Publications: Drafting stronger license agreement protects both parties
A More Valuable Software Patent - Intellectual Property Developments Affecting Software Companies - Software Piracy

Special To The Austin Business Journal

The termination of Power Computer's licensing rights to manufacture Macintosh - compatible computers by Apple Computer Corporation has received a lot of press recently. Apple's refusal to continue licensing improvements to its hardware and operating system emphasizes the significance of several key elements that should be considered in drafting a licensing agreement for intellectual property rights -- providing automatic access to future technological improvements that are key to the marketability of the licensed product, the length of the term of the license and termination clauses in licensing agreements.

The first issue, access to technological improvements to the licensed product over the term of the license, is especially important in the electronics and computer fields, where product innovation is rapid and the life cycle of a product is short. For example, if the party taking the license, called the licensee, manufactures and sells computer hardware in competition with other licensees or with the party granting the license, called the licensor, the licensee must have access to product improvements of the licensor to be able to compete effectively in the market.

Access to improvements to a software operating system or specific application programs needed for the licensee to compete in the marketplace are also critical to keeping the product technologically attractive to the customer. Without access to improvements in technology, the licensed product may become obsolete at worst and less than desirable at best.

What's the solution? Before entering into a licensing agreement, each party needs to assess its needs in terms of product innovation to be competitive. If the licensing agreement is non-exclusive, where the licensee may be competing with the party granting the license, the licensing agreement can include provisions regarding the cross licensing of the rights to future improvements by either party. This cross licensing clause can call for additional royalty payments for these improvements or they can be royalty-free and included in the original royalty payments negotiated at the time of the initial license. The agreement needs to be worded so there is no ambiguity as to what improvements are included and at what cost, if any. If there are competing licensees, a most-favored licensee clause that prevents giving another more favorable royalty rates should also preclude granting another licensee access to technological improvements without offering them to the current licensee. All of these elements are especially important in the rapidly moving technologies of electronics and computer hardware and software where lack of access to improvements can effectively kill the market for a product.

The second issue concerns the importance of the length of the term of the licensing agreement. From the perspective of the licensee, negotiating a sufficiently long license term to maximize return on capital investment and allowing sufficient time to build a viable business and market the product is obviously one of the most important goals of the licensing agreement. On the other hand, the licensor does not want to be trapped in a long-term relationship if the financial benefit is not adequate. There are any number of possible solutions to these problems. In return for a long license term, the licensor can require some combination of the following: minimum royalty payments, a percentage of royalties that increase or decrease based upon the volume of the product sold by the licensee, and inflation clauses or careful choice of the basis on which the royalty is calculated to protect against inflation. As discussed above, the licensor also can require an increase in royalty payments for licensing improvements to the technology.

Finally, in the event the license agreement terminates prematurely, the termination clauses become important to ensure orderly termination of the licensing relationship. Even in the case where the license does not terminate prematurely, the lack of well-drafted termination clauses can cause disputes. In fact, a large percentage of license disputes result from differing interpretations of termination clauses. This is often because many licenses have boilerplate termination clauses that do not adequately address how to terminate the rights and obligations that have been extended in the agreement.

In order to provide for orderly termination of the license, every right granted should have a specific termination scenario envisioned, which should then be drafted into the agreement. For example, if the license has a minimum royalty clause under which the agreement terminates if minimum payments are not made, language should be included to specifically call out when payments are to be made and what constitutes non-payment that triggers the termination clause. If manufacturing is terminated, can the licensee dispose of its product inventory? If there are sublicensees, what are their rights regarding termination? If one party breaches the agreement, a damage amount to be paid can be specified in the contract or a method of calculating the damages to be paid can be included. Although it may prove practically impossible to cover all imaginable termination scenarios, most of the ways in which an agreement can be prematurely terminated can be provided for in the agreement.

Sometimes the reason for inadequate termination planning is a reluctance at the beginning of a relationship, when the license agreement is being drafted, to consider that it may end badly. However, both parties need to acknowledge this possibility up front and plan for it. Discussing the orderly end of a relationship may give the parties insight into each other's motives and expectations. If an agreement that is fair to both parties regarding termination cannot be reached, perhaps it is time to rethink entering into a licensing arrangement.

As an example, in negotiating a license agreement for a client, both parties agreed on almost all of the license terms until termination was discussed. The termination clauses were out of balance and favored the other party, yet the other party refused to compromise. When confronted with this lack of compromise, the client decided the other party was not someone with whom she wanted to enter into a long-term licensing relationship.

During the drafting of the license agreement, care and attention should be paid to these issues of the right to future technological improvements, the term of the license and its termination, so the result is a license that is a fair and balanced agreement that meets the expectations of all parties.