# Introduction to commercial exploitation of Intellectual Property Rights

Intellectual property is acquired so that it can be exploited for commercial purposes. A business may either use intellectual property rights (IPRs) to generate revenues by itself (i.e. by manufacturing and selling products using its own patent and brand names) – this is the most obvious manner to exploit intellectual property rights. A business may also sell the IPRs permanently (through an assignment),or it may allow other entities to use its IPRs through licensing, franchising or technology transfer. Some businesses have earned millions through licensing their technology, while others have expanded globally based on the franchising model. Note – selling the product is different from selling the IPR, that is the, right to manufacture, sell and distribute the product to the market to the exclusion of everyone else.

Ericsson’s example

Ericsson had earlier transferred its mobile handsets business to a joint venture which was owned by Sony and itself. However, the joint venture is presently wholly owned by Sony. Although it does not manufacture handsets anymore, Ericsson owns 30,000 patents pertaining to mobile handset technology, and derives a significant portion of its revenues from licensing this technology to other handset manufacturers. Recently, it even secured a temporary injunction against import of handsets by Micromax (such as Canvas 2, Funbook Talk and Ninja series) on the ground that these imports were violating its patent rights.
For details see here.

Nortel’s example

Businesses can also acquire IPRs (this applies especially to patents) in a particular field to reduce risk of litigation, or as a strategic tool to aggressively enforce patent rights against competitors. For example, recently Nortel Networks Corporation, a US company which was being liquidated, sold its patent portfolio for about US 4.5 billion to multiple technology giants such as Apple, Microsoft, Sony, Research in Motion (RIM), etc. Apple itself acquired over a thousand patents. (See here) In such situations, there is always a risk that a particular company (e.g. Apple) could acquire the entire patent portfolio of the seller (Nortel in this case) and start suing its competitors for infringement across the globe, thus triggering a patent war. Therefore, companies have the objective of acquiring patents which are associated with the field they are operating in, to minimize risk of such litigation. # Licensing and franchising Licensing, franchising, assignment and technology transfer agreements are some of the most common kinds of agreements for commercializing IPRs – the IP creator typically gets a royalty or license fees for such arrangements. It is critical for an entrepreneur to know the key concepts surrounding licensing and franchising agreements – these are often under-negotiated. Lawyers and consultants also have the opportunity to add value at an earlier stage by handholding an uninitiated businessman through the concepts and helping him through the negotiation process. What kinds of IPRs can be exploited through licensing and franchising? Licensing and franchising can be used to commercially exploit all kinds of intellectual property – such as copyrights, trademarks, patents, proprietary know-how, trade secrets and confidential information. This write-up will explain the key clauses in licensing and franchising agreements and get you initiated on the concerns you should keep in mind during negotiation and drafting of such agreements. Most of the clauses discussed in this write-up are common to both licensing and franchising agreements. Whenever a clause or mechanism which is specific to a franchising arrangement only, it has been is specifically indicated. The terms ‘licensor’ and ‘licensee’ also include a franchisor or franchisee in case of a franchisee agreement 1. Recitals Recitals usually are 1-2 line phrases beginning with the word 'Whereas'. For example, a recital could state as follows - Whereas the licensor is the creator and owner of various patents pertaining to wireless communications technology; Whereas the licensee is a manufacturer of 2G and 3G handsets; Whereas the Parties have decided to enter into a licensing arrangement permitting the licensee to utilize patented technologies and brand name of the licensor for manufacturing handsets on the terms mentioned in this agreement. The recitals do not discuss the legal obligations of the parties, but explain the background and circumstances within parties have decided to execute the agreement. Sometimes, businessmen and parties ignore recitals, but it is a good idea to describe them in some level of detail as this will help a court (or arbitral tribunal) in understanding the agreement in its true light in the event of a dispute and it will also bring to light the commercial intent of the parties. It will prevent a party from taking a contrary or inconsistent stance from what has been mentioned in the recitals. 2. Definition Clause ​Every agreement has a ‘definitions’ clause so that key terms used in it can have a specific and determinate meaning which is accepted by both parties. In a licensing or franchising agreement, it is essential to define key terms, such as the following:  Term Definition “Licensed Product or Services”, “Licensed IP” These terms explain the exact scope of the licensed intellectual property rights and the products or services for which the IP has been licensed. “Net/ Gross Revenue” Defines the revenue (some costs may be deducted from the revenue depending on the agreement of the parties). It is extremely important if royalty is based on the revenue. “Territory” Explains the territory over which the licensee can commercially exploit the license. “New IP” Usually seen in agreements where it is contemplated that the licensee may generate new intellectual property. This could be by way of improvements or local additions – it is extremely common in joint venture agreements. The clause helps in defining the ownership and the manner of exploitation of such intellectual property rights. “License” This clause defines the nature and purpose of the license, for example, whether it is exclusive or non-exclusive. Any other characteristics of the license can be included here. Other important terms should also be defined depending on the circumstances and the nature of the contract. 3. Subject matter of the license ​The subject matter over which the license is granted must be clearly identified to prevent confusion later. How should an entrepreneur identify the scope of the license or franchise? There is a simple two-step process for it: • First, decide the subject matter that is being licensed. Is it a simply a brand name, or a character, a food product, or a method? If it’s a fast food product or any other consumer product, are you also selling an experience along with the product? • Second, identify the intellectual property that comprises the subject matter. Is it merely a trademark, is there any other information related to process, design, formulae, information related to appearance (e.g. the appearance of a Subway store or a McDonalds outlet), etc. i) Types of licenses There are various types of licenses, such as an exclusive license, a sole license and a non-exclusive license. An exclusive license prevents everyone (including the licensor itself) from using the intellectual property. A sole license excludes the licensor from licensing the IPRs to any other entity. Note – a sole license and exclusive license can attract competition law requirements. However, the licensor itself can continue to use the IPRs in case of a sole license. A non-exclusive license, in that sense is the least restrictive and the licensor can issue as many non-exclusive licenses as required. While this is the sense in which the terms are used, it is prudent to also clearly specify the precise extent of the licensor and the licensee’s powers. Is an exclusive license preferable to a non-exclusive license? It will always be in the licensee’s interest to negotiate an exclusive or sole license. However, for the licensor, it limits his ability to receive royalties to one source. If the licensee has not previously demonstrated any capability to sell the product, an exclusive or sole license may be a losing proposition for the licensor, as the creator of the IPRs. It is justifiable if the licensee has an extremely strong sales or distribution network, and if, in the opinion of the licensor, providing an exclusive/ sole license will lead to larger aggregate sales (even through a single licensee) as compared to providing a non-exclusive license to multiple licensees. ii) Types of franchising arrangements A franchising agreement could be of various types - ‘business format’ franchising requires a franchisee to follow strict guidelines and operational standards on the development of the product development and marketing. For example – a franchisee of Pantaloons, Walmart, or Carrefour would be considered a business format franchisee. Product franchising involves the franchisee concentrating on one manufacturer’s products, which results in his acquiring the manufacturer’s identity to some extent, in the perception of a customer. For example, consider an ‘Adidas’ or a ‘Dominos’ franchise – the legal owner of the store will not be the American holding company of Dominos (Dominos is brought to India by a listed company called Jubilant Foods) or Adidas, but the customer will perceive the store to be an extension of the parent company itself. In a ‘character merchandising’ franchise, a right which allows the franchisee to manufacture or market products in the name of a famous sports personality, an actor or a fictitious entity, e.g. Britney Spears could grant a franchisee to release a line of perfumes in her own name. Protection of reputation of the personality is one of the key concerns in such an agreement. Any Superman or Batman toys would be examples of character merchandise of a fictitious character. Although legal treatment of franchising agreement does not differ based on their classification, segregating them into different categories helps in understanding the commercial interest behind the transaction. 4. Scope of the license The scope of the license, that is, whether the license is only for use of the brand name, whether it includes the right to manufacture the licensed product, or the right to further develop and improvise the product, should be specified. 5. Restrictions on the licensor/ licensee The grant of the license is coupled with certain restrictions on the licensor and the licensee to protect their business interests. For example, the licensee may be prevented from selling a competitor’s products. Similarly, the licensor may be prevented from providing the license to another licensee within a defined area. For example, a licensor may not be permitted to license any other entity within 3 kilometres of the business of the licensee. There may be a non-compete restriction on the licensor as well – he may not be allowed to directly sell the product within the identified area. The agreement must specify whether the licensee is permitted to grant a sub-license to another entity or whether he must engage in the promotion/ sale of the product himself. Non-compete restrictions should be limited and reasonable, as otherwise they may be violative of the Indian Contract Act, 1872 (prohibiting unreasonable restraints on trade or business) and hence unenforceable in a court. They may also require a Competition Act scrutiny if the restrictions are unfair or anti-competitive. 6. Newly created IP or improvements A licensed product may be improved by the licensee, either on its own or jointly with the licensor. The licensee may also create local variants of the product (if the license agreement permits it to introduce any variations or modifications). Therefore, the agreement must specify whether the licensee has the authority to introduce modifications/ improvements, whether it is required to follow any procedure for initiating such improvements. It should specify who owns the IPRs pertaining to the modified product. More importantly, the procedure for commercial management of the IPR must be clearly specified. Merely specifying that the commercial exploitation of the new IPRs may be as the parties mutually agree may not be sufficient for the purpose. Such a clause may work till the license agreement is valid and the commercial relationship is strong, but a formal procedure may be required to prevent deadlocks in the event that their relationship is strained or in a situation where their commercial interests are no longer aligned. This is important because the value of the new IPR may be greater than that of the originally licensed IPRs. 7. Risk allocation measures – indemnity and limitation on liability A license agreement allocates the risk of certain contingencies, which arise out of the following questions: Who will be liable a defective product (provided by the licensor) is sold by the licensee? Liability from a defective product can be huge, especially if, say, it causes an explosion, or turns out to be harmful for health, etc. What happens if there is a defect in the ownership of licensor over the IPRs? What will happen if the licensee is sued by a third party who claims that the licensee has violated his IPRs by selling the licensed product? Which of the parties assumes the risk in such events? Is there a limit on the liability of the parties in such cases? a. Commercial interest and risk allocation Risk allocation will depend on the nature of IPR and the kind of license that is granted in relation to them. For example, if an entity which owns the patent to a pharmaceutical compound grants a license to develop, manufacture and sell a drug using his compound, it will not like to take the risk for the effects of the product (since it would have been eventually developed by the licensee). However, the licensee may rely on the fact that the compound has been tested and is safe, and therefore wish the risk is on the licensor. If a trademark licensee receives products from the licensor which he is required to sell as per the license agreement, he may require an indemnity from the licensor . If, however, the licensor has also granted the right to manufacture the licensed product, the licensor may seek an indemnity from the licensee for any claims in respect of products sold by the licensee. Usually, such risks are allocated through a ‘representations and warranties’ clause, which is backed by an ‘indemnity clause’. As per the indemnity clause, a party agrees to indemnify the other in case any of the representations or warranties are breached, e.g. if a product liability claim has surfaced. Risk of a defective title in the IPR or of the IPRs infringe a third party’s rights may be placed on the licensor, since he is in a better position to determine about the ownership of the rights. Nevertheless, before entering into the transaction, it is prudent (although not legally required) for a licensee to conduct a preliminary diligence to determine whether the licensor has developed the licensed IPRs. Note: An indemnity will only cover losses and will not permit the licensor to recover any profits or a rate of return. b. Limitation of liability clauses The licensor or licensee (as the case may be) may want to limit liability to a pre-determined cap. What happens in the absence of such a clause? Consider a case where there is no limitation on the liability of a licensor – large claims for indemnity from a licensee could potentially put the licensor out of business. In many cases, third parties intentionally claim exorbitant amounts (hence the indemnity claimed by the licensee will be of a correspondingly high amount) and even though a court may eventually refuse the claim, the initiation of such proceedings can itself cause significant harm to the market positioning and reputation of a business. Therefore, having a clause limiting liability of the licensor / licensee to a finite amount is a prudent idea. The liability cap can be specified as a function of the royalty (e.g. aggregate royalty paid in the last 12 months, etc.). The cap should not be too artificially low otherwise there can be a risk that it may not be upheld by a court. Some risks can also be mitigated by obtaining insurance, e.g. product liability insurance is an efficient way to reduce risk from product liability claims. Sometimes, one of the parties may also require the other party to obtain product liability insurance (up to a specified amount) in its own name. 8. Royalty Payments/ License Fees The agreement must specify the amount of royalty or a licence fee that is payable, manner and time of payment. A variety of payment models are possible, and parties can use any system that enables them to fully reap commercial benefits from the arrangement. For example, royalty can be paid as a lumpsum amount, or a percentage of revenues of the franchisee, a mix of a flat fee and a percentage of revenues or sales. There could also be a staggered fee structure, where the royalty is paid as per a predetermined slab – the rate of royalty will vary depending on the slab in which the sales lie. From the perspective of the licensor, this can incentivize the licensee to sell more units. There may also be stipulations on the franchisee to contribute fixed amounts towards advertising and promotional expenditure of the product. In international transactions, the responsibility of taking necessary regulatory approvals with respect to exchange control, or taxation must be allocated. The licensor/ franchisor may also want the right to conduct (because the royalties are based on the sales) inventory and accounts audits and require the franchisee to supply periodic reports and accounting statements relating to sales. Alternate means of royalty payments It is not necessary to pay royalty in cash or equivalents. Royalty payments can also be made in kind - sometimes, parties mutually license the right to use specific proprietary technology to each other without any cash payment at all. The cross license agreement provides each party the non-exclusive right to the other party’s technology at no charge (and no royalty). Sometimes, cross-licensing agreements may also feature consideration paid in cash (or cash equivalents) – e.g. the cross-licensing agreement between Apple and Microsoft in 1997 required a US 150 million cash infusion by Microsoft into Apple (Microsoft acquired limited shares of Apple in return).

Sometimes, parties set up a joint venture company owned jointly by them – necessary IP rights are licensed to this joint venture company by one or both of the parties, in return for equity shares of the joint venture company. Periodic royalties may also be paid depending on the sales of the joint venture company.  Many joint ventures in the automobile sector use the joint venture structure – e.g. consider Hero Honda, a joint venture between Honda Motors Limited (controlled by Japanese interests) and the Hero Group of India. Under the joint venture, Honda licensed technology to manufacture motorbikes to the Indian joint venture company. The joint venture relies on the marketing and distribution capabilities of the domestic Hero Group to sell the motorbikes.

9.
Timelines

The date from which the agreement comes into force, the period for which it is valid, the process by which it can be terminated, the mode and time of payment, etc. must be clearly specified.

10.
Assignment and change in control

What happens if the licensee sells his business to a competitor? What if there is a change in control of the licensee, or if it is acquired by a competitor?

Sale of the assets of the licensee to a competitor, or a change in the entity which controls the licensee may be against the commercial interest of the licensor – the licensor may want the opportunity to be intimated (and if it chooses, to terminate the license) in the event of such occurrences. Therefore, a clause that prohibits assignment without written permission of the licensor, or states that the agreement would be terminated in case of a change in control if permission of the licensor is not obtained, is usually inserted in license agreements.

If the licensee is depending on the special expertise of the licensor for the commercial utilization of the license, it may not agree to continuing the license in case the licensor assigns its rights under the agreement to another party, or if its control changes hands.

A licensee could insist that in the event a licensor is considering selling its IPRs, it must be offered the same first (called a right to first refusal or right to first offer, depending on the exact wording of the clause).

11.
General provisions

In addition to the above clauses, standard clauses relating to resolution of disputes by
arbitration, specification of the law of the country which governs the contract (if one of the parties is a foreigner), specifying which court has jurisdiction in case of disputes, provisions related to confidentiality, details for notices to each party, etc. must be specified.

In the event of disputes, a defaulting party often tries to argue that their commercial understanding was different from what is contained in the written agreement, or that it was modified after entering into the agreement – this can pose significant obstacles to dispute resolution and may prevent the innocent party from obtaining the desired relief. In order to prevent the defaulting party from taking this stand, it must be mentioned that the written license / franchising agreement captures the ‘entire commercial understanding’ of the parties, and that any subsequent variations can only be made if they are in writing and signed by both parties.

12.
Obligations specific to franchising agreements

Overview of responsibilities of licensor

In a franchising agreement, the franchisor (licensor) will have additional responsibilities as compared to an ordinary license – for example, he may be required to provide:

• detailed product and design specifications,
• support and assistance to the franchisee,
• an operations manual for the staff and officials of the franchisee,
• training to the key sales representatives or staff of the franchisee,
• assistance in obtaining regulatory or legal approvals for conducting the franchisee’s business,
• recommendations regarding advertising and promotional activities.

(The franchisee may have to pay some monetary consideration for training and support from the franchisor)
For example, for a franchise provided by a fast food chain, there will be specifications relating to the appearance of the restaurant, display of the name, procurement of ingredients for the food items, prices, appearance of the serving staff, etc.

Understanding ‘minimum commitments’ of franchisees

• Advertising, purchase or capital commitments: Often in franchising businesses, the franchisor may consider stipulating that the franchisee to contribute a minimum pre-determined amount towards advertising, or in certain industries they require minimum purchase commitments from the franchisee.
At the same time, the franchisee may incorporate a specific obligation of the franchisor to engage in regular promotion activities for the product (in the territory where the franchisee is responsible for marketing the product)
• Infrastructure and capital commitments: The franchisor usually specifies minimum size and infrastructure requirements of the premises and a minimum investment to be made by the franchisee. Franchisors in the restaurant industry (e.g., Subway or McDonalds) also require a minimum upfront capital contribution.
• Monitoring obligations: The franchisor may insist on the right to oversee the operation of the franchisee or depute a manager or supervisor to look into the activities of one or more franchisees, to monitor compliance with the franchising agreement.

A useful key to contract drafting – how do you draft a good contract?

A good contract is essentially one which covers all the possibilities that are likely to arise over the duration of the relationship and provides a clear course that will be taken in each situation. How should you anticipate the different possibilities that can arise? While it is not possible to cover all possibilities at the time of drafting or negotiating an agreement, you should try to ask the question “what if this were to happen?” with respect to the commercial relationship. Try to imagine as many logical possibilities, even if they appear unlikely under the current circumstances. That would give you pointers about which situations you should address in the agreement. You can then draft suitable clauses to address those situations. One should not rule out the possibility of uncertain or unintended events from taking place. Also, one should not presume that the other side will continue to be as cooperative as it currently is.