OPTEON Philip MendesLevel 3, 33 Queen St Brisbane QLD, Australia Ph + 61 7 3211 9033 Fax + 61 7 3211...

OPTEON

Philip Mendes Level 3, 33 Queen St

Brisbane QLD, Australia

Ph + 61 7 3211 9033

Fax + 61 7 3211 9025

[email protected]

Topic 10Fundamentals of Licensing Agreements

WIPO-KIPO-KIPA IP Panorama Business School Investment Summit7 October 2008

Geneva

Outline

Presentation in 3 parts

License Terms Performance Obligations Structure of the Financial Terms of a License

What is a license ?

Owner restriction

Owner’s right

User’s name

User’s obligation

User’s right

Licensed IP

Cannot use IP

To collect royalties

Licensee

Pay royalties

To exploit exclusively

Rented Building

Cannot use building

To collect rent

Tennant

Pay rent

To exclusive use

• Comparison with renting a building

What is a license ?

Legal -binding contract An asset

Contains terms

•Create rights (eg royalties)

•Imposes Obligations (to exploit, to complete R&D, to market

•Creates liabilities

•Warranties and indemnities

•Can be sold

•Can be used as security for a loan

•Can be given by will

Scope: Exclusivity

Exclusive Sole

Exclusivity:

Non Exclusive

One Exploiter – the licensee

Two Exploiters – owner and the

licensee

Numerous Exploiters – owner and

numerous ‘ees

Scope: Exclusivity

Which would be most likely be sort by a licensee ?

What rights does patent confer ? – exclusivity of use

What rights is patent user likely to expect ?

Most common type of license agreement ? Exclusive license

Exclusive license: Where the licensee needs to have the same exclusive rights that a patentee

has Particularly

Biotech ICT

Scope: Exclusivity

Sole License Where rights to exploit are shared between the owner and a single licensee Owner can exploit Owner grants a single license only, there are no other licensees Eg, license of library for screening

Non exclusive license Many licensees All competing with each other Competition reduces price Licensor maximises return by increased volume Eg floppy disk

Scope: Fields of Application

Some technologies lend themselves to different uses.

These are called fields. field of science particular application industry by industry

Some licensees have expertise / marketing networks in some fields but not all.

Would you license in all fields where the licensee has the ability to service

only one, but not others ?

License particular field to match the licensee’s exploitation capability


Biotechnology Fields may be

Human therapeutic and prophylactic applications Diagnostic applications Veterinary applications Plant applications

Would you license a human therapeutic product to a diagnostics company ? A disease resistant Tg plant to a pharmaceutical company ?

Maybe - these days, after mergers, some companies have merged their capability


. .

New formulation for scratch resistant plasticPossible fields:

Bottles for consumer products – injection moulding industry

Car trim – motor vehicle industry

Fashion: Handbags Kitchen appliances –

kettles etc Mobile phones etc

Would we license person in fashion industry rights in relation to mobile phones ?

Would we license motor vehicle trim manufacturer rights in relation to kitchen appliances?


Pick our licensee with the expertise / capability / marketing networks, and license in appropriate fields

Field of Application Appropriate Licensee

Bottles

Car parts and trim

Handbags

Kitchen appliances

Mobile phones

Injection Moulding Industry

Motor Vehicle Industry

Fashion Industry

Appliances industry

Electronics industry


Licensing multiple licensees in multiple feels of application

All are exclusive licensees Not non – exclusive licensees

Multiple licenses does not necessarily mean non exclusive Each license in each field of application is exclusive Each licensee expects the exclusivity to warrant its investment to take to

market Same exclusivity that patent confers

Non exclusive licenses occur when licensees do not have exclusivity and compete with each other Here, each licensee in its field of application, is an exclusive licensee

Scope: Territory

Would we license North America to a European company that had

no distribution networks in US ?

If we did :

there would not be any sales in the US

there wouldn’t be any royalties for US

Why would we license a company to exploit anywhere other than

where it had the capability to market and sell to best advantage ? We wouldn’t.

Scope: Territory

License whole world to:

a multinational that can service the whole world

License North America to:

A company that can service North America (whether in North America or

elsewhere)

License any Territory to a licensee that can exploit in that territory

Key is capability to exploit in the market

No point granting a license to a licensee with no capability to service the

Territory licensed.

Scope: Territory

Would we grant a world wide license to company in our own country ?

No, if it did not have the capability to exploit in the global market If its capability was limited to our own country, that is where the license

would be restricted to

Yes, if1. It can service a worldwide market place2. It has alliance partners and networks with others that can service the

remainder of the world In that case the license would have performance obligations in

relations to sub-licensing to those alliance partners and those networks

Scope: Extent of rights

Extent of rights granted depends on the type of license

A licensee to market globally: Worldwide exclusive license Invariably the case for biotechnology IP May be the case for an ICT technology

A manufacturer to manufacture products and supply them to licensor for sale by the licensor: Manufacturing license only No rights to market, promote or sell

Scope: Extent of rights

Possible scope of rights: To manufacture To market and promote and sell

If license is limited to manufacture, licensee can manufacture, but not sell

If license is to market promote and sell, then manufacturing not permitted – licensor manufactures, and appoints distributors (more likely to be called a distribution agreement than a license agreement)

If license is to manufacture, market promote and sell, then licensee effectively stands in a patent owner’s shoes

Scope: Summary

Licensed rights can be scoped in numerous ways :

Exclusive / Sole / Non Exclusive Field of application Territory Extent of rights

When different rights are combined, the number of possible exclusive licenses is theoretically limitless

Practically: research organisations license worldwide exclusive rights in all fields of application

Term of license

What should the term be ? Depends on the nature of the license:

Biotechnology patents: Typically until the expiration of the last to expire patent (with patent term

extensions) Licensee needs the exclusive rights conferred by the patent

License to a start up company, in any field Typically until the expiration of the last to expire patent Licensee needs the exclusive rights conferred by the patent

ICT: May be expressed as a number of years only

Term of license

Know how:

Effectively a license of confidential information

Has value, but only while the confidential information is outside the public domain

Once it enters the public domain, Looses its value Any person can exploit the confidential information without a royalty

obligation

Term in a know how license therefore expressed as being until the know how enters the public domain Theoretically this may be many years European Union 10 year limit on term of know how licenses

What is licensed: Patent / know how

Typically what is licensed is the combination of Patents

Applications, PCTs, divisionals, continuations in part, grants, re-issues, etc etc

Know how that is, all “intellectual property” in its widest sense, ie all knowledge includes confidential information includes knowledge encompassed in rejected patent claims which may still

have value

Usually in the licensor’s interest to provide everything to the licensee to equip it to the maximum extent to commercialise the IP

What is licensed – Improvements

Should Improvements be licensed ? Improvement is an improvement, modification, enhancement of the

Licensed IP

Licensee has a legitimate expectation of improvements Making the improvements available to the licensee improves its ability to

commercialise, and to compete Not making the Improvement available may encumber the licensee, may

make it less competitive

Licensor has a legitimate reason to provide the improvements as well A better equipped licensee that has greater capability, and greater

competitive edge will do better, in that way maximising the licensor’s return


Should an improvement automatically be caught by the license, with the licensor getting no additional financial return ?

Or, should the licensor be able to get an additional financial return ?

Improvements add to the quantity of the IP Logical that as the quantity of IP is increased, so does its value

Value = X Value = X + Y Value = X+Y+Z


Concept Proof of concept Prototype Trial

Development

Risk

ValuePossible License Point A

IP Value:

X

Possible License Point B

IP Value:

X+Y

Possible License Point C

IP Value:

X+Y+Z

Consider the development / risk / value curve:


The further along the development path a licensor travels (making improvements), the greater its remuneration should be

Logically: An improvements increases the quantity of IP licensed And increases the value of IP licensed

A license at Point A has a value of X eg, a royalty of 3% A license at Point B has a value of X + Y, eg a royalty of 5% A license at Point B has a value of X + Y + Z, eg, a royalty of 8%

Logically therefore, an improvement should result in a higher royalty Our frame of mind should therefore be that an improvement should entitle

a licensor to greater remuneration


But to be pragmatic: Most improvements are small incremental increases in knowledge They fine tune the IP They do not justify additional remuneration to a licensor

What is the boundary ?

Up to which improvements are captured by the license for no additional royalties

From which, if they are to be captured by the licensor the licensor has a legitimate expectation of further royalties ?


For example: if the licensor discover an additional use in another field Is that a thrown in improvement Or does it deserve additional royalties ?

Could that new application if it had been identified earlier Have resulted in a field license, leaving the licensor free to license

separately another licensee with that additional field ? Or, if licensed to the same licensee, would it have justified a higher royalty

payment ?

In these circumstances is it fair that the licensee gets this additional IP thrown in for no further payment ?


A boundary is needed

Possible boundary: If the practice of the improvement would infringe the licensed patent, then

it is thrown in for nothing. Not a desirable boundary: a new application may necessarily infringe the

Licensed IP platform

Another possible boundary: That the Improvements has sufficient novelty to be granted its own patent The better test Still has a problem: the question whether it is an improvement may not be

resolved until a patent is granted


Another limitation on Improvements: That the improvement is created by the same research team that created the

original licensed IP

Why? Cannot capture the improvements across all the activities of a large

licensor, eg,a university University may not know, and cannot manage its obligations to identify

improvements by other staff

Therefore not unfair to limit the Improvement to that Which is created by the same research team Only while they are employed by the licensor

Consent to Sub-licensing

Typical term:Licensee may grant sub-licenses with the prior written consent of the licensor which is not to be unreasonably withheld

Motivation Assess suitability of a sub-licensee

Assess capabilityAssess identify of sub-licensee

Is it a member of corporate group that would embarrass the licensor tobacco group environmentally irresponsible directors questionable

These issues of concern to a university / public sector licensor (ministerial approval / embarrassment)

Consent to Sub-Licensing

Motivation (cont): Assess terms of license

Royalties may be based on Sub-License income Consideration for sub-license may be non-monetary Cross License Other contract Therefore no royalty flowing back to licensor

All proper motivations for a licensor to seek to control sub-licensing

Besides, consent is not to be unreasonably withheld

Constraints on that legal mechanism such that it is incumbent on a licensor to grant consent if a licensee has the capability

Consent to Sub-Licensing

But holding out for this may kill the deal

Pharma / large biotech / multinational is not likely to agree to any restriction on its ability to grant sub-licenses

Given its level of investment US$50m to US$800m, it will typically not be prepared to rely on consent Even if not to be unreasonably withheld Even if incumbent on licensor to give it

Open Position: If licensee gets taken over by a tobacco company or an Exon, it does not want to loose its license, and write off its US$50 to $800m

Holding out for this will kill a deal Licensors may have to be prepared to be relaxed in this

Consent to Assignment

Same issues Licensor is entitled to satisfy itself about the proposed assignee Does the assignee have the same capability Is the licensor concerned about the identity of the proposed assignee

Normally, consent to assignment

1. Expressed as not to be unreasonably withheld Again, makes it incumbent on a licensor to grant consent if a licensee

has the capability

2. Expressed as not required where the assignment arises out of a corporate re-organisation

Patent prosecution

Who should make decisions about patent prosecution: What patent attorneys to engage Scope of claims Negotiations with patent offices What countries to apply for patents

Licensor is the owner, and may feel that it should Licensee that is a pharmaceutical company, multinational will insist on

managing patents They have more at stake Not likely that licensee will make decisions to minimise its royalty obligations

Patent Costs

Regarded as a commercialisation expense Therefore licensee should pay this expense

Licensees may resist paying for patent expenses May argue that patent expenses are an owner’s expense and should be paid

for by the licensor May argue that is prepared to pay patent expenses, but only as an advance

on royalties, so that future royalties are credited Needs to be resisted

Patent expenses are a commercialisation expense and should be paid for by the licensee without clawback

Patent Costs

What if the license is a field License Should licensee pay all costs ? Should Licensee make decision on extent of claims ?

Decisions: Licensor should make decisions given its broader interests in all fields

Patent costs: Licensee argues Licensor should pay patent costs as Licensor will benefit

in other fields But what if first field license is the only license – no other licensein other

fields ? Licensee pays If future second license, Licensee is refunded 50% If future third license, licensee refunded further proportion, etc

Patent Infringements

Who should have responsibility for pursuing infringers ? Licensor may feel that it should Licensee will want to pursue infringers

Protect its commercial interests It’s a commercialisation expense It’s a commercialisation strategy – infringers will need a license Licensee has greater commercial risk: profits are greater than revenues Sometimes infringement proceedings give rise to patent revocation

application by infringer – and licensee will want to control those proceedings

Licensor will want Licensee to pursue infringers Can cost US$2m to “the sky is the limit” Research organisation Licensor unlikely to be able to fund

Patent Infringements

Three Tiers

Parties acting jointly If they agree, they prosecute jointly, pay the costs jointly, benefit from

damages jointly

Likely that licensee will want to pursue infringers solely Solely making decisions in pursuing the infringer Solely paying the expense of doing so Licensee that is exclusive will have the standing to do so

If Licensee does not pursue infringer, licensor may do so

General obligations on licensee

Reporting Progress in further research and development Progress in seeking regulatory approvals Progress in trials (including clinical trials) Marketing strategies Sales forecasts Improvements made

Use of patent numbers Compliance with laws No misleading or deceptive conduct No use of Licensor’s name without consent

Confidential Information

Typical for license to contain all the terms commonly found in a Confidentiality agreement

Usually mutual, as licensee also discloses confidential information to the licensor

Restriction to disclosure to third parties Cannot disclose without consent Can disclose without consent where the purpose of disclosure is

commercialisation Can disclose to employees etc

Restriction on use Cannot use IP except for the purpose of commercialisation

Usual exceptions. Public domain Disclosure from third party etc

Release

Licensee releases licensor from any liability in connection with commercialisation ie, Licensee cannot sue

Licensor if “it does not work”

Licensor cannot assess this, nor make warranties about it at the time of the grant of the license, when more R&D still has to be done

These are matters for the Licensee’s own commercial assessment

Licensor

Licensee

Limitation of Liability

Release does not always work Legal principles may limit their operation

Therefore a limitation of liability Financial limit on what Licensee can sue Licensor for May be expressed as

A stated amount A limit equal to the aggregate of all monies paid under the license

Exceptions not subject to a limitation of liability: Breach of confidentiality Breach of warranties

Indemnity

Indemnity against product liability claims

Release is “Licensee cannot sue Licensor”

Indemnity is “Licensee will pay damages if someone sues Licensor”

Indemnity usual in relation to product liability claims

Hard to envisage a Licensor being liable when it is not the manufacturer / seller

In the US, some law that suggests that an owner of a patent may have a liability

Licensor

Licensor

Someone else

Product liability insurance

Not enough to rely on an indemnity from a licensee Licensor needs to ensure that licensee has the capacity to meet product

liability claims Usual covenant that Licensee takes out and maintains product liability

insurance Reputable insurance company Minimum amount of insurance cover

Some licensees self insure: pharmaceutical companies / multinationals US established product liability claims fund

Therefore little point in requiring a large pharma to self insure Biotech company must insure.

WarrantiesWhat are warranties ?

Warranties are statements made by a licensor Akin to a guarantee A licensee warrants something to be true, that is, the licensor guarantees

something to be true

If the statement is untrue, the licensee can: Sue for damages Terminate the agreement and sue for damages

Therefore important that warranties that are made, are made accurately Important consequences follow from the breach of a warranty

As a rule, a licensor will want to make the minimal warranties sought

Warranties: Warranties about ownership of IP

Not uncommon for a licensor to warrant that the licensor owns the IP being licensed, (or has a license to it)

Should such a warranty be unqualified ? Consider:

Patent application filed License granted in PCT stage Licensor warrants that it owns the IP in that patent application Later, it is discovered that another person has an earlier priority date That other person owns the IP in that patent application, not the licensor

An absolute warranty about ownership would therefore be beached Such a warranty about ownership:

should not be unqualified should be expressed to be made to the best of the licensor’s actual

knowledge

Warranties: Warranties about infringement

Not uncommon for warranties to be sought that a IP does not infringe another person’s IP rights

Should such a warranty be unqualified ? Use of an improvement patent held by the licensor infringes an earlier

patent Or, exploitation of licensor’s patent encumbered by another person’s

blocking patent Neither situation may be known to the licensor Licensor cannot undertake a complete search to be able to ensure accuracy Patent applications may be filed with an earlier priority date, but may not

be published for years afterwards Such a warranty:

should not be unqualified should be expressed to be made to the best of the licensor’s actual

knowledge

Warranties: Warranties about unencumbered rights

Not uncommon for a licensor to be expected to warrant that: No notice has been received of any claim asserting infringement No notice has been received opposing the grant of a patent, or challenging

its validity No license has previously been granted No option to license or right of first refusal has been granted

If any of the above are incorrect, warranties are made subject to disclosures

Should such a warranty be unqualified ? All these are matters within the control of a licensor Licensor should be able to make the warranties sought without any

qualifications

Warranties: Warranties about patents

Common warranties about patents: That named persons are the only inventors No inventor has been omitted from being named in the patent application That no person is named as an inventor who is not an inventor That named inventors are employees of the licensor and made the

invention in the course of employment All patent maintenance, continuation and renewal fees have been paid Patents licensed have not been revoked Patent applications have been made properly No failure to take a required step in the patent application process

Should such a warranty be unqualified ? All these are matters within the control of a licensor Licensor should be able to make the warranties sought without any

qualifications

Expiration and termination

Expiration is where the term of a license ends

Term of x years Licensed rights end on the expiration of x years Any further exercise of rights would infringe the IP

Term until the expiration of a patent Licensed rights end upon the expiration of the patent

Termination occurs unilaterally, one party terminating in response to a termination event taking place

The termination event may also give rise to a right to damages.

Termination

Non sudden termination, with an opportunity to remedy a breach

14 days in breach Notice to remedy requiring remedy within 30 days If still in breach – can terminate

Types of breaches that may give rise to that mechanism Failure to pay a royalty Failure to provide a report Failure to take out product liability insurance Failure to meet a performance obligation

Termination

Sudden termination, without any opportunity to remedy the breach

For Event of Default Where the breach is serious:

Granting a sub-license without consent Assigning without consent Commercialising outside the Field Commercialising outside the Territory

For Insolvency, winding up, bankruptcy, etc

Consequences of termination

Cease using licensed rights Return all confidential information Sometimes, continue sale of products in stock until exhausted, or an agreed

period, such as 6 months Destroy biological materials licensed

Clauses that survive, and continue to operate notwithstanding termination Confidentiality Insurance Release from claims Indemnity against third party product liability claims

OPTEON

Philip Mendes Level 3, 33 Queen St


Ph + 61 7 3211 9033

Fax + 61 7 3211 9025

[email protected]

Performance Obligation

What are performance obligations

Obligations that oblige a licensee to exploit a technology to a minimum extent Licensor seeks to

maximise its financial return on its technology ensure that the licensee does not

underperform, fail to perform “shelve the IP”

Performance obligations oblige a licensee to perform to a minimum extent With termination of the license / damages as the result if the licensee fails to

do so

Are performance obligations necessary?

Postulate: License granted of technology that is not fully developed Licensor licenses to partner with a licensee that has the capability to complete

R&D, and to take to market Engineering product at prototype stage IT Product: patents & theoretical code but no application code Biotech product in late pre-clinical stage, with years of clinical

development still to go Licensee has finite resources Resources sufficient for top 3 projects – this one ranks fourth Licensee makes a prudent commercial decision to defer R&D The technology remains idle, perhaps forever Licensor obtains no financial returns


Postulate: At the time of the license the licensee has best of intentions to commercialise

to the maximum extent Afterwards

Licensee develops its own competing product Licenses in a superior competing product Licenses in an inferior but less expensive competing product

Licensor’s technology remains idle, perhaps forever Licensor obtains no financial returns


In each case Technology is idle Licensor obtains no financial returns Technology is trapped with the non performing licensee

Licensor needs a mechanism to achieve: Termination of license Reversion of rights back to the licensor Licensor free to go out and find another licensee that can perform and

maximise the financial returns back to the Licensor

“Best endeavours” obligations

Licensee to Licensor: “I’ll agree to use my best endeavours to commercialise” May once have been a sufficient obligation

“Best endeavours” obligations were once onerous obligations: Required “leave no stone unturned”: “Best endeavours means what it says - it does not mean second best

endeavours” But best endeavors obligations have been watered down

It requires what “could reasonably be expected... having regard to the circumstances”

commercial and financial considerations can be taken into account to weigh up the reasonableness of the obligation

These commercial considerations may operate to relieve a Licensee from the obligation to perform

A better approach to performance obligations is to negotiate precise performance provisions to provide for the consequences of non compliance

Two phases to consider performance obligations:

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Better approach to performance obligations

Performance obligations - R&D phase

Licensor wants to know that the Licensee Will continue R & D (if applicable)

Will complete R & D (if applicable)

Will expeditiously start and travel the regulatory pathway (if applicable)

Not “shelve” the IP

Commercialisation Milestones Milestones that a Licensee must achieve along the R&D and regulatory

pathway Not achieve milestone – license is ultimately terminated


Commercialisation Milestones: engineering example: If more research is needed to bring product to a market ready state, the

completion of that research

Produce a prototype

Conduct a trial

Complete construction of pilot plant

Complete construction of production plant

Obtain any regulatory approval

Employ a person with particular expertise

Grant a sub license to a partner in key market

First sale anywhere in the world


Commercialisation Milestones: Biotech example: If following completion of research, more research is needed to bring

products to a market ready state, the completion of that research

Completion of animal studies

Completion of collection of data for lodging IND in USA

Commencement of Phase 1 Clinical Studies



Filing of NDA with FDA in USA

Approval of NDA with FDA in USA



If these pre market entry milestones are not achieved There may never be market entry and sales Licensor may never receive royalties

There needs to be mechanisms for Termination Reversion of rights to licensor

So that Licensor can find another licensee Licensor can earn financial returns from a Licensee capable of achieving these pre

market entry commercialisation milestones

Ultimately, failure to achieve these milestones must lead to termination and reversion There may be models that allow flexibility, but ultimately with termination

Performance obligations – Product phase

Performance obligations do not cease after market entry After first sale, Licensor wants to ensure that there is the maximum possible

penetration of the market

Achieved by minimum sales

If minimum sales not achieved: License may convert to non exclusive

Allowing licensor to find another non-exclusive licensee License may be terminated

Rights revert to licensor Again, allowing the licensor to find another licensee

Territory Period Target, in units

USA & Canada Year 1 1.0m

Year 2 1.25m

Each following year 1.5m

European Union Year 1 1.5m

Year 2 1.75m


China & South East Asia Year 1 0.75m

Year 2 1.0m




Might consider:

Broad geographical markets, region by region Smaller geographical markets, country by country

Flat minimum sales in each period Ramped up sales as marketing is ramped up, followed by flat minimum

sales Minimum targets holiday in initial period after market entry, followed by

ramping up, and then flat sales

Reassessment of minimum sales if a competing product enters the marketplace

OPTEON

Philip Mendes

Principal

Level 3, 33 Queen St


Ph + 61 7 3211 9033

Fax + 61 7 3211 9025

[email protected]

Structure of Financial Terms in a License

1. Royalty on sales by a licensee

X% of sales price Gross sales price; or Net sales price

Most common type of royalty provision

Royalty is remuneration for quantity of use Greater the quantity of use, the greater the royalty The more sales, the greater the royalty

But there can be more to a licensor than just a royalty on sales Clever ways for licensors to increase their remuneration Clever ways for licensees to reduce their royalty overhead

2. Royalty upon sub-license income received by licensee

Licensee grants sub-license Sub-licensee will pay to

Licensee Royalties on the sub-

licensee’s own sales Milestone payments, etc

All that income is sub-license income

Licensee pays a royalty of Y% to Licensor on all that income

.

Licensee

Licensor

Sub-Licensee

3. Royalty upon last Licensee’s Sales

Royalty on sale price for which the last licensee sells product

Royalty rate remains fixed, e.g. 2% of sale price of last sale – that is all licensor will receive

Licensor might be better off receiving Y% of Sub-license income – might be greater than this 2% - as Licensee will sub-license after value adding and will secure a substantially higher royalty

.

Licensee

Sub-Licensee

Licensor

Buyer

4. Royalty as a currency

Royalties sometimes expressed as a currency amount, rather than a percentage Eg, on software products, a royalty of $X per unit Eg, computer game

May be an attractive model when the product is expected to have a short product life of say 2 years

Why attractive ? Licensor is assured the same royalty regardless of downward price

fluctuations, which in a product with a short product life may be expected.

4. Royalty as a currency

Dangers

Should not be used where the product has a medium to long product life cycle In this case, can expect upward price fluctuations If fixed currency royalty, value of the royalty reduces over time with

inflation Percentage royalty on invoice price preferred

If financial analysis of royalties have been based and negotiated on currency amounts, convert the currency amount to a percentage on anticipated invoice price

5. Royalty on sales in countries where patent granted

Expressed as: “Valid Patent Claim” Sales in country where but for license product would infringe a granted

patent That is, licensor onlys receive a royalty where sales are made in countries

where the sale of a product is protected by a granted patent Traps:

No royalties on sales made while patent pending (e.g., delays in examination, opposition proceedings etc)

No royalties on sales in countries where patent is not sought, nor granted – ie, if patent in US only, you only get royalties on sales in US

6. Royalty on sales in countries where no patent is granted

This royalty often resisted by licensee – “why should I pay a royalty for sales in countries where there is no patent and I have no power to prevent competitors ?

Royalty might still fairly be payable: Patent may be taken out in 20 – 25 countries and that may represent 90%

- 95% of the global market – so why shouldn’t royalty be paid on sales in remaining countries ?

Licensee will select the countries where patent will be sought Result

pay full / part royalty, reducing by 50% if a competing product enters the marketplace, if it

would have infringed the patent

7. Royalty Splitting – know how

Split royalties so that they are referable to different parts of the IP that is

licensed

Instead of seeking a royalty of 5%:

Royalty of 3% for use of patent

Royalty of 2% for use of know how

Purpose:

If patent is invalidated, license on foot, with a royalty for the know how

component

getting a royalty in countries where there are no patents

8. Royalty stacking

Can arise in two ways

1. Product to be sold needs license in of complementary technology, e.g., a delivery system for a drug another active ingredient for a drug a complementary product where both sold together e.g., a

vaccine cocktail

Sale price of product sold reflects complementary technology as well

2. Freedom to operate – license in patent that is

infringed Cannot reduce royalty by whole amount of royalty paid to another

person Alternative: in each case, reduce royalty by X% of royalty paid

out, up to max of y% reduction on any royalty payment

Stack forfreedom tooperate z%

Stack fordeliverysystem y%

Royalty x%

9. Ramped Up Royalties

As a product is more successful, and costs reduce, royalty increases Licensor forgoes royalties in early stages, in return for higher royalties

later Licensor indirectly contributes to initial manufacturing and marketing

costs

Cumulative gross sales in USD$ Royalty %

Up to 100m 4

100m to 250m 5

250m to 500m 6

500m to 1b 8

1b and over 10

10. Research Tools: Reach Through Royalties

Research tools are tools that enable a product to be developed A valuable piece of IP How do you measure its value to properly remunerate the Licensor that owns the

research tool ? Examples:

License of a Mouse Model Mouse Model validates a drug target Therapeutic drug developed that acts on that target

License of an assay Assay identifies and qualifies a compound that may be developed into a drug

Reach through royalty is a royalty based on the sales of the drug that is developed with the research tool (mouse, assay, etc)

Royalty is not on the technology itself, but instead is a royalty on the sales of the product that is enabled by the technology

In that way measuring the quantity of use of the Licensor’s technology

11. Measuring quantity of use

Royalties are intended to remunerate a Licensor for the use of its technology Greater the quantity of use, the greater the licensor’s remuneration should be

How do you measure quantity of use (and therefore remuneration through royalties) where the technology Is enabling Does not itself produce a product

For example: Software that provides a capability A process technology

Consider some other measurement of the quantity of use of the technology For example

Software program – royalties on reagents Product produced with less cost as a result of a new catalyst

12. Royalties on value added

A license may enable a licensee to sell products But a license may also give the licensee a capability to sell other unrelated products

License may allow a licensee to sell diagnostic reagents But additionally, may equip licensee to sell a diagnostic machine to test the

reagents Licensee is profiting from

Sales of licensed reagents Sales of diagnostic testing machine

License equips licensee to make additional revenues and profits from the diagnostic testing machine

May be legitimate to value the license not just by reference to profits anticipated from reagents But additionally from profits anticipated from diagnostic testing machine

13. “Most favoured” royalty

Most favoured clause is very common in the case of a non exclusive license

Agree on royalty of 10% If licensor later grants a license in the same country to a competing

licensee for a lower royalty, that lower royalty will apply in lieu of the 10% royalty

Sought by non exclusive licensee to enable it to be able to compete

15. Lump Sum License Fees

Once Only License Fee Or, license fee payable by installments

May be the only consideration for the license May be one of a package of other financial terms

Important to try to secure in every license to offset past patent expenses, expenses of doing the deal (travel, legals etc) some part of R & D costs

16. Milestone Payments

Payments made at identifiable points along the development / regulatory pathway

Biotech Milestones

Grant of patent USD $2m

Filing New Drug Application FDA UDS $5m

Commencement Phase II Clinical Trial UDS $10m

Commencement Phase III Clinical Trial UDS $15m

Product registration FDA UDS $30m


Payments made at identifiable points along the development / regulatory pathway

Engineering Milestones

Completion of Prototype USD $2m

Completion of Pilot Plant UDS $5m

Completion of Trial UDS $10m

Completion of Production Plant UDS $15m

Grant of a regulatory approval UDS $30m


Payments made at identifiable points along the marketing pathway

Marketing Milestones

Market launch USD $1m

Granting sub-license in key market (US) UDS $2m

Worldwide sales reaching $X UDS $10m

US sales reaching $Y UDS $10m

Worldwide sales reaching $Z UDS $20m

17. Minimum Annual RoyaltyAlternative to performance obligations

Performance obligations are obligations that a licensee must meet to continue to be licensed

Avoids shelving (non use) of IP Licensor gets no financial return and wants to be able to license someone

else Avoids inadequate performance (e.g., no commercialisation in a major market,

such as US) Licensor gets inadequate financial return and wants to be able to license

someone else


Commercialisation Milestones: engineering example:

If more research is needed to bring product to a market ready state, the completion of that research

Produce a prototype

Conduct a trial

Complete construction of pilot plant

Complete construction of production plant

Obtain any regulatory approval

Employ a person with particular expertise

Grant a sub license to a partner in key market



Commercialisation Milestones: Biotech example: If following completion of research, more research is needed to bring products to a

market ready state, the completion of that research

Completion of animal studies

Completion of collection of data for lodging IND in USA




Filing of NDA with FDA in USA

Approval of NDA with FDA in USA


17. Minimum Annual Royalty Examples of performance obligations

Usually require minimum sales revenue / units sold

Expressed as worldwide / or markets If failure in a market

Exclusivity converts to non exclusivity

Or termination In the market concerned, without

affecting other markets Multinational licensee - none of that is

acceptable Will be prepared to make minimum

annual payments

Territory Period Target, in units

USA Year 1 1,000,000

Year 2 1,250,000

Each following year

1,500,000

Countries in EU

Year 1 1,500,000

Year 2 1,750,000

Each following year

2,000,000

17. Minimum Annual Royalty Alternative to performance obligations

A pharma / multinational will not ordinarily accept performance obligations of these type in an early stage deal

A biotech company will not be able to secure those types of performance obligations from a pharma, and so will also not accept them from a licensor

Alternative is Minimum Annual Royalties A minimum amount of royalties to be paid Licensee must pay the higher of

Actual royalties, or Minimum annual stipulated amount

Ramp up the amount year by year If Licensee elects not to pay, termination

18. Pay royalties on what ?Pay on net profits ?

Would this work ?

“The Licensee will pay a royalty of X% on the net profits from the sale of Products”

How are net profits to be calculated ? Net profits are subject to manipulation Allows overheads to be taken into the calculation, in that way reducing

royalties A 5% royalty on net profits may in fact be a 1% true royalty

18. Pay royalties on what ?Pay on invoice price

Royalties always paid on invoice price That is, royalties are referable to the gross arm’s length sale price of products

Some agreed expenses are deductible taxes, duties, VAT, GST etc on sale credit for products returns trade and quantity discounts

Deduct packaging, freight and insurance Only if separately invoiced Or lump sum deduction, maximum of 3-5%

19. Pay royalties on what ?Bundling

Bundling What is bundling ?

Where the product is sold in a package or bundle with other products Package includes

Licensor’s product upon which a royalty is payable Other products upon which no royalty is paid, or a royalty is paid to another

licensor For example:

two software products sold in a bundle Or, end user license for a process, and technical assistance services

The total price of the package may be discounted Can’t tag royalty to invoice price because invoice price includes other products Tag royalty to the prevailing market price when Product sold unbundled

20. Pay royalties on what ?Combination products

Bundling issues – combination products

But what if there is no prevailing market price for the Product because it is not sold separately

For example, a vaccine that is always sold as a cocktail, that is, multiple vaccines in one injectable – always a combination product

Invoice price may never relate solely to the licensed product Some approaches:

Prevailing market price in another country where it is sold separately (if any)

Royalty on the invoice price of the cocktail (but over time the cocktail may have different components)

As negotiated in the future as prevailing circumstances change (with expert determination if no negotiated outcome)

21. Pay royalties on what ?Sales to related parties – transfer pricing

Licensee may sell products to a subsidiary or related party Non an arm’s length transaction Invoice price presumes that there is a market price – set by prevailing market

conditions A sale to a subsidiary or related party may not be for a market price

There may be an intention to manipulate the invoice price artificially to manipulate a royalty

Or, there may be legitimate reasons for sales to a related party, eg sales from manufacturing subsidiary in one country to a marketing subsidiary in another country

There may be a motivation to take advantage of lower tax rates in another country, so transfer prices may have the objective of choosing a lower tax jurisdiction

21. Pay royalties on what ?Sales to related parties – transfer pricing

Approaches

Royalties based on invoice price to first arm’s length party (ignoring on sales within a company group)

Royalty on prevailing market price Can only work when the licensee sells some products on an arm’s length

basis No grant of sub-license rights to a related party without consent (and deal with

the issue as a part of dealing with the request for consent)

22. Inspection of accounts and audit

Typical to include rights in a license that Licensee must keep good accounting records of items upon which royalties and

other payments are based Keep records to a standard

International Financial Reporting Standards (IFRS) - the accounting standards set by the International Accounting Standards Board

Or, an equivalent in a country (In Australia, GAAP) Particularly important when a licensee has no legal obligation to maintain

books to a certain standard (eg non publicly listed companies) Keep records for a minimum of X period

Avoid time limit on inspecting accounts (eg, only last X number of years records)

Licensor (or appointed auditor) may inspect those accounts (on giving eg 7 days notice) take copies or extracts

22. Inspection of accounts and audit

Costs of inspection and audit Borne by Licensor Unless an underpayment of amounts due to licensor is discovered that exceeds an

agreed amount (eg 5%), in which case, the cost of the audit are payable by the licensee

Inspection of Sub-licensee’s accounts Licensee must report to Licensor

Any inspection or audit of a sub-licensee’s accounts Results of that inspection, including copies of reports

Licensor can exercise Licensee’s rights to inspect Sub-Licensee’s accounts May be considered for appropriate transactions

25. Withholding tax

A tax effectively payable by a non resident Paid by a resident licensee effectively on behalf of a non resident Licensor 5% to 30%

Licensee in USA owes royalties of $100,000 Withholding tax of 10%

Licensee will pay $90,000 to licensor Licensee will remit $10,000 to IRS

In this way, effectively a tax on a non resident licensor entitled to royalties Withholding tax also often paid on interest income and dividends

25. Withholding tax

If a license is silent about withholding tax, the licensee must remit the royalties without deduction

Licensee effectively becomes the taxpayer


Licensee will pay $100,000 to licensor Licensee will remit $10,000 to IRS Licensee has effectively paid the tax

The effective royalty rate is now 10% greater.

25. Withholding tax

Where there is a double tax treaty between the Licensor’s country, and the country where the sale of a product takes place, the Licensor gets a tax rebate for the withholding tax paid

In this way, double tax is avoided


Licensee will pay $90,000 to licensor Licensee will remit $10,000 to IRS Licensor will provide evidence of payment of $10,000 to IRS Licensee pays tax on $100,000, and gets tax credit for $10,000, the amount

withheld

Conclusion

There’s more to a royalty than just filling in a blank on a license template !

Date post:	27-Mar-2015
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OPTEON Philip MendesLevel 3, 33 Queen St Brisbane QLD, Australia Ph + 61 7 3211 9033 Fax + 61 7 3211...

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