Licensing Agreements: Components and Concerns

As we discussed  previously, licensing can be a great way for businesses to profit off of their intellectual property without completely transferring or assigning all of their ownership rights to another party. A license authorizes a licensee to use a licensor’s certain intellectual property rights in specified manners in exchange for compensation. This arrangement allows both parties to exploit each other’s strengths (i.e. brand strength or production methods) for commercial gain. While these types of arrangements can be extremely profitable for both parties, licensors and licensees should have some familiarity with the language of the deal in order to ensure that they are not agreeing to unfavorable terms. This post will discuss the terms common to licensing agreements, and also highlight certain issues that can arise during the course of the contractual relationship.
 
Grant of Rights
The “Grant of Rights” section is the foundation of any licensing agreement. Here, the contract will identify which parties are involved in the transaction and what intellectual property is being licensed.
 
Correctly identifying the parties to a licensing transaction should not be overlooked. Oftentimes, a parent company may comprise of a number of entities so it’s important that the drafter makes sure the intended party is accurately described. For example, by entering into a deal with Activison Blizzard instead of the Overwatch League entity specifically, the extent of your transaction may exceed your original intention, as all of Activision Blizzard’s affiliated companies may be granted the right to use the licensed intellectual property.
 
Additionally, this section should also describe what intellectual property is being licensed. Depending on the purpose of the arrangement, the extent of what intellectual property will be made available can be broad (i.e. all intellectual property) or narrow (specific trademark/slogan). Precisely identifying which intellectual property will be the subject of the license is necessary to ensure both parties are on the same page and not exceeding their rights.
 
Scope of the Grant
The scope of the grant will dictate how the licensee will be able to use the license. Parties should determine whether the license will be exclusive, restrictive to certain geographic locations or sectors, and the term of the agreement when defining the scope of a license.
 
Exclusivity
Generally, there are three types of licensing agreements: exclusive, sole, or non-exclusive. In an exclusive license, the licensee is only the party that can use the licensed intellectual property. This restriction on use also applies the licensor, which tends to cause these types of arrangements to be the most expensive. If a licensor wishes to continuing using the licensed intellectual property, the licensor should look to execute a sole license. This type of license provides the licensee with the right to continue to use its intellectual property, along with the licensor. In a non-exclusive licensing agreement, the licensee will be able to use the intellectual property, but the licensor holds the right to license the property to other businesses. Licensees will often try to push for some kind of exclusivity in a licensing agreement in order to prevent any potential competitors from also obtaining the rights to use the licensed intellectual property in a defined category, but this will also command a higher cost.
 
Territory
Territory rights must also be clearly defined. Parties will want to clarify where the licensee will be able to use the rights granted during the term of the agreement. Many agreements will grant licensees worldwide authorization, but it is not uncommon for licensors to add geographic restrictions if a licensor wants to reserve those areas for other potential partners in the future. These geographic restrictions can be structured in any fashion, but oftentimes will organized by continent, country, or region. For instance, a licensee may be granted a limited right to use the licensed intellectual property within only North America, or more narrowly, the United States, for the duration of the term. These limitations can get tricky as a licensor could also grant to a party exclusive rights for certain territories and nonexclusive rights in others.
 
Term
As with any agreement, the term must also be defined in the agreement. The term of an agreement establishes the time frame of the deal. When deciding on the term, parties should be realistic and consider how long it may take for a licensed product to hit the market. A six-month license may not be wise if this time frame does not allow for adequate product manufacturing, distribution, and marketing. Parties should thoroughly consider this in order to maximize returns from the partnership. The Term may also provide for a specified run-off period beyond the initial term itself whereby the licensee can continue to sell off any remaining stock of licensed items/merchandise. This potentially reduces the sunk cost of remaining inventory.
 
Compensation
The method of compensation used in these types of deals can vary, but will often take the form of: (1) a one time payment; (2) an earned royalty fee with an annual minimum; or (3) a combination of (1) and (2). By opting to use the one time payment method, the licensing party will pay a flat amount, up front, in order to the use the license for the duration of the agreement. While an upfront payment may be beneficial for a licensor who needs additional capital immediately, generally, parties will elect to use the earned royalty fee structure. Under this structure, the licensor will receive a percentage of net sales on products sold that incorporate the licensed intellectual property (approx. 6 to 10 percent). In order to protect against the possibility of poor sales, licensors may require an annual minimum payment to ensure they receive adequate compensation for the license. These payments can get complicated so parties must make sure to include clear payment terms regarding the timing and frequency of payments, as well as the mode of payment. Parties may also want to consider including language that requires a proper accounting report to accompany any royalty payment that is made. Without this, licensors would have a difficult time figuring out whether the appropriate royalty amount has been paid. Additionally, it is not uncommon for licensors that own famous marks to require both an upfront fee and a royalty payment. This allows the mark holder to capitalize on the fact that its marks are famous.
 
Termination
These rights define the circumstances in which the agreement may be terminated. While licenses will terminate upon expiry of the original term and after the exhaustion of all renewal periods, this section may also allow for parties to terminate the license either with or without cause.
 
Both parties should seek to include a list of events (breaches or defaults), which may trigger termination by the licensee or the licensor. For example, licensors will want to include language allows them to terminate a licensee if it: (1) fails to pay royalties; (2) fails to maintain licensor’s level of quality control; or (3) files for bankruptcy. A licensor may also want to include the right to terminate the license if a licensee does not release the targeted product to market within a certain amount of time.
 
Licensees generally have fewer termination rights, as the crux of the deal often relies on their performance. However, in certain situations, licensors may be obligated to advertise the product and conduct promotions. If they do not perform these obligations in an appropriate or timely manner, the licensor may be in breach, thus allowing the licensee to terminate. It’s important to note that agreements should give non-breaching parties the right to terminate, but not force them to do so.
 
Conclusion
These are only a few of the terms that will be included within a licensing agreement. However, familiarizing yourself with these provisions will provide you with a solid foundation when finalizing the deal. By clearly defining what intellectual property will be licensed, the scope of the rights granted, compensation, and each party’s rights of termination, you will be able to understand critical points of the deal and reduce the likelihood of major problems arising thorough the course for the partnership. Still, licensing agreements can include a number of complicated clauses, so it’s essential that you understand each section of the agreement being executing it. If you have any questions regarding the terms of your licensing agreements, please feel free to contact us.