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Considerations In Licensing New Technology

This review begins with the considerations on selecting a type of intellectual
property to protect a new technology and follows up with practical considerations in
licensing the intellectual property protecting the technology.

With a new technology it is not always clear what type of intellectual property is
the best fit to protect the technology. Accordingly, I’m going to take a couple of minutes
to quickly review the relationship between tangible property, intellectual property and
rights in the intellectual property. There are four types of intellectual property -- patents,
copyrights, trade secrets and trademarks. Patents protect the implementation of ideas;
copyrights protect the expression of ideas; trade secrets protect confidential information;
and trademarks protect the identification of the source of goods or services.

In a patent the intellectual property is the patent grant, i.e. U.S. Patent, from the
Federal government. New and useful machines, processes, articles of manufacture, and
compositions of matter may be patented. The rights granted by the patent are the rights
to exclude others from making, using or selling the tangible property incorporating the
invention claimed in the patent.

In copyrights, the intellectual property is a copyright registration certificate issued
by the Federal government. The tangible property protected includes literary works such
as books and computer programs, performing art works such as movies and recordings,
and sculptures. The rights provided by the copyright registration are the rights to exclude
others from reproducing copies of the work, preparing derivative works from the work,
distributing, performing or displaying the copyrighted work.

In the case of trade secrets, the intellectual property is created by a contract and
by a security plan. The contract defines the obligations associated with the confidential
information, and the security plan defines how the confidential information is protected
from public disclosure. The tangible property associated with trade secrets can be
anything that gives a competitive advantage. The rights associated with trade secrets are
the right to use or the right to disclose. Use normally is spelled out with limitations on
internal use and external use and with reference to a specific purpose for the use.

In the case of trademarks, the intellectual property is a registration certificate
issued by the Federal government. The tangible property associated with a trademark
registration is the mark, label, or brand name that identifies a source of goods or services.
The rights associated with the registration certificate are the right to exclude others from
using the trademark or copying the trademark.

With these types of intellectual property in mind, the question becomes where
does the new technology fit? Almost certainly, you can maintain it as a trade secret and
license it as such, and you can also create a trademark for the goods or services resulting
from the technology, and license that trademark.

Fitting the new technology into protection under the patent laws or the copyright
laws can be more difficult. As an example, in the late sixties and early seventies there
was a raging debate over whether computer programs could be protected by patents
and/or copyrights. Many viewed computer programs as nothing more than mathematical
algorithms and that only the computers that ran the mathematical algorithms could be
patented. Others argued that computer programs performed tangible processes producing
tangible results and should be patentable per se, and alternatively, that the code in a
program was a literary work and should be copyrightable. Over the years both of these
latter two arguments won out. In other words, computer programs became patentable as
a new and useful processes, and they became copyrightable as original literary works.

Today the boundaries of patent protection and copyright protection are being
stretched by biotechnology and nanotechnology. The legal and moral issues related to
patenting life forms or copyrighting bio-information go beyond the bounds of our
presentation this morning. However, I feel confident in saying that where there is
economic value, and where great research and development expense needs to be
protected, the U.S. Courts or Congress will find a way. For example, years ago Congress
added asexually-reproduced plants to subject matter that could be patented. More
recently, Congress added protection similar to copyright protection for Mask Works to
protect the masks used to manufacture integrated circuits. Just find yourself a creative
patent attorney who is willing to push the boundaries of protectable subject matter as
defined in the statutes.

Now let us turn to the practical considerations in licensing this technology. I am
going to briefly review types of licenses, royalty considerations, warranty and indemnity
considerations, and exit strategies. When I say a type of licenses, I am referring to
royalty-bearing, paid-up, or cross-license agreements.

What are the considerations in choosing between a royalty-bearing agreement and
a paid-up agreement? If you stand back and look at the business arrangement, you will
soon conclude that if you have a royalty-bearing agreement, you are closely linked to
your licensee's success. In other words, if the licensee makes money, you will receive
royalties and be successful. If the licensee is not successful, you may receive nothing.
On the other hand, in a paid-up license, the licensee has paid you a fixed amount up front.
The licensee is taking all the risks of business, and your only concerns are collateral obligations the licensee might have relative to the licensed technology. Thus, in a
royalty-bearing agreement you are speculating on the business just as the licensee is,
while in a paid-up arrangement the licensor is not speculating and has already been paid
for the license.

One can appreciate that because of the difference in the speculative nature of
these two types of licenses the paid-up fee is generally a fraction of the total potential
royalty-bearing license fee. Typically, a paid-up license might return only a fourth of the
royalty that one would expect from a successful royalty-bearing arrangement.

Another type of license is a cross license agreement where each party has
intellectual property rights that the other party wishes to license. These agreements
usually include future intellectual property rights for a period of years, say five years, and
there is a balancing payment from one party to the other party to reflect the difference in
the value each party realizes out of the cross-license. After five years, the parties would
re-negotiate the license with a new-balancing payment based on the business history over
the previous five years.

In all of these types of licenses the field and license rights may be selectively
chosen to adjust a royalty upwards or downwards. Note that you don't have to just
change the field to change the scope of the license. You can also change the type of
intellectual property licensed and the rights being licensed under each type of property.
If you just adjust the field without adjusting the rights, you have probably licensed too
many rights.

Regarding royalties, some considerations in setting a royalty include industry
practice, a level playing field, the relative market exposure, and most favored licensee
situation. First, industry practice may set bounds on the royalty rate. For example, in the
technical area of computers, a royalty might be set based on the selling price of the
computer or based on the manufacturing cost of the computer. These royalties generally
run between 1% and 10%, with the selling-price royalty being on the lower end of this
range and the manufacturing-cost royalty being on the upper end of this range. On the
other hand, in the software industry royalties tend to run much higher as the predominant
cost is research and development, and manufacturing cost is relatively low. Thus, a 25%
royalty rate is not unheard of for a licensing under a patent to a software invention.

One major consideration of a licensor in granting a license at a given royalty rate
is to make sure that the licensee does not gain a business advantage. In other words,
there needs to be a level playing field relative to the cost of going to market. If the
licensor has spent millions in research and development, then the license rate should
reflect some of that R&D cost to the licensee so that the licensee cannot undercut the
price of licensor’s products in the market.

Market exposure is also another consideration for licensors. If the licensor, for
example, is the largest player in the industry he may have a liability exposure in the
future much bigger than any potential licensee. For example, assume a licensor's share is 50%-60% of the market, and every other competitor's share is 10% of the market. If the
large player sets a high royalty as standard in the industry then an infringement by the
large player on a future intellectual property right of a small competitor in the industry
could cost the large player a very heavy royalty. Accordingly, a licensor with a large
market share may deliberately set a low license rate in expectation that at some point the
company will need a license from others in the industry.

Lastly, relative to royalty considerations, many licensees will insist on what’s
know as a most favored licensee clause. This clause in a royalty-bearing agreement
states that if at a later date, another licensee is given a lower royalty rate under the same
terms and conditions, then the royalty rate in the present license agreement will also be
lowered to that rate. Practically speaking, these clauses do not often come into play
because almost always two separately negotiated royalty-bearing agreements have
different terms and conditions. Thus the most favored licensee clause conditions are
almost never satisfied.

Now let’s consider indemnification and warranty provisions in license agreements
and what is appropriate when licensing technology. It is not unusual for a licensee to
request an indemnity, or save-harmless clause, from the licensor if the licensee is sued for
infringement as a result of using the licensed intellectual property. However, this is not
appropriate. First of all, remember from our initial discussion about the intellectual
property, the liability attaches to products created by use of the rights, and there is no
liability associated with ownership of the intellectual property. Thus, for example, if a
licensee under a patent is charged with infringement under a third-party patent, the
licensee is making, using and selling the goods that carry the liability. There is no
liability to the patent owner. Further, the patent owner has no generation of revenue to
support an indemnity clause for this liability attached to the goods. The revenue to cover
an infringement of a third-party patent is from the sale of the goods by the licensee. The
licensee must view this potential risk of patent infringement of a third-party patent as just
another risk of doing business and price the marketed goods accordingly. If the licensee
insists on an indemnity clause, then the licensor had better raise the royalty rate
significantly so as to cover any possible future liability.

On the other hand, the licensor should be willing to give a warranty that to the
best of the licensor’s knowledge there is no infringement of the licensed intellectual
property. All the licensor is stating in the warranty is that as of the date of the agreement
he/she knows of no infringement. This does not mean the licensor has necessarily
conducted an infringement patent study to determine whether there are any additional
third-party patents under which a license is required to use the invention in this licensed

Other warranties that the licensor should provide include a warranty that there are
no restrictions in agreements with others that would prevent the licensor from granting
the license in the present license agreement. Further, and in the same vane, that the
licensor has the necessary ownership of or a sublicensing right in the intellectual property
to grant the rights in the license agreement. Finally, in the area of copyrights, particularly for copyrighted software, the licensor should be willing to grant what’s called a warranty
of originality. In copyright law, a work is not an infringement of another’s copyrights
unless it is copied. Thus, when the licensor grants a warranty that the copyrighted work
is original with the licensor it is in effect a warranty that there is no infringement of the
copyrights of another.

Lastly, there are exit strategies to be considered and more particularly, what
survives the termination of the license agreement. As in any contract there should be a
planned termination for such things as breach of the agreement and bankruptcy. In
intellectual property licenses some additional considerations relate to what license rights
and obligations should survive and what to do if there is lesser failure, i.e. did not meet
royalty expectations.

If a license is terminated, obligations relating to confidential information should
survive, and obligations associated with a trademark license might survive that relate to
product maintenance to preserve a reputation as to the quality of goods. With respect to a
termination by choice of one of the parties, the licensed rights may survive a sufficient
length of time for the licensee to clear inventory.

There need not be a complete termination of the agreement. If business
expectations are not being met, the nature of the license or the royalty obligation might be
changed by terms of the original agreement. For example, if the licensee has an
exclusive license at a high royalty rate to reflect the exclusivity, the continuation of the
exclusive license might be dependent on a minimum annual royalty payment to the
licensor. If the minimum annual royalty is not met, the license might automatically
become a non-exclusive license with a lower royalty rate.

In closing, there are many aspects of intellectual property licensing that we have
not had time to present today. If you are relatively new to intellectual property licensing,
I would urge you to seek out a second attorney with many years of experience in
licensing to assist you. His or her review of the first draft of you license agreement may
save your client and you much grief during the negotiation of the agreement and during
the life of the agreement. The length of negotiations and the cost associated with the
negotiation can be reduced if all parties understand best practices in licensing.

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