Frequently Overlooked Provisions in Licensing Agreements

Written By:
Scott C. Tips
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Editor’s Note: This article is intended for information purposes only. Because state and municipal laws vary greatly, as do the circumstances of individual cases, readers are advised to contact an attorney for specific legal advice. © Scott C. Tips 2014

“It’s not what you don’t know that kills you, it’s what you know for sure that ain’t true.” How many of us have heard this truism by Mark Twain many a time and nodded our heads in agreement? Well, it certainly applies to business.

Many of you running businesses or engaged in business deals have attorneys who prepare your business agreements for you, or else you or they simply whip out form agreements, sometimes off the Internet, that are then quickly and perfunctorily signed by all parties so that the “real” business of making money may be attended to, and at once. If that is the way that you document your deals, then you are making a huge mistake.

Often, those business contracts look polished and oh, so professional with their legalese and multiple subsections that some of you don’t even understand or feel you need to understand because you have trusted your high-priced lawyer to give you an agreement that works. And, in all fairness, in most cases, those rote, off-the-shelf agreements do work.

But what about those standard agreements that don’t cover the special circumstances that arise from time to time? The sad result could be broken contracts, ruined business relationships and expensive, acrimonious litigation to determine the parties’ rights. We all want to avoid these unfortunate consequences; and this article is intended to help alert you to some of the frequently overlooked provisions in business agreements, especially licensing agreements.

Space limitations force me to focus here on one particular kind of business agreement: licensing agreements. As most of you already know, a license agreement grants a “licensee” the right to make use of another person or entity’s intellectual property (IP) for a price, usually designated as a royalty. License agreements are intended to protect proprietary rights in things such as software, trademarks and proprietary supplement formulas and manufacturing processes. As an interesting side note, even though lawyers invariably draft software agreements as license agreements, they should really be drafted as service agreements. But, that is another subject for another time.

So, whether you have developed a dietary-supplement formula (or trademark or manufacturing process) that you wish to either sell or license to another person or business, or whether you are on the other side of the table and wish to buy or receive the license, you would be very wise to read carefully through your license agreements and make sure that they have considered the following terms.

1. Work for hire. Was your formula (or Web site or graphic artwork) developed for you by an employee or third party? If so, you need to be sure that you have truly acquired all of the rights to the formula in any agreement with the employee or third party who was commissioned to do the work.

L. Donald Prutzman, a New York attorney specializing in such contracts, recommends the following language where applicable: “It is acknowledged and agreed that all Deliverables or other work product created pursuant to this Agreement (the ‘Work’) was and is intended to constitute a work made for hire as defined in the Copyright Act, 17 U.S.C. § 101. To the extent that for any reason the Work does not constitute a work made for hire, and in any event with respect to all rights relating to the Work other than copyright, for valuable consideration, receipt of which is hereby acknowledged, Developer hereby assigns and transfers to the Company and its successors and assigns, all right, title and interest that Developer may have in and to the Work, including, without limitation, any and all worldwide copyright, patent, mask work, trade secret and trademark rights and other intellectual property rights (collectively, ‘Intellectual Property Rights’) inherent therein and appurtenant thereto, together with the right to secure renewals, reissues or extensions of such intellectual property rights, which right, title, and interests shall be held to the full end of the term for which such intellectual property rights or any renewal or extension thereof is or may be granted, and the right to sue for any and all past infringements.”

It is very important that you make sure that you own the IP rights to whatever you are buying or selling. Purchasers of IP rights should get a covenant, representation and warranty that the IP-rights seller is the true owner of such rights and has the legal right to sell them.

2. Royalties and profit sharing. Assuming that the IP rights are not sold outright, royalties, periodic payments and/or profit sharing will be covered in the contract. But, as they say, the devil is in the details. All too often, the contract language is vague and sloppy and can lead to later disputes over such wording. So, be as precise as possible with this language.

In the case of royalties, define the royalties and any exclusions as precisely as possible, such as: “‘Net Sales’ shall mean the total invoiced sales price of Licensee, or any affiliate of License, to customers not affiliated with Licensee, provided, however, that Net Sales to any retail store or store chain affiliated with Licensee shall be deemed made at the greater of (i) the actual invoiced sales price, or (ii) the average invoiced sales price for the Licensed Product during the License Quarter of such sale, excluding trade discounts actually taken, freight, state and federal taxes and authorized returns evidenced by credit memoranda. No other exclusions shall be made. For purposes of this Subsection X, ‘affiliated with Licensee’ shall mean being a direct or indirect parent or subsidiary of Licensee or being under common control with Licensee.”

3. Royalty payments and reporting. Pay particular attention, too, to the manner of royalty payments and their reporting. Make sure that payments are provided for regularly and that the reporting requirement is tied to each payment and includes language such as “Royalty reports shall show the calculation of the royalty in sufficient detail for Licensor to ascertain the method and correctness of such calculations.”

Too many times the royalty report is too vague to allow the payee to determine if it is accurate or not, which is why many attorneys will actually attach as an exhibit to the contract a sample royalty-reporting form that the parties agree will be used as the model form. If you are the Licensor (payee), then you will also want to incentivize royalty payments by making sure to include penalty language for late payments, as in: “Any royalties not paid when due shall accrue interest at the rate of 1.5% per month, or the maximum amount permitted by law, if lower.”

4. Audit rights. As I’ve often said to my own clients, the percentage royalties to be paid to you are absolutely meaningless if you do not have the means to verify such payments! Or, as a famous politician once said, “Trust but verify.”

To define payment and audit rights carefully, again Mr. Prutzman provides sample language: “Licensee will keep all proper books and records of account and all proper entries therein relating to the distribution and sale of Licensed Products and Net Sales and will retain the same for not less than three years after the end of the Term. Licensor may cause an audit to be made, at its expense, of Licensee’s records in order to verify royalty payments hereunder. Any such audit shall be conducted only by a certified public accountant after prior written notice to Licensee, and only during regular business hours at Licensee’s offices and in such a manner as not to unreasonably interfere with Licensee’s normal business activities. If any audit hereunder shall determine that royalties for any License Quarter have been underpaid (a) licensee shall immediately pay any underpayment, plus applicable interest, to Licensor, and (b) if such underpayment shall be in an amount greater than four percent (4%) of the Royalties due with respect to such License Quarter, Licensee shall reimburse Licensor for the cost of conducting such audit.”

On the Licensee’s side, protection can be afforded to the Licensee by including language that no royalty period may be audited more than once, no audit may be made on a contingency-fee basis (i.e., no “fishing expeditions”) and that the licensee should have full access to the audit if a claim is made.

5. Indemnification. Indemnification clauses in licensing agreements are so often looked at by the parties and even the attorneys as so much boilerplate that they are rarely given more than a cursory glance before the agreements are signed. This is a mistake. Indemnities are like insurance policies and they deserve deeper review.

If you are the party granting the indemnification to another par­­ty, then you should consider ways to limit your liability. Your indemnity payments could be limited to the dollar amount of the licensing fees paid and they could be limited by avoiding indemnification altogether if you were not the party that actually engaged in the conduct that created the liability. Some indemnification language will also exclude consequential and punitive damages. (But, beware, some States such as New York, do not allow parties to exclude themselves from liability for gross negligence or willful misconduct.) Why include such limits of liability? You don’t want the risks of doing business to be greater than the benefits you hope to gain.

General Points to Consider
• Remember, clear contracts are generally enforced as written. So, be clear and avoid costly mistakes.
• If your sales channel is the Internet, then your agreement’s territory is worldwide.
• Do not enter into a license agreement without an exit strategy. Every license agreement ultimately ends, so make sure that your plans are in place for that time when your own agreement ends.
• The term of the license should allow you (the licensee) a reasonable time to recoup your investment in the deal. Anything less is unfair to you and ill-advised for the other party.

Remember
Please keep in mind that the points made here are for information only. I recommend that you engage and consult with an attorney experienced in these matters. As a guide only, some of the many attorneys with such experience are L. Donald Prutzman and his partner Mark Grossman of the firm Tannenbaum Helpern (New York City), Todd Harrison of Venable LLP (Washington, D.C.), Terry Gross of Gross Belsky Alonso (San Francisco), and William R. Christian of Rodi, Pollock (Los Angeles). There are numerous others, but these are the ones who immediately come to mind.

Regardless of whom you engage to help you legally with your contracts, remember that you, yourself, bear ultimate responsibility for ensuring that you not only make the best deal possible, but that also you document that deal as thoroughly as possible too.

Above all, remember that any deal must have benefits for both sides. Do not be like Attila the Hun ravaging Europe, trying to conquer every single thing that you can. Those deals, even if successfully won, will not last. So, make a fair deal for all sides and then enjoy the long-term benefits. WF

A graduate of the University of California at Berkeley Law School, Scott C. Tips currently practices internationally, emphasizing Food-and-Drug law, business law and business litigation, trade practice, and international corporate formation and management. He has been involved in the nutrition field for more than three decades and may be reached at (415) 244-1813 or by e-mail at scott@rivieramail.com.

Published in WholeFoods Magazine, February 2014