Licensing

A Licence defines the arrangements by which the owner of a right grants permission to exploit that right to one or more others. The arrangements are normally established for the mutual benefit of all involved, and takes the form of a written Licence Agreement. Those involved are referred to as “parties” to the agreement.

One common licensing situation occurs where one party - the “Licensor” – has goods or services which he is unwilling or unable to exploit, and another party - the “Licensee” – is willing and able to exploit the market for those goods or services. For a licence to have any value to either party, the Licensor must have some legally enforceable right in respect of his goods or services. For example, the Licensor may have an enforceable patent or registered design protecting the goods or services, or rights in respect of trade marks, copyright, know how, plant and equipment, dies or moulds or trade secrets.

A Licence Agreement should not be composed as an instruction manual setting out how the Licensee and Licensor are to carry on with their business. For parties which are at “arms-length” in the deal, the licence agreements are not normally meant to give one party dominance over the other. An exception may be the case of a Franchise Agreement between a Franchisee who is eager to benefit from the Franchisor’s good will and reputation and a Franchisor who is concerned with maintaining standards in respect of products or services to be provided by others under his name.

In order to understand what may be gained from licensing, a sound knowledge of the available forms of protection is desirable because most licence agreements grant permission to the licensee to exploit the rights embodied in such protection. It can readily be appreciated that the more comprehensive the protection held in the name of the Licensor, the more value will attach to the licence.

Negotiations between a Licensor and Licensee will normally centre on monetary values and the quantity and quality of goods or services to be made under licence. Monetary values typically include, for example, an initial lump sum payment, and royalties, regular minimum payments and the like. Many licences are established on the basis of royalties alone. It is suggested that the licence should be based on a figure which cannot be readily manipulated by accounting procedures. For example, “profit” is a figure which can be manipulated by accounting treatments, whereas, for example, quantity of product manufactured or sold is not so prone. It is also common to include a performance clause, such as a minimum monthly, quarterly or annual royalty payments. In considering such arrangements, attention should be given to taxation and other legal obligations. Suitable termination clauses will be required to accommodate the circumstances where either party fails to perform or if any party simply does not want to continue with the relationship.

One of the major monetary issues to settle between the parties is that of the remuneration payable by the licensee to the licensor. Typically, the remuneration is in the form of a royalty payment. It is normally considered appropriate that the licensee should enjoy the major proportion of the benefits of exploitation of the licensed products. Accordingly, over many years, a “one quarter” rule has developed, meaning that the licensor should receive about one quarter of the expected profits of the exploitation of the licence. Accordingly, if the expected profits are 20%, then the royalty payable would be set at 5% (being ¼ of 20%). The basis for calculation for the expected profit is normally what is referred to as a “fully loaded” profit — that is, a profit in respect of which overheads such as management and administration (M&A) and research and development (R&D) costs are taken into consideration. The royalty rate itself, once established by the one quarter rule, is normally based on a figure which cannot be readily manipulated by accounting treatments, such as, for example, percentage of invoice sales.

After the basic considerations have been settled, the frame of a Licence Agreement may be constructed. The basic "heads of agreement" which are generally agreed as satisfactory to both parties are settled and used to draft of a suitable Licence Agreement. Standard clauses for maintaining the real worth of the licence fee and protecting both parties from what are regarded as reasonably foreseeable possibilities should be added and the final agreement submitted for approval and possible amendment by both parties. Once all parties are satisfied, the Licence Agreement is executed by the parties. The licence is then in effect.

The actual "heads of agreement" selected by the parties depend on the prevailing circumstances at the time as well as what may reasonably be predicted. For example, the parties would normally consider what the licensor has to offer and the licensee's willingness to gain the anticipated advantages offered. The licence agreement must be formulated so that it is not disadvantageous to any of the parties concerned, so that the quality of the goods or services are maintained and regulated and so that in the event of foreseeable contingencies a suitable outcome can be achieved quickly whereby continued promotion and sale of the product or process is not adversely affected.

Typical clause headings for intellectual property licences are as follows:

  1. Definitions;
  2. Royalties;
  3. Minimum Sales;
  4. Term of agreement;
  5. Territorial restriction and type (e. g. sole, exclusive or non-exclusive);
  6. Use of trade marks;
  7. Sales promotion (best endeavours to meet demand, etc.);
  8. Compliance with specifications of licensor;
  9. Improvements (disposition of intellectual property in relation thereto);
  10. Assistance in manufacture and at whose cost;
  11. Accounts;
  12. Royalties to cease on invalidity of protection;
  13. Determination in certain events (general);
  14. Licensee and/or licensor not to assign without approval;
  15. Granting of sub-licences;
  16. Notice of infringement;
  17. Actions for infringement;
  18. Validity of patent or other intellectual property right;
  19. Petition for revocation of patent protection (or other attack on the IP);
  20. No other licence at less royalty;
  21. Service of Notices;
  22. Interpretation and/or arbitration.

The Licence Agreement should not be executed until both parties have had the document or documents perused by a legal practitioner — preferably one who is experienced in commercial law and not too focussed on taking an adversarial position with the other party, but at the same time, protecting the interests of the party he or she represents. Additionally, the legal practitioners will ensure the document complies with legal requirements governing “agreements”, “contracts”, “deeds” and such like and possibly attend to such other matters which may be required, such as the registration, stamping or taxation of such documents. Moreover, legal practitioners can advise generally and in relation to clauses which may well be “legal”, but not necessarily “enforceable”.

The aim of a licence is to enable two or more parties to co-operate for their mutual benefit, and in any endeavour it is mostly up to the entrepreneurial skills of the parties or their negotiators to make a venture succeed. This cannot be achieved by having a licence agreement alone, no matter how comprehensive or mutually beneficial the agreement may seem. In fact there are many successful agreements based on little more than mutual trust and understanding between the parties. This is not to say that a licence is not needed. It is nearly always preferable, and the more at stake, the more it becomes essential. However, it should be appreciated that all parties concerned should work hard at maintaining the long term relationship so that it remains healthy and beneficial to all parties.

This page was updated on Tuesday, 21 May 2013.


2013 Bill Anderson