A large amount of the average company’s capital value subsists in its intellectual property (IP). However, this value is very volatile, and if not developed and adequately protected a company’s IP may not be commercialised to its fullest potential. It is therefore important for IP owners, IP developers and those seeking to commercialise IP to understand exactly how the licences they negotiate operate and what rights are being granted.

In this article, the first of a three-part series, Partner Hayden Delaney and Associate Briar Francis discuss the starting point of all IP licences: the IP; and why it is important to know exactly what you are negotiating for.

Key points

  • Parties negotiating an IP licence agreement should have a sound understanding of exactly what the IP subject of the licence is to avoid signing off on an agreement that doesn’t meet the parties’ needs.
  • IP licences will sometimes grant rights to the licensee in relation to all of the IP the licensor owns; this is rarely necessary and could pose a number of risks to the licensor.
  • It is prudent for both parties to conduct due diligence on the IP being licensed before signing any agreement.

The basics

When we talk about IP, we generally mean legally recognised proprietary rights, namely:

  • patents;
  • trade marks;
  • designs;
  • plant breeder’s rights; and
  • copyright.

These IP rights are exercisable against the public at large and are considered personal property. All of the above IP rights can be registered in Australia, except copyright which automatically vests upon creation subject to certain criteria being satisfied.

Quite often, the IP rights listed above will be bundled together with similar concepts, such as ideas, know-how, trade secrets, confidential information and data. These other forms of information are not proprietary rights in the proper sense and can’t be exercised against the public at large, but often it is important to include protections for this information when looking to start a new business venture.

An IP licence agreement is a type of contract that authorises one party to use the IP of another party for certain purposes. It should not be confused with an agreement to assign the IP rights of a party; there is no transfer of ownership to the IP rights in an agreement that deals solely with licensing those IP rights. As with most contracts, there is no ‘one size fits all’ for IP licences given the very different nature of each arrangement.

What IP is being licensed?

Identifying what IP is to be licensed is a vital but sometimes difficult starting point when agreeing to a licence. Both parties need to have a solid understanding of what will be licensed so that the negotiation of the terms surrounding that licence goes smoothly. The first step is generally to get a clear understanding of what the licensee wants to do with the IP, and then ascertain whether the IP in question has the functionality to meet the licensee’s needs. If this cannot be reconciled between the parties, then there is no point in continuing negotiations unless the IP can be further developed (by either party) to meet the licensee’s needs.

Example: Party 1 has created new technology designed to assist doctors in diagnosing certain conditions. Party 2 wishes to use this technology in its medical practises, so it needs to be granted a licence to use the IP in that technology from Party 1. In conducting due diligence enquiries before the parties negotiate the terms of the licence, it comes to light that the development of the technology is at a very early stage and is not currently capable of use on patients. Party 2 discovers that the technology won’t be ready for use in the real world until significant further resources are dedicated to rigorous testing and obtaining the required approvals. Party 2 withdraws from the arrangement because there is too much uncertainty regarding whether the technology is actually viable.

The parties (and the licensee in particular) will also need to be across whether the subject matter of the licence is “IP” in a technical sense. For example, in most jurisdictions patent applications are not an intellectual property right (but a potential future right, if the patent proceeds to grant) meaning that the licensee’s rights are also restricted. There is also a possibility that the patent may never be granted, which could result in a licence of that IP becoming redundant. If the licence is dealing with an application to register IP, then the licence agreement should contemplate what happens if the application fails (in part or in whole).

Further, in certain arrangements licensing the use of actual IP, the IP rights themselves will also need to be accompanied by a right to use or access confidential information, trade secrets, know-how and other materials such as user guides, analytical data, plans and client lists.

Example: Party 1 wants to engage Party 2 to distribute its products overseas. This would include granting a licence to Party 2 to use and commercialise the IP rights in the products, such as the trade marks for the products. But Party 2 will probably also need a licence to the user manuals for the products so that they can be translated, and access to Party 1’s marketing data and strategies to ensure that the marketing of the products overseas is successful.

The next step is to identify just what IP is needed from the licensor to make the arrangement feasible. Licensors should avoid blanket clauses that licence all of the IP they own to the licensee (unless this is absolutely necessary) as this increases the risks of misuse of the IP by the licensee. In contrast, licensees need to verify that what the licensors are prepared to offer is the entirety of what is necessary for them to use the IP as planned. These factors will also be necessary to consider when determining the scope of the licence, which we discuss further in the second part of this series.

Example: Party 1 is licensing its software to Party 2, and also doing some development work to the code to ensure Party 2 can use it for its business purposes. To be able to use the code as anticipated, Party 2 will need a licence not just to the binary or compiled form of the software, but to both Party 1’s existing source code, and the future code developed for Party 2 (as well as any revisions, patches or updates).

It should be noted that there can be multiple IP rights that need to be licensed to use an IP asset. There may be patentable technology, as well as a registered design making up an industrial invention, and it may be agreed that the licensor’s trade marks are to feature on the product or packaging. Similarly, a key part of a particular software program may be a patentable methodology, and copyright subsists in the source code of that software as well.

Parties can often reach a stumbling block when they realise that they have limited a licence in a very narrow sense and have not anticipated how the IP may change or develop throughout the term of the arrangement. Care should be afforded to ensure that the licence covers any future rights that may be needed to carry on the arrangement, for example where the licence is for a patent application that is likely to become registered at a later date or could require significant revision before reaching registration.

Due diligence

Due diligence will be crucial for licensees to determine whether the IP assets subject of the licence:

  1. exist in the form represented by the licensor;
  2. are sufficient for what the licensee wants to do, now and in the future;
  3. where possible, are registered;
  4. where possible, are valid and not subject to challenge; and
  5. do not infringe the intellectual property rights of a third party.

We see too many licensees who skip due diligence citing unnecessary expense, sign on the dotted line and then end up with deficient IP, IP that doesn’t function as they had envisaged, or a curtly worded cease and desist letter in their inbox from a third party.

Similarly, due diligence is recommended for licensors so that they have some assurance that the company or person they are licensing to is not at risk of insolvency or some other adverse event (which could impact the licence granted).

Conclusion

There is a tendency when negotiating an IP licence to race straight to drafting the agreement to get the arrangement off the ground in as little time as possible, particularly in industries where technology changes faster than the time it takes to implement it. But there is value in taking a step back initially to make sure that the agreement will serve the parties’ purposes, and diligence in identifying the IP to be licensed can save thousands later down the track.