Guide to Licensing - Part II

WHO ARE YOU LICENSING TO?

A final key issue for a licensor to consider before entering into any licensing arrangement is the deal as envisaged by the licensee. Is the licensee intending to use the product for its own use, or is it on-licensing the product to end-users?
For example, the licensee may be acting as a value added reseller of the licensor’s product: taking the licensor’s technology, adding functionality or some form of application, and reselling the enhanced product to end-users.
The risk for the licensor is that while it may be happy to allow the licensee to on-licence in this way, the licensor’s contract is with the licensee and not with the end-users. The licensor cannot therefore contractually control the way in which the end-user uses the enhanced product: for example, in the case of software on-licensed to an end-user, the original licensor has no direct contractual ability to prevent the end-user from modifying or attempting to decompile the software’s code.

Licensors can deal with this problem in two ways. Firstly, the licensor can impose an obligation on the licensee to include in the licensee’s agreements with end-users restrictions on the end-user’s use of the licensor’s technology. Alternatively, the licensor can use its licence agreement with the licensee to oblige the licensee to require end-users to enter into direct agreements with the licensor in the form of an end-user licence agreement.

KEY LICENSE TERMS

This section lists commercial provisions which commonly feature in licence agreements. Depending on the particular licensing transaction, some of the terms may or may not be relevant: for example, a SaaS (software as a service) licence will not contain provisions relating to the delivery or installation of the software forming the basis of the SaaS service. Additionally, it is important to remember that the description of the provisions is structured from the licensor’s point of view: the recommendations are made to protect the licensor, and should not be followed by any organisation acting as licensee.


PRODUCT PERFORMANCE TERMS

· delivery/installation: although not applicable to all licences, many agreements will have provisions specifying how the licensor’s product will be delivered to the licensee and/or installed. The scope of the arrangements vary from deal to deal: in the case of a simple transaction, delivery may simply be specified to occur on a particular date; in the case of a heavy-weight IT implementation, there will be a formal implementation plan with specific milestones to be achieved by the licensor.

The licensor should take care in relation to the following areas:
· timing: although the licensor may be happy to comply with specified delivery dates, it should take care to avoid any commitment that “time is of the essence” in relation to delivery. This imposes an extremely strict obligation on the licensor to meet the agreed delivery dates: failure by the licensor to do so will usually constitute a breach of contract sufficient to allow the licensee to terminate the license agreement.

· Transfer of risk/title: licensors should take particular care to ensure there’s no wording in agreement referring to the transfer of title to any product being transferred from licensor to licensee. This would mean that ownership of the product passes from the licensor to the licensee: this would turn the licensing arrangement into a sale.

Wording dealing with the transfer of risk, however, can be found in licence agreements, particularly where licensed technology is contained in hardware. A transfer of risk transfers responsibility for protecting and insuring the product: it is in the licensor’s interests to ensure that transfer of risk occurs no later than the point of delivery.

· delay payments: in a complex installation, and particularly in relation to the public sector, the licensee may require compensation payments from the licensee if the licensee fails to achieve milestone stages on time. Ideally, these should be resisted: the licensor could as an alternative suggest that the sums payable to it for installation be linked to fulfilment of milestones, in order to induce it to fulfil milestones on time.

Care needs to be taken here as to how a licensor can demonstrate that a milestone is fulfilled: this should not be left to the sole opinion of the licensee. In any case, any delay payment structure should relieve the licensor from making compensation in specified situations, such as where installation was prevented by acts beyond the licensor’s reasonable control, or by any action or inactivity of the licensee.
· acceptance tests: again, these may not apply to all licence agreements, but are commonly required by licencees requiring larger than average software installations. The ideal position for the licensor is that the product is deemed accepted on delivery: however, the licensee may require some ability to test the product before confirming that it is accepted.

If the licensor is prepared to accept some degree of acceptance testing, it should take particular care in relation to the following:

· what are the tests? The licensor should at all times seek to control the extent of the tests: under no circumstances should the licensor accept any test standard allowing the licensee free range to decide whether the product does what the licensee wants it to. If possible, acceptance tests should be formulated by the licensor to ensure that fulfilment of the tests is within the capability of the product
· who decides if the tests are passed? The licensor should avoid allowing the licensee to determine this in its complete discretion: ideally, the requirement should be that the tests are passed when the licensor demonstrates material fulfilment of the acceptance tests.

In any case, the licensor should seek extra protection by specifying that acceptance is deemed to have occurred where no contrary notification has been made by the licensee within a specified time period, or where the licensee has remained silent on the tests but has put the product into every day use.

· What happens if the tests aren’t passed? A contract drafted aggressively in the licensee’s favour may specify that failure to pass acceptance tests allows the licensee to terminate and reclaim all fees paid by it. This should be avoided: the licensor should argue to keep any payments made so far, and should be allowed at least a couple more attempts to remedy any problems and re-test the product before termination occurs.

· warranties: the warranties available in a licence agreement are normally limited:

· product performance: the licensor usually has to give some warranty that the product will perform in a certain way for a certain length of time after delivery or, if required, satisfaction of acceptance tests. The test is typically that the product will perform in accordance with the product’s specification, which will be included in the licence agreement (see below).
While committing to this as a principle, the licensor can take a number of steps to diminish the burden of this commitment. Firstly, the standard of performance: the licensor should as a starting point argue that the equipment should only perform “materially” in accordance with the specification. Secondly, the length of the warranty period should be restricted as far as possible, for example to three months.

Next, if the licensor gives this warranty it should argue that this is its sole commitment to the performance of the product, and should include into the agreement an exclusion of all other warranties, whether express or implied at statute or at common law. Finally, the licensee should seek to control what happens if the licensee can show that the performance warranty is breached in the warranty period: instead of allowing the licensee to reclaim fees it has paid, the licensor should commit to replacing or repairing the equipment within a reasonable time.

· right to grant licence: the licensor will normally warrant that it has the right to grant the licence. This impacts directly on the “back-to-back” issue raised in the earlier section, Where does your IP come from? The wording of the warranty will normally require the Licensor to promise that it has secured all necessary consents to licence its product. If the product contains IP obtained by the licensor from a third party, and the licensor doesn’t have the right to on-license that IP to the licensee, the licensor will be in breach of this warranty.

Here, too, the licensor can control the scope of damage caused by this warranty being breached. Instead of allowing the licensee to claim back costs it has suffered as a result of the warranty breach, the licensor can try to negotiate provisions stating that the licensee’s sole remedy is for the licensor to replace the product with IP which won’t breach the warranty, or to obtain the necessary permissions from the owner of infringing IP to avoid breach of the warranty in the future.

· service level agreements: a licence drafted in the licensor’s favour will provide that at the end of the performance warranty period, the licensor is no longer responsible for the product’s performance. Any problems with performance will thereafter be dealt with by maintenance services provided by the licensor, for which the licensee will pay.

If maintenance services are required, their extent will typically be described in a schedule to the contract: the licensee may well seek to impose some performance standard, including by requiring certain service levels to be stated. An example of this would be time periods for response by the licensor to the licensee’s notification of a problem.

The licensor may be happy for minimum service levels to be specified, if it is confident of reaching them. Alternatively, the licensor may seek to dilute the service levels, for example by stating that they are only target service levels.
· product specification: licensees will want to ensure that a clear and precise specification is included in the licence. This enables the licensee to tie down the licensor to delivering a product which achieves a specified performance standard.

Licensors therefore have to be very careful in how the specification is described. In many cases, the less specific commitment in terms of functionality, the lower the performance standard the licensor will have to attain. However, in certain situations it is absolutely in the licensor’s interest to be as specific as possible: an example from the biotech industry would be the licensing of a process as a trade secret, where it is in the licensor’s interest to describe the process as clearly as possible in order to delineate precisely the extent of the trade secret.
Finally, it may well be sensible to build an element of flexibility into the specification: licensing objectives change, and products are continually modified and enhanced.

IP OWNERSHIP PROTECTION TERMS

· scope of licence: this is a crucial clause in any licence. The licensor will want to control what the licensee can do with the product. The extent of this control varies according to the deal: a licensor distributing software to users around the world will have less restrictions than a licensor allowing a very limited number of licensees to exploit the licensor’s technology. Main examples of controls are as follows:

· exclusivity: licensing a product on an exclusive basis means the licensee is the only person able to use the product. In certain situations, including an exclusive license of copyright, this can prevent the licensor itself from using the product.

An absolute exclusive licence is therefore relatively rare, and is usually found in media circles: for example where a broadcaster is commissioning a television programme or a film, and requires an exclusive licence for a period of time to allow it the sole right to exploit the product.

More usually, exclusive licences are granted on a territorial basis, and/or for a particular business demographic: for example, licensing to the automotive industry in the island of Ireland. This allows the licensor to licence separately to the automotive industry outside Ireland, and/or to non-automotive industries in or outside Ireland.

The commercial rationale behind giving exclusive licences, whether territorially or demographically defined, is that the licensee should pay a premium for receiving the commercial advantage of being the sole licensee of a particular product within a regional/demographic market.

The size of the premium will depend on the size of the commercial advantage, but a licensor should always consider the ability of the licensee fully to exploit the licensed product within its market. Does it have the ability to use the product in the best way to meet the licensor’s aspirations for the relevant market, which could be pure revenue receipts or raising the profile of the licensee’s brand? Is there a risk that by granting the licensee some form of exclusivity, the licensor is limiting its own prospects by missing out on alternative, perhaps superior, partners within the excluded market?

Finally, in any commercial area where the licensor wishes to be able to sell to the licensee’s competitors, the licensor needs to check that the licence is expressed to be on a non-exclusive basis.

· non-transferability: the licence should make it clear that it is non-transferable, so that the licensee cannot transfer its benefit under the licence to another party with whom the licensor would have no contract and who the licensor would not be able to control. The licence should also restrict the licensee from sub-licensing, unless the licensor has agreed that the licensee can do this (in which case, the licensor should be imposing obligations on end-users: see EULAs below)

· restrictions on scope of use: the licensor will wish to place a number of restrictions on the licensee’s use of the licensed product. This may include a limit on the number of users of the product (above which limit the licensee must pay an additional licence fee), or a restriction on the use of the product for any other purpose than the licensee’s stated business use.

Additionally, different licences would place specific restraints on the licensee from doing anything with the licensed product which could give the licensee a proprietary interest in it, or understanding of how the product operated. For example, a software licence should always prevent the licensee from modifying or decompiling the product, in particular way as would give the licensee access from the object code to reach the source code.

In summary, the scope of the licence needs to be particularly carefully considered and drafted. The licensor needs to balance the creation of a licence which the licensee will accept with the certainty that the scope of the licence does not rob the product of its IP protection, nor restrain the licensor’s commercial activities in its desired markets.
· confidentiality: confidentiality clauses in licence agreements are usually included as a “boilerplate” term expected of any contract documenting a business arrangement. Usually, the clause obliges each party (licensor and licensee) to protect the other party’s confidential information.

The licensor needs to take care here: the protection may be useful to preserve any of the licensor’s confidential information (such as pricing information, business methods, even the licensor’s performance under the licensing contract). In particular, in a trade secret licensing agreement, care needs to be taken to ensure that the full extent of the trade secret is classed as confidential. However, care needs to be taken in defining what the licensee’s confidential information is: in particular, will it include data processed by the licensee as part of its business, for instance customer data? For example, a SaaS system licensor whose system inadvertently disclosed customer information could in this situation find itself in breach of confidentiality requirements.

In certain situations, however, the confidentiality wording is mandatory to protect the licensor’s IP: for example, licensing of any process as a trade secret. In situations where the licensor wishes to ensure the licensee’s confidentiality, the licensor should also consider an explicit indemnity from the licensee to compensate it financially for any loss suffered as a result of a confidentiality breach. Additionally, the licence should allow the licensor to take pre-emptive steps to prevent a breach where it believes this likely, for example by obtaining an injunction.

· escrow: in certain licensing situations, particularly in IT transactions, the licensee may call for products to be placed in escrow. An escrow agreement is a tri-partite arrangement under which the licensor agrees to deposit a copy of the product with an escrow agent. The escrow agent undertakes to the licensee that it will deliver a copy of the product to the licensee in certain events, including in particular the insolvency of the licensor.

Escrow agreements are of particular use where a licensee believes itself dependent on the licensor’s product, and fears that its ability to use the product will be materially affected by the licensor’s insolvency. In a software licensing situation, the source code of the software would be held in escrow and released to allow the licensee to develop the code itself or get outside assistance to do so.
If licensors find themselves forced to accept escrow agreements, the terms of the escrow agreement should be carefully examined: in particular, the terms stating when the product held in escrow is released to the licensee. One thing for the licensor to be wary of is any commitment that its product is released upon its insolvency: there are several stages of insolvency, and the licensor should avoid escrow being triggered at too early a stage of the insolvency process.

· ownership of IPRs: another particularly important clause in any licence agreement. This clause should make it clear that the licensor retains ownership of all IPRs licenced by it under the agreement. The licensee should acknowledge that it gains no interest in these rights, and cannot deal with them (for example, by leasing, sub-licensing, charging by way of security) in any way other than specifically and explicitly permitted by the licensor. It is imperative that the licensor asserts its ownership in this way to ensure that it retains control if its IP.

· EULAs: end-user provisions are appropriate where the licensee has the licensor’s permission to on-license the product to its own customers. The licensor’s concerns here are explained in greater detail in the preceding section, Who are you licensing to?

LIMITATION OF LIABILITY TERMS

· liability for breach of performance warranty: the manner in which the licensor should limits its liability for failure of the product to work properly is described more fully at Warranties above. The licensor should resist as far as possible any attempt by the licensee to seek an indemnity from the licensor. This would allow the licensee a contractual right to claim compensation of loss it can prove it suffered as a result of the product’s failure to perform. Indemnification is a contractual obligation on the licensor: if the licensee can establish loss, the licensor has to pay up.

The licensor should argue that, instead of having the advantage of a contractual right to compensation, the licensee should only get compensation if the courts think fit: i.e., the licensee has to demonstrate the worth of its claim by first proving it in the courts.

If the licensee successfully negotiates an indemnity, the licensor should insist that the indemnity is subject to a financial cap: see general limitation below.

· liability for breach of intellectual property rights warranty: again, the recommended limitation of liability is detailed at Warranties above. Here, too, the licensee may well seek a specific indemnity to compensate it for loss occasioned by a third party claim that the licensee’s use of the product infringes the third party’s IPRs. The request for this indemnity should be dealt with as per the previous bullet point. Additionally, the conduct of any such third party claim should be transferred into the control of the licensor, so that the licensor can be confident that the licensee will not admit to breach of the third party’s IPRs, or offer any settlement amount, without the licensor’s approval.

· general limitation: it is a commercially accepted principle that a licensor may attempt to limit various grounds on which it may be liable to the licensee. This principle is based on the concept that the value of the licensed product in the licensee’s business, and the potential damage which the licensee may suffer if the product fails, may far exceed the price paid by the licensee to the licensor.
Losses fall into different types:

· death or personal injury caused by the licensor’s negligence: a licensor cannot exclude its liability for this sort of loss

· damage to tangible property: because of the relatively wide availability of insurance on reasonable terms against liability for damage to tangible property, it is not unusual for there to be a specific limit for property damage which is capped at a higher amount than the limit for financial losses

· financial loss: the remaining category of loss is largely financial. A licensor should seek to limit the scope of loss in two ways. Firstly, by negotiating a financial cap, reasonably proportionate to the amount received by the licensor by way of payment: secondly, to exclude liability for a range of losses which are not direct consequences of the licensor’s act and which are too indirect reasonably to be compensated.

One final point: it is always in the licensor’s interest to limit its liability as far as possible. Generally, however, limitations of liability apply to both parties to a contract: the licensor needs to take care that by negotiating a low liability cap it has not inadvertently restricted its own ability to claim adequate sums from the licensee, for example where the licensee breaches its own obligations. At the most extreme, a licence negotiated aggressively in the licensor’s favour would only allow limitation of the licensor’s liability to the licensee, and not vice-versa: the success of such a limitation would depend, as ever, on the bargaining power of the parties.


PROTECTING THE DEAL TERMS

· payment: clear terms describing how the licensor will be paid are obviously crucial to a licence agreement. The timing of payments depend on the deal: in shorter transactions, the licensor may require payment up front: in longer transactions, the licensor may be happy to receive payment on a periodic basis. In transactions where the licensor has to incur significant initial costs itself to meet installation or implementation requirements, the licensor will typically ask for a large payment to cover its own costs up front, and then a subsequent periodic annual charge for licencing and perhaps maintenance. The successful licensor will negotiate the periodic payments as being annually in advance.

The licensor should also consider on what basis it wishes to be paid. Will it require a flat fee? Is the licence agreement sufficiently lengthy as to require price increase mechanisms to be included? If the licence is on an exclusive territorial or demographic basis, the licensor may want an increased reward in exchange for its grant of exclusivity: for example, it may require the licensee to buy a minimum amount of the licensed product, or commit to a minimum number of sales within a particular period. The licensor could require that these minimums increase as the contract continues.

Frequently, the licensor requires a percentage share of the revenues as its payment. The licensor must take particular care over how its share is calculated: what revenues is the share based on? Are taxes deducted first? Is any other amount, for example the licensee’s purchase or installation costs? Care in drafting the basis of revenue share calculation will protect the amount payable to the licensor.

· duration: the licensor will wish to ensure that the license runs for an appropriate length. This requires careful thought: too short, and the licensor might not receive sufficient payment to recompense its own investment in the license; too long, and the licensor may find itself trapped into an unprofitable transaction. The licensor should consider its own business model to see the minimum length it wants a contract to last in order to recover costs and hit its commercial targets: the licensor can also control risk here by ensuring that appropriate termination provisions are inserted into the licence.

· termination and its consequences: termination has two important purposes for the licensor:

· firstly, to ensure that it can terminate its relationship with the licensee in the event of the licensee’s material breach of the licence agreement, or the licensee’s insolvency. This can protect the licensor against any actual, or even anticipated, disclosure or unauthorised modification of the licensor’s IP: it can also, where drafted appropriately, allow the licensor to terminate the licence if the licensee continually fails to pay

· secondly, the licensor may require a termination “at will” provision. This is a break clause allowing either party to close down the contract by giving written notice. The licensor will, as noted at duration above, wish there to be a minimum period in which the licensee cannot terminate at will. For example, a licence agreement may specify that there is a licence period of five years, after which the agreement can be terminated by either party on three months’ written notice.

In an relationship where a licensor is receiving a revenue share payment, a licensor can use a termination at will provision effectively to hedge its bets: it may want a five year relationship, for example, but also want the ability to get out of the relationship after three years if the licensee is not succeeding in exploiting the licensed product. In such a situation, the licence would allow for a minimum five year lock-in term, but would allow either party to terminate at the end of year three if the revenue share received by the licensor at that point was less than an agreed amount.

The final point in relation to termination is that the licence should be very clear about the consequences of termination. Fundamentally, the licence to use the licenced property should be stated to cease. If the licensor requires any materials or product to be returned, this should be stated in the contract.