Licensing Agreements: Ten Important Provisions

Licensing can be a very important aspect of a company's business, whether as a licensor granting a person or entity the right to exploit or use intellectual property, products or services; or as a licensee needing to use or exploit the rights.  If you are a business that either will be licensing its rights or needs to license rights of a third party, below are ten key points you should understand with respect to licensing agreements.

1.  Determine the Proper Licensor.  This may seem obvious, but if you are the licensee, conduct the due diligence to ensure that you are licensing the rights from the actual owner.  While its is very unlikely this would be a concern when licensing from Apple, companies do not always make sure they have properly obtained the licensed rights to the exclusion of third parties.  You certainly do not want to find you have been paying royalties to the wrong party.  

2. Describe What is Being Licensed.  OK, this also may seem obvious, but be sure to clearly define the rights that are being licensed.  For example, the license to a song may be for use in a movie, but not on an album containing songs from the movie or licensing a logo may be for use on a hat but not on a t-shirt.

3. Define the Scope of the License.  When defining the scope of the license, consider the following topics:

        a.  Limitations:  Are there any limitations on the license:  for example, if intellectual property rights are involved, the license may only allow use of the rights in a particular product or service of the licensee but not in other products or services of the licensee (for example, having the right to use one's trademark on t-shirts you sell, but not on any other type of garment).
        b.  Territory:  the geographic limits of the license, i.e., where the licensee can use/exploit the rights.
        c.  Time:  how long does the license last; is it renewable, and if so what are the terms for renewal.
        d.  Revocable/Irrevocable:  some licenses can be revoked and others cannot; if it is revocable, define the events that lead to revocation.
         
4. Licensing Fees/Royalties.  Licensing fees can be structured in many different ways rather than simply monthly or annual payments.  As the Licensor, you might want a one-time fee upon execution of the agreement or an initial payment plus a a monthly set fee or a fee based on a percentage of sales.  As the licensee, if you are concerned about cash flow, a percentage of sales might make sense, but if you think sales could sky rocket, maybe you feel a flat fee is preferable.

5.  Updates and Fixes.  You see it all the time; new versions of software are issued or product or service bugs are corrected.  So, if you are the licensee make sure the agreement includes the right to receive all updates to whatever you are licensing.  If you are the licensor, you miay want to offer updates as you would much prefer to have properly working goods/services in the marketplace rather than allowing inferior products to tarnish your reputation.  On the other hand, the licensor may want require additional licensing fees or exclude the use of new versions containing significant changes to the licensed goods or services.

6. Assignment.  Consider how you want the license to be treated in the event of the sale of the company or of its assets.  As licensor, you may be agreeable to any assignment as long as the new licensee can demonstrate financial ability to make the royalty payments, on the other hand you might want to require consent as a condition of any assignment. 

7. Licensor Bankruptcy/Escrow Protection for Intellectual Property.  The license agreement absolutely should address the issue of the bankruptcy of the licensor.

        a.  Assumption of License.  Under the Bankruptcy Code, licenses are generally held to be executory contracts, giving the licensor the right to reject (i.e., terminate) or assume (i.e., continue in force) the license if it can meet the terms of the license agreement.  If you are the licensee in such a scenario, and there are assurances the licensor can continue to perform its obligations under the license, then you are unlikely to object to assumption/continuation of the license.

       b.  Rejection of Licensee.  The bigger issue arises if the licensor rejects the license, but licensee wants to continue as it needs the license for its business.  Under section 365(n) of the Bankruptcy Code, the licensee actually has the right to require the license remain in force provided licensee continues to make all royalty payments.  However, there are a few important caveats: 

                    (i) the license will remain in force but the licensor is released from any obligations to update which may existed under the licensing agreement -- if continued development is important, the licensee should consider if there are other alternatives before continuing a rejected license under Section 365(n);

                   (ii) Section 365(n) cannot be invoked by trademark licensees;
               
                   (iii) The application of 365(n) is limited to US bankruptcies, so if the licensor is a foreign company, the licensee may not have any way to preserve the license.       
 
      c.  Escrow of Source Code.  In technology licenses, a great avenue of protection for licensees is to require the licensor to deliver the licensed intellectual property to the licensee at the commencement of the license.  A licensor may object to the turnover of the IP to the licensee in this manner, in which case the licensee should demand a technology/source code escrow whereby the technology or source code (as applicable) is turned over to an escrow agent who holds it for release in the event of certain defined events (like a bankruptcy).  Also, be sure the license agreement requires the licensor to give you updates or deposit them with the escrow agent as they are issued so that you always have the latest versions.

8.  Indemnification.  Each party should include indemnifications protecting them from wrongdoing by the other party.  Among other things, the licensee should be indemnified from infringement claims asserted by third parties who assert intellectual property rights; while the licensor should be indemnified from misuse by licensee.

9.  Representations/Covenants.  The licensing agreement should include representations and covenants protecting each party.

     a. Licensee.  The licensee should be sure the agreement includes: (i) a representation by the licensor as to the ownership of the licensed rights and non-infringement, (ii) an obligation to continue to maintain as current all intellectual property filings, and (iii) any warranties as to licensed goods or services.

    b. Licensor.  The licensor will want the licensee (i) to comply with any laws regulating its products or services and obtain any permits as may be required, (ii) not do anything that infringes the rights of third parties, and (iii) maintain high standards with respect to quality of its use, marketing, packaging of the licensed goods/services or of products/services incorporating licensed intellectual property.    

10. Audit Rights/Termination.

  a.  Audit Rights.  If the royalties are based on sales by licensee, the licensor should require a right to receive periodic sales reports and to audit sales information.

 b.  Termination.  The Agreement should expressly state the conditions under which either party will have a right to terminate the license agreement -- even if it is an irrevocable license.  Termination can be based on obvious events such as a defined termination date, bankruptcy or in the event of a material breach by a party, but it can also be based on financial terms such as the failure to reach certain minimum sales or the failure to actively exploit/market the goods/services. 

Most businesses will need to execute a licensing agreement at some point; it may be simply as part of an agreement to use standard software or an application and as to which there is no room to negotiate the terms.  However, when the licensed rights, goods or services are essential part of the business itself make sure to consider the above ten issues before executing the license agreement.

Disclaimer:  The discussions in this blog do not constitute legal advise nor create any attorney-client relationship.  You are urged to seek the advice of an experienced lawyer who can provide counsel with respect to your corporate/business law matters.