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Key terms for robust licensing

Posted on 08 October 2009

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By Susie Slaughter, Slaughter and May

Whatever the economic climate, licences warrant careful drafting since they are generally long-lasting agreements. In the biotechnology arena they also have an important role for both licensors and licensees in demonstrating commercial progress.

For a research-based company, the signing of a licence agreement is an important validation of its technology, and it of course secures a revenue stream. For a larger company, an in-licence may bring in new technology or revitalise its product pipeline.

Key agreements are scrutinised when companies are engaged in fundraising. The particular terms are crucial in protecting both parties’ investment, and uncertainties can lead to costly disputes. In difficult economic times, the fault lines may reveal themselves earlier. This article looks at some of the key terms in licences and suggests ways to address the issues they raise.

Licensing Strategy

A balance needs to be struck between securing terms which:

  • are flexible enough to allow for developments in the market or the licensee’s business,
  • provide the licensor with adequate and predictable remuneration,
  • reflect the relative bargaining positions of the parties (often a young biotechnology company will be in need of funding for further R&D and the keenness of the licensee will depend upon how good the technology is and what alternatives are available), and
  • enable the parties to extricate themselves from the arrangement in appropriate circumstances.

Funding needs may well prevail, but where there is flexibility, it is important to consider the motivation for and timing of licensing. Where a product is unproven and at an early stage, a licence can generate much-needed revenue, but it may be at the cost of a lower royalty and therefore of reduced return later. These issues will affect the licence terms. For example, an early licensee may require greater flexibility to withdraw if the product is less successful than anticipated or its own priorities alter. In other cases, the creator of the product or technology may simply not have the resources to commercialise it (either at all, or in some fields of application or territories). An early licence can then be a way of generating revenue from an asset that might otherwise be unused. Licences are often a key ingredient in the settlement of actual or prospective disputes and in these cases operate much less as working documents governing an ongoing relationship, and more as insurance policies against litigation.

Due Diligence

In difficult economic times and in difficult countries, it is particularly crucial to select a partner carefully and to gain a full understanding of the value of the technology being licensed. This can be difficult if choice is limited or if there is time pressure. Issues to consider include the following:

  • If you are licensor: is the licensee genuinely interested in the product and likely to remain so long term? Can you get a better return by signing up with one exclusive licensee or can a number of licensees better service a wide field of potential applications?
  • If you are licensee: what rights does the licensor hold, what do they cover, are there risks of invalidity? Can equivalent technology be obtained elsewhere? Does the licensor’s portfolio present a broader infringement risk not addressed by the licence?
  • For both parties, how financially sound is the party you are actually contracting with? Do you need a parent company guarantee? In difficult jurisdictions, it can be crucial in practical terms to have a partner who knows the local regulations and culture.

This article looks at key terms from an English law standpoint.

There is, however, a high degree of standardisation in international licensing contracts where the same issues will arise, and a licence will often encompass many jurisdictions.

Nonetheless, the effect of particular drafting may vary with local law and should be checked.

Key Terms in Licence Agreements

The key issues which any technology licence should address are as follows:

  • Scope, including subject-matter, field of use, territory and exclusivity,
  • Ownership of improvements and maintenance and enforcement of patents,
  • Payment,
  • Assignment, sub-licensing and change of control,
  • Warranties, indemnities and limitations of liability, and
  • Term and termination rights.

Scope of Licence

Subject-matter

It is vital that the licensed rights are defined as clearly and accurately as possible, to avoid disputes in the future. A smaller, younger company may have less bargaining power but should resist calls to grant a wide licence, since this may be perceived as reducing the value of key assets. On the other hand, a licensee will not want to run the risk of being sued for infringement of a relevant patent which is outside the licence.

A compromise may be access to further technology on agreed terms. If registered rights such as patents are to be licensed, these should be listed in a schedule. If the licence includes know-how, reaching an agreed definition can be more difficult. Thought may also need to be given to technical assistance from the licensor or access to its internal records.

Licences are typically drafted by reference to the scope of the claims of a patent (with the effect that an argument as to the scope of the licence becomes equivalent to a full-blown infringement dispute). Often this is sensible, although in some cases where a narrower scope can be clearly defined this can simplify things and provide greater certainty as to what is within the scope of the licence.

Where complex arrangements are necessary because the parties will have a degree of ongoing contact, the more detailed provisions of a collaboration agreement may well be appropriate.

Trade marks may be relevant: will the licensor and licensee sell the product under the same name (the licensor will probably own the mark) or under different names (each will own their mark)? If relevant patents are close to expiry a trademark may be crucial.

Field of use

The field in which the licensee may use the licensed rights is often the most contentious and heavily negotiated part of a licence. It can also be a difficult concept to capture in words.

The licensor will want the field to be drawn as narrowly as possible, whereas the licensee will argue for a wide definition. It may be crucial for the licensor to ensure that it remains able to maximise value by licensing in other fields.

Territory

It is important for a licence to set out expressly the territories in which a licensee may exercise its rights. Competition law may impose restrictions on the extent to which a licensee can be prevented from dealing outside that territory. Where patent protection has limited territorial coverage, know-how may still provide a basis for a licence. Thought should be given to the impact of patent rights expiring or being invalidated in different countries.

Exclusivity

The parties must decide whether the licence is to be exclusive, non-exclusive or sole. There is often confusion over the meaning of the terms ‘exclusive’ and ‘sole’: ‘exclusive’ means that only the licensee can use the licensed rights, ‘sole’ means that both licensee and licensor can use the rights. It is worth setting out each party’s rights rather than simply relying on these terms. Different exclusivity restrictions can be combined with fields of use and territories, so a licensee can have, for example, exclusive rights to develop a drug for a particular type of cancer in the United States and Europe, and a non-exclusive licence for another indication in the rest of the world. Exclusivity may be limited so that, for example, if the licensee fails to meet certain commercial targets, its licence may become non-exclusive.

Exclusive licensees have certain automatic legal rights, so it is important that these are appreciated and, if appropriate, expressly varied in the contract. It is particularly important for a young company to balance the need to secure agreements and revenue against the risk of restricting its future activities.

The grant of an exclusive licence may generate greatest revenue but also limits the commercial options going forward and an unsuccessful exclusive licence can have a significant effect on value.

Rights in Improvements

The basis of a licence is that the licensor retains ownership of the licensed rights. However, there is often a question as to who has the right to use and exploit any developments made to the technology during the licence term.

Depending on the circumstances, a technology licence may permit the licensee to use any improvements which the licensor may make to the technology. Alternatively, the licensee may be given a first option to acquire rights to any developments made by the licensor.

More importantly from the licensor’s perspective, the licensee may make improvements to the licensed technology, which the licensor will want the right to use. There is a temptation for a licensor to seek an exclusive licence or outright assignment of any improvements made by the licensee.

However, the parties need to be aware that provisions of this type generally offend against competition rules and are likely to be unenforceable. However, it is permitted (and very common) for the licensor to have a non-exclusive licence-back to use licensee improvements.

There is also the question of whether a right to use improvements should continue after the licence is terminated. This is likely to depend on why the agreement was terminated and by whom.

It will be sensible to split ownership of improvements according to the field of technology or the inventing party. The temptation to opt for joint ownership should generally be resisted, as it complicates arrangements and will leave the parties in a relationship that may outlast the licence.

Maintenance and Enforcement of Patents

In negotiating a patent licence, the parties must consider who is to assume responsibility for, and bear the costs of, maintenance and enforcement. In the case of a worldwide licence of a number of patents, maintenance costs will be considerable. Generally, the obligation to maintain the licensed patents will remain with the licensor as owner, but the responsibility and/or part of the cost is sometimes borne by the licensee, particularly in the case of an exclusive licence. An exclusive licensee will also want the right to take enforcement proceedings against third-party infringers (under English law this right is conferred by statute). A licensor should bear in mind that proceedings are likely to include defence of an invalidity attack and may therefore wish to retain control.

Whichever party bears primary responsibility, the agreement should provide that if it does not wish to maintain or enforce the licensed rights, the other has the right to do so. It is also advisable to include a provision for reciprocal notification of infringements of which either side becomes aware and to deal with each party providing assistance to the others, access to information and sharing of costs, damages and liability.

Payment

Long lead times on biotechnology products make for difficult financial calculations. There are several elements to licence funding: up-front payments, milestones and royalties. Again the balance between these will depend on the circumstances, in particular the extent to which the technology is key and/or proven or early stage and/or replaceable. Payments are an important tool for the licensor in incentivising the licensee.

Ideally a licensor will have specific performance obligations with deadlines imposed on the licensee. In practice, however, a payment obligation is often more effective as an incentive and easier to enforce.

Up-front Payment

For the licensee, this is the cost of buying into a licence or project. For the licensor, it is an opportunity to recoup its initial investment and thereby create the potential to diversify.

‘Milestone’ Payments

Milestone payments are sums payable on the happening of predetermined events. Common milestones are when a compound enters into a new stage, for example, the move from research to pre-clinical development, pre-clinical to Phase I, Phase I to Phase II, and so on. Other milestones can be linked to regulatory consents in major territories or first marketing of a product. It is important that technical milestones are clearly identifiable. The licensee will need to be satisfied that they are achievable in the set timetable. If not, is the penalty financial and/or a right of termination or loss of exclusivity?

Royalties

The objective for the majority of bio-industry productlicensing arrangements is the payment of a double-digit royalty on product sales. It is perhaps the easiest sum for the licensee to agree to pay, in that it is only due if sales are made.

However, the level and scales will be heavily dependent on the other payments that are negotiated. Another issue will be whether there are to be minimum royalties. The licensee will need to be satisfied that these leave adequate margin for error, failing which a change in circumstances may lead to loss of the licence. Sometimes a loss of exclusivity in those circumstances is a more palatable alternative, although this may remove the licensor’s ability to secure a premium for exclusivity. The receiving party should ensure that the party making the payments keeps adequate records and that there is a right to examine the information on which royalty information is based. The tax implications of any payment structure should also be considered.

Who Can Use the Licensed Rights?

The parties should agree at the outset who will be permitted to use the licensed rights. The three areas to consider are:

  • sub-licensing,
  • assignment, and
  • change of control provisions.

In general, a licensor will wish to be able to control who has access to its IPRs, whereas the licensee will seek to negotiate as much flexibility as possible. Restricted access will be a particularly critical issue if valuable know-how is licensed.

The ability to move the licence about is particularly important in the biotechnology sector, where technology and companies change hands regularly.

A common compromise is for the licensee to be able to assign and/or sub-license to affiliates without the consent of the licensor and to other parties with consent, not to be unreasonably withheld or delayed. This allows the licensor to object if, for example, the licensee proposes to assign the license to a competitor of the licensor. Change of control is usually dealt with in the termination provisions (see ‘Term and Termination’ below).

Warranties, Indemnities and Limitations of Liability

The licensor will commonly be asked for the following warranties:

  • that the licensor has the authority to enter into the licence,
  • that the grant of the licence by the licensor will not conflict with any of the licensor’s existing contractual obligations,
  • that the licensor owns and has the right to license the rights (for example, it has not already granted exclusivity to another party), and
  • that the licensee’s exercise of the rights granted will not infringe the intellectual property rights of any third party.

This is perhaps the most significant warranty, and the licensee may request that it is supported by an indemnity from the licensor. The licensor will want to ensure it is confined to the IP being licensed and that the licensee is responsible for its contribution to any infringement. That boundary can be difficult to identify.

A licence will generally also contain obligations on the licensee. These may include:

  • a warranty that the licensee has the authority to enter into the agreement,
  • an obligation to use best endeavours to maximise sales,
  • an agreement not to take any action to damage or impair the licensed rights, and/or
  • a warranty or indemnity in respect of product liability (except to the extent that is covered by the licensor’s warranties).

A prohibition on the licensee challenging the validity of the licensed rights may in some cases offend competition rules, but a challenge can, generally speaking, legitimately be made a ground for termination. There may also be obligations in relation to maintenance and enforcement of the licensed rights.

Sometimes limitations on liability (for example, exclusions for consequential loss) and caps are overlooked in licence negotiations. They should be regarded as critical. Thought should also be given to covering the gaps with insurance (particularly in relation to product liability) and to exclusion of pre-contractual statements.

Term and Termination

For a licensee, it may be desirable to seek an automatic rollover at the end of the initial term, or at least a contractual right of renewal, to allow for development of the licensee’s business plans. A licensor may seek a shorter term, again as an incentive on the licensee to perform, and to provide the flexibility to move to a new licensee if there is underperformance.

In any event, the parties should ensure that the licence term does not exceed the term of protection of the licensed patents, except to the extent that know-how is also licensed.

In addition to being commercially undesirable from the licensee’s perspective, attempts to restrict the licensee beyond the expiry of the licensed rights are likely to be unenforceable as being in conflict with EU competition law rules.

Commonly there are grounds for termination in the event of the following.

Insolvency

This is the standard right for either party to terminate if the other party becomes insolvent or ceases to carry on business etc.

Breach

The right to terminate for ‘material breach’ is considered by many to be standard. There is merit, however, in providing for specific events to trigger a termination right. This gives greater certainty and an ongoing measure of performance. Termination may, for example, be linked to milestones.

Change of Control

This is a provision allowing a party to terminate if the other company is acquired by a third party. This is particularly important for biotech companies that need flexibility to seek investment to fund R&D. A pharmaceutical company will not wish to lose the licence or collaboration simply because its ownership is changed. However, a bioscience company will not wish its project to be suppressed by the new owner.

Neither party will want to be forced into a commercial relationship with a company which it would not have chosen and which may be a competitor.

On Notice or for Convenience

Rarely (generally where one party has a particularly strong bargaining position) a broad termination right may be granted. A licensee facing this should try to get some compensation to recoup its investment in the technology.

Dispute Resolution and Governing Law

It is often difficult but very important to consider what mechanism is used to resolve disputes in the event that the parties fall out in the future. Unfortunately, there is no such thing as the ideal dispute resolution clause for all contracts.

These clauses are especially sensitive to circumstances. For example, arbitration in a neutral territory can be a real deterrent to disputes escalating, but if enforcement action is needed it may be slow and expensive. Disputes may lead to multiple proceedings since if there is an attack on the validity of the patent that may need to be pursued in another forum.

While a party may feel comfortable with its home law and jurisdiction this may in fact be less effective in keeping a dispute out of a particularly undesirable jurisdiction than an arbitration clause if there is insufficient connection to the chosen jurisdiction.

Alternative dispute resolution is always worth considering (while preserving the ability to take urgent action in the courts if necessary). This might encompass:

  • Levels of escalation within the management of the two parties: this can really take the heat out of disputes.
  • Mediation: this is generally more likely to be effective if the parties are willing participants; if not it, will just increase costs and introduce delay.
  • Expert determination: this can be quick and cost-effective, particularly for technology-related disputes (for example, a scientist might be appointed to give a view on achievement of a milestone or an accountant on a royalty dispute).

Other Important Terms

Other clauses should not be dismissed as boiler plate as they can be key, particularly if a relationship breaks down (whether as a result of bad relations or simply a change in commercial direction). These include:

  • Confidentiality: where a balance is to be struck between proper protection and flexibility.
  • Force majeure: this can be a fertile ground for disputes if too widely drafted. If performance is likely to be dependent on outside forces (for example, supply of materials), it is better to deal expressly with these issues under the terms relating to performance obligations, payment or termination.
  • Variation of the agreement.

Conclusion

Speed is often crucial in securing licensing arrangements. The best way of keeping to a timetable is to have in mind from the start the key issues (as reflected by the key clauses) in the licence. These can give structure to the negotiations and allow the issues to be agreed in principle early on rather than have them emerging later in the drafting stage.


This article was provide by Bio-Science Law Review, published by Lawtext Publishing Ltd. For further details visit: www.lawtext.com

 

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