Top 11½ Mistakes in License Agreements. Top 11½ Mistakes in License Agreements. Introduction. Explanation of Title. 10. Not Conducting Due Diligence

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1 If If it it is is the the latter, latter, then then you you should should know know that that I I am am always always joking joking when when I I talk talk on on the the phone. phone. Adam Petravicius Jenner & Block LES Annual Meeting September 24, 2003 Introduction Speaker Background Format of Presentation Questions and Comments Anytime Please Hold Applause Until End Explanation of Title NEW AND IMPROVED TOP 10 LIST 15% MORE content for the SAME PRICE!!! Regular Top 10 list PLUS 3 BONUS ISSUES! * (each bonus issue is valued at ½ point to give you even more content!!!) *Bonus issues are not actual bonuses or issues, but are instead topics that I wanted to work into this speech. * If If you you can can read read this, this, you you either either have have very very good good eyesight eyesight or or you you have have access access to to special special surveillance surveillance equipment. equipment. Not Conducting Due Diligence Parties frequently enter into major license agreements without conducting any due diligence License terms will probably not cover risk Warranty disclaimers Exclusion of consequential damages Limitation of liability Insufficient resources Conduct reasonable due diligence Business Legal Due Diligence Issues Legal Ownership and license rights Scope and sufficiency Validity and enforceability Third-party claims Business Value Reputation Capability 1

2 Ignoring Legal Framework Licenses are governed by general rules of contract law 9. Ignoring Legal Framework However, there are additional legal rules that are specific to licenses Ignore these rules at your peril! Examples Antitrust No safe harbor for intellectual property Potential for big stakes (e.g.( e.g.,, Microsoft) Reference materials: > ABA IP Newsletter Summer 2003 > DOJ and FTC Antitrust Guidelines for Licensing Intellectual Property Misuse Can affect ability to enforce intellectual property Recent cases: > Scheiber v. Dolby Lab., Inc. > Bayer AG v. Housey Pharmaceuticals, Inc. 8. Creating Terminal Confusion 9. Ignoring Legal Framework Creating Terminal Confusion License agreements often have unclear or inadequate term and termination provisions In many cases, license terms are contradictory For example, licenses are often characterized as perpetual or irrevocable But these licenses often contain language that all license grants s will automatically terminate upon expiration or termination of the agreement Clearly spell out: Term of license Events triggering termination Effect of termination (survival) Issues to Consider Term Expressly define terms like perpetual or irrevocable Termination Triggers Consider using express negative covenant > Otherwise improper use of IP by licensee may not be breach Do not rely on bankruptcy as a termination trigger Effect of Termination Expressly address existing rights and obligations > Use non-specific survival clauses carefully Consider need for new rights or obligations (e.g.( e.g.,, return of confidential information) 2

3 Survival Checklist License grant Sublicenses Key restrictions (e.g.( e.g., reverse engineering) Royalties Records Audit rights Confidentiality Warranties and disclaimers Limitations of liability Indemnification Dispute resolution procedures Choice of law Transition rights Time limit on claims 7. Exposing Secrets 8. Creating Terminal Confusion 9. Ignoring Legal Framework Exposing Secrets Key Contract Issues License agreements often involve an exchange of trade secrets or confidential information, even if it is not the primary purpose of the agreement Yet license agreements often omit or contain inadequate provisions regarding confidentiality Even more importantly, parties often rely solely on contract rights to protect their information and fail to take other essential steps Once information is disclosed, its value may be destroyed forever Internet makes widespread disclosure fast and easy Contract remedies may be limited Protected information Marking requirement Oral or visual information Method of disclosure Use restrictions Access restrictions Required protection Be careful about relying only on reasonable efforts or same degree of protection language Consider including specific requirements Other Essential Steps Selective disclosure Proper marking Access and copy controls Documentation Return and destruction procedures Employee training Technology solutions 6. Gambling on Liability 7. Exposing Secrets 8. Creating Terminal Confusion 9. Ignoring Legal Framework 3

4 Gambling on Liability Liability issues are often not considered carefully Yet intellectual property claims can create significant liabilities And improper use of intellectual property rights can lead to substantial losses Pay careful attention to liability provisions and make sure that they are tailored to the deal Liability Provisions Warranties and disclaimers Exclusive remedies Failure of essential purpose Limitation of liability Exceptions Exclusion of consequential damages Exceptions Indemnities Insurance Dispute resolution procedures Entire agreement Special Considerations Limit ability to bring claims outside of contract Structure warranties to avoid fraud claims Include strong entire agreement provision Use broad arising under or relating to language in liability provisions Balance liability exposure against need for meaningful remedies In many claims involving IP, direct damages may be small while consequential damages are large Review exceptions carefully Special Considerations Review scope of indemnity claims carefully Watch out for indemnity short circuit > Limit indemnities to third-party claims > Be careful when using general breach of agreement as standard for indemnification Allocate risk based upon deal economics, not based upon theoretical fairness > Tie risks to rewards Legal Issues versus Business Issues BONUS ISSUE #1 Avoid making artificial distinctions between legal issues and business issues All legal issues have business implications All business issues have legal implications Creating these distinctions may lead to poor communication and decision-making All relevant players should understand the deal and review entire license 4

5 Not Watching the Money Disagreements regarding royalties are another significant source of disputes Although parties spend significant time discussing royalties, their discussions are often poorly documented Read the royalty provisions again, again and again! Make your lawyers be anal Royalty Provisions Amount Fixed amount Unit amount Percentage amount Minimum amount Sliding scales Timing and risk of non-payment Reporting Make reporting a meaningful enforcement tool Record keeping and audit rights Use them Royalty stacking Getting 100% of the Percent Carefully define the base amount Affiliate sales Bundling Discounting Components Consider using minimum royalty amounts If using net sales, specify exactly what can be subtracted from gross sales Adjust the math for sublicenses Example of Bad Math Sales by Licensee: Unit price = $100 Royalty = 3% Margin = 10% Sales by Sublicensee: Unit price = $100 Royalty = 8% $ (sale price) = (gross profit) (licensor royalty) = 7.00 (net profit) $ (sale price) = 8.00 (licensee royalty) (licensor royalty) = 7.76 (net profit) 4. Missing the Next Next Thing 5

6 Missing the Next Next Thing Licenses often fail to address improvements or address them inadequately Licensees may find themselves stuck with old technology (or other IP) while licensors may find themselves giving away more than they intended Carefully address possibility of improvements by either licensor or licensee Also consider this issue during due diligence Improvement Terms Define what is meant by an improvement Not limited to literal improvements Consider substitutes or next generation technology Specify what rights, if any, exist in improvements Consider requiring additional consideration Be wary of rigid terms that lock in a party Also be wary of moving forward too quickly Especially software 3. Forgetting about Practicalities 4. Missing the Next Next Thing Forgetting about Practicalities Many license agreements fail to address the mechanics of the deal Or if the mechanics are addressed, they are often impractical Understand how the key elements of the deal will be implemented and document them as appropriate Stating the obvious in an agreement is easier than fighting later about what is obvious Examples Consider where IP resides and how it will be transferred Trade secrets and know-how Software and other media Consider whether additional information or materials are needed to take full advantage of the licensed IP For patents, access to know-how and detailed specs For software, access to proprietary software tools For copyrights, a master copy in appropriate form Impractical Solutions in Software Licenses Escrow arrangements are often implemented in ways that fail to achieve their purpose Trigger events Timing Learning curve Late discovery of problems Acceptance criteria are often missing or ill-defined Objective versus subjective Closed versus open-ended ended 6

7 Battle of the Forms BONUS ISSUE #2 External battle mine versus yours There is a real advantage to controlling the document Consider drafting quality more than substantive terms > It is easier to correct the substantive terms Read the other party s form very carefully, especially if the other party is a repeat player Internal battle Distinguish between forms and precedent > Precedent often consists of negotiated agreements Always tailor form to deal 2. Poorly Defining Scope of License 3. Forgetting about Practicalities 4. Missing the Next Next Thing Poorly Defining Scope of License The scope of a license is often unclear The overused and very tired comma Significant license disputes often result from disagreement regarding scope of license Read license grant again, again and again! Look for holes Let your lawyers be anal Focus Areas Licensed IP List versus category Current versus future Rights granted Exclusive versus non-exclusive Fields of use Third-party access Sublicenses Affiliates Contractors and vendors Drafting Considerations Make effective use of defined terms Avoid lumping together different forms of IP Reference statutory or legal rights Avoid contradictory terms (e.g. e.g.,, sole and exclusive ) Consider supplemental or explanatory provisions (e.g. e.g.,, carve-outs or express examples) 7

8 The Words We Use BONUS ISSUE #3 Many disputes result from poorly-drafted agreements Vague or ambiguous language Lack of detail Parties often unaware of potential dispute until it is too late Often easier to resolve dispute up-front When drafting or negotiating: Identify and test key assumptions Read language critically Be aware of filtering Lack of Detail / False Assumption Contract to ship goods on the ship named Peerless But there were TWO ships named Peerless Each party had a different ship in mind The ships left port on a different date, leading to a dispute 1. Failing to Address Future Business Changes 2. Poorly Defining Scope of License 3. Forgetting about Practicalities 4. Missing the Next Next Thing Failing to Address Future Business Changes Licenses often have very long duration Perpetual Life of patent Yet many licenses contain terms that are static and do not address potential changes in business environment Consider how changes can affect fundamental deal points and include terms to address changes Express terms Mechanism or procedures Examples Changes in technology Business downturns Acquisitions and divestitures Market decline Improvements Substitutes 8

9 Adam Petravicius Jenner & Block One IBM Plaza Chicago, IL (312)