Transcript Topic 10 Fundamentals of Licensing Agreements WIPO-KIPO-KIPA IP Panorama Business School Investment Summit 7 October 2008 Geneva OPTEON Philip Mendes Level 3, 33 Queen St Brisbane QLD, Australia Ph.

Topic 10
Fundamentals of Licensing Agreements
WIPO-KIPO-KIPA IP Panorama Business School Investment Summit
7 October 2008
Geneva
OPTEON
Philip Mendes
Level 3, 33 Queen St
Brisbane QLD, Australia
Ph + 61 7 3211 9033
Fax + 61 7 3211 9025
[email protected]
Outline
 Presentation in 3 parts
 License Terms
 Performance Obligations
 Structure of the Financial Terms of a License
What is a license ?
•
Comparison with renting a building
Rented Building
Licensed IP
Owner restriction
Cannot use building
Cannot use IP
Owner’s right
To collect rent
To collect royalties
User’s name
Tennant
Licensee
User’s obligation
Pay rent
Pay royalties
User’s right
To exclusive use
To exploit exclusively
What is a license ?
Legal -binding contract
Contains terms
•Create rights (eg
royalties)
•Imposes Obligations (to
exploit, to complete
R&D, to market
•Creates liabilities
•Warranties and
indemnities
An asset
•Can be sold
•Can be used as security for
a loan
•Can be given by will
Scope: Exclusivity
Exclusivity:
Exclusive
Sole
Non Exclusive
One Exploiter –
the licensee
Two Exploiters –
owner and the
licensee
Numerous
Exploiters –
owner and
numerous ‘ees
Scope: Exclusivity
 Which would be most likely be sort by a licensee ?
 What rights does patent confer ? – exclusivity of use
 What rights is patent user likely to expect ?
 Most common type of license agreement ?
 Exclusive license
 Exclusive license:
 Where the licensee needs to have the same exclusive rights that a patentee
has
 Particularly
 Biotech
 ICT
Scope: Exclusivity
 Sole License
 Where rights to exploit are shared between the owner and a single licensee
 Owner can exploit
 Owner grants a single license only, there are no other licensees
 Eg, license of library for screening
 Non exclusive license
 Many licensees
 All competing with each other
 Competition reduces price
 Licensor maximises return by increased volume
 Eg floppy disk
Scope: Fields of Application
 Some technologies lend themselves to different uses.
 These are called fields.
 field of science
 particular application
 industry by industry
 Some licensees have expertise / marketing networks in some fields but not all.
 Would you license in all fields where the licensee has the ability to service
only one, but not others ?
 License particular field to match the licensee’s exploitation capability
Scope: Fields of Application
 Biotechnology
 Fields may be
 Human therapeutic and prophylactic applications
 Diagnostic applications
 Veterinary applications
 Plant applications
 Would you license
 a human therapeutic product to a diagnostics company ?
 A disease resistant Tg plant to a pharmaceutical company ?
 Maybe - these days, after mergers, some companies have merged their
capability
Scope: Fields of Application
.
.
New formulation for scratch
resistant plastic
Possible fields:
 Bottles for consumer
products – injection
moulding industry
 Car trim – motor vehicle
industry
 Fashion: Handbags
 Kitchen appliances –
kettles etc
 Mobile phones
 etc
Would we license person in
fashion industry rights in
relation to mobile phones ?
Would we license motor
vehicle trim manufacturer
rights in relation to kitchen
appliances?
Scope: Fields of Application
 Pick our licensee with the expertise / capability / marketing networks, and
license in appropriate fields
Field of Application
Bottles
Car parts and trim
Handbags
Kitchen appliances
Mobile phones
Appropriate Licensee
Injection Moulding Industry
Motor Vehicle Industry
Fashion Industry
Appliances industry
Electronics industry
Scope: Fields of Application
 Licensing multiple licensees in multiple feels of application
 All are exclusive licensees
 Not non – exclusive licensees
 Multiple licenses does not necessarily mean non exclusive
 Each license in each field of application is exclusive
 Each licensee expects the exclusivity to warrant its investment to take to
market
 Same exclusivity that patent confers
 Non exclusive licenses occur when licensees do not have exclusivity and
compete with each other
 Here, each licensee in its field of application, is an exclusive licensee
Scope: Territory
Would we license North America to a European company that had
no distribution networks in US ?
If we did :
there would not be any sales in the US
there wouldn’t be any royalties for US
Why would we license a company to exploit anywhere other than
where it had the capability to market and sell to best advantage ?
We wouldn’t.
Scope: Territory
 License whole world to:
 a multinational that can service the whole world
 License North America to:
 A company that can service North America (whether in North America or
elsewhere)
 License any Territory to a licensee that can exploit in that territory
 Key is capability to exploit in the market
 No point granting a license to a licensee with no capability to service the
Territory licensed.
Scope: Territory

Would we grant a world wide license to company in our own country ?

No, if it did not have the capability to exploit in the global market
 If its capability was limited to our own country, that is where the license
would be restricted to

Yes, if
1. It can service a worldwide market place
2. It has alliance partners and networks with others that can service the
remainder of the world
 In that case the license would have performance obligations in
relations to sub-licensing to those alliance partners and those
networks
Scope: Extent of rights
 Extent of rights granted depends on the type of license
 A licensee to market globally:
 Worldwide exclusive license
 Invariably the case for biotechnology IP
 May be the case for an ICT technology
 A manufacturer to manufacture products and supply them to licensor for sale
by the licensor:
 Manufacturing license only
 No rights to market, promote or sell
Scope: Extent of rights
 Possible scope of rights:
 To manufacture
 To market and promote and sell
 If license is limited to manufacture, licensee can manufacture, but not sell
 If license is to market promote and sell, then manufacturing not permitted –
licensor manufactures, and appoints distributors (more likely to be called a
distribution agreement than a license agreement)
 If license is to manufacture, market promote and sell, then licensee effectively
stands in a patent owner’s shoes
Scope: Summary
 Licensed rights can be scoped in numerous ways :




Exclusive / Sole / Non Exclusive
Field of application
Territory
Extent of rights
 When different rights are combined, the number of possible exclusive licenses
is theoretically limitless
 Practically: research organisations license worldwide exclusive rights in all
fields of application
Term of license
 What should the term be ?
 Depends on the nature of the license:
 Biotechnology patents:
 Typically until the expiration of the last to expire patent (with patent term
extensions)
 Licensee needs the exclusive rights conferred by the patent
 License to a start up company, in any field
 Typically until the expiration of the last to expire patent
 Licensee needs the exclusive rights conferred by the patent
 ICT:
 May be expressed as a number of years only
Term of license
 Know how:
 Effectively a license of confidential information
 Has value, but only while the confidential information is outside the public
domain
 Once it enters the public domain,
 Looses its value
 Any person can exploit the confidential information without a royalty
obligation
 Term in a know how license therefore expressed as being until the know how
enters the public domain
 Theoretically this may be many years
 European Union 10 year limit on term of know how licenses
What is licensed: Patent / know how
 Typically what is licensed is the combination of
 Patents
 Applications, PCTs, divisionals, continuations in part, grants, re-issues, etc
etc
 Know how
 that is, all “intellectual property” in its widest sense, ie all knowledge
 includes confidential information
 includes knowledge encompassed in rejected patent claims which may still
have value
 Usually in the licensor’s interest to provide everything to the licensee to equip
it to the maximum extent to commercialise the IP
What is licensed – Improvements
 Should Improvements be licensed ?
 Improvement is an improvement, modification, enhancement of the
Licensed IP
 Licensee has a legitimate expectation of improvements
 Making the improvements available to the licensee improves its ability to
commercialise, and to compete
 Not making the Improvement available may encumber the licensee, may
make it less competitive
 Licensor has a legitimate reason to provide the improvements as well
 A better equipped licensee that has greater capability, and greater
competitive edge will do better, in that way maximising the licensor’s
return
What is licensed – Improvements
 Should an improvement automatically be caught by the license, with the
licensor getting no additional financial return ?
 Or, should the licensor be able to get an additional financial return ?
 Improvements add to the quantity of the IP
 Logical that as the quantity of IP is increased, so does its value
Value = X
Value = X + Y
Value = X+Y+Z
What is licensed – Improvements
 Consider the development / risk / value curve:
Possible
License
Point A
Possible
License
Point B
Possible
License
Point C
IP Value:
IP Value:
IP Value:
X
X+Y
X+Y+Z
Value
Risk
Development
Concept
Proof of concept
Prototype
Trial
What is licensed – Improvements
 The further along the development path a licensor travels (making
improvements), the greater its remuneration should be
 Logically:
 An improvements increases the quantity of IP licensed
 And increases the value of IP licensed
 A license at Point A has a value of X eg, a royalty of 3%
 A license at Point B has a value of X + Y, eg a royalty of 5%
 A license at Point B has a value of X + Y + Z, eg, a royalty of 8%
 Logically therefore, an improvement should result in a higher royalty
 Our frame of mind should therefore be that an improvement should entitle
a licensor to greater remuneration
What is licensed – Improvements
 But to be pragmatic:
 Most improvements are small incremental increases in knowledge
 They fine tune the IP
 They do not justify additional remuneration to a licensor
 What is the boundary ?
 Up to which improvements are captured by the license for no additional
royalties
 From which, if they are to be captured by the licensor the licensor has a
legitimate expectation of further royalties ?
What is licensed – Improvements
 For example: if the licensor discover an additional use in another field
 Is that a thrown in improvement
 Or does it deserve additional royalties ?
 Could that new application if it had been identified earlier
 Have resulted in a field license, leaving the licensor free to license
separately another licensee with that additional field ?
 Or, if licensed to the same licensee, would it have justified a higher royalty
payment ?
 In these circumstances is it fair that the licensee gets this additional IP thrown
in for no further payment ?
What is licensed – Improvements
 A boundary is needed
 Possible boundary:
 If the practice of the improvement would infringe the licensed patent, then
it is thrown in for nothing.
 Not a desirable boundary: a new application may necessarily infringe the
Licensed IP platform
 Another possible boundary:
 That the Improvements has sufficient novelty to be granted its own patent
 The better test
 Still has a problem: the question whether it is an improvement may not be
resolved until a patent is granted
What is licensed – Improvements
 Another limitation on Improvements:
 That the improvement is created by the same research team that created the
original licensed IP
 Why?
 Cannot capture the improvements across all the activities of a large
licensor, eg,a university
 University may not know, and cannot manage its obligations to identify
improvements by other staff
 Therefore not unfair to limit the Improvement to that
 Which is created by the same research team
 Only while they are employed by the licensor
Consent to Sub-licensing
 Typical term:
Licensee may grant sub-licenses with the prior written consent of the
licensor which is not to be unreasonably withheld
 Motivation
 Assess suitability of a sub-licensee
Assess capability
Assess identify of sub-licensee
 Is it a member of corporate group that would embarrass the licensor
tobacco group
environmentally irresponsible
directors questionable
 These issues of concern to a university / public sector licensor (ministerial
approval / embarrassment)
Consent to Sub-Licensing
 Motivation (cont):
 Assess terms of license
 Royalties may be based on Sub-License income
 Consideration for sub-license may be non-monetary
 Cross License
 Other contract
 Therefore no royalty flowing back to licensor
 All proper motivations for a licensor to seek to control sub-licensing
 Besides, consent is not to be unreasonably withheld
 Constraints on that legal mechanism such that it is incumbent on a licensor to
grant consent if a licensee has the capability
Consent to Sub-Licensing
 But holding out for this may kill the deal
 Pharma / large biotech / multinational is not likely to agree to any restriction on
its ability to grant sub-licenses
 Given its level of investment US$50m to US$800m, it will typically not be
prepared to rely on consent
 Even if not to be unreasonably withheld
 Even if incumbent on licensor to give it
 Open Position: If licensee gets taken over by a tobacco company or an Exon, it
does not want to loose its license, and write off its US$50 to $800m
 Holding out for this will kill a deal
 Licensors may have to be prepared to be relaxed in this
Consent to Assignment

Same issues
 Licensor is entitled to satisfy itself about the proposed assignee
 Does the assignee have the same capability
 Is the licensor concerned about the identity of the proposed assignee

Normally, consent to assignment
1. Expressed as not to be unreasonably withheld
 Again, makes it incumbent on a licensor to grant consent if a licensee
has the capability
2. Expressed as not required where the assignment arises out of a corporate
re-organisation
Patent prosecution
 Who should make decisions about patent prosecution:
 What patent attorneys to engage
 Scope of claims
 Negotiations with patent offices
 What countries to apply for patents
 Licensor is the owner, and may feel that it should
 Licensee that is a pharmaceutical company, multinational will insist on
managing patents
 They have more at stake
 Not likely that licensee will make decisions to minimise its royalty obligations
Patent Costs
 Regarded as a commercialisation expense
 Therefore licensee should pay this expense
 Licensees may resist paying for patent expenses
 May argue that patent expenses are an owner’s expense and should be paid
for by the licensor
 May argue that is prepared to pay patent expenses, but only as an advance
on royalties, so that future royalties are credited
 Needs to be resisted
 Patent expenses are a commercialisation expense and should be paid for by the
licensee without clawback
Patent Costs
 What if the license is a field License
 Should licensee pay all costs ?
 Should Licensee make decision on extent of claims ?
 Decisions:
 Licensor should make decisions given its broader interests in all fields
 Patent costs:
 Licensee argues Licensor should pay patent costs as Licensor will benefit
in other fields
 But what if first field license is the only license – no other licensein other
fields ?
 Licensee pays
 If future second license, Licensee is refunded 50%
 If future third license, licensee refunded further proportion, etc
Patent Infringements
 Who should have responsibility for pursuing infringers ?
 Licensor may feel that it should
 Licensee will want to pursue infringers
 Protect its commercial interests
 It’s a commercialisation expense
 It’s a commercialisation strategy – infringers will need a license
 Licensee has greater commercial risk: profits are greater than revenues
 Sometimes infringement proceedings give rise to patent revocation
application by infringer – and licensee will want to control those
proceedings
 Licensor will want Licensee to pursue infringers
 Can cost US$2m to “the sky is the limit”
 Research organisation Licensor unlikely to be able to fund
Patent Infringements
 Three Tiers
 Parties acting jointly
 If they agree, they prosecute jointly, pay the costs jointly, benefit from
damages jointly
 Likely that licensee will want to pursue infringers solely
 Solely making decisions in pursuing the infringer
 Solely paying the expense of doing so
 Licensee that is exclusive will have the standing to do so
 If Licensee does not pursue infringer, licensor may do so
General obligations on licensee
 Reporting
 Progress in further research and development
 Progress in seeking regulatory approvals
 Progress in trials (including clinical trials)
 Marketing strategies
 Sales forecasts
 Improvements made




Use of patent numbers
Compliance with laws
No misleading or deceptive conduct
No use of Licensor’s name without consent
Confidential Information
 Typical for license to contain all the terms commonly found in a
Confidentiality agreement
 Usually mutual, as licensee also discloses confidential information to the
licensor
 Restriction to disclosure to third parties
 Cannot disclose without consent
 Can disclose without consent where the purpose of disclosure is
commercialisation
 Can disclose to employees etc
 Restriction on use
 Cannot use IP except for the purpose of commercialisation
 Usual exceptions.
 Public domain
 Disclosure from third party etc
Release
 Licensee releases licensor from
any liability in connection with
commercialisation
 ie, Licensee cannot sue
Licensor if “it does not work”
 Licensor cannot assess this, nor
make warranties about it at the
time of the grant of the license,
when more R&D still has to be
done
 These are matters for the
Licensee’s own commercial
assessment
Licensor
Licensee
Limitation of Liability
 Release does not always work
 Legal principles may limit their operation
 Therefore a limitation of liability
 Financial limit on what Licensee can sue Licensor for
 May be expressed as
 A stated amount
 A limit equal to the aggregate of all monies paid under the license
 Exceptions not subject to a limitation of liability:
 Breach of confidentiality
 Breach of warranties
Indemnity
 Indemnity against product liability claims
 Release is “Licensee cannot sue Licensor”
 Indemnity is “Licensee will pay damages if someone sues Licensor”
 Indemnity usual in relation to product liability claims
 Hard to envisage a Licensor being liable when it is not the manufacturer / seller
 In the US, some law that suggests that an owner of a patent may have a liability
Licensor
Someone else
Licensor
Product liability insurance
 Not enough to rely on an indemnity from a licensee
 Licensor needs to ensure that licensee has the capacity to meet product
liability claims
 Usual covenant that Licensee takes out and maintains product liability
insurance
 Reputable insurance company
 Minimum amount of insurance cover
 Some licensees self insure:
 pharmaceutical companies / multinationals
 US established product liability claims fund
 Therefore little point in requiring a large pharma to self insure
 Biotech company must insure.
Warranties
What are warranties ?
 Warranties are statements made by a licensor
 Akin to a guarantee
 A licensee warrants something to be true, that is, the licensor guarantees
something to be true
 If the statement is untrue, the licensee can:
 Sue for damages
 Terminate the agreement and sue for damages
 Therefore important that warranties that are made, are made accurately
 Important consequences follow from the breach of a warranty
 As a rule, a licensor will want to make the minimal warranties sought
Warranties:
Warranties about ownership of IP
 Not uncommon for a licensor to warrant that the licensor
 owns the IP being licensed, (or has a license to it)
 Should such a warranty be unqualified ?
 Consider:
 Patent application filed
 License granted in PCT stage
 Licensor warrants that it owns the IP in that patent application
 Later, it is discovered that another person has an earlier priority date
 That other person owns the IP in that patent application, not the licensor
 An absolute warranty about ownership would therefore be beached
 Such a warranty about ownership:
 should not be unqualified
 should be expressed to be made to the best of the licensor’s actual
knowledge
Warranties:
Warranties about infringement
 Not uncommon for warranties to be sought that a IP does not infringe another
person’s IP rights
 Should such a warranty be unqualified ?
 Use of an improvement patent held by the licensor infringes an earlier
patent
 Or, exploitation of licensor’s patent encumbered by another person’s
blocking patent
 Neither situation may be known to the licensor
 Licensor cannot undertake a complete search to be able to ensure accuracy
 Patent applications may be filed with an earlier priority date, but may not
be published for years afterwards
 Such a warranty:
 should not be unqualified
 should be expressed to be made to the best of the licensor’s actual
knowledge
Warranties:
Warranties about unencumbered rights
 Not uncommon for a licensor to be expected to warrant that:
 No notice has been received of any claim asserting infringement
 No notice has been received opposing the grant of a patent, or challenging
its validity
 No license has previously been granted
 No option to license or right of first refusal has been granted
 If any of the above are incorrect, warranties are made subject to disclosures
 Should such a warranty be unqualified ?
 All these are matters within the control of a licensor
 Licensor should be able to make the warranties sought without any
qualifications
Warranties:
Warranties about patents
 Common warranties about patents:
 That named persons are the only inventors
 No inventor has been omitted from being named in the patent application
 That no person is named as an inventor who is not an inventor
 That named inventors are employees of the licensor and made the invention
in the course of employment
 All patent maintenance, continuation and renewal fees have been paid
 Patents licensed have not been revoked
 Patent applications have been made properly
 No failure to take a required step in the patent application process
 Should such a warranty be unqualified ?
 All these are matters within the control of a licensor
 Licensor should be able to make the warranties sought without any
qualifications
Expiration and termination
 Expiration is where the term of a license ends
 Term of x years
 Licensed rights end on the expiration of x years
 Any further exercise of rights would infringe the IP
 Term until the expiration of a patent
 Licensed rights end upon the expiration of the patent
 Termination occurs unilaterally, one party terminating in response to a
termination event taking place
 The termination event may also give rise to a right to damages.
Termination
 Non sudden termination, with an opportunity to remedy a breach
 14 days in breach
 Notice to remedy requiring remedy within 30 days
 If still in breach – can terminate
 Types of breaches that may give rise to that mechanism
 Failure to pay a royalty
 Failure to provide a report
 Failure to take out product liability insurance
 Failure to meet a performance obligation
Termination
 Sudden termination, without any opportunity to remedy the breach
 For Event of Default
 Where the breach is serious:
 Granting a sub-license without consent
 Assigning without consent
 Commercialising outside the Field
 Commercialising outside the Territory
 For Insolvency,
 winding up,
 bankruptcy, etc
Consequences of termination
 Cease using licensed rights
 Return all confidential information
 Sometimes, continue sale of products in stock until exhausted, or an agreed
period, such as 6 months
 Destroy biological materials licensed
 Clauses that survive, and continue to operate notwithstanding termination
 Confidentiality
 Insurance
 Release from claims
 Indemnity against third party product liability claims
Performance Obligation
OPTEON
Philip Mendes
Level 3, 33 Queen St
Brisbane QLD, Australia
Ph + 61 7 3211 9033
Fax + 61 7 3211 9025
[email protected]
What are performance obligations
 Obligations that oblige a licensee to exploit a technology to a minimum extent
 Licensor seeks to
 maximise its financial return on its technology
 ensure that the licensee does not
 underperform,
 fail to perform
 “shelve the IP”
 Performance obligations oblige a licensee to perform to a minimum extent
 With termination of the license / damages as the result if the licensee fails to do
so
Are performance obligations necessary?
 Postulate:
 License granted of technology that is not fully developed
 Licensor licenses to partner with a licensee that has the capability to complete
R&D, and to take to market
 Engineering product at prototype stage
 IT Product: patents & theoretical code but no application code
 Biotech product in late pre-clinical stage, with years of clinical
development still to go
 Licensee has finite resources
 Resources sufficient for top 3 projects – this one ranks fourth
 Licensee makes a prudent commercial decision to defer R&D
 The technology remains idle, perhaps forever
 Licensor obtains no financial returns
Are performance obligations necessary?
 Postulate:
 At the time of the license the licensee has best of intentions to commercialise to
the maximum extent
 Afterwards
 Licensee develops its own competing product
 Licenses in a superior competing product
 Licenses in an inferior but less expensive competing product
 Licensor’s technology remains idle, perhaps forever
 Licensor obtains no financial returns
Are performance obligations necessary?
 In each case
 Technology is idle
 Licensor obtains no financial returns
 Technology is trapped with the non performing licensee
 Licensor needs a mechanism to achieve:
 Termination of license
 Reversion of rights back to the licensor
 Licensor free to go out and find another licensee that can perform and
maximise the financial returns back to the Licensor
“Best endeavours” obligations
 Licensee to Licensor:
 “I’ll agree to use my best endeavours to commercialise”
 May once have been a sufficient obligation
 “Best endeavours” obligations were once onerous obligations:
 Required “leave no stone unturned”:
 “Best endeavours means what it says - it does not mean second best
endeavours”
 But best endeavors obligations have been watered down
 It requires what “could reasonably be expected... having regard to the
circumstances”
 commercial and financial considerations can be taken into account to
weigh up the reasonableness of the obligation
 These commercial considerations may operate to relieve a Licensee from
the obligation to perform
Better approach to performance obligations
 A better approach to performance obligations is
 to negotiate precise performance provisions
 to provide for the consequences of non compliance
 Two phases to consider performance obligations:
Deal
Signed
Pre market entry
R&D phase
First
Sale
Post market entry
Product phase
End
of
Term
Performance obligations - R&D phase
 Licensor wants to know that the Licensee
 Will continue R & D (if applicable)
 Will complete R & D (if applicable)
 Will expeditiously start and travel the regulatory pathway (if applicable)
 Not “shelve” the IP
 Commercialisation Milestones
 Milestones that a Licensee must achieve along the R&D and regulatory
pathway
 Not achieve milestone – license is ultimately terminated
Performance obligations - R&D phase
 Commercialisation Milestones: engineering example:
 If more research is needed to bring product to a market ready state, the
completion of that research
 Produce a prototype
 Conduct a trial
 Complete construction of pilot plant
 Complete construction of production plant
 Obtain any regulatory approval
 Employ a person with particular expertise
 Grant a sub license to a partner in key market
 First sale anywhere in the world
Performance obligations - R&D phase
 Commercialisation Milestones: Biotech example:
 If following completion of research, more research is needed to bring
products to a market ready state, the completion of that research
 Completion of animal studies
 Completion of collection of data for lodging IND in USA
 Commencement of Phase 1 Clinical Studies
 Commencement of Phase 2 Clinical Studies
 Commencement of Phase 3 Clinical Studies
 Filing of NDA with FDA in USA
 Approval of NDA with FDA in USA
 First sale anywhere in the world
Performance obligations - R&D phase
 If these pre market entry milestones are not achieved
 There may never be market entry and sales
 Licensor may never receive royalties
 There needs to be mechanisms for
 Termination
 Reversion of rights to licensor
 So that
 Licensor can find another licensee
 Licensor can earn financial returns from a Licensee capable of achieving these pre
market entry commercialisation milestones

Ultimately, failure to achieve these milestones must lead to termination and reversion
 There may be models that allow flexibility, but ultimately with termination
Performance obligations – Product phase
 Performance obligations do not cease after market entry
 After first sale, Licensor wants to ensure that there is the maximum possible
penetration of the market
 Achieved by minimum sales
 If minimum sales not achieved:
 License may convert to non exclusive
 Allowing licensor to find another non-exclusive licensee
 License may be terminated
 Rights revert to licensor
 Again, allowing the licensor to find another licensee
Performance obligations – Product phase
Territory
Period
Target, in units
USA & Canada
Year 1
1.0m
Year 2
1.25m
Each following year
1.5m
Year 1
1.5m
Year 2
1.75m
Each following year
2.0m
Year 1
0.75m
Year 2
1.0m
Each following year
1.25m
European Union
China & South East Asia
Performance obligations – Product phase
 Might consider:
 Broad geographical markets, region by region
 Smaller geographical markets, country by country
 Flat minimum sales in each period
 Ramped up sales as marketing is ramped up, followed by flat minimum
sales
 Minimum targets holiday in initial period after market entry, followed by
ramping up, and then flat sales
 Reassessment of minimum sales if a competing product enters the
marketplace
Structure of
Financial Terms in a License
OPTEON
Philip Mendes
Level 3, 33 Queen St
Principal
Brisbane QLD, Australia
Ph + 61 7 3211 9033
Fax + 61 7 3211 9025
[email protected]
1.


Royalty on sales by a licensee
X% of sales price
 Gross sales price; or
 Net sales price
Most common type of royalty provision

Royalty is remuneration for quantity of use
 Greater the quantity of use, the greater the royalty
 The more sales, the greater the royalty

But there can be more to a licensor than just a royalty on sales
 Clever ways for licensors to increase their remuneration
 Clever ways for licensees to reduce their royalty overhead
2.




Royalty upon sub-license income
received by licensee
.
Licensee grants sub-license
Sub-licensee will pay to Licensee
 Royalties on the sublicensee’s own sales
 Milestone payments, etc
All that income is sub-license
income
Licensee pays a royalty of Y% to
Licensor on all that income
Licensor
Licensee
Sub-Licensee
3. Royalty upon last Licensee’s
Sales



Royalty on sale price for which the.
last licensee sells product
Royalty rate remains fixed, e.g. 2%
of sale price of last sale – that is all
licensor will receive
Licensor might be better off
receiving Y% of Sub-license income
– might be greater than this 2% - as
Licensee will sub-license after value
adding and will secure a
substantially higher royalty
Licensor
Licensee
Sub-Licensee
Buyer
4. Royalty as a currency
 Royalties sometimes expressed as a currency amount, rather than a percentage
 Eg, on software products, a royalty of $X per unit
 Eg, computer game
 May be an attractive model when the product is expected to have a short
product life of say 2 years
 Why attractive ?
 Licensor is assured the same royalty regardless of downward price
fluctuations, which in a product with a short product life may be expected.
4. Royalty as a currency
 Dangers
 Should not be used where the product has a medium to long product life cycle
 In this case, can expect upward price fluctuations
 If fixed currency royalty, value of the royalty reduces over time with
inflation
 Percentage royalty on invoice price preferred
 If financial analysis of royalties have been based and negotiated on currency
amounts, convert the currency amount to a percentage on anticipated invoice
price
5. Royalty on sales in countries
where patent granted



Expressed as:
 “Valid Patent Claim”
 Sales in country where but for license product would infringe a granted
patent
That is, licensor onlys receive a royalty where sales are made in countries
where the sale of a product is protected by a granted patent
Traps:
 No royalties on sales made while patent pending (e.g., delays in
examination, opposition proceedings etc)
 No royalties on sales in countries where patent is not sought, nor granted
– ie, if patent in US only, you only get royalties on sales in US
6. Royalty on sales in countries
where no patent is granted


This royalty often resisted by licensee – “why should I pay a royalty for sales in
countries where there is no patent and I have no power to prevent competitors ?
Royalty might still fairly be payable:



Patent may be taken out in 20 – 25 countries and that may represent 90%
- 95% of the global market – so why shouldn’t royalty be paid on sales in
remaining countries ?
Licensee will select the countries where patent will be sought
Result


pay full / part royalty,
reducing by 50% if a competing product enters the marketplace, if it
would have infringed the patent
7.
Royalty Splitting – know how
 Split royalties so that they are referable to different parts of the IP that is
licensed
 Instead of seeking a royalty of 5%:
 Royalty of 3% for use of patent
 Royalty of 2% for use of know how
 Purpose:
 If patent is invalidated, license on foot, with a royalty for the know how
component
 getting a royalty in countries where there are no patents
8.



Royalty stacking
Can arise in two ways
1. Product to be sold needs license in of complementary
technology,
 e.g., a delivery system for a drug
 another active ingredient for a drug
 a complementary product where both sold together e.g., a
vaccine cocktail
Sale price of product sold reflects complementary technology
as well
2. Freedom to operate – license in patent that is
infringed
Cannot reduce royalty by whole amount of royalty paid to another
person
Alternative: in each case, reduce royalty by X% of royalty paid
out, up to max of y% reduction on any royalty payment
Stack for
freedom to
operate z%
Stack for
delivery
system y%
Royalty x%
9.



Ramped Up Royalties
As a product is more successful, and costs reduce, royalty increases
Licensor forgoes royalties in early stages, in return for higher royalties
later
Licensor indirectly contributes to initial manufacturing and marketing
costs
Cumulative gross sales in USD$
Royalty %
Up to 100m
4
100m to 250m
5
250m to 500m
6
500m to 1b
8
1b and over
10
10. Research Tools:
Reach Through Royalties







Research tools are tools that enable a product to be developed
A valuable piece of IP
How do you measure its value to properly remunerate the Licensor that owns the
research tool ?
Examples:
 License of a Mouse Model
 Mouse Model validates a drug target
 Therapeutic drug developed that acts on that target
 License of an assay
 Assay identifies and qualifies a compound that may be developed into a drug
Reach through royalty is a royalty based on the sales of the drug that is developed with
the research tool (mouse, assay, etc)
Royalty is not on the technology itself, but instead is a royalty on the sales of the
product that is enabled by the technology
In that way measuring the quantity of use of the Licensor’s technology
11.
Measuring quantity of use


Royalties are intended to remunerate a Licensor for the use of its technology
Greater the quantity of use, the greater the licensor’s remuneration should be

How do you measure quantity of use (and therefore remuneration through royalties)
where the technology
 Is enabling
 Does not itself produce a product
For example:
 Software that provides a capability
 A process technology



Consider some other measurement of the quantity of use of the technology
For example
 Software program – royalties on reagents
 Product produced with less cost as a result of a new catalyst
12. Royalties on value added





A license may enable a licensee to sell products
 But a license may also give the licensee a capability to sell other unrelated products
License may allow a licensee to sell diagnostic reagents
 But additionally, may equip licensee to sell a diagnostic machine to test the
reagents
Licensee is profiting from
 Sales of licensed reagents
 Sales of diagnostic testing machine
License equips licensee to make additional revenues and profits from the diagnostic
testing machine
May be legitimate to value the license
 not just by reference to profits anticipated from reagents
 But additionally from profits anticipated from diagnostic testing machine
13. “Most favoured” royalty
 Most favoured clause is very common in the case of a non exclusive
license
 Agree on royalty of 10%
 If licensor later grants a license in the same country to a competing licensee
for a lower royalty, that lower royalty will apply in lieu of the 10% royalty
 Sought by non exclusive licensee to enable it to be able to compete
15. Lump Sum License Fees
 Once Only License Fee
 Or, license fee payable by installments
 May be the only consideration for the license
 May be one of a package of other financial terms
 Important to try to secure in every license to offset
 past patent expenses,
 expenses of doing the deal (travel, legals etc)
 some part of R & D costs
16. Milestone Payments
 Payments made at identifiable points along the development /
regulatory pathway
Biotech Milestones
Grant of patent
USD $2m
Filing New Drug Application FDA
UDS $5m
Commencement Phase II Clinical Trial
UDS $10m
Commencement Phase III Clinical Trial
UDS $15m
Product registration FDA
UDS $30m
16. Milestone Payments
 Payments made at identifiable points along the development /
regulatory pathway
Engineering Milestones
Completion of Prototype
USD $2m
Completion of Pilot Plant
UDS $5m
Completion of Trial
UDS $10m
Completion of Production Plant
UDS $15m
Grant of a regulatory approval
UDS $30m
16. Milestone Payments
 Payments made at identifiable points along the marketing pathway
Marketing Milestones
Market launch
USD $1m
Granting sub-license in key market (US)
UDS $2m
Worldwide sales reaching $X
UDS $10m
US sales reaching $Y
UDS $10m
Worldwide sales reaching $Z
UDS $20m
17. Minimum Annual Royalty
Alternative to performance obligations
 Performance obligations are obligations that a licensee must meet to continue
to be licensed
 Avoids shelving (non use) of IP
 Licensor gets no financial return and wants to be able to license someone
else
 Avoids inadequate performance (e.g., no commercialisation in a major market,
such as US)
 Licensor gets inadequate financial return and wants to be able to license
someone else
17. Minimum Annual Royalty
Alternative to performance obligations
 Commercialisation Milestones: engineering example:
 If more research is needed to bring product to a market ready state, the
completion of that research
 Produce a prototype
 Conduct a trial
 Complete construction of pilot plant
 Complete construction of production plant
 Obtain any regulatory approval
 Employ a person with particular expertise
 Grant a sub license to a partner in key market
 First sale anywhere in the world
17. Minimum Annual Royalty
Alternative to performance obligations
 Commercialisation Milestones: Biotech example:
 If following completion of research, more research is needed to bring products to a
market ready state, the completion of that research
 Completion of animal studies
 Completion of collection of data for lodging IND in USA
 Commencement of Phase 1 Clinical Studies
 Commencement of Phase 2 Clinical Studies
 Commencement of Phase 3 Clinical Studies
 Filing of NDA with FDA in USA
 Approval of NDA with FDA in USA
 First sale anywhere in the world
17. Minimum Annual Royalty
Examples of performance obligations




Usually require minimum sales revenue
/ units sold
Expressed as worldwide / or markets
If failure in a market
 Exclusivity converts to non
exclusivity
 Or termination
 In the market concerned, without
affecting other markets
Multinational licensee - none of that is
acceptable
 Will be prepared to make minimum
annual payments
Territory
Period
Target, in
units
USA
Year 1
1,000,000
Year 2
1,250,000
Each
following year
1,500,000
Year 1
1,500,000
Year 2
1,750,000
Each
following year
2,000,000
Countries
in EU
17. Minimum Annual Royalty
Alternative to performance obligations
 A pharma / multinational will not ordinarily accept performance obligations of
these type in an early stage deal
 A biotech company will not be able to secure those types of performance
obligations from a pharma, and so will also not accept them from a licensor
 Alternative is Minimum Annual Royalties
 A minimum amount of royalties to be paid
 Licensee must pay the higher of
 Actual royalties, or
 Minimum annual stipulated amount
 Ramp up the amount year by year
 If Licensee elects not to pay, termination
18. Pay royalties on what ?
Pay on net profits ?
 Would this work ?
“The Licensee will pay a royalty of X% on the net profits from the sale
of Products”
 How are net profits to be calculated ?
 Net profits are subject to manipulation
 Allows overheads to be taken into the calculation, in that way reducing
royalties
 A 5% royalty on net profits may in fact be a 1% true royalty
18.
Pay royalties on what ?
Pay on invoice price
 Royalties always paid on invoice price
 That is, royalties are referable to the gross arm’s length sale price of products
 Some agreed expenses are deductible
 taxes, duties, VAT, GST etc on sale
 credit for products returns
 trade and quantity discounts
 Deduct packaging, freight and insurance
 Only if separately invoiced
 Or lump sum deduction, maximum of 3-5%
19.






Pay royalties on what ?
Bundling
Bundling
What is bundling ?
 Where the product is sold in a package or bundle with other products
Package includes
 Licensor’s product upon which a royalty is payable
 Other products upon which no royalty is paid, or a royalty is paid to another
licensor
 For example:
 two software products sold in a bundle
 Or, end user license for a process, and technical assistance services
The total price of the package may be discounted
Can’t tag royalty to invoice price because invoice price includes other products
Tag royalty to the prevailing market price when Product sold unbundled
20.
Pay royalties on what ?
Combination products
 Bundling issues – combination products
 But what if there is no prevailing market price for the Product because it is not
sold separately
 For example, a vaccine that is always sold as a cocktail, that is, multiple
vaccines in one injectable – always a combination product
 Invoice price may never relate solely to the licensed product
 Some approaches:
 Prevailing market price in another country where it is sold separately (if
any)
 Royalty on the invoice price of the cocktail (but over time the cocktail may
have different components)
 As negotiated in the future as prevailing circumstances change (with expert
determination if no negotiated outcome)
21. Pay royalties on what ?
Sales to related parties – transfer pricing
 Licensee may sell products to a subsidiary or related party
 Non an arm’s length transaction
 Invoice price presumes that there is a market price – set by prevailing market
conditions
 A sale to a subsidiary or related party may not be for a market price
 There may be an intention to manipulate the invoice price artificially to
manipulate a royalty
 Or, there may be legitimate reasons for sales to a related party, eg sales
from manufacturing subsidiary in one country to a marketing subsidiary in
another country
 There may be a motivation to take advantage of lower tax rates in another
country, so transfer prices may have the objective of choosing a lower tax
jurisdiction
21. Pay royalties on what ?
Sales to related parties – transfer pricing
 Approaches
 Royalties based on invoice price to first arm’s length party (ignoring on sales
within a company group)
 Royalty on prevailing market price
 Can only work when the licensee sells some products on an arm’s length
basis
 No grant of sub-license rights to a related party without consent (and deal with
the issue as a part of dealing with the request for consent)
22. Inspection of accounts and audit

Typical to include rights in a license that
 Licensee must keep good accounting records of items upon which royalties and
other payments are based
 Keep records to a standard
 International Financial Reporting Standards (IFRS) - the accounting standards
set by the International Accounting Standards Board
 Or, an equivalent in a country (In Australia, GAAP)
 Particularly important when a licensee has no legal obligation to maintain
books to a certain standard (eg non publicly listed companies)
 Keep records for a minimum of X period
 Avoid time limit on inspecting accounts (eg, only last X number of years
records)
 Licensor (or appointed auditor) may
 inspect those accounts (on giving eg 7 days notice)
 take copies or extracts
22. Inspection of accounts and audit

Costs of inspection and audit
 Borne by Licensor
 Unless an underpayment of amounts due to licensor is discovered that exceeds an
agreed amount (eg 5%), in which case, the cost of the audit are payable by the
licensee

Inspection of Sub-licensee’s accounts
 Licensee must report to Licensor
 Any inspection or audit of a sub-licensee’s accounts
 Results of that inspection, including copies of reports

Licensor can exercise Licensee’s rights to inspect Sub-Licensee’s accounts
 May be considered for appropriate transactions
25. Withholding tax



A tax effectively payable by a non resident
Paid by a resident licensee effectively on behalf of a non resident Licensor
5% to 30%


Licensee in USA owes royalties of $100,000
Withholding tax of 10%


Licensee will pay $90,000 to licensor
Licensee will remit $10,000 to IRS


In this way, effectively a tax on a non resident licensor entitled to royalties
Withholding tax also often paid on interest income and dividends
25. Withholding tax


If a license is silent about withholding tax, the licensee must remit the royalties without
deduction
Licensee effectively becomes the taxpayer


Licensee in USA owes royalties of $100,000
Withholding tax of 10%



Licensee will pay $100,000 to licensor
Licensee will remit $10,000 to IRS
Licensee has effectively paid the tax

The effective royalty rate is now 10% greater.
25. Withholding tax
 Where there is a double tax treaty between the Licensor’s country, and the
country where the sale of a product takes place, the Licensor gets a tax rebate
for the withholding tax paid
 In this way, double tax is avoided
 Licensee in USA owes royalties of $100,000
 Withholding tax of 10%




Licensee will pay $90,000 to licensor
Licensee will remit $10,000 to IRS
Licensor will provide evidence of payment of $10,000 to IRS
Licensee pays tax on $100,000, and gets tax credit for $10,000, the amount
withheld
Conclusion
 There’s more to a royalty than just filling in a blank on a license
template !