Collecting Royalties under a Patent License

by Mark Malek

Professor Dennis Crouch of Patently-O recently posted an article about the difficulties in collecting royalties pursuant to a patent licensing agreement.  In his post, Professor Crouch referenced a report by Invotex, which noted that 86% of licensees misreported their royalties to their licensor.  This, unfortunately, is not surprising, and is part of the reason why the process of entering into a patent (or any IP) licensing agreement can be so time consuming.

The Invotex report sets forth some of the very issues that a patent licensing attorney tries to avoid when entering into a licensing agreement on behalf of a client that is the licensor.  Often times, however, the negotiation process does not allow for the “tight” agreement that the licensor’s attorney wants.  Instead, licensing agreements can often be open to interpretation.

Some of the royalty reporting errors indicated in the Invotex report include questionable license interpretation, underreported sales, disallowed deductions, underreported sublicenses, and math errors.  There are, of course, ways to avoid these various debacles in the contracts.

The terms of the licensing agreement can vary so much, and should be approached in different ways depending on whether you are the licensee or licensor.  For example, if you are the licensor, i.e., you are licensing your IP to someone that is going to sell it and pay you some amount of money, you likely want that amount of money to be readily quantifiable.  Accordingly, your licensing agreement should seek out a definable number, i.e., $x per unit that is manufactured.  Of course, if you are the licensor, such a term can be unfavorable to you.  $x per unit that is manufactured guarantees that you will have to pay the licensor, regardless of whether or not you are able to sell a single unit.  A better option for a licensor may, for example, be $x per unit sold or, better yet, x% of gross sales or, even better yet, x% of net profit.

Now comes the various ways that the numbers can be fudged.  If you agree to an x% of net profit, how is the net profit calculated?  What if you licensed your product to a large company that sells many products?  Are the costs associated with other products to be factored into the cost associated with selling the product that you have licensed?  These, among many, many other questions, need to be answered before the licensing agreement is entered into.

Another term that I often like to consider is exclusivity.  If you are the licensee, you may want the licensing agreement to provide you with the exclusive right to the IP.  Of course, this can sometimes come with a bit higher price tag.  If you are to expect the licensor to put all of their IP eggs in one basket, then you should likely expect to pay more.  The converse may be true for the licensor.  The licensor must analyze whether or not it would be worth it to grant an exclusive license to the IP.

Mandatory minimums sometimes find their ways into licensing agreements.  These can be very beneficial to the licensor and, if the licensee can deliver on their promises, can be likewise beneficial.  Mandatory minimums can be calculated many different ways.  For example, the mandatory minimum may be tied to the number of products being manufactured, sold, delivered, etc.  The mandatory minimum may also be tied to sales, i.e., a minimum amount of gross sales.  Finally, the mandatory minimum may simply be tied to the royalties, i.e., a minimum royalty guarantee to the licensor.

To wrap it up, the one issue that is sure to destroy any licensing negotiation is reasonableness.  Whether you are the licensee or the licensor, it is really important to approach the negotiation from a reasonable perspective.  When negotiating a license for IP, it is assumed that both the licensee and the licensor see some sort of advantage of working together with one another.  If, however, either the licensee or the licensor are not reasonable in their expectations, then a license agreement might not ever come to fruition.  Worse yet, if the licensee and the licensor still manage to enter into a license agreement while either party is still advocating what may be considered an unreasonable position, then the licensing agreement may just end up in litigation.

The above is truly a very short list of the things that should be considered when entering into a licensing agreement.  There are so many other things that can and should be considered.  At the end of the day, the ultimate advice is to seek out the involvement of an attorney when entering into a licensing agreement.  When seeking out an attorney, please be sure to check into the attorney’s experience with licensing agreements.  These can be very specialized documents, and an attorney who does not have experience with licensing agreements might not be doing you any favors.