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The following discussion thread excerpt is from an ongoing law.com seminar “Licensing Agreements: How to Draft and Enforce Them,” moderated by D. Patrick O’Reilley of Finnegan, Henderson, Farabow, Garrett & Dunner. Program contents include seminar discussions and a robust library of documents, including panelist submissions and articles from American Lawyer Media publications. CLE credit is available in over 20 states. For information on this program and other law.com seminar offerings, please visit www.law.com/seminars. D. PATRICK O’REILLEY OF FINNEGAN, HENDERSON, FARABOW, GARRETT & DUNNER, WASHINGTON, D.C. Because of market and cost issues, there is usually a narrow range of profit available for a particular product. A license requires the licenser to share that profit with the licensee. Indeed, as a general rule, the licensee usually gets a larger share than the licenser. If the licenser exploited the patent and technology himself, he would not have to share the profit. (1) So, why does a licenser grant a license? What business advantages compel granting licenses? (2) Besides sharing the profit, what other business disadvantages may the licenser suffer? (3) What are the business advantages and disadvantages to the licensee? ELAINE D. ZIFF, SKADDEN, ARPS, SLATE, MEAGHER & FLOM, NEW YORK A licenser grants a license for many reasons. If the owner of the intellectual property is an individual, university, or small company, then it may not have the resources, know-how, or desire to commercialize a product based on the intellectual property, or to maintain a distribution and marketing network. Finding a well-funded licensee willing to make a commitment to promote the licensed product and/or guarantee minimum royalties may yield greater profits to the licenser than attempting to sell the product itself. An individual licenser may also obtain a valuable consulting contract, or equity in the licensee’s company, in addition to royalties. A licenser may be able to grant many nonexclusive licenses, such as may be the case with a software application. If so, it may come out commercially ahead of exploiting the product itself. (Of course, this must be balanced against the likelihood that each licensee will pay a lower royalty for a nonexclusive, as opposed to an exclusive, license.) Likewise, exclusive licenses can be carved up into different fields of use. As a result, a licenser may be able to obtain licensees who are specialists in each market, potentially increasing the licenser’s royalties. Licenses for cartoon characters or sports logos have this advantage, as there are often different licenses for clothing, toys, party goods, school supplies, etc. Each licensee can give the licensed product maximum exposure in its own market. A license granted in the context of settling infringement litigation has the obvious benefit of resolving the dispute. In the case of patent infringement disputes where there are counterclaims, a license issued in settlement frequently includes reciprocal cross-licenses, thus giving the licenser rights to use the opposing party’s patents or technology. All this would suggest that licenses are the best way to go. But being a licenser can have its disadvantages. Granting any license can result in missed opportunities. Even issuing a nonexclusive license will dissuade certain other potential licensees from seeking licenses since they can no longer get an exclusive one. In addition, picking the “wrong” licensee can result in lower than anticipated profits for the licenser. Although this can be ameliorated with contractual provisions providing for minimum royalties and minimum sales, the licenser often hopes that the licensee will exceed the contractual minimums. Moreover, the “wrong” licensee can bring down the value of a licensed trademark, to the extent that its own reputation declines or it commits breaches of the license agreement. Like any long-term relationship where the parties have joint but also divergent interests, there is a risk that the licenser/licensee relationship may become contentious. License agreements typically contain many provisions that can trigger ongoing power struggles, such as provisions requiring that the licenser approve the licensed products, or requiring that the licensee meet development milestones or undertake its “best efforts” to promote the licensed products. Finally, if the licensee should go bankrupt, recapturing the license may be difficult for the licenser. Contractual provisions purporting to terminate a license agreement upon the licensee’s bankruptcy, or providing that the license rights cannot be assigned, may not be enforceable then. GREGORY BATTERSBY, GRIMES & BATTERSBY, STAMFORD, CONN. [As to:] “(1) So, why does a licenser grant a license? What business advantages compel granting licenses?” Elaine is right on the mark with respect to character and ancillary product licensing. In most instances, the licenses are being granted to licensees for products that the licenser is unable (or unwilling) to produce. In such instances, these licenses are being granted for both the revenue potential from the licensee as well as for the trademark exposure which they may bring. In the 1980s, at least one of the major soft drink companies entered into permissive use agreements under which they would allow others to use their marks on a wide variety of collateral merchandise “for the advertising and exposure associated therewith.” When they learned that they could also receive revenue for the grant of such rights, they quickly turned these permissive use arrangements to royalty-bearing licenses. Many of the sports leagues (crass commercialists through and through) look to the revenue generated from their “properties” divisions as a way to underwrite expansion, strikes, etc. Similarly, the studios regularly bank on their merchandising revenues to help subsidize production, etc. Another major soft drink company entered into a licensing program in order to strengthen their trademark portfolio due to the broader range of product classes that they now controlled. They believed (rightfully so) that it would be easier to convince a judge that there was a likelihood of confusion between XYZ Cola and XYZ tote bags if they had licensees already in the apparel and accessories areas. [As to:] “(2) Besides sharing the profit, what other business disadvantages may the licenser suffer?” Again, Elaine is right on the mark. Potential product liability exposure is another problem for licensers since the courts have regularly held that a trademark licenser is potentially liable for injury or death caused by defective licensed products. While indemnification and product liability insurance generally protects the licenser, there is always the situation where an uninsured deadbeat slips through the cracks leaving the licenser as the “deep pocket.” Finally, there is the issue of “image,” which is always a question for corporate licensers who fear that schlock, licensed products will tarnish the corporate image. That is usually addressed by exercising greater selectivity with respect to licensees. [As to:] “(3) What are the business advantages and disadvantages to the licensee?” Again, in the trademark/merchandising area, the disadvantages typically relate to: (1) a dumb business deal with oppressive advances and guarantees, e.g., many of the Star Wars licenses; (2) an unrealistic licenser who nitpicks them to death in the product approval area and prevents them from meeting market deadlines; and (3) a greedy licenser who uses the licensee to develop a market for the licensed products and then, once the market is established, shops the license to others when it comes time for renewal. Each of these points can be easily addressed in the agreement. STEPHEN MCKENNA, PATTISHALL, MCAULIFFE, NEWBURY, HILLIARD & GERALDSON, CHICAGO The potential licenser must decide whether the proposed license fits into the overall strategic plan of the company. If it does not, then the licenser should not do the deal, no matter what the terms. This may seem simplistic, and it is. But, as the owner of a small technology company, I know how tempting it is to scrap a strategic plan for short-term revenue. A good adviser should occasionally ask simplistic questions to ensure that the client has not unnecessarily ignored important strategic considerations as a result of entrepreneurial zeal or short-term pressures. If the strategic plan calls for a license of the type proposed, then the specific questions should be considered. 1. A licenser typically uses a license to maximize the value of an investment in some technology. A license can be a more cost-effective method for maximizing value than exploitation. The value may be measured in two primary ways. First, the value may be measured in monetary terms — i.e., will the license make the licenser lots of money? Second, it can be measured in strategic terms — i.e., will the license help the licenser’s position relative to its competitors, in the eyes of investors, or in the eyes of the public? A license may also be measured according to a combination of these factors. In any event, the form and terms of the license must advance the stated goal. For example, if success is going to be measured by revenue, then an exclusivity provision is important only if it will result in greater revenue (from this or subsequent licensees). Whereas, if success will be measured by strategic value, then an exclusivity clause may be the most important part of the license. 2. Technology licensers can suffer in a variety of ways. For example: (a) The licenser may simply be wrong in its conclusion a license is the best way to maximize the technology’s value. Sometimes it takes a bad license for the licenser to truly understand the best way to maximize the value of its work. (b) A licenser may suffer by putting its technology in the hands of an unworthy or irresponsible licensee. The licensee’s use of the technology may so harm the reputation of the licenser or the technology in the eyes of other potential licensees, the public, competitors or the investment community that it is not worth the monetary or strategic value of the deal. (c) A licenser may learn that many of the factors that led to the decision to license rather than exploit (e.g., the development, marketing, sales, and support costs associated with each option) actually favor exploitation. Often only in fulfilling the licenser’s responsibilities under a license will many of these costs be truly discovered. In any of these instances, if the licenser has not done enough diligence on the licensee and its planned use of the technology, or if the license does not have appropriate “outs,” then the licenser and licensee may be in for rocky times. 3. Licensees face much of the same basic analysis as a licenser, except that the choice is licensing vs. developing rather than licensing vs. exploiting. The licensee must be certain that the license fits the company’s overall strategic plan and that it is the best tactic for effecting that plan. Against the license’s economic or strategic value must be weighed the costs and the risks of licensing someone else’s work. RICHARD WYDE, DAVIS WRIGHT TREMAINE, SEATTLE (1) So, why does a licenser grant a license? What business advantages compel granting licenses? Of course, I agree with all the comments above and would expand on a few points. Software licensers, who develop a product to take to market, often lack the resources, vision or infrastructure to take fullest advantage of their assets. For example, they may lack the internal staff to sell the product worldwide. Or, the licensee may be a developer that believes it can “productize” software, which it developed for a single buyer, into the general market. As a result, the licenser will often grant a license to allow others to attempt to exploit new markets that it would not otherwise reach. (2) Besides sharing the profit, what other business disadvantages may the licenser suffer? The licenser may lose the opportunity to better exploit a new market that it has licensed to the licensee. However, as the other commentators have noted, such a license typically includes provisions to protect the licenser from failures of the licensee to satisfactorily exploit the product, such as requiring that minimum sales or minimum revenues from such sales be provided each year, particularly in an exclusive arrangement. Or, in a nonexclusive license, the licenser could find itself competing against the licensee in several ways. First, the licensee may attempt to sell the product to the licenser’s potential customers. Or, the licensee could develop new products, either as improvements to or complementary to the licensed product in ways that hurt the licenser. Or, the licensed product may fill a gap in the licensee’s product line in a way that now makes its product line complete and dominant in the market. (3) What are the business advantages and disadvantages to the licensee? The licensee can save R&D costs that it might otherwise incur. Access to new technology also allows a licensee to learn more about the technology and expand into new markets and development avenues that would otherwise be unavailable. One large disadvantage is that some venture capitalists may be reluctant to fund entities that lack ownership in their underlying technology. Also, licensees may be subject to the whims of their licensers with regard to support, enhancements, and obsolescence of functionality. Licensees which have made investments in their marketing efforts also risk losing their investments at the end of the term of the license if the licenser is not satisfied with the licensee’s efforts or wants to exploit the territory or field of use it had previously licensed. D. PATRICK O’REILLEY OF FINNEGAN, HENDERSON, FARABOW, GARRETT & DUNNER, WASHINGTON, D.C. All points made are valid. Some others worth considering as reasons for granting a license include: creating a market for convoyed sales (e.g., license the razor in order to sell blades), benefit from testing is less regulated countries (license new drugs in other countries in return for test results and money, of course), and initial entry into foreign markets (a license is a lot easier than importing and selling directly or building a plant in a country where regulations or culture make market entry difficult). Reasons for not granting a license, in addition to sharing potential profit and possibly creating a competitor, include loss of control over proprietary information. No matter how extensive the contractual controls and limitations, nothing in a contract can prevent the licensee from deliberately or unintentionally breaching the agreement and destroying or misappropriating the information. The contract only includes consideration and remedy provisions; the latter is the only protection and they only have effect after the breach has occurred. A license including proprietary information probably should include consideration guarantees that are equal to the value of the information being transferred on the assumption that, despite termination provisions regarding nonuse and return, the transfer is in effect a sale. With today’s peripatetic employees, proprietary information in the form of their skill and experience will flow like water throughout an industry.

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