Licensing Termination Provisions for Under-performing License Agreements
After securing a patent on an invention and you are making money, another company may want to use the patented technology in their product or service. To give a business the right to use the patented technology, the patent holder and the business enter into a contract for the right to use the intellectual property of the patent holder. The relationship might start off well but over a period of time with the pressures of business, the patent holder or the licensee may want to get out of the license. Because the patent holder may be dissatisfied with the licensee, the patent holder must negotiate the terms of the agreement so that the patent holder can terminate license when that happens. We will explore licensing termination provisions which would help the patent holder get out of the license when it is not beneficial.
First off, why would a patent holder want to license the technology out to someone else if they are using the patented technology in its own products?
In many instances, I would agree. Why would you want to let a competitor incorporate your patented feature into their product offering? You would think that there would be very little incentive for a patent owner to allow others to compete against them in the marketplace. The theory would be that every widget that the competitor sells is one less widget that the patent holder could have sold and made a profit.
Two benefits for extending a license
Here are two reasons the patent owner may want to license the patented technology out to others such as cross-licensing.
- Expand current market share: The inventor has started to market and manufacture the patented product but is unable to fully penetrate the market. The inventor may want to collaborate with another company that might have a better distribution model or some specialized knowledge to bring revenues to the next level and penetrate the market. The potential licensee may have special know-how that is useful to the patent owner that will allow them to expand their market share. In this instance, it may be worthwhile to allow others to license out the patented technology.
- Different niche: If the potential licensee wants to utilize the patented technology in an unrelated niche field from that of the inventor.
Typically, an inventor would get a patent in their niche field. However, the goal of patent protection is, yes, to secure patent protection in the inventor’s niche field but over the long run to broaden the scope of patent protection into other niches or what we refer to as fields of use.
To give you an example, if the inventor patented a feature that goes on a desktop computer, the goal would be to secure a patent for the feature as it would be incorporated into a desktop computer. However, a good patent strategy would be to expand that patent protection by building a portfolio of patents to include laptops, smartphone, etc. Since the inventor is not in these other niches, a possible win-win situation would be to license and collect royalties from multiple licensee from diverse niches while still selling widgets in the inventor’s own niche.
Why is it important to negotiate licensing termination provisions to help you exit a license agreement?
Okay, now that possible reasons for extending a license has been discussed, the thought process of reviewing the license agreement will be discussed.
An important structural aspect of a license agreement is the “exit.” There is no clause or title referred to as the exit but it is important to learn about how to set up the contract through the licensing termination provisions so that the patent holder can terminate the agreement and exit the deal. After all, the patent owner wouldn’t want to be bound by the deal if it isn’t beneficial.
The patent owner and the licensee wouldn’t want to be bound by the deal if it is not beneficial to either one of them. If the term of the license agreement is five years but one party fails to deliver on results, then the other party would want to be able to exit the deal. During negotiations, the patent owner may puff up the benefits of the technology and the licensee may exaggerate its ability to market the invention. The puffery and the exaggeration increase the expectations of the parties as they enter into the license agreement. This sets up the relationship for failure because one or both parties won’t be able to live up the expectations that they set up for themselves. One or both parties may want to exit the deal and terminate terminate the agreement.
How to build in the exit in a license agreement?
A good place to start is the termination or term of the license provisions. This section will provide the conditions under which the parties can terminate the agreement. Thinking in terms of worst case scenario is a good idea when reviewing a license agreement. If the term of the license agreement is five years, then the patent owner needs to consider whether it is acceptable to have this entity as a licensee during the entire five year period. For example, let’s say that the licensee exaggerated its capabilities but only delivers meager results during those five years. Would that be acceptable? Would it be acceptable for the patent owner to be bound by the license agreement for the full five years?
If the license agreement is exclusive to one licensee and the licensee is not performing as claimed during the negotiation process, then that would be a bad deal because the patent owner would have to accept meager results and would not be able to license the patented technology out to others because of its exclusivity. The agreement should have a way that the patent owner can terminate the agreement before the five years is up.
Nonexclusive agreement doesn’t necessarily help
The patent owner might think that setting up the license agreement as a non-exclusive license so that the patent holder can extend multiple licenses might be the way to mitigate being bound by a nonperforming license. However, that might not be the case. If the patent owner found another licensee but that licensee wanted an exclusive, then the deal cannot be made because the patent owner cannot get out of the non-exclusive license and cannot extend an exclusive license.
The non-exclusivity of the license agreement only allows the patent owner to extend additional non-exclusive licenses.
Two provisions for negotiating in an exit to the license agreement
Two provisions can be written into the license agreement which require the licensee to make the licensor or patent holder satisfied with the license are performance milestones and a minimum yearly royalty. If these requirements are not met by the licensee, then the licensee would be in breach of the agreement. The contract would allow the patent holder to provide notice that the license will be terminated. The patent holder can exit the agreement before the full term of the agreement.
The first is performance milestones. These are acceptable performance markers that make the agreement attractive in terms of whether the patent owner would want to stay in the agreement. For example, performance milestones may be a series of concrete steps that the licensee must take within a certain period of time.
In the beginning, the concrete steps may be to:
- prepare a business plan,
- build a website,
- set up manufacturing for the patented technology,
- get three distributors or
- whatever steps the parties agree are reasonable.
As time progresses, the performance milestones may turn into minimum yearly sales requirements. If the performance milestones are not met, the terms of the agreement should allow the patent holder to give notice to the licensee and terminate the contract. The performance milestones can mimic those activities that are required for the licensee to build up sales. If the licensee is not doing the basics, then that would frustrate the patent holder. The patent holder would naturally want to terminate the license.
Minimum yearly royalty
The second is referred to as a minimum yearly royalty. The minimum yearly royalty is a minimum dollar amount that the patent holder would like to be paid for the licensee to tie up the patent rights of the patent holder. The minimum yearly royalty is the royalty that the licensee is required to pay even if the royalty calculations based on sales fall below the amount of the minimum yearly royalty. By paying the minimum yearly royalty, the licensee forces the patent owner to stay in the agreement if the licensee believes that the drop in sales will go back up in future years. The licensee doesn’t have to lose the rights granted under the license just because of a bad year or missing one of the performance milestones.
The minimum yearly royalty should be the amount that the patent holder would want to make to be satisfied with the contact. In the event that the licensee is not able to generate enough sales to exceed the minimum yearly royalty, the licensee must still pay the minimum yearly royalty or the patent holder has the option to terminate the license. The patent owner could exit the agreement if and when the minimum yearly royalty is not paid. The minimum yearly royalty is a minimum benefit that the patent owner is willing to accept to maintain the license.
Many different terms of the agreement needs to be negotiated when reviewing a license agreement. A quick search on the internet will uncover various lists produced by other attorneys regarding specific provisions and clauses. However, the performance milestones and the minimum yearly royalty should be negotiated into the agreement. Otherwise, the patent holder risks the possibility that they would be required to stay in the agreement.