How to write license agreements to ensure monitoring and auditing is as simple as possible.
Solving the puzzle of royalty terms need not be complicated. Having a good understanding of the motivations of both parties in a royalty arrangement will help to get a deal where both parties begin seeing profit.
This was the topic of a seminar (“Licensing Compliance – Getting What You Negotiated – Pitfalls and Best Practices”) hosted recently by MATTO (Massachusetts Association of Technology Transfer Offices). This event was mainly attended by tech transfer professionals from Massachusetts-based academic institutions.
There was a focus on three clauses in licenses that tend to breed complications. Two clauses – concerning combination product and royalty stacking –are responsible for many “difficult-to-audit” agreements and a third clause – which refers to royalties paid by a sublicensee to the licensee on sales of licensed products — makes it difficult for universities to predict royalties from sales. The licensee and licensor generally take opposite sides on these clauses. To simplify things I will refer to the licensor as the “university” and licensee as the “company”. These three clauses are all changes from a straight royalty on sales of licensed product, i.e., sales times royalty rate = royalty.
Combination product language refers to a situation where the licensed product is sold as a combination – that is, at least some of the product’s value and therefore its sales price is due to a non-licensed product or item, An example is a drug (licensed product) sold pre-loaded in a syringe (non-licensed product). The company doesn’t want to pay the royalty on the sales price of the non-licensed part of the product. Combination product language is a solution often suggested by the company and agreed to by the university. There are lots of ways this can be handled. The most common is to multiply the sales price by something like A/(A+B); A being the price of the licensed product (the drug) and B being the price of the non-licensed portion (the syringe) when each is sold alone. This simple example works well, but what if the syringe is custom-made just for this drug and has no separate price B? There are lots of times where A and/or B (and C and D, as things get complicated) don’t have sales prices that are easily determined. In such cases having this type of combination product language in the agreement can lead to all kinds of difficulties, including litigation, to determine a fair royalty amount.
Royalty stacking occurs when a product is covered by IP held by more than one party. For example a medical device may require one license for the device itself and a second license for the software to run it. This situation would require separate royalties for each license. The company may argue that under such circumstances the royalties are too high for them to be competitive. Royalty stacking is one answer; both royalties are lowered as long as both licenses are required. There are lots of way this can be done too. Typically one royalty is lowered by 50% of the royalty paid to the other licensor, with some limit as to how much the royalty can be reduced.
Companies like combination product and royalty stacking clauses because they lower the royalties. Universities do not particularly like these clauses for the same reason. And, in addition to lowering royalties, combination product and royalty stacking can be erroneously calculated (not always by mistake) thus lowering the royalties the university receives by even more. Companies, too, have the added burden of accurately calculating the royalties, a task made difficult (and expensive) if lots of different products are being sold in different combinations and with different third-party licenses required.
The third issue discussed was how royalties on sales by a sublicensee are passed back to the university. There are two basic ways this is handled. The first, usually favored by the company, is that a fraction of all payments from the sublicensee to the company be paid to the university. For example 20% of all payments (with specific exceptions) from the sublicensee to the company will be paid to the university. The company likes this because it gives them flexibility in structuring the sublicense. The university usually accepts this type of payment but worries that royalties on sales by the sublicensees may be too low (the sublicense may not even have a sales royalty). Since royalties on sales usually constitute the bulk of any money coming back to the university, the university would prefer another approach, in which the sublicensee pays the same (or greater) royalties on sales as the company and the company passes back to the university the same royalty the company would have paid if it had made the sale directly.
So was there a consensus on how to handle these three changes from a straight royalty on sales? No — in licensing there is never a consensus because each license is distinctive, and every university and company is trying to accomplish something different with each deal (which is why I don’t usually believe in “express licenses” – a fashionable type of license that some universities are promoting). However, quite a few attendees said they would be willing, in some cases, to lower the royalty rate in exchange for dropping combination product and royalty stacking clauses and having a straight pass-through of the royalty on sales by the sublicensees. If 5% is the usual royalty rate asked by universities, some said that they would accept a straight 3% on sales by the company and sublicensees without any reductions due to combination product or royalty stacking clauses.
I think this solution may work for the company in many situations but not all. The big advantage is the simplicity of calculating royalties and performing audits and the certainty of the royalty stream coming back to the university from sublicensee sales.
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