Avoiding Common Misperceptions and Mistakes in Patent License Agreements

Negotiating and drafting the terms of a patent license can be difficult, contentious, and time consuming, especially when the parties are in a hurry to proceed with the broader business venture of which the license is but one part. However, those who decide to skip or skimp on the troublesome details of license drafting will often later face the consequences of a poorly thought-out license relationship ' consequences that are significantly more troublesome and costlier than the burden of thoroughly and accurately documenting the intended terms of the relationship at the outset. Even more frustrating is the experience of drafting a license that diligently attempts to address the business or legal issues thought to be important at the outset of the license relationship, only to discover later that a crucial (but possibly latent) problem was overlooked or inadequately addressed.

Many problems and pitfalls relating to patent licenses can be averted by consulting an attorney skilled in patent transactions prior to agreeing on definitive license terms. Moreover, having an attorney that has a thorough understanding of the types of problems that frequently arise in patent licenses can place a party at a considerable advantage in the important initial deal proposal and licensing negotiations ' well before preparation of a final license for execution. A party can thus take steps to ensure from the outset that the final license will take into account the issues that are likely to be of most concern to that party.

An understanding of common licensing pitfalls is not simply a means by which one party can secure a tactical advantage or win a lopsided license solely in his favor. Indeed, one of the benefits of awareness of potential patent license problems is in avoiding situations in which license terms, initially negotiated without an eye toward their practical workability, when placed in context, become so manifestly unworkable that both parties will ultimately have to accede to their revision ' revision that may be to the detriment or delay of the parties' business relationship.

Term Sheets

Patent licenses, like many contracts or transaction documents, often have their genesis in a “term sheet” or letter of intent, wherein the parties outline the substantive terms of their intended business relationship and of the definitive agreements that will ultimately govern the relationship. One of the most common problems arising during the negotiation of the definitive agreements for a transaction is a term sheet that impedes implementation of the eventual license or further business development with other parties because it does not fully or accurately define the terms of the intended business relationship. For example, parties should avoid agreeing to a firmly binding term sheet unless substantial research has been conducted regarding the other party to the agreement and the proposed relationship between the parties.

Term sheets should generally include a definite termination date, typically within a year. This expiration period prevents the term sheet from hampering later business prospects if a license is not eventually negotiated with the other party to the term sheet. In some cases, a nonbinding term sheet can be more than sufficient to set out the intentions of the parties and to highlight important issues. These issues are best explored in actual license negotiations prior to signing any binding documents. Similar precautions should be taken before agreeing to lockup clauses, exclusive-dealing periods, and other limiting provisions that attempt to make nonconsummation of the license deal highly problematic for one or both parties (recognizing, of course, that there may be times when one party has, and wishes to exert, strategic leverage by binding its counterpart in just such a fashion).

Field of Use

Probably the most difficult and most neglected portion of any patent license is the definition of the license scope or field of use. Although it is possible for a licensor to allow the licensee to use the licensed patent for any purpose, most agreements only intend to allow use of the licensed patent for a fairly specific field of use.

For example, a new and patented engine type may have potential uses in cars, lawn mowers, motorcycles, motorboats, or other engine-propelled systems. A licensee who makes only lawn mowers is not likely to develop the other uses for such an engine. Therefore, the licensor would ideally like to limit the license with that licensee to cover only the licensee's actual product. One approach might be to say that the field is limited to “lawn mowers.”

This approach appears simple, but may mask subtle complexities. Do “lawn mowers” include self-propelled push lawn mowers and riding lawn mowers? Do they include large commercial lawn mowers? If the licensee only makes riding lawn mowers, but the licensor believes the license covers self-propelled push mowers and commercial mowers, or if self-guided robotic lawn mowers may possibly become a lucrative market several years into the term of the license, the parties are not actually in agreement as to all of the issues that may ultimately assume commercial importance. However, they likely will not recognize this incipient ambiguity until much later, after the license agreement has become effective. An amicable resolution of later-arising differences may be possible, but it is equally possible that the newly discovered disagreement will precipitate claims of breach and failure of the business relationship.

Taking the time to define a field of use definition in detail during negotiation may lead to contentious negotiations on the field of use in the short term, but is advisable as it may allow the parties to reach a much more accurate and clear agreement that will provide workable terms for the duration of the business relationship patent regarding the licensed patent.

Form Licenses

Another potential pitfall lies in the use of form licenses, including form joint development, joint venture, and sponsored research agreements. The process of drafting a license from a model, even when appropriate, is not a simple or mechanical undertaking. Although many of the provisions in a license may and often should be modeled on like provisions from previous, similar agreements, each business arrangement is unique. As a result, a form license may not accurately reflect the true intentions and understandings of the parties. Therefore, although a form license may, in a particular instance, turn out to be an appropriate starting point for a given agreement, every license should be reviewed to ensure (a) that it reflects the actual intent of the parties, and (b) that its various provisions, taken in conjunction with the business relations between the parties and with any other unique features of the pending business deal, do not create any unintended consequences.

Preserving Parties' Respective Rights of Patent Ownership and Control

Typically, both parties to a transaction will own, or wish to gain an interest in, a patent relating to the subject matter of the underlying business. Each party will naturally wish to define clearly, and to maximize, their legal and beneficial interests in the patent that is important to achieving its respective business goals.

Thus, there will scarcely be a patent license in which the following issues, for instance, do not merit close consideration and negotiation:

(a) the licensee's right to sublicense or otherwise pass through to third parties the licensor's patent rights;

(b) the licensor's agreement to indemnify the licensee against third-party claims of patent infringement (and specifically, the nature and extent of the licensor's indemnification responsibilities);

(c) any provisions or pre-existing agreements that extend a party's patent rights or obligations to its “affiliates,” because such open-ended provisions can often create latent third-party interests substantially affecting the overall transaction and the benefits and burdens accruing to the principals to the license; and

(d) any covenant not to sue granted from licensor to licensee (and/or to the licensee's affiliates).

If clauses addressing these issues are not properly worded, the license could unwittingly grant a right of use in the licensor's patent to a large segment of the licensor's competitors.

Definitions and Recitals

Definitions and terms in an agreement should be the subject of careful scrutiny to determine if multiple interpretations are possible. If that is the case, the terms should be drafted more carefully. It may be helpful to have one or more discussions between the business representatives of the parties focusing solely on their interpretation of and intentions with respect to each major term and provision. Such discussions (and discussions about other major intended purposes and effects of the definitive agreements) should begin as early as the term sheet preparation period, and proceed through execution of the final license. These discussions provide the additional benefit of aiding in the preparation of a thorough and comprehensive defined-term list.

The recitals are another frequently overlooked portion of the license agreement that may have a significant effect. If a term of the agreement is vague or the agreement lacks useful provisions to address a given situation, a court will attempt to determine the manifest mutual intent of the parties. It will then construe the contract in light of this intent. The recitals generally give the court a clear indication of the parties' ostensible reasons for entering into the contract, as well as other general clues as to their intent. Accordingly, in drafting licenses, one should make certain that the recitals clearly and accurately reflect the basic motivations and economic expectations of each party.

Consider Future Transactions

Finally, in negotiating and drafting a given license agreement for a company, it is important to keep in mind that the company's business plan may change in the future, the company/subsidiary involved may itself be sold or merged, or the underlying patent assets may be (or may need to be) bought or sold in the future. Accordingly, licenses should be negotiated with an eye toward keeping the company's, or parent company's, options regarding future transactions or other changes in the intended use of the patent in question as open as possible.

Conclusion

Despite the difficulties one may face in drafting a good license agreement, keeping the principles discussed here in mind will make the process somewhat easier. More importantly, these guidelines may help avoid costly errors, inefficient negotiation of impractical terms, or entry into a one-sided or disadvantageous agreement that does not express or facilitate both parties' intended business purpose. The ultimate purpose of a license agreement is to effectuate a mutually profitable business arrangement between the parties. Thus, taking care to ensure that the license thoroughly and accurately contemplates and describes their intentions and the proposed nature of the business arrangements, in terms that are flexible enough to accommodate later-arising changes in circumstance and to avert foreseeable pitfalls or ambiguities, can pay dividends for all parties to the license.

Negotiating and drafting the terms of a patent license can be difficult, contentious, and time consuming, especially when the parties are in a hurry to proceed with the broader business venture of which the license is but one part. However, those who decide to skip or skimp on the troublesome details of license drafting will often later face the consequences of a poorly thought-out license relationship ' consequences that are significantly more troublesome and costlier than the burden of thoroughly and accurately documenting the intended terms of the relationship at the outset. Even more frustrating is the experience of drafting a license that diligently attempts to address the business or legal issues thought to be important at the outset of the license relationship, only to discover later that a crucial (but possibly latent) problem was overlooked or inadequately addressed.

Many problems and pitfalls relating to patent licenses can be averted by consulting an attorney skilled in patent transactions prior to agreeing on definitive license terms. Moreover, having an attorney that has a thorough understanding of the types of problems that frequently arise in patent licenses can place a party at a considerable advantage in the important initial deal proposal and licensing negotiations ' well before preparation of a final license for execution. A party can thus take steps to ensure from the outset that the final license will take into account the issues that are likely to be of most concern to that party.

An understanding of common licensing pitfalls is not simply a means by which one party can secure a tactical advantage or win a lopsided license solely in his favor. Indeed, one of the benefits of awareness of potential patent license problems is in avoiding situations in which license terms, initially negotiated without an eye toward their practical workability, when placed in context, become so manifestly unworkable that both parties will ultimately have to accede to their revision ' revision that may be to the detriment or delay of the parties' business relationship.

Term Sheets

Patent licenses, like many contracts or transaction documents, often have their genesis in a “term sheet” or letter of intent, wherein the parties outline the substantive terms of their intended business relationship and of the definitive agreements that will ultimately govern the relationship. One of the most common problems arising during the negotiation of the definitive agreements for a transaction is a term sheet that impedes implementation of the eventual license or further business development with other parties because it does not fully or accurately define the terms of the intended business relationship. For example, parties should avoid agreeing to a firmly binding term sheet unless substantial research has been conducted regarding the other party to the agreement and the proposed relationship between the parties.

Term sheets should generally include a definite termination date, typically within a year. This expiration period prevents the term sheet from hampering later business prospects if a license is not eventually negotiated with the other party to the term sheet. In some cases, a nonbinding term sheet can be more than sufficient to set out the intentions of the parties and to highlight important issues. These issues are best explored in actual license negotiations prior to signing any binding documents. Similar precautions should be taken before agreeing to lockup clauses, exclusive-dealing periods, and other limiting provisions that attempt to make nonconsummation of the license deal highly problematic for one or both parties (recognizing, of course, that there may be times when one party has, and wishes to exert, strategic leverage by binding its counterpart in just such a fashion).

Field of Use

Probably the most difficult and most neglected portion of any patent license is the definition of the license scope or field of use. Although it is possible for a licensor to allow the licensee to use the licensed patent for any purpose, most agreements only intend to allow use of the licensed patent for a fairly specific field of use.

For example, a new and patented engine type may have potential uses in cars, lawn mowers, motorcycles, motorboats, or other engine-propelled systems. A licensee who makes only lawn mowers is not likely to develop the other uses for such an engine. Therefore, the licensor would ideally like to limit the license with that licensee to cover only the licensee's actual product. One approach might be to say that the field is limited to “lawn mowers.”

This approach appears simple, but may mask subtle complexities. Do “lawn mowers” include self-propelled push lawn mowers and riding lawn mowers? Do they include large commercial lawn mowers? If the licensee only makes riding lawn mowers, but the licensor believes the license covers self-propelled push mowers and commercial mowers, or if self-guided robotic lawn mowers may possibly become a lucrative market several years into the term of the license, the parties are not actually in agreement as to all of the issues that may ultimately assume commercial importance. However, they likely will not recognize this incipient ambiguity until much later, after the license agreement has become effective. An amicable resolution of later-arising differences may be possible, but it is equally possible that the newly discovered disagreement will precipitate claims of breach and failure of the business relationship.

Taking the time to define a field of use definition in detail during negotiation may lead to contentious negotiations on the field of use in the short term, but is advisable as it may allow the parties to reach a much more accurate and clear agreement that will provide workable terms for the duration of the business relationship patent regarding the licensed patent.

Form Licenses

Another potential pitfall lies in the use of form licenses, including form joint development, joint venture, and sponsored research agreements. The process of drafting a license from a model, even when appropriate, is not a simple or mechanical undertaking. Although many of the provisions in a license may and often should be modeled on like provisions from previous, similar agreements, each business arrangement is unique. As a result, a form license may not accurately reflect the true intentions and understandings of the parties. Therefore, although a form license may, in a particular instance, turn out to be an appropriate starting point for a given agreement, every license should be reviewed to ensure (a) that it reflects the actual intent of the parties, and (b) that its various provisions, taken in conjunction with the business relations between the parties and with any other unique features of the pending business deal, do not create any unintended consequences.

Preserving Parties' Respective Rights of Patent Ownership and Control

Typically, both parties to a transaction will own, or wish to gain an interest in, a patent relating to the subject matter of the underlying business. Each party will naturally wish to define clearly, and to maximize, their legal and beneficial interests in the patent that is important to achieving its respective business goals.

Thus, there will scarcely be a patent license in which the following issues, for instance, do not merit close consideration and negotiation:

(a) the licensee's right to sublicense or otherwise pass through to third parties the licensor's patent rights;

(b) the licensor's agreement to indemnify the licensee against third-party claims of patent infringement (and specifically, the nature and extent of the licensor's indemnification responsibilities);

(c) any provisions or pre-existing agreements that extend a party's patent rights or obligations to its “affiliates,” because such open-ended provisions can often create latent third-party interests substantially affecting the overall transaction and the benefits and burdens accruing to the principals to the license; and

(d) any covenant not to sue granted from licensor to licensee (and/or to the licensee's affiliates).

If clauses addressing these issues are not properly worded, the license could unwittingly grant a right of use in the licensor's patent to a large segment of the licensor's competitors.

Definitions and Recitals

Definitions and terms in an agreement should be the subject of careful scrutiny to determine if multiple interpretations are possible. If that is the case, the terms should be drafted more carefully. It may be helpful to have one or more discussions between the business representatives of the parties focusing solely on their interpretation of and intentions with respect to each major term and provision. Such discussions (and discussions about other major intended purposes and effects of the definitive agreements) should begin as early as the term sheet preparation period, and proceed through execution of the final license. These discussions provide the additional benefit of aiding in the preparation of a thorough and comprehensive defined-term list.

The recitals are another frequently overlooked portion of the license agreement that may have a significant effect. If a term of the agreement is vague or the agreement lacks useful provisions to address a given situation, a court will attempt to determine the manifest mutual intent of the parties. It will then construe the contract in light of this intent. The recitals generally give the court a clear indication of the parties' ostensible reasons for entering into the contract, as well as other general clues as to their intent. Accordingly, in drafting licenses, one should make certain that the recitals clearly and accurately reflect the basic motivations and economic expectations of each party.

Consider Future Transactions

Finally, in negotiating and drafting a given license agreement for a company, it is important to keep in mind that the company's business plan may change in the future, the company/subsidiary involved may itself be sold or merged, or the underlying patent assets may be (or may need to be) bought or sold in the future. Accordingly, licenses should be negotiated with an eye toward keeping the company's, or parent company's, options regarding future transactions or other changes in the intended use of the patent in question as open as possible.

Conclusion

Despite the difficulties one may face in drafting a good license agreement, keeping the principles discussed here in mind will make the process somewhat easier. More importantly, these guidelines may help avoid costly errors, inefficient negotiation of impractical terms, or entry into a one-sided or disadvantageous agreement that does not express or facilitate both parties' intended business purpose. The ultimate purpose of a license agreement is to effectuate a mutually profitable business arrangement between the parties. Thus, taking care to ensure that the license thoroughly and accurately contemplates and describes their intentions and the proposed nature of the business arrangements, in terms that are flexible enough to accommodate later-arising changes in circumstance and to avert foreseeable pitfalls or ambiguities, can pay dividends for all parties to the license.