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Considerations in licensing

What is a licence?

A licence is permission to do something that would, in the absence of permission, infringe intellectual property rights. It is different to an assignment, which is a transfer of ownership of the intellectual property.

Using a house as an analogy for the intellectual property, renting the house is like granting an exclusive licence, while selling the house would be an assignment.

A licence does not have to cover all the rights enjoyed by the IP owner. The owner may licence the right to market products but not manufacture them for example, or market products in a particular country or for particular uses but not others. In this way, each exclusive right of the IP owner (for example, if we are talking about patent rights relating to a new vaccine, to make, use, exercise and vend) can be sliced and diced according to field of use (eg animal not human), region (Europe not the rest of the world), vertical markets (to wholesalers not retailers) and horizontal markets (over the counter not prescription).

All forms of IP can be licensed, including patents, trade secrets (know-how), copyright, trade marks, designs and plant variety rights.

The rewards obtained by the licensor for the grant of rights can include an upfront payment, ongoing royalties, milestone payments, equity, services, R&D funding and access to improvements.

Licenses are often confused with other forms of commercial agreements, such as distribution agreements, agency agreements and franchise agreements which in some cases, do involve certain elements of licensing.

A distribution agreement is essentially an agreement by a manufacturer to supply product to a distributor, who will add a margin and resell the product and generally represent and support the product in the market. The product is sold to the distributor’s own account. The distributor will usually warehouse the product, and sell directly to the public or engage with retailers. The agreement could be exclusive or non-exclusive. No licence is required in this arrangement because the distributor is simply reselling product purchased from the IP owner. In some cases, a trade mark licence may be entered into with the distributor as part of the distributorship, for example, if the distributor is producing its own advertising material and such like, to ensure control is retained over use of the trade mark.

An agency agreement is like a distribution agreement, except the agent sells on behalf of the manufacturer, not on its own account, and usually for a commission. The agent is essentially a contracted sales representative for the manufacturer. The agent can bind the manufacturer to contracts if authorised to do so.

A franchise agreement is a very specialised form of a licence agreement, involving a trade mark licence combined with at least a know-how licence and sometimes a copyright licence. Essentially, the franchisor gives the franchisee the right to use a particular reputable brand name and a business system (set out in a manual). A franchise usually involves a greater degree of involvement by the franchisor in the franchisee’s business and reliance by the franchisee on that assistance, than in the case of a licensor/licensee relationship. The agreement is founded upon the principle of mutual good faith.

Why enter into a licence?

The desirability of a licence arrangement has to be considered from two perspectives, that of the potential licensee (“licensing-in”) and of the potential licensor (“licensing-out”).

Licensing-in is appropriate when a protected technology could provide a significant competitive advantage, and it is either impossible to design around the protection, and/or it is more cost effective to pay a royalty for use of the technology than to create it from scratch or design around the protection.

Licensing-out is an effective strategy in circumstances where giving third parties access to the technology in return for a fee will generate greater revenue for the same or less risk as not granting access. For example, granting rights in foreign territories or in relation to non-core applications for the technology.

The licensing process

The first step is to assess the opportunity presented, that is whether to grant a licence to a particular licensee, or to accept a licence for a product or process. Usually, the initial approach will be by way of a letter outlining the opportunity, together with a brief synopsis of the technology and a process for advancing the discussions.

The person receiving the letter seeking an expression of interest will then engage in a fact finding exercise, using any available external resources. These may include accessing annual reports, conducting searches of:

  • Companies office records on the company;
  • Its directors and shareholders;
  • Personal property register searches;
  • Intellectual property register searches; and
  • The internet. Once this initial review is complete the decision is made whether to progress further with the opportunity.

Usually, a confidentiality agreement will be signed, which will permit full disclosure of the innovation, unpublished patent applications, business plans and other commercial information. At this stage, each party may conduct its own preliminary opportunity assessment and due diligence investigation. The preliminary due diligence is likely to cover the technology, reputation, market share information, sales force and processes, financial information and culture of the other party.

At this point the negotiation is under way. The parties may reach agreement upon the key terms and conditions of their licence, and record these in a memorandum of understanding or heads of agreement. This may or may not be a legally binding agreement, so it is important to address this issue specifically. Usually the intention is to record the essentials of the deal, to provide a degree of certainty to each side while the final formal agreement is drafted and executed.

In some cases, due diligence will not occur until after the parties have signed a memorandum or heads of agreement.

Once the formal licence agreement has been signed, the physical process of technology transfer commences. This may involve a period of training by representatives of the licensor, delivery of prototypes, manufacturing drawings, software, operations manuals and such like.

Once the technology transfer has been completed, there may be ongoing involvement and interaction in the form of audits, performance monitoring and strategic reviews of the relationship.

Joint ownership issues

In the absence of an agreement to the contrary, each co-owner of a patent can make, use, exercise and vend the patented invention without accounting to the other co-owners. However, again subject to an agreement to the contrary, a co-owner of a patent cannot licence or sell the patent rights without the consent of all other co-owners.

A joint owner of copyright can do any of the restricted acts without consent from the other co-owners, can grant non-exclusive licenses, but cannot grant exclusive licenses.

Wherever possible, joint ownership should be avoided. Instead of sharing ownership, the parties should consider sharing the benefits of ownership (such as sharing in revenues generated from the product/process). The lines of accountability and control are clear, which leads to less confusion and fewer disputes.

Balancing risk and reward

The negotiation of a licence is essentially the allocation of risk and reward between the licensee and licensor. The more risk taken on by the licensee, the greater its portion of the reward from the innovation should be. This fundamental tenet should be remembered when a licensor is first seeking a licensee. The more risk the licensee can take out of the equation, the easier it will be to find a licensee and the better the licence terms will be for the licensor.

Accordingly, if the innovation is a mere idea without proof of principle, then the licence is a very risky proposition for the licensee. With proof of principle, there is less risk, and a working prototype will remove even further risk. If the licensor can demonstrate sales in another market, then again, it has reduced the risk from the licensee’s perspective.

With this in mind, the licensor must make a decision as to when it will be best to try to licence the IP. Simple net present value calculations based on revenue forecasts for each scenario can be conducted to determine the optimum point at which to begin licensing.