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Drafting a Licensing Agreement, A Patentee Perspective

Written by Gene Quinn
Patent Attorney & Founder of IPWatchdog
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Posted: Aug 12, 2011 @ 4:48 pm
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Having an attorney draft a licensing agreement, or a licensing expert negotiate a licensing agreement, from start to finish would obviously be the best way to proceed. But there will always be some who will choose to proceed on their own to negotiate a licensing and/or draft an agreement.  This can certainly be dangerous, but sometimes there is no alternative given finances.  Whether you are going to represent yourself or work with an attorney or licensing professional, it is a worthwhile endeavor to engage in some of the strategic thinking, which must be the precursor to any memorialized deal.

First, when embarking upon a licensing path it is absolutely essential that you stop thinking in terms of a template for a license and start thinking in terms of clauses for a license. Attorneys cringe when they hear someone ask for a contract or license template. The reason for this is every situation is different. Certainly there are standard clauses that need to be there, but a license is just an agreement between the parties who sign the document and enter into a business relationship.  As a result, the license needs to memorialize what you and the other party have or will agree to moving forward.

Notwithstanding what is said above, when most attorneys draft a license they will start with clauses from other agreements and modify them to fit the particular situation and desires of the parties. That is the way I always draft agreements and that is how my own law school professor taught us many years ago. The best place to start to find sample licensing agreements is at a law library. This is true because the really useful licensing and contract books that attorneys use are also extremely expensive to purchase, sometimes costing as much as $1,000. But don’t worry, you might just be surprised to learn that law libraries are all over the place. Many court houses have at least a modest library, and all law schools have extensive libraries, which is a requirement for ABA approval.  ABA approval is the holy grail or certifications for law schools so if you can get access to a law school library you are all set. Even a modestly stocked library might be sufficient in a quest for sample licensing agreements, but I would call ahead to see if they have what you need. Law schools will definitely have what you need, but again, call ahead. Some law schools do not let members of the general public use the library.

What you will need is an encyclopedia of forms. West has an encyclopedia set called West’s Legal Forms. In the Second Edition it is Volume 25 that relates to patents (I know this because I own that volume myself). There are a number of good sample licenses in the West book. If you find a library that has a good intellectual property section (which is becoming easier given the growth of this field of practice) there will be several smaller encyclopedias dedicated to patent licensing, such as Milgram on Licensing. In most libraries the form books will be in one location and the IP books in another location, so be sure to check both locations.

There are also some decent books you can get from your local book store, but these books will not have the amount of information and samples that a form encyclopedia would have. You can also probably find some sample agreements online as well. Probably the best online examples would come from universities. A lot of universities have sample agreements online. These agreements, however, may not be right for every situation. Frequently universities are licensing early stage technologies, sometimes even before a patent has been obtained and many times before a patent has issued. Remember, as you build your draft license, or a wish-list of terms to take to your attorney or licensing professional, you don’t want to copy any single form.  Instead go through the examples you can collect and pick clauses (or paragraphs) that seem to fit your needs and preferences. So the more examples you have the better.

PAYMENT RELATED CONSIDERATIONS

As for what needs to be in a license, there are a lot of things that do, but definitely pay particular attention to how royalties will be paid. After all, that is the primary reason the patentee or inventor wants to enter into such an arrangement.

You might want to consider some type of up front guaranteed payment to ensure that you get at least something.  This may seem overly pessimistic, but it is the job of any attorney negotiating or drafting a license to assume that things will go wrong.  The agreement can never contemplate everything, but with respect to payment you need protection. What if the licensee is paying you a defined percentage of sales but then decides to offer your product for free, or as an add-on to a sale, as is common in direct TV marketing?  If your product is used as a “come on” and given away for free even 100% of $0 is still $0.  That is why some type of minimum payment can be quite beneficial.

Another important consideration is this: what does the phrase “percentage of sales” mean?  Accountants have all kinds of terms they can throw around to confuse you.  Consider whether the royalty will be paid on profits or net proceeds. Net proceeds are typically calculated as the total amount of a sale less transaction costs associated with the sale, but make sure you read the definition section of any license you sign.

In terms of profits, it is quite easy from an accounting standpoint to sweep all kinds of expenses into the equation to show less profit.  In fact, over the years I have seen accountants masterfully prove that something that anyone in their right might would consider profitable really produced a loss.  That is good when it comes time to pay taxes, but not good for you the licensor dependent on maximizing the number you get a percentage from.  With this in mind, many times you will be better off to accept a lesser royalty on net proceeds than a larger royalty on profits. It is also easier from an accounting perspective to just use net proceeds.

It is also a good idea to include a clause that allows for some form of an accounting, which will allow you to access the financial records to verify compliance with royalty requirements.  Of course, you also want clear due dates for payments and likely penalties for late, or at least repeatedly late, payments.

NON-PAYMENT RELATED CONSIDERATIONS

In addition to the aforementioned financial terms, you should also consider include the following:

  1. Patent Marking: According to 35 U.S.C. 287(a), you cannot receive damages in a patent infringement action unless the product being is “marked” with the U.S. Patent No.  The statute explains: “[N]o damages shall be recovered by the patentee in any action for infringement, except on proof that the infringer was notified of the infringement and continued to infringe thereafter, in which event damages may be recovered only for infringement occurring after such notice.”  So you should make sure there is some requirement that the licensee mark the product with the Patent No.
  2. Type of License: What kind of license do you want to give to the licensee?  There are primarily three choices: (1) an Exclusive License; (2) a Non-Exclusive License; or (3) a Sole License. An Exclusive License is one where you basically transfer all of the rights to make, use, sell and import to a single entity.  With a Non-Exclusive License you transfer the rights to make, use, sell and import but also reserve the right to license others; thus the Non-Exclusive License is frequently characterized as merely as permission or a covenant not to sue.  A Sole License typically permits both the patent holder and licensee to exploit invention covered by the patent, so it falls between an Exclusive License and Non-Exclusive License in terms of the rights conveyed.   Generally speaking, the more rights you give the licensee the higher you can expect your payments to be.  For many inventors there is little negotiating room, particularly if you want a big retailer or manufacturer to license your patent. They hold the cards, have the distribution chain you desire and will almost certainly dictate most (or all) terms.
  3. License Duration: How long do you want the license to last?  Before you say “as long as possible,” consider the real possibility that sales might not meet expectations, which mean your payments might be quite a bit lower than you anticipated. While many don’t see it this way, the reality is a patent has a short duration, and for many products the market half-life will be well shorter still than the entire patent term.  The last thing you want is to get locked into an under performing agreement that wastes patent and market life-span when other options might prove more lucrative.  With this in mind you might have the license last for an initial period and be renewable, or have the license terminate in the event sales do not reach a particular threshold or they decline.  Having a minimum payment you can live with makes this somewhat less important, but not irrelevant.
  4. Patents & Trade Secrets: Once upon a time it was more difficult to obtain a license without an issued patent, and some companies still adhere rather strictly to the requirement a patent already be issued prior to licensing.  Many companies, however, will consider licensing a pending patent application.  But what happens if the U.S. Patent and Trademark Office refuses to issue a patent?  Does your licensing agreement evaporate?  Even if you never obtain a patent you have still provided the licensee with something of value, as evidenced by their willingness to pay a royalty.  The information you disclosed, which you didn’t have to disclose, was likely protected as a trade secret, which can be quite valuable.  Therefore, you really want to make sure any agreement relates to both patents and trade secrets.  While you cannot collect on a patent license after the patent expires you can still keep collecting on a trade secret license under the right factual scenario.
  5. Right to Sub-license: If you give a party a license and they have a right to sub-license they are allowed to provide others permission to use your patent/invention.  With the right accounting procedures in place this isn’t likely very problematic in the case of an Exclusive License.  You just want to get paid the agreed rate per each sale.  But sub-licensing or even licensing subsidiaries in the case of a Non-Exclusive License or Sole License can be more concerning.  You just want to make sure you know who will or could get rights and how you would get paid.  If you are entering into a Sole License and expecting only you and one other company in the market you might not want sub-licensees cannibalizing market share even if you do get paid.
  6. Dispute Resolution: By this point this type of clause is likely standard in most every contract or license, but you want to consider what happens if everything goes bad and there is a disagreement about what the terms of the agreement mandate.  Do you want to litigate?  If you do want to litigate where do you want to litigate?  Would you prefer arbitration instead of litigation?  Arbitration can be much quicker, much less expensive, but it largely doesn’t give you any right to appeal an adverse decision.
The above discussion of financial and non-financial related considerations is not intended to be exhaustive, but should give you an idea about at least some important terms from the patentee/inventor perspective.
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Posted in: Business, Educational Information for Inventors, Gene Quinn, Inventors Information, IP News, IPWatchdog.com Articles, Licensing, Patents


About the Author

is a US Patent Attorney, law professor and the founder of IPWatchdog.com. He is also a principal lecturer in the top patent bar review course in the nation, which helps aspiring patent attorneys and patent agents prepare themselves to pass the patent bar exam. Gene started the widely popular intellectual property website IPWatchdog.com in 1999, and since that time the site has had many millions of unique visitors. Gene has been quoted in the Wall Street Journal, the New York Times, the LA Times, USA Today, CNN Money, NPR and various other newspapers and magazines worldwide. He represents individuals, small businesses and start-up corporations. As an electrical engineer with a computer engineering focus his specialty is electronic and computer devices, Internet applications, software and business methods.

 

 


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6 comments
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  1. Hello Gene-

    Thanks for delving into this issue a bit for us, which is rarely discussed anywhere. Since I just recently filed a formal application the topic is of some interest for me. Performance clauses, sunset clauses, and exclusive versus non licenses might make a big difference for me if I decide to license instead of boot-strapping things on my own More profit and more control in the latter case, but it will of course be much riskier. I might have found an Angel investor to make a start-up possible, but as you of all will probably appreciate, that could dissappear in a matter of days or a few seconds.

    Regards,
    Stan~

  2. Thanks Stan. Glad you found the article useful. Good luck with the Angel! I hope it works out for you.

    -Gene

  3. Gene,

    Defining the royalty base (e.g., “percentage of sales”) is a huge issue, and one that all parties to the agreement (not just the attorneys) should understand. Another related issue is how to determine what it the appropriate percentage for calclulating the royalty using that royalty base. You can probably imagine how many times I’ve been asked “what’s an appropriate royalty percentage” by a client, and how many times I’ve told them it depends on a number of factors, including the industry involved, how many units of the product are expected to be sold, what is the margin (e.g., net profit however calculated) for the particular industry, etc. For example, in a high volume but low margin industry such as foods/beverages, a lower royalty percentage might be appropriate. In a higher margin industry, such as drugs, a higher royalty percentage might be appropriate. My point here is that there isn’t a “template” cookie-cutter answer to what is the appropriate royalty percentage, but instead you’ve got to do some research on the industry involved and use some smarts to figure it out for each case.

  4. Please pardon the thread crossover – see the FTC Proposal thread.

    The “proper” royalty base does not exist because that is a market driven point of negotiation.

    That is another reason why compulsory licensing is a dangerous concept. The reality of the market is that there will not always be a license drafted, there will not always be a meetign of the minds. It is up to the participants to agree to agree and the power to walk away from any deal is a critical component of the free market system. By forcing an agreement, the government has become a Nanny-state intruder into the freedom to contract that is getting the short shrift.

    This is not to say that a State’s police powers cannot intervene – but it is to say that the type of intervention is necessarily a Federal power and any such intervention – by the appropriate branch of the government (the legislature) will need to meet a strict scrutiny analysis – which entails that no other mechanism is available, and as this country has had such a mechanism for hundreds of years, any compulsory licensing law would have (and properly should have) an extremely uphill battle.

  5. I have an agreement with company to manufacture and sell our patented product,(utility patent#6,092484) we are not happy wih agreement. itwas for 1 year and to be reevaluated at one year ,it didnt happen due to BP oil spill. it crushed the market. It is starting to come back what are our options?

  6. As a result, the license needs to memorialize….what does this mean?