing Agreement Take?
Although licensing agreement precedents exist, there can be no standard or generic form for a licence. Each licence deals with specific areas, peculiar to the circumstances of the case. Notwithstanding this, each agreement should contain certain provisions so as to protect both the licensor and the integrity of the product. Any agreement must, therefore, be tailored to suit the individual situation, taking into account all pertinent surrounding factors. In essence, an inventor may choose any terms on which he wishes to base his relationship with the potential licensee. Obviously, if the licensee is a larger entity with a healthy financial background, it is likely that he will retain the power to bargain and will, therefore, ultimately determine the terms of the agreement, subject to any competition law constraints which may affect it. On creating an effective licensing agreement, there are general considerations in relation to its content that should be thought about.
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5 Preliminary Considerations – Is Licensing an Option,
and is it the Best Option?
Although it may seem to be an obvious point, one must initially consider whether the intellectual property is actually capable of being afforded legal protection. Once it has been established that the intellectual property can be protected and a licence may be granted, the inventor or indeed the company who owns the invention must decide whether or not they could simply operate/market/manufacture the product themselves. It may be more advantageous for the inventor to act on his own behalf, thereby securing the full benefit of the product. If the inventor decides that it is not practicable for him to market/manufacture/operate the product himself, thought must be given to whether or not it would be best to grant a licence or sell the product.
8 Royalty Levels
One must decide upon the royalty levels which the licensing agreement should grant. It is necessary to consider all the possible options available to the parties. For example, if a down-payment is made on signature of the licence, this should be sufficient to enable the licensor to recoup the investment it has made in the product. Further, if such a payment is made, the licensor and licensee ought to negotiate whether it is simply a one-off payment or an advance against future and expected royalties. As previously mentioned, the royalty rate is based on various considerations, ranging from the degree of exclusivity conferred by the licence, the anticipated commercial benefits which the technology will potentially deliver upon the licensor, to the industry practice in the relevant sector.
6 Selecting a Licensee
If the grant of a licence is deemed appropriate and the inventor finally decides to pursue the option to license, the next step is to select a suitable licensee. This selection should examine the following: • A potential licensee who is trying to break into the field of the licensor’s new technology may be preferable to one which is already competing with the technology. This may involve a conflict of the licensee’s interest in the promotion of the manufacture or sale of the competing technologies.
9 Confidentiality
Confidentiality is, undoubtedly, a fundamental consideration where intellectual property rights are concerned. Information dealing with technical or medical advances which may be disclosed in the licence may be unpatented, or indeed, even if information is to be patented, it may
Licensing contd.
not yet be published. This would allow others to infringe upon this information and the advances made, claim them and profit from them. Other types of information which would be of commercial value, for example, sales projections and client details, should also be kept confidential to ensure that no-one is able to exploit licensed information without possessing a licence to do so. or not it would a feasible option for the royalties to be routed through tax-favourable jurisdictions, thereby allowing the licensor to maximise their investment in the agreement.
13 How Should the Agreement be Structured?
The provisions of the agreement are similar to any other agreement. They must, however, be constructed to result in an effective licensing agreement for the licensee and to establish a profitable income stream whilst providing protection for the licensor and his product.
10 Heads of Agreement
In order to clarify exactly what is to be contained in the licensing agreement and to record the commercial terms of the licence in advance, it may be useful to consider non-binding, or partially binding, heads of agreement. This should explain to both parties that if they proceed with the investment at this stage, it will be at their own risk.
14 Parties
The parties to the agreement are usually the inventor or owner and the licensee. It may, however, be necessary to introduce other parties to the proceedings in order to reinforce the protection given to the confidentiality of the licensed intellectual property by joining the licensee’s major shareholders as parties to guarantee the obligation of the licensee. Any additional parties, however, should only be added once consideration has been given and specialist advice sought in relation to the impact competition law would have in such a union.
11 Jurisdiction
The jurisdiction for the governance of the agreement must be stipulated and if any alternative dispute resolution is to be permitted, it should also be included. If, however, a licensing agreement involves any law outside the jurisdiction where the agreement is constructed, for example, in the case of an overseas licensee, it is necessary to consider the extent of the advice which will be essential regarding the application of local law to the proposed licence arrangements. An extension of this consideration of multiple jurisdictions is, of course, the examination of the potential application of European Community, United Kingdom and any local laws which impact on the competition aspect of the licensing agreement. This should now include an assessment as to whether the licence will be caught by Article 81(1) of the EC Treaty. This section of the Treaty prohibits agreements which may affect trade between Member States and which have as their object or effect the prevention, restriction or distortion of competition within the common market.
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15 Definitions
Precise and accurate definitions should be drafted for all terms used in the agreement. A narrow and definite drafting will ensure that advantage is not taken of a wide definition for the term “licensed product” and restricting the range of products to which the licence applies. With regard to “net sales price”, a clear definition must be provided, as this is typically what will have been defined as the basis for the calculation of royalties. It must be decided and specified in the definitions, in order to avoid subsequent confusion, at what stage deductions pertaining to the licence of the product, for example delivery charges and sales taxes, should be made.
12 Taxation
Another practical consideration is the effect of taxation on any royalties earned from the licence. If the licensee is overseas, it is necessary to investigate whether or not the royalty payments are subject to withholding taxes and if there is a double taxation treaty which will enable the licensor to recover all or part of the sums withheld. In order to combat this, a grossing up clause, which is a calculation of the amount that would be required in the case of an investment subject to tax to equal the income from that investment as if it were not subject to tax, may be necessary in the licence. It must be borne in mind that where substantial sums of money are involved in a licensing agreement, specialist advice should be sought regarding whether
16 Scope
The scope of the licence should also be clearly defined and all the following should be detailed within the agreement: • the nature of the licence – exclusive, sole,
non-exclusive;
• the territory covered – it is best to avoid including
ambiguous terms, for example, Europe and Africa,
but rather specify exactly the area to be covered;
• whether or not it is for manufacture, operation
or sale, or a combination;
• whether or not sub-licensing is permitted; • whether or not sub-contracting the manufacture
or operation of the licence is permitted.
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17 Royalties
One of the fundamental areas to be considered by both parties is, undoubtedly, the payment of royalties and the manner in which they are to be paid. It is necessary to specify how the following factors should be handled: • whether there is to be a down- payment and whether or not there will be a single payment representing future use or if it is an advance against royalties; • the rate of the royalties; • what the rate is to be based upon, for example, sales turnover, percentage per licensed product or share of the net profits; • if there is a minimum royalty payment in
a period and what that period will be;
• how payment is to be made and how much interest will be incurred should a payment not be made; • whether the payment is inclusive or exclusive of VAT. right to utilise any improvements to the product made by the licensee. It may be that the parties to the agreement negotiate to disclose any improvements made by either party to the other, subject to any conditions regarding confidentiality, allowing the parties and the product to develop and advance. This must be considered in conjunction with EC competition laws and again, specialist advice should be sought when dealing with this.
19 Confidentiality
This concept is essential given the potential nature and value of the licence. There should, therefore, be a clause confirming the reciprocal confidentiality regarding certain specified information with which both parties must comply.
20 Termination 18 Obligations
Licensees will undertake to perform, or not perform certain obligations which will be contained in the agreement. The licensor should ensure that the licensee is under an obligation to use its best endeavours to exploit the licensed product to the maximum capacity. Notwithstanding this, the licensor must impose quality control obligations in order that the integrity of the product is maintained and all quality marks, local and other regulations are complied with. The licensor may also include, in the licensee’s obligations, that the licensee should provide guarantees to its customers and provide service and repair facilities to maintain the quality and standard of the licensed product. A product liability indemnity should also be sought by the licensor to protect them from any potential problems which the licensor may incur throughout the course of the agreement. Further protection for the licensor and his product should be derived from the prevention of the licensee from poaching or soliciting any of the licensor’s personnel and also, preventing the licensee from using the licensor’s technology to construct facilities for third parties. The licensor should then consider whether he should give any warranties in return. This type of warranty is usually drafted to provide the licensee with recourse to the licensor. It is typical in this type of clause for the licensor to simply state that he owns the intellectual property right. He may further warrant that operating within the scope of the licence will not infringe any third party intellectual property rights. Improvements to the product must also be dealt with in the agreement. The licensor may wish to have the All agreements should, of course, include a clause to terminate the agreement by both parties. It is necessary to specify the circumstances in which it is permissible to terminate a contract. These may include failure to pay or achieve a certain level of royalties, breach of confidentiality or insolvency. It may further benefit the licensor to specify other circumstances in which a termination is appropriate and permissible. The consequences of such a termination would, obviously, be the end of the agreement. It is vital, however, to stipulate that some clauses subsist, for example, a non-disclosure of confidential information, the return or destruction of certain products and indeed the amendment of details of registration of the product. Within this clause, the manner in which unsold products are dealt with should be stated, whether it be taking into account royalties of the unsold product and allowing the licensor to retain the excess, by including a buy-back option for the licensor or whether the product simply reverts to the licensor.
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21 Conclusion
A licence is a very useful way for the inventor and owner of product to exploit it to its full value and maximise his return without relinquishing title to it. He remains the owner, whilst allowing the licensee to manufacture and market the product. For an inventor who is without the skills or finance to take full advantage of the product in question, a licence provides an outlet for the use, promotion and occasionally, the improvement of a product.
This guide is provided to give an overview of the principal areas when considering Licensing.
Detailed legal advice should always be sought.
FOR FURTHER INFORMATION: CONTACT KATHY McCONVILLE, BUSINESS INFORMATION SERVICES
T: 028 9069 8127 E: kathy.mcconville@investni.com