Word of law: An intellectual property licensing primer

The old adage “it is easier to seek forgiveness than permission” does not apply to a well-managed intellectual property (IP) portfolio, especially in the manufacturing sector. The commercial and legal reality is that many suppliers and contract manufacturing customers require written agreements authorizing – or licensing – use of their IP with certain conditions, to protect their IP used in the manufacturing process. Similarly, a proactive manufacturing company that uses its proprietary processes to manufacture goods under a supply agreement will typically incorporate IP license provisions in their supply contracts. What follows is a non-exhaustive primer on the various types of licenses, and typical clauses in manufacturing supply agreements.

1. What is an IP license?

In basic terms, a license is permission or authorization to undertake a specific activity. An everyday example is a driver’s license. In the IP context, an IP license is an agreement where the IP owner (the licensor) gives an entity using the IP under the agreement (the licensee) permission to use the IP, subject to the provisions set out in the license. 

2. What types of IP licenses are there?

There are three types of IP licenses:

a. non-exclusive

b. exclusive

c. sole

In a non-exclusive license, the licensor is allowed to license the IP to third parties other than the licensee. The licensor is also allowed to use the IP for its own purposes. In my experience, this is the most common license type. 

Exclusive and sole licenses are sometimes used interchangeably or together, often to great confusion. Confusion is the last thing anyone should want in a contract, as the rationale for a written contract is to clearly state the terms of the deal between the parties. This is so that each party is clear on their respective rights and obligations under the deal to successfully manage the commercial relationship, and to provide a roadmap to an adjudicator in the event of dispute.  

An exclusive license is often – but not always – understood to mean that the only entity who can use the licensed IP is the licensee; not even the licensor can use the licensed IP. A sole license is often – but again not always – understood to mean that there is only one licensee – the entity specified in the licensee – and the licensor can also use the licensed IP. 

The problem is that sometimes what is meant to be an exclusive license is really a sole license, and vice versa.  The solution is to specify in an exclusive or sole license what is meant by the term “exclusive” or “sole”, and whether the licensor can also use the licensed IP. And never use the phrase “exclusive and sole” in a license agreement. 

3. Can all forms of intellectual property be licensed? 

Yes. All forms of IP – typically taken to mean copyright, industrial designs, integrated circuit topographies, patents, trademarks and trade secrets and know how – can be licensed. Of course, this is contingent on the licensor being able to license the IP to a licensee, subject to the licensor having that right in the first place. The right to license IP is usually based on the licensor owning the IP being licensed, or a contractual right to sublicense – that is, license third party owned IP to others, with the owners’ permission. 

4. What are typical clauses that are seen in license agreements used in the manufacturing sectors?

a. The license grant: The grant will often refer to specific IP set out in a schedule to the license. In the contract manufacturing context where purchase orders (POs) or statements of work (SOW) are used to fulfill orders under a supply contract, often the IP in question may not be specified in the supply agreement, but are rather specified in each PO or SOW, with the governing agreement referring to the licensed IP in terms of ownership without particularity.

b. Territory and term: These clauses respectively specify in which country the IP may be used, and the term of the license. A license term may automatically extend for a renewal period specified in the license. Such renewal is often conditional on the licensee being in good standing with respect to its contractual obligations under the license.

c. Royalty rates and payment schedules:  These provisions specify any payment due from the licensee to licensor to use the IP, a payment schedule, and the content of the royalty report if the royalty is based on sales. Royalty payments can be structured in a variety of ways. Examples include:

i. An upfront flat fee royalty at the start of the license agreement, with additional royalty payments due at the time of any license renewal. In the industrial design and patent context, it is not unusual to see royalty rates that decrease over the lifetime of the industrial design and/or patent registration. This is because there may be competing industrial designs or inventions on the market at the time of renewal. 

ii. An upfront flat fee royalty at the start of the license agreement, with additional royalty payments due quarterly based on the licensee’s sales. Such additional fees are usually calculated using a royalty rate that is a percentage of net sales, with the percentage based on what is standard (or “market”) for the specific industry sector (for example, automotive and chemical).

iii. A royalty calculated as a percentage of net sales. Again, the percentage is usually based on what is “market” for the specific industry.

d. Audit clauses: This can refer to both:

i. Royalty payment audit clauses, allowing the licensor to audit the books and records of the licensee to ensure that royalty payments calculated on a percentage of sales and paid to the licensor are accurate. Often, the licensor must pay a financial penalty if the reported royalty is incorrect by a certain amount.

ii. Quality control audit clauses in trademark license agreements for licensed goods, where the licensor or its designate monitors the quality or characteristics of the goods bearing the trademark. Such monitoring is required so that the licensor maintains its trademark rights. Without such monitoring, the licensor can lose its trademark rights.

e. “To each their own” with respect to IP ownership: In contract manufacturing arrangements where the customer’s and the manufacturer’s respective IP are used by the manufacturer to produce goods for the customer, the license will often state that each party owns its own IP. Often, such licenses will also state that the license is granted by one party to the other is solely for the production of the manufactured goods contemplated in the agreement. Such license provisions can be part of the contract manufacturing agreement, or a separate license agreement.

f. Express prohibitions on infringement and/or reverse engineering:  IP licenses will often contain express prohibitions on licensee’s infringing and/or reverse engineering the licensed IP to make it clear that the license is not an invitation to infringe the licensor’s IP.

g. Representation, warranties and indemnities with respect to IP infringement: It is routine in IP license agreements for the licensor to provide a representation and warranty that the licensed IP is not infringing, and to indemnify the licensee if the licensee faces infringement allegations from third parties over the licensee’s use of the licensed IP.

h. Assignment and sublicenses:  IP licenses should state whether either of the parties can transfer (“assign” in legal jargon) its rights and obligations under the license to a third party. It should also state whether the licensee is allowed to further license (“sublicense” in legal jargon) the licensed IP to third parties.

i. Governing law:  Any properly drafted contract should state which jurisdiction’s law governs any legal disputes regarding the license, to avoid a prolonged fight over which jurisdiction’s laws are used to interpret and enforce the terms of the license. Such “choice of law” clauses usually specify that the governing law is the jurisdiction of commercially important or the only IP under the license (for example, Canada in respect of a Canadian patent license), or a jurisdiction in which one of the parties’ has a significant commercial presence.

j. Dispute resolution: Any properly drafted commercial agreement should state whether disputes under the agreement are subject to arbitration or litigation. Arbitration clauses should provide some parameters regarding how the arbitration will be conducted (for example, the number of arbitrators, where the arbitration will take place, and what arbitration proceeding rules will govern how the arbitration is conducted). If disputes under the license are to be litigated, the courts where the trial is to take place should be specified, again to avoid a bun fight between the parties over the trial’s location. Otherwise, similar to disputes between the parties over governing law, the parties can also spend significant sums on legal fees before a trial starts over where that trial should take place. 

While there is little variation in the types of licenses in terms of exclusivity and what is good practice in terms of license drafting, what is a suitable license agreement to reflect the commercial reality between two parties can vary greatly. This is beneficial, as it allows for licensing arrangements to be tailored to meet the parties’ respective needs. 

Lorraine M. Fleck (M.Sc.F., LL.B.) is an Ontario lawyer and Canadian trademark agent. She practices as in-house legal counsel at an international consumer packaged goods company, and as principal of Fleck Innovation Law, a Toronto firm that has been recognized by Canadian Lawyer magazine as one of the top 10 intellectual property boutiques in Canada.