A licence, is nothing more than permission to do something that otherwise would not be permitted. In fact, all manner of intellectual property rights are apt to be licensed to others, and for many patents, licensing is the most important way to exploit them. In this article, our intellectual property solicitors discuss how you can determine the value of your patent and explain what terms you should include in your patent licensing agreement.
- Why licensing is an attractive option for patent rights owners
- Determining the value of your patent
- What to include in your patent licence agreement
- Difficult Clauses
- Negotiating terms – How to prepare
- Granting of the patent licence
- Alternatives patent licensing
Why licensing is an attractive option for patent rights owners
There is no mystery about why you might choose to exploit a patent you own by allowing others to work it, rather than working it yourself. For a start, if you don’t have a factory, it might well be easier to find someone who does, rather than build, and equip, your own. Even if you could afford to do it yourself, you might be able to get your invention into production and onto the market much more quickly by finding a licensee.
Finding a licensee may also be a good way to break into a new market, overcoming language problems and familiarity with local legal and other requirements. And, whether you’re looking to get started or to expand what you are already doing, granting a licence to another business will spread the risk.
A licence might also be needed to settle a patent dispute with someone who has infringed your patent. That’s a very different situation from a licence between willing parties, and it’s not the purpose of this article to deal with licences like that. Nor does this article deal with compulsory licences, which may be imposed by law on the owners of patents in certain circumstances.
Determining the value of your patent
To strike a good licensing deal, you need to be in the right place at the right time - and you need at least a bit of luck.
- Where does your invention fit into the supply chain - is it something that end users will want to buy, or is it something that a manufacturer can use?
- Is your invention in an expanding field? Even the most brilliant invention in the field of coal-mining won't be as valuable now as an invention in the renewable energy sector.
- Is there already a market for your invention, or will the licensee have to put a lot of effort into advertising to tell customers why they need it? That will have a big impact on how much they will be willing to pay you to use it.
You'll have to be adaptable, too. If new developments in technology make your patent less valuable you will have to work to make sure your patents, and licences of them, retain their value. And, as with every agreement, you will always have to be prepared to walk away if it no longer makes sense - either not to do the deal, or invoke the termination provisions if you have granted a licence.
What to include in your patent licence agreement
Patent licences do not come in a “one size fits all” form. Most of the terms will probably have to be individually negotiated – starting with the most basic issue: what sort of licence is it to be?
Patent licences – and licences of other intellectual property – come in three broad types, and generally in three broad price ranges. Your licensee will be prepared to pay more or less, depending on what rights you want to retain, but usually commercial considerations will dictate that you grant an exclusive licence.
- Exclusive – under an exclusive licence the licensee alone will be able to work the patent within the agreed scope. If your aim is to get your products made locally for a national or regional market that you haven’t broken into yourself, the licensee is likely to want a clause that will stop you competing by selling goods that you manufacture in that same market, or granting a licence to its existing competitor in the next town. Granting an exclusive licence means that your agreement contains restrictions on competition, and it will have to comply with competition law rules - you will not be free to agree whatever you like, and will need expert advice from a patent attorney to avoid problems.
- Non exclusive – you retain the right to grant licences to other manufacturers in the territory, or within the same field of use. This probably does not give the licensee the comfort it needs before putting money into new production lines and factories, so is unlikely to be the right sort of deal for a patent – but sometimes it will be suitable.
- Sole licence – you won’t grant a licence to anyone else in the territory (or for that field of use, or however else the scope of the licence might be limited) but there’s nothing to stop you working the patent yourself. The prospect of facing competition from its licensor is unlikely to be attractive to a licensee, but again it might sometimes work.
Clauses to include in your patent licence
Start date and duration: there may be good reasons for selecting a particular start date, but the date on which the licence agreement is executed will often do the job. The licence could be granted for a set term, or it could last as long as the licensed patents. If there are multiple patents involved, the agreement might allow royalties to reduce as the patents expire. Once all the patents have expired there is nothing left to pay for. However, the licence could still be relevant if know-how is included and remains secret, and often there will be a trade mark licence rolled up in the arrangement for which the licensee should continue to pay (and indeed the value of a licence to use the trade mark might well increase over time, as the reputation of the licensed goods grows).
There will also be clauses dealing with termination, including where one of the parties commits a breach (see below) but in addition to that it is common to deal with the situation where revenue does not meet expectations. The last thing you want is to be tied into an under-performing licensee for the lifetime of the patents, and one way to avoid problems is to make the licence non-exclusive if targets are not met: that way you can appoint a new licensee, or perhaps start to sell your own products.
Payment/Payment schedule: Obviously the agreement needs to deal with the amount of royalties, and any other payments that may be due. Royalties are usually periodic, but there could be a lump sum payable for the grant of the licence either instead of or as well as periodic royalties. Thought should be given to what is the appropriate period for payments, which will have a big impact on cashflow. And writing in a stipulation about minimum royalties may be a useful way to ensure that the licensee focuses on making the licence work, perhaps more effectively than the threat of termination if they fail to meet targets.
This is also the point at which to mention that licence agreements should ideally (for the licensor) contain clauses permitting them to pay visits to the licensee and carry out checks and audits, to make sure they are being paid what is due to them.
Termination clauses: Although the licence will expire by effluxion of time, it’s important to make sure that it can be terminated if the other party is in breach. This does not have to be a summary matter: it took you some time to find the licensee, and you don’t want to find that if they don’t pay on time your only sanction is to terminate the agreement. If a breach can be cured, it is usually better to give the defaulting party 30 days or so to put it right before using the nuclear option and terminating the agreement.
The licence can also provide for termination for convenience, on a few weeks’ or months’ notice, but patent owners looking for licensees are unlikely to find takers for a deal that could be undone for no reason over a short time.
How to terminate the patent licence: The whole point of having a written agreement is to achieve certainty about the terms of the deal, and the goal of certainty would not be achieved if the carefully-crafted agreement could be terminated by a phone call. Notice should be required to be in writing, and it is normal to go into some detail about how it should be delivered.
Consequences of not following the correct procedure: If a party fails to follow the correct procedure to terminate the agreement, you need to think carefully about what the consequences should be. If a party wants to get out of an agreement but misses the exit, the result is probably that both parties end up in a relationship with someone they don’t want to work with any longer. This may look like a matter to be agreed between the parties if it happens, but if the agreement sets out a process for dealing with it (the party receiving the notice can choose to waive the defect, for example) it might make for an easier parting of the ways.
Dispute resolution clause: Rather than submitting to the courts - with all the expense and publicity that entails - it is common to find that all manner of commercial agreements, including patent licences, include specific provisions about resolving disputes. This often means arbitration (still expensive, but private) but may also include mediation, where a neutral third party helps the parties settle their differences, and sometimes expert determination, where the parties agree to accept what an expert tells them to do, which may be appropriate if there is a disagreement about a technical matter.
Know how licence: A patent does not provide a complete set of instructions on how to implement the invention it protects. The law requires a patent to disclose enough to enable someone who knows the relevant area of technology to work the invention, but the owner of the patent is likely to know a great deal more about the best way to do it. That know-how, which the patent owner will be anxious to keep secret, should also be made available to the licensee - not only will that help ensure that the products made by the licensee are of high quality, but it may also provide a way to keep the agreement going (and royalties coming in) after the patents expire.
Other considerations to include in a patent licence
- Who is responsible for enforcement action? The law deals with the rights of licensees to take action against infringers - and of course the licensee has as great an interest in protecting the patent as the owner does. If the licensee is in another country, the owner of the patent (especially if it's a SME or an individual inventor) might have good reason to hand responsibility to the licensee.
- Who is responsible for renewals? If renewal fees are not paid on time, the patents at the heart of the deal could be lost. If the owner fails to renew, the licensee will normally want to take care of it - the attraction of the licence is that it enjoys the protection of the patent, so unless the royalties have become onerous (and perhaps the patents haven't long left to run) you should keep the patents in force.
- How much can I expect to receive in royalty payments? There are as many answers to this question as there are patent licensing deals in the world. It's almost entirely a commercial question, one for a valuer not a lawyer, although there are decisions on compulsory licensing which give an indication (where the Comptroller General of Patents will take 5 per cent as a starting point for a simple mechanical invention). That's not to say that you can always set whatever rate you want, though: in some situations (in particular where use of a patented invention is essential for complying with a standard) the terms of the licence have to be fair, reasonable and non-discriminatory ("FRAND") to meet the requirements of competition law.
Some clauses in a patent licence need specialist expertise. This is particularly the case when an exclusive licence has to comply with competition rules, including the technology transfer block exemption (which is not covered in depth in this note).
- What are the rights over which the licence is granted? Typically, there will be rights over know-how as well as identified patents. The territorial scope of the licence will determine which patents should be included - if the licensee is going to be manufacturing in France and supplying the market there, it only needs licences over patents that are effective in France. The licence might also extend to copyright (for example, in computer programs or engineering drawings) and designs that are needed to make the products, as well as trade marks owned by the licensor, if they want to be identified on the licensee's products.
- What about know-how? The licensee will want access to the patent owner's know-how, but for a licence to be effective the know-how must be secret, substantial and identified.
- How will any relevant know-how be identified? It's very hard to identify information, much easier to identify documents - so there should be a record of what documents, containing the know-how, are handed over to the licensee at the outset and from time to time during the term of the licence.
- How will it be shared between the parties? At the start of the licence, the disclosure of know-how will all be one-way, from the licensor to the licensee. The licensee will no doubt have their own know-how, and care must be taken to identify that and treat it appropriately (which may mean leaving it out of the arrangements, or allowing the licensor access to it, or whatever works in the particular situation). During the term of the licence, though, both parties are likely to create more know-how: do they share it (and if so on what terms), or do they keep it themselves? If there are multiple licensees (where the licences are geographical, for example) it may be appropriate to ensure that they share know-how among themselves, too.
- What happens if the know-how becomes public? If it's no longer secret, the basis for granting a licence to use it falls away and may have to terminate - and if it has become public through some act or omission of the licensee, that should be grounds for termination in itself.
- What about patent applications? if the licence covers patent applications and they never get granted, the licence should be worded so that it remains in force for any other patents that are included and also for know-how, copyright, designs, and trade marks.
- Can you charge royalties for sales in countries not covered by the patents? You probably can, if you structure the licence correctly. The first thing to consider is whether the licensee is given rights to make the product - and if they are, does it matter where they are sold? The second consideration is whether, if the licence is to market the products rather than to make them, there is a patent covering the other market and if so whether you have licensed it to someone else. Within the EU, trying to restrict cross-border sales can be illegal, and outside the EU there may be similar rules in other trading blocs. There is no single answer to this question, so your licences will have to be carefully crafted to achieve the commercial result you want within the law of the territories concerned.
- What is the Field of Use? Different licensees can be allowed to work the invention in different fields. An invention might be of value in the automotive and aerospace industries, and you might want to grant licences to different companies in those two areas. Defining the Field of Use by industry might be enough, but a more nuanced approach could be necessary - boundaries that are clear today could be blurred tomorrow, and may disappear altogether next week. The Field of Use can also be defined by the different roles potential customers play in the industry, such as Tier1s in automotive. Another possibility is to define it by reference to size, power, mass or some other engineering-led criterion.
- Improvements. What will the rights be over further developments that the licensor makes - will they be included in the licence, or subject to a separate deal? It will probably make a difference if the licensee is also paying for development work in parallel, and the licensee's contribution will have to be recognised.
- Improvements by the licensee. How will the rights over further developments that the licensee makes be treated? It will probably make a difference if the licensee did that development using know-how provided by the licensor under a parallel development agreement under which the licensee commissions the design that is the subject of the licence.
- Who will manufacture? British R&D companies may be tempted to take on manufacturing obligations without the necessary infrastructure, but that can be risky. It’s often better to commit to the manufacture of proof-of-concept or pre-production products only, and to give the customer (if they are larger) the option to do the mass-manufacture itself or to commission third parties to do so.
- Second-sourcing. If the customer wants to be able to second-source products, are there any limits on who it can use?
Negotiating terms – How to prepare
Planning and preparation are essential to negotiating the best deal. If you haven't already got someone interested in taking a licence, you'll have to start by finding a prospective licensee (or two, or more) - which may be a matter of doing your own research, using your own contacts, or engaging an innovation broker to help.
If you have someone lined up, the next step is to draw up heads of agreement or a term sheet in consultation with them. As far as the fundamentals go, there's not much point in making a unilateral offer: if you propose a non-exclusive licence, but they want an exclusive one to justify the investment they are going to have to make, things are not going to proceed very far. In a geographical licence, the territory is likely to be easily defined. Identifying the field of use might be more difficult, depending on the parties' ambitions. Other terms, such as royalty rates, will probably emerge from a horse-trading process.
Because exclusive patent and know-how licences raise competition law issues, you should take expert legal advice even at the pre-contractual stage to ensure that you are not promising the licensor things that you are not allowed to deliver.
Granting of the patent licence
Once the terms of the agreement have been settled and set out in your term sheet, they need to be translated into a contract with all the ancillary stuff that makes a contract work but which you don't deal with at the negotiating stage. As well as making sure that the agreement complies with competition rules, if they apply, attention has to be given to the "boilerplate" clauses that ensure it works. It's likely to be a big document, but there is quite a lot of detail that needs to be included.
Alternatives patent licensing
Patents don't earn money by themselves. Someone has to work the inventions protected by the patents, making and selling products. If you can't, or don't want to, do it yourself, you need to find some other way to get those products on the market - which is the aim of granting a licence. There are other possibilities: you can sell your patent to another enterprise and let them worry about exploiting it, making sure that they pay you for the privilege - whether that's a lump sum at the outset or periodic payments while the patent remains in force, or both. You can also start a joint venture with one or more others who bring different things to the party - manufacturing and marketing expertise, for example, to complement your inventiveness. But the heart of a joint venture arrangement is a licence of the patents, so what we have said above still holds true.
A final possibility might be to use your patent as security and raise a loan on it, but unless it's already proving itself in the market - that is, someone is making the products and people are buying them - lenders aren't likely to be very interested, so this possibility is ancillary to the "do it yourself" and licensing approaches.
Getting a patent granted for your invention is an important first step, which gives you legal protection. But it doesn't give you an income, and granting licences to others to work the invention in return for paying you a royalty is a common way to exploit a patent. You have to get the terms right, though, and that means negotiating the best possible deal for the parties as well as ensuring that you don't agree anything unlawful. Harper James patent attorneys have wide experience of negotiating and drafting patent licences, contact us today and arrange your initial no-obligation consultation.