Understanding Licensing Agreements

Intellectual property management is a key part of any successful business, and licensing agreements are an essential component. Your ideas, or those of your employees, provide you with the products or advantages needed to compete in a competitive market. Those ideas (or their outputs) can form part of your intellectual property portfolio.

When people normally think or hear about intellectual property, they think about the protections intellectual property rights afford to owners of that right. That is certainly true, but less considered is the concept of sharing, selling, or distributing that right to others – to businesses or individuals.

That is where intellectual property licencing becomes relevant. Whilst intellectual property licencing can be integrated with a wide range of different agreements, this blog will focus on the basic model: the licencing agreement.

Licensing agreement – the basics

Intellectual property refers to unique creations of the mind that can be protected in some way. The UK’s Copyright, Designs, and Patents Act 1988 is the modern law that protects the key forms of intellectual property encountered everyday – copyright, designs, and patents. Copyright refers to creative works – like writing (including computer source code), art, or dramatic performances. Designs refer to the appearance of a certain item. Patents cover inventions or a different way of enacting a physical process.

There are other types of intellectual property. The other two main types are trademarks (covered by the Trade Marks Act 1994) and trade secrets (covered by the Trade Secrets (Enforcement, etc) Regulations 2018).

A licencing agreement is an agreement between two (or more) parties that controls how intellectual property is to be licenced, that is, how it will be shared or made available to another party (the licensee) whilst ownership remains with the owner (the licensor) and under what terms.

Key elements of a licencing agreement

In setting out the above, we have discussed the first two key elements of a licencing agreement: who is granting the licencing to whom, and what right or rights are being licenced.

These elements have two very important initial considerations.

The first is that it is necessary to ensure that the licensor actually has the ability to grant the licence. In most circumstances, this will be clear – the first owner of a copyright is the author. But there may be a situation where a licensor has an intellectual property right under its own licence, and is therefore sub-licencing the copyright out to a third party (discussed in more detail below). Further, another common situation is intellectual property developed by a contractor for a business instead of an employee of that business. Absent written evidence to the contrary, the position at law is that the contractor owns the intellectual property in the work product that it creates in return for compensation. This can produce difficulties down the line, and from the perspective of any licencing agreement, it would not in fact be an effective, enforceable licence. This is why most licencing agreements contain a licensor’s warranty that it owns or has the right to sub-licence the relevant intellectual property.

The second element requires equal attention. Say you want to licence a leaflet containing descriptions of your products. The copy and the images will have copyright attached to them, but your logo may in fact be a trademark. If your licencing agreement does not cover both types of intellectual property, the licensor and licensee will both be negatively impacted. The licensor will have potentially lost control over an important part of their intellectual property portfolio, and the licensee may be paying for something it has not in law received.

There are three further key elements of a licencing agreement worth discussing:

• Scope of the licence: the scope of the licencing agreement can be tailored to meet the parties’ needs. The common negotiating points are around the following issues.
  • Permitted use: in other words, what the licensee may do with its licence – in software licensing agreements it is common to see restrictions limiting the licensee’s right to modify source code (in which copyright subsists). Another facet of this is the way in which the subject of the licence may be used – again, a software licence may seek to include certain types of acceptable and prohibited use. But this can extend to any type of intellectual property; a business may not permit its trademark to be used in certain contexts, for example.
  • Sublicensing: the licensor may or may not wish to grant the licensee the ability to transfer the licence to another party, and the terms of that sublicence may be further negotiated.
  • Transfer: a licensee may seek to obtain the right to transfer the licence to another entity without seeking the licensor’s consent (commonly a group entity), which becomes relevant in mergers or corporate restructuring.
  • Territorial rights: intellectual property exploitation may be limited to certain territories (by country or other geographical area).
  • Exclusivity: the licensee typically would wish to grant a ‘non-exclusive’ licence to the licensor, meaning that it is free to grant other licences to third parties as it likes. An exclusive grant would mean that the licensee is the only holder of the licence, making it more valuable to it.
  • Revocation: the parties may seek to agree on certain circumstances where a licence can be revoked or suspended, or to restrict that right entirely.
  • Conduct of rights: if litigation is a potential risk (it almost always is), the parties should agree on who will have conduct of an action against a third party.

• Payment and royalties: obviously, the parties will wish the secure the best compensation terms available. The term payment usually refers to a set lump sum to secure the rights for the term of the licence (discussed below), or a monthly set payment (i.e a subscription). A royalty typically refers to a set amount (usually expressed as a percentage) the licensee must pay for its usage. For example, an artist would receive a royalty payment for every album sold, or in the more modern context every time (or group of occurrences) a song is streamed by an end user.  

• Termination or renewal: like any agreement, licencing agreements can be time limited, automatically renew, or renew at the option of the parties (or one party) after a set period. The slight difference with intellectual property rights is that they can be granted on a ‘perpetual’ basis. If there is no right of revocation, there may be situations where a licencing agreement lasts for as long as the parties exist, or until the right expires. Copyright, for example, subsists for 70 years after the death of the author.

Benefits and risks

The benefits and risks in respect of licencing agreements are equally subject to one of the most pervasive legal maxims: ‘it depends’.

In the broadest sense, licencing agreements provide the licensor with a revenue stream it otherwise would not have had whilst remaining in control of its intellectual property. The extent of that control is, in many ways, subject to the provisions of the licensing agreement as discussed above.

But more factual matters also have bearing on the ability of a licensor to control the use of intellectual property which is common to almost any commercial agreement. To protect your rights, it follows that the ultimate option against a bad actor is litigation. But the licensee may not have the resources to compensate you for your loss if it breaches the terms of the licensing agreement. Or, as we commonly advise our clients, the licensee may be based in a jurisdiction that may not be conducive to enforcing an English judgment. Even if it is, this process may be prohibitively expensive for the licensor; effectively meaning that the licensor has put its intellectual property at great risk for little gain. Intellectual property infringement and theft is extremely common, leading brands spend billions on enforcement even where their licencing agreements are watertight. The licensor must always have the realities of the situation in mind when it is sharing its intellectual property with third parties.

That general point aside, certain types of licencing agreements have very clear advantages. In the distribution of goods contexts, licencing agreements can unlock the benefits of a licensor’s distribution network without taking on the associated costs of setting up those networks themselves. Nestlé’s licencing agreement with Starbucks is a case in point. Equally, licensors can benefit from saving the time and labour involved in developing their own competitive intellectual property and simply buy access to the works of others. Spotify would not be a viable business if it had to purchase all the intellectual property rights to the music and other media on its platform – instead it pays fees and royalties to attract users to its application.

This leads naturally to a further pro or con. Where an licence agreement is relying on the licensee’s performance, this can both act as an enhancement or a drawback depending on how the licensee performs. In a goods context, the licensee’s ability to sell products and consequently to realise or enhance the licensor’s intellectual property can be entirely down to how well a licensee can sell products, whether that relies on the capacity of staff, connections in the territory and so on. As in many situations, the licensor should always consider whether it can do things better than the licensee.

Negotiation tip

Negotiating a licence agreement is no different than any other commercial negotiation. With the above points firmly in mind, both parties will be well placed to negotiate a licence agreement that suits their needs – or to walk away if it does not.

One tip, however, that we like to discuss with clients is the price. This is always a commercial point, but a little legal background can be useful here.

When the Court assesses quantum (how much a party will owe to another following litigation) in intellectual property infringement cases, a method of calculation is the ‘hypothetical licence fee’. Damages (or loss of profits) is assessed by reference to the value of a hypothetical licence that the infringer would have had to pay if it had properly obtained a licence through a licence agreement or other contractual mechanism.

In this legal point there is the commercial reality that value is not always about what the licensee would be willing to pay, but what other third parties would be willing to pay to licence your intellectual property. If another willing buyer would willingly step in, then your valuation is realistic. If they would not, or there is no other third party that would be willing to use your intellectual property, then the potential licensee is at an advantage. When you are developing your business’ intellectual property portfolio, or looking to acquire one by licence, this is a very helpful point to keep in mind.

Conclusion

Dealing with intellectual property and negotiating licensing agreements is a complex, but frequently encountered, area of commercial life.

A licensing agreement can unlock significant commercial benefits, but there are many pitfalls for the unwary. In the event of a dispute, the Court cannot be relied upon to step in an uphold your rights. A strong and fully thought through licensing agreement is the natural first step to protecting and exploiting your intellectual property portfolio.

At EM Law, we are experts in intellectual property. We help clients at all stages of commercial life develop, protect, and enhance their intellectual property rights. If you have any questions, or would like to discuss how we could help draft your next licencing agreement please do not hesitate to contact Neil Williamson or Colin Lambertus directly or via our website here.