Drafting a Licensing Agreement, a Patentee Perspective

Image Source: 123RF.com ID 21818236 © alexskopjeHaving an attorney draft a licensing agreement, or a licensing expert negotiate a licensing agreement, from start to finish is obviously the best way to proceed. But there will always be some who will choose to proceed on their own to negotiate a licensing and/or draft an agreement.  This can certainly be dangerous, but sometimes there is no alternative given financial constraints.  Whether you are going to represent yourself or work with an attorney or licensing professional, it is a worthwhile endeavor to engage in some strategic thinking, which absolutely must be the precursor to any memorialized deal.

First, when embarking upon a licensing path it is absolutely essential that you stop thinking in terms of a template for a license and start thinking in terms of clauses for a license. Attorneys cringe when they hear someone ask for a contract or license template. The reason for this is every situation is different. Yes, there are standard clauses that need to be there, but a license is just an agreement between the parties who sign the document and enter into a business relationship.  As a result, the license needs to memorialize what you and the other party have or will agree to moving forward.

Notwithstanding what is said above, when most attorneys draft a licensing agreement they will start with clauses from other agreements and modify them to fit the particular situation and desires of the parties. So just because you will want a custom contract that actually captures the agreement you’ve reached doesn’t mean that you can’t start with some basic provisions and modify them as necessary.


The best place to start to find sample licensing agreements is at a law library. This is true because the really useful licensing and contract books that attorneys use are also extremely expensive to purchase, sometimes costing as much as $1,000. But don’t worry, you might just be surprised to learn that law libraries are all over the place. Many court houses have at least a modest library, and all law schools have extensive libraries, which is a requirement for ABA approval.  ABA approval is the holy grail or certifications for law schools so if you can get access to a law school library you are all set. Even a modestly stocked library might be sufficient in a quest for sample licensing agreements, but I would call ahead to see if they have what you need. Law schools will definitely have what you need, but again, call ahead. Some law schools do not let members of the general public use the library.

What you will need is an encyclopedia of forms. West has an encyclopedia set called West’s Legal Forms. In the Second Edition it is Volume 25 that relates to patents (I know this because I own that volume myself). There are a number of good sample licenses in the West book. If you find a library that has a good intellectual property section (which is becoming easier given the growth of this field of practice) there will be several smaller encyclopedias dedicated to patent licensing, such as Milgram on Licensing. In most libraries the form books will be in one location and the IP books in another location, so be sure to check both locations.

There are also some decent books on licensing agreements you can get from your local book store, but these books will not have the amount of information and samples that a form encyclopedia would have.

Of course, you can also find some sample agreements online as well. Some of the best online examples might come from universities. A lot of universities have sample agreements online. These agreements, however, may not be right for every situation. Frequently universities are licensing early stage technologies, sometimes even before a patent has been obtained and many times before a patent has issued. There are also a number of places online where you can obtain form agreements, or even create a quasi-original agreement yourself.

Remember, as you build your draft license, or a wish-list of terms to take to your attorney or licensing professional, you don’t generally want to copy any single form.  If you are going to do this yourself you probably want to consult as many of the aforementioned resources as possible. Go through the examples you can collect and pick clauses (or paragraphs) that seem to fit your needs and preferences. The more examples you have the better.

Before proceeding, a word of caution. Even if you are going to create your own license agreement you probably should get an attorney who specializes in contracts, particularly technology transfer agreements, to look it over just to make sure you haven’t made any glaring mistakes.


Payment Related Licensing Agreement Considerations

As for what needs to be in a licensing agreement, there are a lot of things that do, but definitely pay particular attention to how royalties will be paid. After all, that is the primary reason the patentee or inventor wants to enter into such an arrangement in the first place.

If possible, you might want to consider some type of up front guaranteed payment to ensure that you get at least something.  This may seem overly pessimistic, but it is the job of any attorney negotiating or drafting a license to assume that things will go wrong.  The agreement can never contemplate everything, but with respect to payment you need protection. What if the licensee is paying you a defined percentage of sales but then decides to offer your product for free, or as an add-on to a sale, as is common in direct TV marketing?  If your product is used as a “come on” and given away for free even 100% of $0 is still $0.  That is why some type of minimum payment can be quite beneficial.

Of course, you can’t always get the licensee to agree to a minimum payment or an up front guaranteed payment. So the first and most important thing anyone can tell you about negotiating is that it is critically important to understand the situation. If you really want to do a deal and the overall deal is good enough you shouldn’t let one term here or there deter you from signing. On the other hand, if the overall deal is not good enough then you shouldn’t sign it. It can be tricky to decide, even trickier when you are the inventor because as the inventor you will frequently have an inflated view of what the invention should be worth. Everyone needs to make money for the deal to be one worth doing. Being reasonable but firm can be a challenge even in the best circumstances when you are not as emotionally invested in the negotiation as you undoubtedly will be.

Another important payment consideration is this: what does the phrase “percentage of sales” mean?  Accountants have all kinds of terms they can throw around to confuse you.  Consider whether the royalty will be paid on profits or net proceeds. Net proceeds are typically calculated as the total amount of a sale less transaction costs associated with the sale, but make sure you read the definition section of any license you sign.

In terms of profits, it is quite easy from an accounting standpoint to sweep all kinds of expenses into the equation to show less profit.  In fact, over the years I have seen accountants masterfully prove that something that anyone in their right might would consider profitable really produces a loss.  That is good when it comes time to pay taxes, but not good for you the licensor dependent on maximizing the number you get a percentage from.  With this in mind, many times you will be better off to accept a lesser royalty on net proceeds than a larger royalty on profits. It is also easier from an accounting perspective to just use net proceeds.

It is also a good idea to include a clause that allows for some form of an accounting, which will allow you to access the financial records to verify compliance with royalty requirements.  Of course, you also want clear due dates for payments and likely penalties for late, or at least repeatedly late, payments.



Non-payment Licensing Agreement Considerations

In addition to the aforementioned financial terms, you should also consider including the following in any licensing agreement:

  1. Patent Marking: According to 35 U.S.C. 287(a), you cannot receive damages in a patent infringement action unless the product being is “marked” with the U.S. Patent No.  The statute explains: “[N]o damages shall be recovered by the patentee in any action for infringement, except on proof that the infringer was notified of the infringement and continued to infringe thereafter, in which event damages may be recovered only for infringement occurring after such notice.”  So you should make sure there is some requirement that the licensee mark the product with the Patent No.
  2. Type of License: What kind of license do you want to give to the licensee?  There are primarily three choices: (1) an Exclusive License; (2) a Non-Exclusive License; or (3) a Sole License. An Exclusive License is one where you basically transfer all of the rights to make, use, sell and import to a single entity.  With a Non-Exclusive License you transfer the rights to make, use, sell and import but also reserve the right to license others; thus the Non-Exclusive License is frequently characterized as merely as permission or a covenant not to sue.  A Sole License typically permits both the patent holder and licensee to exploit invention covered by the patent, so it falls between an Exclusive License and Non-Exclusive License in terms of the rights conveyed.   Generally speaking, the more rights you give the licensee the higher you can expect your payments to be.  For many inventors there is little negotiating room, particularly if you want a big retailer or manufacturer to license your patent. They hold the cards, have the distribution chain you desire and will almost certainly dictate most (or all) terms.
  3. License Duration: How long do you want the license to last?  Before you say “as long as possible,” consider the real possibility that sales might not meet expectations, which mean your payments might be quite a bit lower than you anticipated. While many don’t see it this way, the reality is a patent has a short duration, and for many products the market half-life will be well shorter still than the entire patent term.  For some products (think toys) the product life may last 1 or maybe 2 years. The last thing you want is to get locked into an under performing agreement that wastes patent and market life-span when other options might prove more lucrative.  With this in mind you might have the license last for an initial period and be renewable, or have the license terminate in the event sales do not reach a particular threshold or they decline.  Having a minimum payment you can live with makes this somewhat less important, but not irrelevant.
  4. Patents & Trade Secrets: Once upon a time it was more difficult to obtain a license without an issued patent, and some companies still adhere rather strictly to the requirement a patent already be issued prior to licensing.  Many companies, however, will consider licensing a pending patent application.  But what happens if the U.S. Patent and Trademark Office refuses to issue a patent?  Does your licensing agreement evaporate?  Even if you never obtain a patent you have still provided the licensee with something of value, as evidenced by their willingness to pay a royalty.  The information you disclosed, which you didn’t have to disclose, was likely protected as a trade secret, which can be quite valuable.  Therefore, you really want to make sure any agreement relates to both patents and trade secrets.  While you cannot collect on a patent license after the patent expires you can still keep collecting on a trade secret license under the right factual scenario.
  5. Licensing a Patent Application: When you are licensing a patent application there remains uncertainty about whether a patent will ever issue. Increasingly companies are willing to enter into license deals with only a patent application pending, sometimes even with just a provisional patent application pending. It all depends upon how much they like the invention. Don’t expect the royalty to be the same with only a patent application pending. Without knowing whether any exclusive rights will ever issue, or whether exclusive rights that do issue will be commercially useful to protect the invention, a licensee will likely want to pay less, perhaps quite a bit less, while you only have a patent pending. There is nothing wrong with having the royalty rate escalate if and when a patent does issue though. Further, although not really implicated in this article, you can now accelerate a patent application at the patent office for the payment of a fee, which could be well worth the extra cost depending upon the structure of the licensing agreement.
  6. Right to Sub-license: If you give a party a license and they have a right to sub-license they are allowed to provide others permission to use your patent/invention.  With the right accounting procedures in place this isn’t likely very problematic in the case of an Exclusive License.  You just want to get paid the agreed rate per each sale.  But sub-licensing or even licensing subsidiaries in the case of a Non-Exclusive License or Sole License can be more concerning.  You just want to make sure you know who will or could get rights and how you would get paid.  If you are entering into a Sole License and expecting only you and one other company in the market you might not want sub-licensees cannibalizing market share even if you do get paid.
  7. Dispute Resolution: By this point this type of clause is likely standard in most every contract or license, but you want to consider what happens if everything goes bad and there is a disagreement about what the terms of the agreement mandate.  Do you want to litigate?  If you do want to litigate where do you want to litigate?  Would you prefer arbitration instead of litigation?  Arbitration can be much quicker, much less expensive, but it largely doesn’t give you any right to appeal an adverse decision.

The above discussion of financial and non-financial related considerations is not intended to be exhaustive, but should give you an idea about at least some important terms for any licensing agreement from the patentee/inventor perspective.


Image Source: 123RF.com ID 21818236 © alexskopje


Warning & Disclaimer: The pages, articles and comments on IPWatchdog.com do not constitute legal advice, nor do they create any attorney-client relationship. The articles published express the personal opinion and views of the author as of the time of publication and should not be attributed to the author’s employer, clients or the sponsors of IPWatchdog.com.

Join the Discussion

4 comments so far.

  • [Avatar for Ajay Panwar]
    Ajay Panwar
    May 3, 2016 12:34 am

    can a licensee agree to waive their right to challenge the patent’s validity is considered as an anti competitive activity for example in India It is not lawful to insert such clause. Insertion of such clause will be a defense against a party who holds such patent in an infringement matter if any contract has such a clause.

  • [Avatar for Anon]
    May 1, 2016 07:30 am

    Such clauses may be nothing more than eye candy as the courts have not enforced them, leaning instead to the “policy” implication that such a restraint on “truth” will not be tolerated.

    However, if you are in such a position as to be the challenger, you still have a contractual duty to continue paying any such license even as you challenge the basis of the license.

  • [Avatar for Benny]
    May 1, 2016 05:10 am

    I have seen such a clause. Also, an obligation not to assist third parties in challenging validity.

  • [Avatar for Ken]
    April 30, 2016 11:19 am

    Very nice article…one thing I was wondering is, can a licensee agree to waive their right to challenge the patent’s validity (and are there any rules/limits about this)?

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