Licensing Intellectual Property Rights

What is a license?  In a nutshell, it is a promise not to sue.  For example, the fictitious 007 British spy had a "license to kill."  In essence, this was a promise from the British government not to prosecute 007 for the many murders he committed provided he continue to save civilization from world domination by various evil-doers. 

Thus, the license agreement fundamentally involves the licensor promising not to sue the licensee for using the licensor's intellectual property.  In return, the licensee pays the licensor a royalty.

Types of Licenses

In the realm of intellectual property there are several licenses of particular interest that our firm sees with great frequency:

1. Patent Licenses

A patent gives the owner the right to exclude others from making, using, selling, offering to sell or exporting the invention claimed in the patent.  A patent license can take many forms but the most common types are generally exclusive and non-exclusive licenses.  Owning an exclusive license to a patented technology may be made contingent on the company producing a predetermined amount of royalties.  Another type of exclusive license may be limited to a particular industry or geographic territory.  Intuitively, a non-exclusive license means that multiple parties may concurrently license the technology, even if they are competitive with each other. 

Assignment of Patent Licenses

Many clients are surprised to discover that the type of license granted (non-exclusive versus exclusive) may have a substantial impact in the event the company is sold or acquired.  The general rule (unless otherwise provided) is that exclusive licenses are transferred upon a sale but non-exclusive licenses are not.

Furthermore, even if there is an anti-assignment clause, the seller can still acquire the license by structuring a reverse merger into a shell subsidiary of a larger company. The licensee survives the merger into the shell subsidiary and thus the licensee (and its license agreements) survive intact.

Enforcement of Patent Rights

As a general rule, a non-exclusive licensee cannot sue a non-licensed entity for patent infringement.  The non-exclusive licensee must demand that the patent owner take steps to enforce the patent rights.   An exclusive licensee generally can sue for patent infringement.

2. Trademark Licenses

There are two main considerations regarding trademark licensing: (1) whether the license would be deemed "naked" and (2) whether the trademark license would effectively become a franchise.

Quality Control in Trademark Licensing

Imagine if you could pay $1,000 to get a trademark license to the COCA COLA trademark with no strings attached.  You would bottle your own concoctions and then label them COCA COLA.  You would probably sell a tremendous amount of product at first.  However, consumers would soon realize that the taste, quality and ingredients of your product are different.  Consumers would then lose faith that the bottle of COCA COLA they purchase will taste the same every time.  Thus, if a trademark is licensed without quality control over the end product, then the license is deemed "naked" and such activity constitutes grounds that the trademark has gone abandoned.  As the Ninth Circuit stated:

The licensor owes an affirmative duty to the public to assure that in the hands of his licensee the trademark continues to represent that which it purports to represent. For a licensor, through relaxation of quality control, to permit inferior products to be presented to the public under his licensed mark might well constitute a misuse of the mark.  Siegel v. Chicken Delight, Inc., 448 F.2d 43, 171 U.S.P.Q. 269 (9th Cir. 1971), cert. denied, 405 U.S. 955, 31 L. Ed. 2d 232, 92 S. Ct. 1173, 172 U.S.P.Q. 577 (1972).



Accordingly, a trademark license must account for periodic oversight by the licensor to monitor the quality and consistency of the products licensee sells under the trademark.

Is the Trademark License a Franchise?

The three elements of a franchise are:  (1) initial fee in excess of $500.00; (2) licensing of a trademark; and (3) providing substantial assistance or control.   Because the courts have overwhelmingly required a trademark licensor to exercise quality control over the licensee's products, two of the three elements of a franchise are already met. 

Virtually all trademark licenses initially contemplate an up-front license fee in excess of $500.  Therefore, the question to ask is whether your trademark license is, in reality, a franchise. 

3. Software Licenses

Our practice regularly handles both sides of software development transactions.  The developer on one side and the customer on the other.  We frequently encounter inexperienced attorneys demanding that the software developer indemnify the customer for use of the software.  For example, in the event that the software was found to infringe upon a patent, the software developer would "indemnity, hold harmless and defend the customer."

A developer would not assume such broad and unlimited liability unless:

1. The developer had complete control over the deployment of the application;

2. The developer had the authority to shut down execution of the application in the event a claim was made, thereby mitigating any future damages attributed under the provision;

3. The developer had a substantial ongoing royalty stream to pay for the indemnification overhead; and

4. The project was worth at least $250,000 amortized over 24 months.

Even with these circumstances, a developer would need an opt-out clause in the event: (1) the allegedly infringing product could not be modified to avoid infringement and (2) a license could not be secured to continue to use the product. Typically, the developer would be able to walk away from infringement liability by paying out either the last 6-12 months of licensing payments, or a pro-rata share of the one-time development costs on a 5 year product lifespan. For example, if a project had an upfront fee of $500,000 and the product was deemed infringing after Year 1 (and no way to circumvent or license), then the developer would return $400,000. If the infringement was found in Year 4, then a refund of $100,000 would be given. The window would close at Year 5 (end of the product lifespan). Some larger companies (Fortune 500) we work with insist on a 7-year lifespan.

Absurd Results

In most cases, indemnifying a custom software project  by the developer would lead to absurd and unconscionable results. The developer would effectively be an unpaid IP insurer of the customer’s business activities. If a claim is made, the customer could continue to rack up liability that the developer would have to pay. Furthermore, the customer could deploy the solution in a manner or in combination with other technology that would cause an originally non-infringing solution to become infringing. Again, the developer would have no means to limit its liability.

How to Advise the Customer Demanding Indemnity

1. You are producing software in accordance with the customer’s specifications;

2. You will have no control over how they deploy it, market it, or use it with other technologies;

3. You cannot provide development services at the price quoted and then also retain IP counsel to clear the technology for non-infringement;

4. At the costs quoted you cannot allocate capital to an infringement defense fund to adequately cover a potential infringement;

5. The customer is in a better position to mitigate damages, defend allegations and potentially license the IP asserted against it.

 

 

Intellectual property licensing arises in various circumstances.  A license may be granted to a company seeking to manufacture a novel product developed by an inventor.  Two companies settling a software copyright infringement litigation may agree upon a software license so there is no disruption in the defendant's product availability.  A trademark license may be granted to permit another company to use a mark provided the underlying product is of a certain quality and consistency.