This article is written by Shaivi Shah, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.com.

Introduction 

The modern world of business and its accompanying transactions consist of a host of different types of business relations. One among these is a licensing arrangement wherein one individual/entity gives another individual/entity the right to use a right, trademark, method, formulation, product or some other asset owned from a business point of view for mutual benefit. In this context, the individual/entity granting the right on the other is termed as the “Licensor” while the receiving party is termed as the “Licensee”. 

Principle Concept of a License

Simply put, a license is a means by which an asset owned by one party can be used by another party in exchange for a payment or a series of payments being made. Such a consideration is termed as a “Royalty”. Most commonly the assets exchanged in such an arrangement may be certain intellectual property rights, products, formulations, etc. Examples include the right to sell a particular product in a particular geographically demarcated area using a certain trade name, the licensed right to publish someone else’s literary work, etc. 

In general practice, licenses are reduced to written contracts that specify the rights, obligations, duties, limitations and payment schemes that have been agreed upon by the parties in question. The rights granted via a license may either be absolute, i.e., an “absolute license” may be granted, or only certain rights or rights that may need to be shared with others, i.e., a “non-exclusive” or “limited” license. In case of a breach of any of the terms of the Licensing Agreement, the license may lapse and be terminated. The licensee may also be required to pay penalty charges. 

The nature of the relationship between two parties in a licensing agreement generally involves a more passive attitude from the licensor as long as he/she/it regularly receives his/her/its royalty while the licensee operates in a more proactive manner. The licensee actively engages in exploiting the licensed asset for the purposes of business and trade or development. The licensee is entirely authorised to do this as long as he keeps up his end of the bargain by paying his royalty in accordance with the terms laid down in the contract. 

A license must be looked upon as a temporary and limited transfer of rights over an asset as, ultimately, the ownership rights over the asset will remain with the licensor. An alternative to this restrictive arrangement is the actual purchase of the asset by the licensee from the licensor. However, in most practical scenarios, licensors don’t opt to sell their assets as they prefer further reaping the benefits of licensing it in the future or in alternative territories and for alternative purposes. Thus, a license is essentially merely a group of rights over an asset assigned to the licensee while the ownership continues to remain with the licensor. 

Example of a Licensing Deal

A good example to understand the basics of a licensing agreement would be the licensing deal that was entered into between Nestle and Starbucks. In May of 2018, the two entered into a 7.15 billion dollar deal whereby Starbucks (the licensor) granted Nestle (the licensee) the exclusive rights to sell Starbucks’ products (single-serve coffees, chai-tea lattes, ground coffee beans, Starbucks merchandise, etc.) internally through its global distribution channels and network. In addition to this Nestle was to pay Starbucks royalties on the packaged teas and coffees sold by them. 

The benefit to Starbucks, along with the monetary consideration, was the access to Nestle’s international platform which enabled it to establish brand recognition globally instead of being confined to North America. From Nestle’s perspective, the exchange permitted it to have access to Starbucks’ incredibly popular products as well as the brand’s spectacularly strong public image. 

Advantages of Licensing 

The advantages of licensing must be viewed from two perspectives – that of the licensor as well as the licensee. 

Advantages for the Licensor

1. As was seen in the previous segment of this article, licensing enables the licensor to access international distribution platforms that will give his/her/its products, trade name, formulations, etc. a global reach. 
2. Lower capital requirements and reduced costs for distribution are a by-product of licensing for the licensor. 
3. The licensor can exploit his/her/its assets in an optimized manner by earning a passive income from them in the form of royalties. 
4. The licensor is in a position to observe, learn and implement the expertise and skills of the licensee. 

Advantages for the Licensee

1. The licensee would have easier and quicker market access as he/she/it would be utilizing established intellectual property. 
2. The licensee would be saved the effort of having to pool together and gather resources for the purposes of research and development towards developing his/her/its own products or services. 
3. The licensee will be in a position to generate revenue off of the intellectual property of another.

Disadvantages of Licensing 

The disadvantages of licensing must also be viewed from two perspectives – that of the licensor as well as the licensee. 

Disadvantages to the Licensor

1. The licensor would no longer be in possession of the ability to control his/her/its own intellectual property either entirely or to a certain extent. 
2. In certain licensing agreements, the licensor may be put in a position where he/she/it would have to depend of the skills, abilities and resources of the licensee for his/her/its own income.
3. The licensor may expose himself/herself/itself to the risk of intellectual property theft. 

Disadvantages to the Licensee

1. The licensee is required to invest heavily in infrastructure for production, marketing, selling, distribution, etc. 
2. The licensee would be solely dependent on the intellectual property of the licensor for the generation of his/her/its own income. 
3. The licensee is often called upon to pay a fee or royalty upfront to the licensor without being able to gauge whether or not the product or formulation would pay off in the market in terms of returns on investment. 

5 Common Mistakes to be Avoided while Drafting a Licensing Agreement

• Foregoing the Inclusion of a “Grant-back Clause”

This common error made by first-timers in drafting a license agreement may put the licensor at the risk of infringing his/her/its own patents. When the drafter does not include a grant-back clause, he/she fails to address the regulation of improvements made by the licensee. This allows the licensee to file improvement patents of his/her/its own that have the potential of making the licensor’s technology, formulation or product obsolete. It may even prohibit the licensor from profiting from its own products of formulations with the improvements. 

Including a grant-back clause in a licensing agreement will give the licensor the protection of being granted back any improvements in his/her/its patented products or formulations that were licensed out. This should especially be used in those agreements where the licensor can expect that the licensee will improve upon the licensed technology or curate a superior formulation or product, thus, giving the licensor equal-footing to compete in the market-place. 

A sample clause that can be referred to is given as follows – 

“The above grant is subject to a reservation of rights by Licensor for itself to practice, and have been practiced by other not-for-profit entities for purposes of collaborative research with Licensor, under the Licensed Patents for educational, research, patient care and treatment, and other internal purposes. Licensor further excludes from the license granted herein the right to bring an infringement action against … any Inventor or their present or future not-for-profit employers, for infringement of any of the Licensed Patents in carrying out not-for-profit research.”

• Neglecting to Provide for a Patent Marking clause

Section 111 of the Patents Act, 1970 states that patent owners must mark their products with their patent numbers so that they may collect damages for infringement of their patents. These damages may be collected for the period of time that existed between the infringement of the patent and the filing of the complaint by the patent owner or any other notice of infringement that may have been brought to the attention of the alleged infringer by the patent owner. Further, even authorized users of the patent must mark the products protected from any claims of the patent. These efforts made by the patent owner as well as authorized licensees of providing a “constructive notice” of patent protection is made in order to protect the public from prosecution for innocent infringement.

As marking of patents is not made compulsory under Indian laws, it is extremely important to include a patent marking clause within a licensing agreement in order to ensure that the absence of patent marks on products doesn’t serve as a strong ground of defence for patent infringers and prevent monetary settlements or compensation from being awarded. 

The following clause can be used as a template – 

“Licensee shall, and shall require its Affiliates and Sublicensees, to, mark Licensed Products sold by it hereunder (in a reasonable manner consistent with industry custom and practice) with appropriate patent numbers or indicia to the extent permitted by Applicable Law, in those countries in which such markings or such notices impact recoveries of damages or equitable remedies available with respect to infringements of Patents.”

• Failure to Set Performance Expectations 

The failure to provide a clause stating detailed performance expectations and benchmarks, along with a timeline and milestone model, to be followed and achieved would prevent the licensor from making the most out of his/her/its intellectual property. The licensee would be allowed to get away with making virtually no sales or meaningful performances, while still having locked up the exclusive or partial license over the patented intellectual property. Thus, including a clause stating performance expectations such as initial marketing dates, minimum sales limits and minimum royalty expectations is important.

A clause along the lines of the one provided below can be used for reference – 

“Company shall use its best efforts to bring Licensed Products to market. In partial satisfaction of its diligence obligations, Company shall achieve the following commercial goals (the Milestones) by the dates set forth below.”

• No Clause Providing for Advance Payment of Patent Costs

The onus of handling all patent activity generally falls on the licensor. Such activity can often become quite costly, and thus, not including a clause that would account for reimbursement for the same to the licensor is a grave error that can be made by first-time drafters. Drafters should keep in mind the requirement to include a clause calling for the advance payment by Licensees to Licensors as reimbursement for such expenses, or at the very least, provide for a clause containing a proper timeline for repayment by the Licensee. 

The following proviso can be added to the agreement to provide for the same – 

“Any patents in a particular country for which payment is not received shall be removed from this agreement.”

• Not Providing for Approval of Marketing or Advertising Materials of Patented Product

This clause is of prime importance. Marketing and Advertising materials shape consumer perspectives about the patented products or technology, which in turn would certainly determine their willingness to purchase and use them. Further, apart from having the potential to affect the goodwill of the patented product, not having the right to approve the marketing materials would prevent the licensor from being able to achieve or realize the vision he/she/it had for products or technologies created from his/her/its own intellectual property. These issues would negatively impact the sales of the product or technology after the license expires and is granted back. 

The following clause may be referred to – “Neither the Licensee nor any of its Subsidiaries have granted rights to market or release any sort of marketing and advertising materials without obtaining the prior approval of the authorised personnel acting on behalf of the Licensor.”

Conclusion

While discussing the potential mistakes one may make while drafting a licensing agreement may not make for the most interesting read, knowing what not to do can significantly improve one’s drafting skills and enable them to take care of and protect their client’s interests in a more comprehensive manner. Further, it is recommended, not just for licensing agreements but contracts in general, to revisit the terms of the contract periodically (Eg. – every year) and make sure that it is up-to-date, and thus, stay on top of all contractual obligations. 

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