26/28/04/2014 - Licensing Agreements

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BOEHMERT & BOEHMERT

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Commercialization Procedures: Technology Acquisition/Marketing/Valuation/ Licensing, Companies Legal Contracts and Agreements

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(Paper presented by Prof. Dr. Heinz Goddar, German Patent Attorney, European Patent and Trademark Attorney, Boehmert & Boehmert, Munich, Germany, , http://www.boehmert.de, Past President of LES International (LESI), at WIPO National Seminar “Intellectual Property Rights (IPRs) and its Role in Economic Development”, Tehran, April 26 – 28, 2014)

1. What is “Licensing”?

Licensing means "permitting", and quite in general nothing can be licensed which the potential licensee is enabled or permitted to do even without the permittance by the potential licensor.

Usually, and at least in the understanding of this paper, by "licensing" it is understood that a third party, the licensee, is enabled to use patents and/or other intellectual property rights, particularly trademarks, abbreviated as “IPRs“, owned by the licensor, which otherwise the licensee could not use. Insofar, one has to distinguish between two completely different aspects of licensing, namely the enabling and the permitting aspect. As an example, in case of a pure know-how license, licensing means that the licensor enables the licensee to use the licensed know-how by disclosing same to the licensee, since otherwise, without the specific knowledge achieved by licensing, the acquiring party, the licensee, as a matter of course could not use such know-how. In other cases, like in a pure patent or trademark license, where the licensor would not undertake any obligation to teach the licensee anything more than one could already learn from a respective patent specification, and even essentially nothing in case of trademark licensing, there is only a licensing in the sense as granted by the patent and the trademark, respectively.

In any case, securing its exclusivity by appropriate IPRs with respect to a certain technology, trademark, design, copyright, or trade secret, is the first duty of any potential licensor, since without such title and right, i. e. without IPRs in the most general sense, there is nothing to prohibit, and therefore also nothing to permit and accordingly to license for the licensor.

2. Typical Kinds of License Agreements – Exclusive, Non-Exclusive, “Sole” Licenses

License Agreements can provide for the transfer of rights to the licensee in many different manners.

A first kind of licenses, particularly in case of patents, are exclusive licenses, in which the patentee (or owner of secret know-how) does not retain any right to use the licensed technology, as an example, itself. In such a case, the licensor is left with the formal right and title in the respective patent etc., without any right to develop further activities in relation to the licensed subject.

A different kind of an exclusive license, often designated as "sole" license, means that the licensor grants an exclusive license with the exemption, however, that the licensor is entitled to continue using the licensed subject. In a strictly legal sense, according to German Law, even such a license can have a so-called factual effect, like an exclusive license, making it impossible for the licensor to dispose of the licensed patent etc. in any manner, different from non-exclusive licenses to be discussed below, even in cases where such a non-exclusive license contains the obligation of the licensor not to grant any further sub-license.

Strictly to be separated, under legal aspects, from the aforementioned two different kinds of exclusive licenses, in which, e.g., the licensor cannot dispose in any manner of the licensed patent etc. anymore, though possibly being entitled ("sole" license) to continue using the licensed right himself, are non-exclusive licenses. These can either be given in the manner that the licensor is not restricted at all to grant further non-exclusive licenses to third parties, but also in a manner in which the licensor undertakes not to grant any further non-exclusive licenses to other parties. The latter is not an "exclusive license", however, rather there is only the legal, private obligation of the licensor towards the licensee not to grant any further licenses, with no effect for the factual ability of the licensor to dispose of the licensed right

etc.

As one can imagine, of course the kind of license granted influences the amount of royalties and remuneration to the licensor, respectively, to be discussed lateron, the general rule being that the higher the exclusivity granted to a licensee, the higher the remuneration for the licensor.

Specific problems very often are created by the lack of understanding of the difference between a really “exclusive” license and a “sole” license. As an example from the own practice of the author: Not too long ago, a German manufacturer of medical instruments, of a not too big size, which thereafter became a client of the author of this paper, had a serious problem. The German company, having an excellent patent portfolio, but neither the personnel nor the money to develop production, got a very generous, as it seemed, offer to take an exclusive license under the major part of its patent portfolio, covering its main product, from an U.S. company. An exclusive license agreement was concluded, with a substantial initial down-payment, of a world-wide nature, whereafter the German company finally hoped to have the possibility to develop production to an extent that it could satisfy the demands of the German and even European market. Shortly after conclusion of the agreement, the German company was requested by the U.S. licensor to stop production, because of the existence of the exclusive license. Fortunately, because of the interest of the U.S. licensor in the continuing cooperation of the main inventor in the field in question and the respective future consultancy services, was prepared to renegotiate the deal to the extent that, based on the principle of various territorial restrictions, a solution which was acceptable to both parties could be found.

What the German company in this case had in mind, and thought to have concluded, was a “sole” license agreement, but unfortunately the whole character of the agreement, as well as the wording, just was different. Care must be taken in view of such pitfalls!

3. Warranties

Typically, in license negotiations the licensee will request the licensor to give three different kind of warranties, namely a) that the use of the licensed technology does not infringe any third parties’ rights, b) that the licensed patents are valid, c) that the licensed products have certain technical qualities, like yield in case of a chemical method of manufacturing etc., and d) that the licensed products do not do any harm to customers, users etc., i.e. product liability should be on the shoulders of the licensor.

Out of the aforementioned three types of typical warranty situations, c) is easiest to solve, since, from the viewpoint of the author, it is related to something which the licensor, by due diligence and knowing its technology, can rather easily agree on: Provided that the license agreement is absolutely clear with regard to the e. g. kind in which a yield should be measured, quality should be determined etc., such a warranty can be given based on full own experiences of the licensor with certainty.

It can only be warned against warranties of the kind as mentioned under a) and b) however: The licensor, under no circumstances, can be sure that the licensed patent(s) are valid, since it is always possible that a certain piece of prior art shows up which never was found in any earlier search. The same applies for third parties’ patents as mentioned under b).

It is therefore strongly recommended to agree in license agreements only on clauses of the type that the licensor assures that according to its best knowledge the patent(s) is/are valid and the licensed technology does not infringe any third parties’ rights.

Also, product liability, as listed under d) above, is extremely critical. The licensor usually is neither familiar with use in control of the specific market situations the licensed technology is subjected to, and accordingly it would not appear as fair to burden such a kind of “warranty” to the licensor.

4. Special Provisions Concerning Trademark Licensing

Both the German Trademark Act, namely in its Article 30, and the Community Trademark Regulation, in its Article 22, explicitly provide for the possibility to license a trademark out either for all or only a part of the goods and services, respectively, covered by the trademark. Also, it is explicitly said that a license can be granted either for the whole territory covered by the trademark, i. e. in case of a German trademark the whole of Germany, or in the case of a Community Trademark (CTM) the whole European Union, and it is also clearly stated that a license can be exclusive or non-exclusive, all as discussed above with regard to patents.

A specific aspect of licensing of trademarks is that only if a permanent quality control by the licensor takes place the use of the trademark by the licensee is considered as being of a nature which fulfils the requirements of use of the trademark, i. e. avoids cancellation possibilities even if the licensor does not use the trademark himself or herself, respectively. If a respective provision is not contained in a license agreement, and, even worth, if no factual control takes place, the use of the trademark by the licensee would not be sufficient for preventing the trademark from cancellation because of non-use.

5. Financial Terms in Licensing Agreements

5.1. Running Royalties

In most license agreements, “running royalties” provisions are found which usually are formulated in the manner that the licensee has to pay to the licensor a certain percentage of a “provision”, based on the net turnover the licensee achieves with licensed products. Running royalties, in other words, are “success-dependant”, they are strictly related to the volume of the commercial success which the licensee achieves with the license granted. If running royalties are determined in the manner of fixed payments per volume unit soled by a licensee, which sometimes is done, there will be no automatic adjustment to the price development of the respective market, particularly not to inflation. Accordingly, in such a case a clause should be introduced into a license agreement which makes the fixed payment per unit soled depending on the development of e.g. prices, like consumer index, in a territory involved, which is normally the territory of the licensor.

If running royalties, however, are formulated as a percentage, an “automatic” adjustment to price developments takes place, which makes a formula of the aforementioned kind, namely an index-related provision, unnecessary.

As for the height of running royalties, there is no fixed rule to achieve. Very often one finds, however, both in literature and also in practice, royalty rates of about 25 % of the profit before taxes which the licensee achieves either with the respective specific product or which is generally observed in the respective industry.

In other words, if the earnings before income tax (“ebit”) in such a field of technology is
10 %, like e.g. in some parts of machinery in Germany, a royalty rate of 2.5 % might be observed. If in a pharmaceutical blockbuster case the profits before tax would lie in the region of 60 %, just as an example, one may find royalty rates of 15 % or even higher.

Very often, the royalty rates will follow a decreasing scale, based on the volume of turnover achieved by a licensee. This could look like follows: For the first 1 Mio. € turnover per year, the royalty rate would be 4 %, for the next 1 Mio. € per year, 3 %, for the next and all higher turnovers 2 %. Also, a total cap p.a. can be used, or even a total cap for the time of use of the license, i.e. after a few years the license would be fully paid up.

All these formulas are common in international licensing, and, if wisely used, give both licensor and licensee a high degree of contractual flexibility.

5.2. Minimum Royalties

Another element very often found in license agreements are the minimum royalties already discussed above. As for the height of such minimum royalties, one never, practically, will observe that the minimum royalties would be higher than, say, 50 % than the accumulated running royalties to be expected for the respective business year if the business plan on the basis of which the parties have concluded the license agreement, i.e. the “expectations” of the parties, would be fulfilled. More often, one will find minimum royalty rates between 10 % and 40 % of the aforementioned expected running royalty rates, in an accumulated form, for the respective calendar year.

When agreeing on minimum royalties in a license agreement, one should make sure that the parties clearly distinguish between the use of minimum royalties as an “insurance” policy in favour of the licensor, with the aim of giving the licensor the possibility to terminate the agreement, or, as an example, to modify an otherwise exclusive or sole license agreement into a non-exclusive license agreement, if certain minimum payments are not made. This use of minimum royalties, usually on a scale based on business plan principles, i. e. varying over the years of the lifetime of such a license agreement, makes a lot of sense.

Another type of minimum royalties, however, is sometimes agreed on in a form which imposes onto the licensee the obligation under all circumstances to pay certain minimum fees per calendar for a certain period of time, without a termination possibility for the licensee. This can be the way into bankruptcy, if the license product does not fly or other circumstances prevent the licensee from making successful use of the agreed on license. From the author’s viewpoint, an agreement on such a type of minimum royalties should only be made if in fact the minimum royalties are some kind of instalment payments for the transfer of know-how, whereby replacing an otherwise heavy initial down-payment, since otherwise the commercial uncertainties for the licensee might not be tolerable.