Negotiating licences ‐ issues to consider

1. Licensee and licensor details

Consider withholdings taxes, transfer pricing and exchange control issues when concluding international licences, in particular where the parties are connected.

For example, "manufacturing" licences concluded between foreign licensors and South African licensees require DTI approval; and international licences between connected persons must levy an arm's length royalty.

Where regulatory approval is required, the licence should include a suspensive condition, suspending the "coming into effect" of the licence.

2. Types of intellectual property licensed (patents, designs, copyright, trademarks, know‐how)

Identify all the intellectual property required by the licensee. In many instances, a patent licence requires a licence in the associated know‐how.

3. All Types of licensed rights

Only licence the rights that you intend the licensee to exercise. Also beware of implied licences granted in terms of IP Acts. For example, according to s58 of the South African Patents Act:

58In default of an agreement to the contrary: (a) a licence to make a patented article shall carry with it the right to use or offer to dispose of or dispose of the patented article; and (b) a licence to use or exercise a patented process shall carry with it the right to make, use or offer to dispose of or dispose of the product of the process.

Accordingly, never licence a supplier to make products without specifically limiting his right to use and dispose of the products.

4. Type of licence and rights granted

One has the option to conclude:

Do not conclude "sole and exclusive" licences.

5. Licensed territory and field of use

Try to limit the scope of the licence to territories where the licensee has a presence. If the licensee wishes to increase its market into "virgin territories":

Do the same for "fields of use".

6. Sub‐licensing

Do not permit sublicensing unless absolutely necessary. If sublicensing is permitted, ensure that each such sub‐licence / sub‐licensee requires your prior written approval. Carefully review the royalty and royalty payment clauses in the sub‐licensing agreements and ensure that you receive what you expect to receive.

7. Various forms of upfront royalties / licence fees

Upfront royalties communicate a commitment by the licensee and accelerate his marketing efforts.

8. Various forms of running royalties

Royalties linked to sales price is preferred. Do not link royalties to profits and do not provide for a fixed payment "per product sold" unless the royalty provision includes an annual escalation clause.

9. Minimum royalties

As a general rule, include minimum royalties where an exclusive licence is granted.

Clarify whether the licensee is liable to pay all minimum royalties, or whether failure to meet such hurdles grants the licensor a right to terminate the agreement.

10. Late payment provisions

Ensure that the interest payable on late payments is punitive ‐ it must exceed the licensee's borrowing cost. Otherwise, the licensor could easily find himself a banker to the licensee.

11. Auditing rights

Provide for access to books of account of the licensee and payment of the auditing fee by the licensee where the discrepancy between royalties paid and payable exceed 15‐20%.

12. Termination of the licence

Where the agreement does not provide for minimum royalties, consider a 2‐3 year initial term, renewable at the discretion of the licensor / upon certain hurdles being satisfied.

13. Arrangements regarding surplus stock on termination

On termination, is the licensor required to purchase excess stock at cost or may the licensee dispose of such stock for a given period following termination of the licence?

14. Warranties

Consider inserting warranties that: the licensor is the proprietor of the licensed intellectual property / rights; the intellectual property is valid and in force; and that the exercise of the licensed rights does not infringe the intellectual property of third parties. Licensors, attempt to dilute these warranties "to the best of your knowledge". Remember that to defend an infringement action in the US will typically cost more than US$5m and the licensor may be liable for this cost + damages + punitive damages if he warranted that "the exercise of the licensed rights does not infringe the intellectual property of third parties".

15. Improvements to the intellectual property by licensee and licensor

Licensors should be careful extending licences in respect of future intellectual property developed by the licensor. Consider extending only non‐exclusive rights in such intellectual property.

Also, note that clauses requiring assignment to the licensor of improvements made by licensees typically contravene competition laws. Consider securing only a royalty‐free, perpetual, non‐exclusive licence in respect of such intellectual property.

16. Marketing obligations imposed upon licensee

Provide that the licensee is required to exercise his best / reasonable / reasonable commercial efforts to create and satisfy the market for the products. Licensors should aim for "best efforts", whereas licensees should target "reasonable commercial efforts".

17. Indemnities

Does the licensee indemnify the licensor against product liability claims? Damages caused by the action / inaction of the licensee, etc?

Remember that in the US, product liability claims may be instituted against the retailer, manufacturer or licensor.

18. Technical assistance

Is the licensor required to provide technical assistance, where necessary, and what consideration will be payable for such services.

Note: In international licences, do not "roll‐up" payments for "use of intellectual property" (i.e. the true licence), continuing R&D (modifications) and technical assistance into a single "royalty payment clause". Apportion the payments according to the three categories as their tax consequences differ.

19. Quality control

This is particularly important when licensing trademarks. Various territories provide for expungement of trademarks where quality control is not exercised.

20. Infringement

Who defends the action? Who pays for the cost to bring the action? Who participates in damages? May the other party join in proceedings? If the licensee brings an action, is he required to bring it in the name of the licensor? If so, is the licensee required to indemnify the licensor? We suggest that licensors retain control over infringement proceedings.

21. Third party claims of infringement

See comments relating to infringement. We suggest that licensee retain control over claims of infringement by third parties.

22. Maintenance of intellectual property

Who controls prosecution and maintenance of intellectual property and who pays the associated costs? We suggest that the licensor retains control over such actions at the cost of the licensee.

23. Acknowledgements

You may wish to include acknowledgements that all intellectual property and necessary know‐how has been provided to the licensee.

24. Confidentiality

Always include a confidentiality provision where know‐how or other confidential information is disclosed to the licensee. This clause should survive expiry, cancellation or termination of the licence.

25. Arbitration

Include arbitration provisions only where the relationship between the parties is sensitive or open court proceedings would result in disclosure of confidential information. Remember that arbitration is generally more expensive than court proceedings.

Alternatively, use arbitration provisions to remedy complications surrounding enforcement / choice of law. For instance, when you wish to apply South African law but will most probably only be entitled to institute action outside of South Africa.

26. Assignment of rights and obligations

Licences are generally personal. Licensees are seldom entitled to assign their rights, whereas licensors should consider providing for assignment on notice to the licensee.

27. Governing law

Consider where causes of action will typically arise, i.e. where the licensee exercises its rights. Also consider where licensee’s assets are located, and ensure that the governing law coincides with these considerations. Alternatively, amend the default position by way of an arbitration clause.

(Updated 2007)

Articles: Commercial