Pre–Licensing Due Diligence In Patent Licensing: Mitigating Legal And Commercial Risks

Introduction : Once a person, entity, or institution owns a patent, the patentee has the exclusive rights under Section 48 of the Patents Act, 1970, for a period of 20 years from the date of filing of the patent application, as provided under Section 53 of the Act. Licensing is one of the most commonly used methods by patentees to commercialise their inventions and bring them to the market while retaining ownership of the invention.

A licence is a legal agreement by which the owner of an invention (the licensor) grants rights to the licensee to make, use, and/or sell the invention within the framework of the licence agreement. It is to be noted that the terms and conditions of the licensing agreement govern the relationship between the parties, irrespective of the name or title of the document, whether it is called a licensing agreement, assignment agreement, or co-ownership agreement. Section 68 of the Patents Act, 1970, expressly mandates that an assignment of a patent or a share in a patent, a mortgage, licence, or the creation of any other interest in a patent shall not be valid unless the agreement is in writing and reduced to the form of a document embodying all the terms and conditions governing the rights and obligations of the parties.

In this context, drafting an agreement that accurately conveys the intention of the parties entering into the agreement is paramount to preventing disputes between the parties and the subsequent litigation costs associated with them.

Due diligence is a necessary first step before embarking on any kind of business transaction and is particularly important when considering entering into a long-term business relationship such as a license agreement. Such an exercise is the process of gathering as much information as possible on the potential licensor or licensee, the technology and other similar technologies available in the market or being developed, the market, the legal and business environment (local or international, as the case may be) and any other information that would enable the potential licensor or licensee to be better informed. This article provides an insight into patent licensing due diligence and discusses what counsel for a licensee should verify before entering into the licence agreement.

Essential due diligence considerations governing the parties' IP interests

The key clauses which are indispensable in a patent licensing agreement and should necessarily be elucidated to confirm the intention of the parties are:

Ownership of IP Clause: This is a primordial clause of the agreement, and it unequivocally states that the agreement merely grants the right to use the IP but does not transfer the ownership of the IP, thus retaining the proprietary rights over the IP. It clarifies whether the licensor intends to be the sole owner or whether both the licensor and the licensee share ownership, i.e., whether they are entering into a joint ownership agreement. It also conveys the intention of the parties regarding who shall own the IP in relation to any future developments or modifications made to the patent.

Since the primary purpose of this clause is to clarify who shall be the owner of the IP, it also has implications for determining which party has the right to file an infringement suit and the maintainability of such a suit concerning third-party infringement.

Scope Clause: This clause is intended to determine the boundaries of the permitted purpose of the licence, including the field of use, i.e., the licensor’s right to restrict the use of the patent in a particular domain; the geographical area within which the licensee is permitted to use within the permitted purpose, manufacture, or sell the invention; whether the licensee is permitted to further license the patent, i.e., sublicensing; and the boundaries or the terms and conditions governing the use of the patent.

Maintenance Status Clause: This clause clarifies the obligation as to which of the parties shall pay the maintenance fees. As it is known that if the periodic maintenance fees are not paid within the mandated period, the patent lapses, i.e., it will no longer be protected by the respective patent office and will enter the public domain. Failure to pay these fees in accordance with the agreement may result in a breach of contract and the payment of damages thereunder.

Encumbrances Clause: This is one of the most important clauses that a licensee should accentuate, to ensure that there are no encumbrances or impediments involved that may affect the enforcement of the licensing agreement. The essential encumbrance check involves ensuring that:

• The patent is free from any third-party claims and legal burdens.
• The patent has not been previously exclusively licensed, as the licensing rights may already have been granted to another party.
• The patent has not been pledged or mortgaged as security for a loan; if yes, the necessary provisions to be incorporated considering the legal implications.
• The patent is not jointly owned with another company, as the licensing rights cannot be enforced without obtaining the prior consent of the co-owner.
• No court or authority order has been passed restraining the enforcement of the licensing rights.

Confidentiality clause: As it is insufficient to enter into negotiations solely based on trust, particularly when there is no certainty that such negotiations will ultimately culminate in a licensing agreement, it becomes incumbent upon the parties to execute a mutual non-disclosure agreement before commencing substantive licensing discussions. Even where negotiations are successful, and before entering into the licensing agreement, it remains inherently important, given the nature of intellectual property rights, to clearly define what constitutes "confidential information." Such a definition should preferably encompass not only information expressly disclosed to the recipient but also any information that the recipient receives or becomes aware of as a consequence of the negotiations or the agreement. The agreement should further restrict the use of such information solely to the purposes specified therein and provide adequate safeguards against its unauthorised disclosure. It should also clearly specify the survival of these confidentiality obligations following the termination or expiry of the agreement and prescribe whether, and within what timeframe, the confidential information must be returned or permanently destroyed.

Governing Law and Dispute Resolution Clause: This is one of the most vital clauses, as it clarifies the governing law applicable to the agreement in cases where the parties belong to different jurisdictions and the preferred mode of dispute resolution. It also specifies the place and mode of dispute resolution, such as arbitration, if chosen by the parties. In the absence of such a clause, a considerable amount of time may be spent determining the applicable law and jurisdiction before the dispute is adjudicated, thereby causing unnecessary delay and expense.

Essential contractual clauses protecting the commercial interest of the parties

Indemnity Clause: The primary purpose of this clause is to act as a deterrent against the breach of the terms of the licensing agreement, i.e., a breach of contract by either of the parties. This clause covers the damages to be paid for such breach, along with the reasonable payment of settlement amounts and attorney's fees. It is also preferable to have a temporary injunction and specific performance clause under this section, as compensation in the form of damages alone might be inadequate, and it is important to restrain the violating party from continuing its act of violation. Moreover, it might not be easy to obtain a temporary injunction in the absence of such a clause in the agreement, as courts apply a higher balance-of-conveniences test and require the plaintiff to show that irreparable harm would result if such an order is not granted. Considering this burden, it is always preferable to incorporate a clause enabling the parties to seek a temporary injunction, along with damages for breach, reasonable settlement amounts, and attorneys' fees.

Warranties Clause: This clause is incorporated to affirm that the facts asserted or stated by the licensor, such as ownership, encumbrances, and other relevant aspects, are true. This clause imposes an obligation on the licensor to compensate the licensee for the damages suffered due to such erroneous statements of fact. By incorporating this clause, the licensee can seek damages for breach of warranty and enforce indemnification, where provided under the agreement.

Audit Rights Clause: Generally, in a patent licence, the royalty to be paid to the licensor is calculated as a percentage of sales or revenue. The licensing agreement may incorporate an audit rights clause to inspect the books and records, upon the requisite notice, to ensure that royalties are not underpaid due to underreporting. This clause also serves the additional purpose of ensuring that the licensee is carrying out its activities in strict adherence to the licensing agreement.

Practical due diligence checklist for startup commercialisation

Start-ups often operate to bring innovation to market. Similarly, a patentee enters into a licensing agreement to bring the invention to market, thereby fostering collaboration between the patentee and a start-up. It is to be remembered that, since start-ups are burgeoning or new entrants to the market, they rely on external funding. In this regard, it becomes of utmost importance to instill confidence in investors regarding the successful commercialisation of the invention. Considering this, along with ensuring clarity concerning the above-mentioned clauses, the essential practical due diligence checks that a start-up should undertake before entering into a patent licensing agreement are:

1. To reiterate, ensure ownership of the technology by verifying whether the patent is proprietary and whether all statutory and procedural requirements have been complied with to ensure its protection and commercialisation in the relevant market. In the case of cross-border patents, ascertain whether the patent continues to remain valid and enforceable in the country where the start-up intends to bring the invention to market.
2. To reiterate, ascertain whether any third-party rights or encumbrances that affect enforcement of the licensing agreement.
3. Analyse the valuation of the technology by determining whether the technology serves to reduce costs, improve performance, or provide any other identifiable commercial benefit.
4. Conduct a Freedom to Operate (FTO) analysis to ensure that the product does not infringe any third-party intellectual property rights in the practical application of bringing the innovation to market.
5. Analyse the commercial viability of the licensed product by determining whether the anticipated revenue from commercialisation is sufficient to recover the costs of licensing, manufacturing, regulatory compliance, marketing, and other associated expenses while generating a reasonable profit.
6. Before negotiating a patent licence, evaluate the availability and cost of alternative technologies. This enables the start-up to determine the commercial value of the licensed technology and provides leverage during negotiations relating to royalties and other commercial terms.
7. Analyse the amount of income that the new technology is likely to generate.
8. Consider the intrinsic quality of the technology, including its significance and stage of development; the protection afforded by the patent, including its scope and enforceability; market considerations, including market size and share; competitive considerations, including third-party competition; licensee values, including capital, research, and marketing capabilities; financial considerations, including profit margins, costs of enforcement, and warranty services; risk factors, including product liability and patent litigation; legal considerations, including the duration of the licence rights; and governmental considerations, including local laws governing royalty terms and currency movement.
9. Assess the commercial relationship between the licensor and the licensee, including whether they are competitors operating in the same territory and line of business or whether they stand in the relationship of an inventor and promoter. Consider also the effect of selling the patented product in promoting the sale of other products of the licensee and the extent of such derivative or convoyed sales.
10. Consider the established profitability of the product made under the patent, its commercial success, current popularity, and the utility and advantages of the patented invention over existing technologies or devices used for achieving similar results.
11. Consider the nature of the patented invention, the character of its commercial embodiment as owned and produced by the licensor, and the benefits derived by those who have used the invention.
12. Determine whether the commercialisation of the patented invention requires the execution of ancillary intellectual property agreements, such as a trademark licence where the start-up is granted the right to use the trademark along with the patented invention, or agreements relating to technology know-how, trade secrets, or other proprietary rights necessary for the effective commercialisation of the invention.
13. Where necessary, obtain the opinion of qualified experts regarding the technical, commercial, or financial aspects of the proposed licensing transaction.
    

Conclusion

Although this article attempts to discuss certain fundamental concepts underlying a patent licensing agreement, the essential clauses that ought to be incorporated, and the due diligence checks that should be undertaken before entering into such an agreement, it must be noted that these are neither exhaustive nor capable of uniform application in every licensing transaction. The nature of the patented invention, the relevant market, the commercial objectives of the parties, and the terms of the proposed agreement may give rise to additional considerations during the course of negotiations. Such considerations should be taken into account with the ultimate objective of ensuring that the licensing arrangement is best suited to the commercial requirements and business plans of the parties.

In this context, it is recommended to identify all possible legal and commercial issues at the negotiation stage by taking the assistance of legal professionals on intellectual property aspects and financial and commercial advisers on the commercial viability of the transaction. The issues so identified and mutually settled should then be carefully incorporated into the licensing agreement. A patent licensing agreement, therefore, ought to be drafted with the utmost care and circumspection to minimise the possibility of future disputes and ensure the effective commercial exploitation of the patented invention for the mutual benefit of the parties.

Author :- Harini Srinivasan, in case of any query, contact us at Global Patent Filing or write back us via email at support@globalpatentfiling.com.