The owner of an IP right may grant licences to third parties to use those IP rights in one way or another. In such licences, a licensee sometimes has the right to grant sublicences. In this section, licensing of IP rights such as a trademark, copyrighted work, patent or software application will be discussed.
Core licence clause #
The essence of a licence is usually reflected in one key licence provision and, if necessary, elaborated in subsequent clauses. In the licence clause, probably more than in any other type of agreement, the key elements of the agreement are identified.
Subject to the terms of this Agreement, Licensor hereby grants Licensee, and Licensee hereby accepts a perpetual, non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to use the Licensed Trademark in the Territory in connection with Licensed Products only.
The core licence clause (whether included in a Trademark licence agreement, Patent licence agreement, Software licence agreement or other IP-licence) would contain the following elements:
- Licence grant. The wording reflects the grant of licensed rights (“hereby grants”, “hereby accepts”). The word hereby is essential since it prevents that an additional written licence grant must be signed (as is typically required in connection with intangible rights);
- The licensed object. For example a trademark, patent, copyrighted work, know-how, software;
- The scope could include:
- type of use (e.g. manufacture, import, export, market, sell, distribute, use);
- territory restrictions (this could be a specified region, country, or worldwide);
- exclusivity (sole or non-exclusive);
- market segment restrictions (e.g. fitness-shops, shopping malls, supermarkets, webshop);
- the right to grant sub-licences; and
- duration (perpetual or irrevocable, or a specified time limit).
- Licence fees (i.e. royalty bearing, royalty-free or fully paid-up).
Differentiation in licensed uses. If the licence differentiates for the various uses, the above core licence clause becomes a matrix of several licences, each of which apply to a different scope and each subject to varying conditions. For instance, the above example could differentiate between the types of permitted uses as to degree of exclusivity, geographical reach, right to sub-license and royalty:
Licence. Subject to the terms of this Agreement, Licensor hereby grants to Licensee and Licensee hereby accepts:
(a) a non-exclusive, royalty-free licence, without the right to grant sub-licences, to demonstrate the Licensed Trademark in connection with Licensed Products only; and
(b) an exclusive, royalty-bearing licence, with the right to grant sub-licences, to make and have made the Licensed Trademark in connection with Licensed Products only.
(c) a non-exclusive, royalty-bearing licence, without the right to grant sub-licences, to market, have marketed, offer for sale, have offered for sale, sell, have sold, or otherwise distribute or have distributed, the Licensed Trademark in the Territory in connection with Licensed Products only.
Note that the verb “to use” is omitted in all subparagraphs. Instead, each subparagraph includes a specific type of ‘use’. Item (c) demonstrates that the possible differentiation in licensed uses might be very specific.
Licence elements #
Geographical and market-related scope. A licence involving the sale of a patented product or a product or service under a trademark licence agreement is often limited to a certain geographical area (i.e. a region, a country or part of a country), and sometimes also to a specific market segment (e.g. supermarkets, petrol stations, bars or restaurants), or a type of promotion or customer channel (e.g. general consumers, tv-broadcasting, printed magazines, or luxury brand shops). See also sections 2.4, lead-in, (a) and (b).
As regards patents, the licence should not cover geographical areas in which no patent was granted. Furthermore, a licence must be considered to be a technology licence. However, the licensee may argue that the licensor failed to deliver what was agreed: a patented invention.
Exclusivity. A licence is either ‘exclusive’ or ‘non-exclusive’. “Exclusive” means that nobody is entitled to use the licensed IP in the agreed territory, market segment and customer channel, not even the licensor. If the licence is a sole licence, the licensor may not grant a licence to another in the same territory, market segment or customer channel. Nevertheless, the licensor itself remains entitled to distribute in that area. In other words, the licensee will be the only (sole) licensee for that area, operating alongside the licensor. See also sections 2.4, lead-in, (a) and (b).
Important incompatibilities. Both an exclusive and a non-exclusive arrangement may severely restrict the freedom of the licensor in its freedom to undertake sales activities or to appoint other potential licensees who may be more successful:
- The appointment of an exclusive licence for a certain market segment in a certain territory prohibits the subsequent appointment of a (even non-exclusive) licence in the same territory for a broader market.
- The appointment of a non-exclusive licence for a certain territory prohibits the subsequent appointment of an exclusive licence in that same territory (even though the former is not de facto active in the market segment or customer channel covered by the latter). In such case, the second licence must contain a carve-out permitting the first licensee to continue its activities.
- If a licensee is appointed with an exclusivity arrangement for a term of five years and the licensee does not generate any sales, the territory and market segment for which the licensee is appointed will effectively be ‘blocked’ for alternative sales efforts during those five years.
Temporal scope. Most licences are either perpetual or have a specific term. If the licence clause includes the word “perpetual”, there is no further need to provide for a termination mechanism. A term licence would be limited by the time period of the agreement. It is uncommon to address this in the licence clause and is usually stipulated in an article on ‘term and termination’. The agreed term should enable the licensee to recover its investments made in relation to the licensed IP (and make profit).
Occasionally, a licence is granted for the duration of a project. For example, if a party agrees to provide certain services with which it makes use of proprietary technology of the customer or a supplier of the customer, the service provider would need a licence to carry out the agreed services. Similarly, if parties enter into a joint development agreement, one or both parties might need a licence to complete their part of the agreed development work. Such licence might be implied by the scope of the agreement, but an express project-licence emphasises the proprietary nature of the IP involved and might bring to light which limitations ought to apply to such project-licence.
Right to sub-license. In some cases, a right to grant sub-licences is desirable. For example, if the licensee is granted a licence in respect of a territory whilst it cannot (or will not) exploit the full capabilities of the licensed IP alone. In such case, whilst the licensee might be in a better position to obtain the maximum potential of the market, it would be appropriate to grant sub-licensing rights. In sub-licensing, the licensor usually requires the licensee to assume a larger responsibility in case of IP infringements by third parties in that territory.
More common situations in which sub-licences are necessary, relate to the use of the IP by (a) companies affiliated to the licensee, and (b) subcontractors of the licensee. An example of a clause permitting such sub-licences:
Permitted sub-licences. Subject to the limitations applicable to Licensee, Licensee is entitled to grant sub-licences to:
(a) its Affiliates, which are not also an Affiliate of a third party, with the limited right to [use] the Trademark, provided that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such sub-licensed Affiliate ceasing to be an “Affiliate” of Licensee;
(b) its suppliers and subcontractors, with the limited right to use the Trademark for Licensee’s exclusive benefit, provided that the sub-licence shall be no more extensive than is strictly required for providing such subcontractor’s services to Licensee, and provided furthermore that such sub-licence terminates (i) upon termination of this Agreement, or (ii) upon such subcontractor ceasing to be a subcontractor of Licensee for the sub-licensed type of services. Each sub-licence as referred to in this paragraph (b) shall be subject to the prior written approval of Licensor, which approval shall not unreasonably be withheld or delayed.
Competition law restrictions. In patent and know-how licence agreements, the parties should be free to compete with their own developed products, improvements or new applications of the technology to the extent that these are independent from the licensee’s initial know-how. It is permitted to oblige the licensee to grant a non-exclusive licence to the licensor for improvements and new applications of the licensed technology. For important prohibitions, see section 5.6(b).
Irrelevant licence elements. In the core licence clause, it is generally not necessary to stipulate matters which are otherwise implied by (contract or IP) law. Such words, as they are occasionally used, include:
- Non-transferability or non-assignability of the licence: the general contract law principles for transferability of the licence agreement apply. This means that, in order to be legally effective, such a transfer requires the consent of all the parties to the licence agreement. This means that the licensor has the right to refuse and thereby prevent any transfer.
- Irrevocability of the licence: general contract law provides that contracting parties are bound by the terms of their agreement. Revocation of the licence is only possible on grounds provided by the applicable law which justify a term licensor for improvements inaction of the licence (e.g. rescission in case of material breach or termination by a receiver in bankruptcy) or grounds expressly stipulated in the licence agreement (e.g. in cases of material breach, bankruptcy or change of ownership over the licensee).
- Personal nature: this is the same as the non-transferability of the licence and a statement that the licence is personal is therefore redundant. Every contract is personal to the parties involved.
Licences are fully paid-up, royalty-free or royalty-bearing. A royalty-free licence is common in joint development projects and for service providers in the context of their provided services. Also, the right to give demonstrations or to hand out free (complimentary or testing) samples of a product is often free of charge.
Fully paid-up. If the licence is fully paid-up, it means that the licensee acquires the rights to use, as stipulated in the licence agreement, after a one-off (lump sum) payment. This licence fee structure is usually applied if the parties want to materialise the licence in one settlement, or more commonly, if the payment in periodical instalments is impracticable (e.g. in case of a broadly defined patent, if the licensee is active in a different industry and not amongst the usual customers of the licensor) or if the collection of licence fees is undesirably burdensome (e.g. in case of consumers or large numbers of users).
Royalty-bearing. Royalty-bearing licences take countless forms. A royalty implies the payment of a (recurring) licence fee, the amount of which is often dependent on the volume of “net sales” (turnover) of the product in which the IP is used or applied. It is important to define what the royalty amount covers. A common reference figure is a percentage of the net sales of the products on which the trademark is used or for which the manufacture of the licenced patent or know-how is used:
Net Sales definition. In patent or technology licences:
Net Sales means the aggregate amount of sales prices of the Products received by the Licensee and its affiliated companies, excluding:
(a) taxes and duties paid by the Licensee for the sale of any Products;
(b) insurance, packaging and transportation expenses of Products;
(c) deliveries of Products to Licensee’s affiliated companies to the extent that such deliveries are also included in such affiliated companies’ aggregated sales prices; and
(d) normal discounts, returns and rebates to Licensee’s customers.
In trademark licences, the above item (c) should be replaced by:
(c) deliveries of Products to Licensee’s affiliated companies for internal use by such affiliated companies only;
In both definitions, certain product-unrelated pricing elements, relating to delivery, logistics and insurance, are taken out of the net sales definition. The two definitions are different:
- In patent and technology licences it is important to capture (in case of a process-related patent) all processes where the licensee applies the patented invention or (in case of a product-resulting patent) all products sold by the licensee and its affiliates (even if there is no sub-licensing right). Any captive product sales (i.e. internally to affiliated companies) should be included at the Net Sales amounts received by that affiliated company from its customers (deducting the captive transfer price) but should be calculated at an arm’s length price.
- In trademark licences, internal sales are irrelevant and only the sales realised by the licensee and its affiliated companies vis-à-vis their customers is relevant. The brand does not operate as a particular unique selling point.
A percentage of net sales results in zero (nil) royalties if the licensee makes no sales efforts at all. Therefore, in many turnover-related licences, the licensor requires a minimum sales effort from the licensee by agreeing on a minimum royalty commitment: regardless of whether the licensee achieves the agreed minimum level of net sales, it must still pay for it (‘take or pay’).
NRE. In some industries, it is common to pay a part of the licence fees in an upfront lump sum amount. Such non-recoverable or non-recurring engineering fee is also known as “NRE”. This is useful if the licensor has to undertake development work in order to fit its product with the licensed IP into a given environment. The results of the development can be licensed to other parties as well. The possibility to relicense the IP justifies that the licensor assumes the costs of the investment, whilst the upfront payment is a way of financing the development work.
Royalty reporting. If any part of the licence fees is directly linked to (sales) amounts realised by the licensee, it is inevitable that the licensee reports on its sales. Accordingly, the licensor will require that the licensee maintains accurate bookkeeping and its records must enable the calculation of royalties by reference to the sales. In other words, the licensee must be able to account for the precise number of products in which the licensed IP was used (and the sales prices received for each product).
It is common to require quarterly reporting, although monthly reporting (in case of questionable debtors or high volumes of sales) and annual reporting (in case of low sales volumes or long lead times) also are agreed on. Royalty reports should be submitted within a few days after the end of the reporting period. Payment of the royalty should be made shortly thereafter (sometimes after the issuance of an invoice).
Royalty audits. If royalties are dependent on a variable, such as fluctuating sales amounts, it is appropriate to provide for an audit right: a right of the licensor (or its independent auditing firm) to verify the accuracy of the licensee’s royalty reports. In many industries, a royalty audit is considered to be a step-up to terminating the licence. Nonetheless, an audit clause usually addresses the maximum frequency of permitted audits (if previous audits revealed no irregularities), that an audit must be announced in advance, that it must take place during working hours, as well as a ‘penalty’ mechanism for settling misreported royalties. An example of a royalty audit clause is included in Model international trademark licence agreement (Section 6.6).
Note: this chapter is also included in the e-book Cross-border contracting – How to draft and negotiate international commercial contracts, written by Weagree-founder Willem Wiggers and published by the ITC (the joint agency of the U.N. and WTO) and downloadable free of charge.