Canada’s Intellectual Property Law Firm

Licensing basics: part 2

Show me the money (or some other kind of consideration). In exchange for granting a license to subject matter covered by IP rights, the Licensor will wish to be compensated in some form or another. Very often the compensation for the Licensor is provided in the form of cash. The payments can be structured in many different ways, such as an up-front payment and/or a payment spread out over part or all of the term of the license. The payment may be linked to the amount of the Licensee’s revenue or profit, or to the level of sales of licensed goods. For example, a royalty is often paid by the Licensee based on a percentage (usually, but not always in the range of about 1-10% of sales). The payments may escalate or decrease over time and/or depend upon the level of sales.

It is advantageous for the Licensor to have a compensation scheme where the amount owing can be readily ascertained and minimizes the prospect of disputes. For example, the Licensor can try to base a royalty upon the actual numbers of units made under the license (thus obviating prospects of licensed products being given away by the Licensee at less than fair market value) in exchange for other consideration being given to the Licensee. However, more often the royalty is based upon actual sales of licensed products (either volume of licensed products sold, or upon the revenue derived from such sales). Where the royalty is unit-based, the Licensor should try to avoid having to take into account any products that are “given away” or any “returns” or the like. This would just complicate the calculation.

If the payment to the Licensor is linked to the number or value of licensed products made or sold, the Licensor is often well advised to obtain protection in the form of performance clauses and/or minimum royalty provisions. Performance clauses may for example require the Licensee to sell a minimum amount of product in a given time period, otherwise be subjected to some kind of negative consequence, including possibly providing the Licensor with an option to terminate the license. Similarly, should the royalty payment in a given time period fail to reach a threshold, a minimum payment provision could be activated.

While not discussed in detail here, it is also important that the Licensor have adequate audit and reporting provisions, and that once the license has been executed, that the Licensor utilize these provisions to monitor the compliance of the Licensee. Licensees, however well intentioned, can make mistakes in their counting!

To further encourage Licensee compliance with payment obligations, the license might also provide for additional compensation to be paid to the Licensor if the Licensee does make a “mistake”, particularly if it’s a big mistake!

In addition to payments of money, the Licensor may also or alternatively seek non-monetary compensation. The available types of non-monetary compensation are limitless, and may be broadly considered as anything that has value to the Licensor. Some typical examples of non-monetary compensation include a license-back from the Licensee to Licensee’s IP rights. It should be noted that when licensing his own IP rights to a Licensee, a Licensor may be able to secure his own license to a Licensee’s IP rights on relatively favorable terms. Particularly if the Licensor is intending to operate in competition with the Licensee, a failure to secure rights to Licensee’s present and future IP rights, may leave the Licensor at a significant disadvantage in the marketplace.