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Thursday, 14 October 2010

Guide to Licensing


Licence comes from licens, the Latin for the verb "to be permitted". The concept of permission is central to licensing: the owner of a particular product is permitting someone else to use the product. The owner wants both to allow use of the product, but also to protect its ownership: the licence agreement allows fulfilment of both of these requirements.

A licence arrangement is a useful alternative to a sale or a purchase arrangement. In a sale, the seller transfers legal ownership of the sold article to the buyer: the deal is over at that point. In a licensing situation, the licensor retains ownership of the product and can derive a lasting range of benefits: a continued revenue stream, the ability to provide maintenance and support services to the licensee, the ability to share in any intellectual property rights (IPRs) generated by the licensee through use of the licensed product - these are all benefits which, if the licensee agrees, can arise from a licensing relationship.

Licensing can also be a strategic decision: for example, a company may be rich in intellectual property (IP), but may not have the resources to manufacture products based on the IP. Alternatively, the company may not have the ability to market its product. Finally, and frequently, a company may recognise that its product is best sold as a component of a bigger product created by another organisation: allowing the other organisation to manufacture and market saves the company significant costs, and may allow important access to a significant market share.

All of the commercial situations listed in the previous paragraph should be achieved through the use of a licence, in order to protect the licensor's ownership of IP in its product. The licence will contain an explicit assertion of the licensor's ownership of the IP, and will carefully define the scope of the licensee's right to use the product.

Commercially, therefore, a licence is a contractual relationship which balances the licensor's ability to derive benefit through exploitation of its product with its ability to protect ownership of its IP.


There is an almost infinite number of licensing arrangements: software licences, outsourcing arrangements, pharmaceutical or bio-tech licensing and distribution arrangements, end user licence agreements to name but a few. Licensing arrangements can differ widely on commercial terms. For example, a telecoms company licensing its product to the public will have a standard form agreement containing contractual protections for the licensor appropriate to an organisation contracting with customers numbering in hundreds of thousands. Different contractual terms will be contained in a license where an IP company contracts with a handful of organisations around the world, offering each organisation exclusivity within the organisation's particular territory.

Different types of contract differ radically in their terms: an SaaS company's license terms will vary significantly from a pharmaceutical company entering into an R&D development. This is hardly unexpected: the differing terms reflect the number of different commercial transactions that can be achieved through licensing.

But there are some contractual aspects which are common to every license. This goes back to the central purpose of any licence, being to protect. Each licence should always achieve the following three types of protection:

o Protection of ownership of IP: the licensor's IP is a significant asset of the company into which time, resources and cost have been invested. The key purpose of a licence is to preserve the licensor's ownership of its IP.

The contractual terms which are used to preserve this ownership are detailed at section C below. However, it may be fair for an IP owner to object that its IP is already protected by some aspect of intellectual property law: for example, the company's product may be an invention protected by a patent, or source code for software protected by copyright, or even a process protected as a trade secret. If the product is already protected in this way, why should it separately require protection through a licensing agreement?

This question seems even more relevant when the fact is taken into account that a license agreement can be said to diminish a product's existing protection, by allowing the licensee to use the product. In this sense, a license is an agreement to do something with someone else's property which, were it not for the license, could be legally prevented and/or could give rise to a legal cause of action (breach of copyright, breach of patent, breach of confidentiality). If a licence is diminishing pre-existing protection in this way, how can it itself be regarded as providing protection?

The issue here is that the product may well be protected by intellectual property law, but this protection will suffer as soon as the owner allows use of the product by another person. A properly drafted license, therefore, will allow this use, but only on terms which carefully define the scope of the use and protect the IP of the licensor.

For example, consider a situation where a company wishes to licence a secret process to another company. Such processes are typically protected as trade secrets. Trade secrets are an incredibly fragile form of intellectual property, since they can only be classified as a trade secret while they are an actual secret: as soon as the process is divulged to the public, it loses any right to be qualified as a trade secret. In this example, the licensor of the trade secret has successfully maintained the secrecy of the process, for instance by limiting physical access to the process operation area and limiting knowledge of the process to a small group of people, as well as imposing strict confidentiality obligations in employee contracts and on visitors to the licensor's premises. The licensor now wants to divulge the trade secret to the prospective licensee: how can he do this without compromising the essential secrecy of the process?

The answer is that the licence agreement will be used to maintain the secrecy of the process, by clearly identifying the extent of the trade secret and placing detailed confidentiality obligations on the licensee and its staff. This is an example of a fundamental quality of any licence, the protection of the licensor's intellectual property.

o Protection of reward. The fundamental aim of a licence may be to protect the licensor's IP ownership, but almost as important an objective of the licence is to secure the licensee the benefit expected as a reason for entering into the licence in the first place.

The benefit is usually financial: the licence will contractually oblige the licensee to make a payment to the licensor. However, in many situations the benefit may not be financial: the licence may occur as part of a collaboration agreement between two organisations sharing their IP to create some greater product; alternatively, the benefit may simply be exposure of the licensor's product to the licensee's client base to increase brand profile.

Whatever the nature of the benefit, the licensor's right to it should be clearly explained in the licence agreement: this then gives the licensor a contractual right to the particular benefit, and failure on the licensee's part to provide the benefit will entitle the licensor to sue for breach of contract.

o Protection against liability. The third protection offered by a licence is the scope for a licensor to limit its liability to the licensee, or the licensee's end-users, for certain types of breach committed by the licensor.

Why should a licensor be allowed to limit its liability for its product? Firstly, it is relatively commercially accepted that if a product fails to work, the licensor should not be responsible for repaying the initial sums paid by the licensee, plus the licensee's cost of replacing the product, plus the cost to the licensee of every possible consequence of the product's failure to work. These costs could amount to a financial sum which is disproportionate to the amount of payment originally received by the licensor. As a commercially standard principle, therefore, the licensor should be able to place a financial cap on its liability (although there are certain liabilities which may not be limited by law, such as liability for death or personal injury caused by the licensor's negligence).

Secondly, a less subtle reason for limiting the licensor's liability is that it is obviously in the licensor's interests to do so. This point increases in importance in a situation where a licensor has licensed a product to numerous licensees, and the product develops a generic flaw: if each licensee claimed successfully, the licensor would be facing a huge bill. The further the licensee can limit liability in each licence, the lower the size of overall cost. The licence can therefore provide protection to the licensee by controlling the scope of the licensor's liability.


It is important to remember that an organisation may be licensing even though it is not in the process of taking its product to market. Any arrangement where an organisation allows another organisation to use its IP will involve licensing. Examples include:

o R&D: contracting with another organisation to pool resources with the aim of developing an improved product, or a combination of each party's product, will necessarily involve licensing.

Consider the following situation, which is a typical R&D collaboration scenario. Two parties enter into a contract to further the development of a product incorporating IPRs owned by either party. One party may be developing and providing hardware, and will therefore own the IPRs subsisting in the hardware. The other may be providing technology to enable the operation of the hardware, and will own IPRs in that technology. The parties work together to develop and test the combined product. In order to achieve these objectives, a correctly drafted collaboration contract would contain the following licences:

o Each party would license to the other party the use of such pre-existing intellectual property rights in the licensor's product as the licensee needs to use in order for it to complete its share of the collaboration services. Pre-existing intellectual property rights means rights existing at the point that the collaboration agreement begins;

o The contract would also deal with new intellectual property rights generated by either party during the course of the collaboration services. Typically, the contract would state that each party owns intellectual property rights it generates during the contract, and would license the use of such intellectual property rights to the other party to the extent required by the other party to fulfil its collaboration services obligations; and

o Finally, the contract would typically assert each party's rights of ownership of its intellectual property rights, and impose contractual restrictions on the other party's use of such rights.

oDuring manufacture: IP companies frequently lack the resources to manufacture their product: alternatively, they may find it more cost effective to outsource the manufacture process.

Any contract resulting in the manufacture of a product will need to allow the manufacturer to use the IP comprising the product. In order to protect the IP, the IP owner will impose restrictions on the scope of the manufacturer's use of the IP: for example, limiting such use solely to the purpose of manufacturing the required product, and limiting permission to use the IP solely to the duration of the agreement. An example of this would be a manufacturing arrangement entered into by a pharmaceutical company wishing to produce a particular pharmaceutical product. The composition of the product is likely to be protected by patent: the actual process by which the product is made may well be a trade secret. The manufacturing agreement will have to be a carefully drafted licence to allow the manufacturer to make the product, and will have to licence the intellectual property as follows:

o The licence to use the patent requires particular attention. A major problem with patent licenses lies in the fact that a patent does not grant the patent owner the right to make anything: rather, it grants the owner the right to prevent anyone else from making, using or selling the invention. It follows that any attempt to phrase a licence in a way that explicitly permits the licensee to make, use or sell the patented invention is invalid. Worse, if the licensee has obtained an explicit warranty from the licensor that the licensor has the right to grant the license, the licensor will be in breach of this warranty and liable to the licensee.

Instead, a patent licence needs to grant the licensee protection from infringement lawsuits being brought by the licensor for the licensee's making, using or selling the patented invention.

o The process protected as a trade secret needs extreme protective measures, given the fact that a single unintentional disclosure of a trade secret can rob it of its secrecy and thereby forfeit its protection.

The manufacturing agreement will therefore impose extensive confidentiality obligations on the manufacturer in relation to the use of the process.

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