Licensing Patents and Trade Secrets

Jun 2000 – Article
Presented at the American Conference Institute's Licensing Intellectual Property Conference, Chicago, Illinois June 5-7, 2000

James D. Hamilton, Esq. *

William E. Beaumont, Esq. **

Opinions expressed in this article are solely those of the authors and are not attributable to Oblon, Spivak, McClelland, Maier & Neustadt, P.C.

CONTENTS

§1.01 Determining What Rights Are Licensable

[1] When to Consider Licensing Patent Rights

[2] When to Consider Licensing Trade Secrets

[3] When to Consider Licensing Both

§1.02 Types of Licenses

[1] Exclusive, Nonexclusive and Other Variations

[2] License vs. Assignment

§1.03 Determining Compensation

§1.04 What Rights Should the Licensor Retain?

 

§1.05 Transferability of Rights

§1.06 Warranties and Indemnification

 

§1.07 Term and Termination

§1.08 Confidentiality and the Preservation of Confidentiality

§1.09 Arbitration Provisions

§1.10 Special Considerations in Licensing Pharmaceutical and Biotechnological Innovations

[1] Defining What is to be Licensed: Supplementing §1.01

[2] Confidentiality: Supplementing §1.08

[3] Determining the Value of Pharmaceutical and Biotechnological Innovations

[4] Existing Versus To-Be-Developed Technology

[5] Bankruptcy

§1.01 Determining What Rights Are Licensable

A determination of what intellectual property rights can and should be licensed requires an initial recognition as to what rights are protectable as patents and what information, if not patentable, qualifies as a trade secret. A patent is a limited monopoly granted by the United States government for an invention and is granted for a limited period of time as permitted under Article 1 of the United States Constitution[1]. Patents comprise a legal monopoly granted to the inventor, licensee or assignee of the invention and includes a limited legal right to exclude others from making, using or selling that which has been patented for the duration of a patent. Patents are only granted after an examination of a patent application and a comparison of the same with already existing prior art. Statutory bars to patentability can occur, however, and may arise from specified events wherein the invention has been dedicated to the public. For example, the public use or sale of an invention in the United States is a bar if such takes place more than one year prior to the date of the application for a patent in the United States.[2]

[1] When to Consider Licensing Patent Rights

Licensing an invention requires the initial steps of evaluating the patent or patents to be licensed including determining the validity and scope of such patents and determining the potential value of the patents to be licensed. Once these steps have been completed, it is then possible to implement the strategy selected by adopting an appropriate business plan or revenue model, ranging from a simple nonexclusive license agreement to a much more complicated joint venture. Once that procedure has been followed, it is possible to determine the specific type of license to be granted, be it exclusive or nonexclusive, a simple paid-up license, a right-to-use agreement and a determination as to whether a technology research and development agreement is needed in consideration of improvements to the patented technology that may later be developed by the licensor or licensee.

An evaluation of the patent requires a thorough review of the same to determine what systems, methods or products the patent covers and to determine whether industry has already adopted the technology covered by the patent or could use the patented technology to develop and commercialize new products or services. Once this step has been concluded, it can result in a list of potentially valuable patents which will be helpful in identifying those companies which have potential use of the patented technology.

Assessing the validity and scope of the patents to be licensed is the next logical step and is of great importance insofar as it permits an early determination as to whether the project of licensing the patent is likely worth pursuing on the basis of the strength of the patent and the likelihood that, if asserted against others, the validity thereof could be successfully defended. Once this step has been completed, one can then proceed with attempting to identify potentially infringers of the patent.

A useful tool in accomplishing this is for a licensor to monitor the issuance of subsequent patents and to particularly note if any of such issued patent cites the licensor's patent in the list of references published on the title page of each patent, as shown below:

It is for this reason that in-house counsel or their outside counsel and consultants should conduct timely checks of the records of the U.S. Patent Office. This can now be by on-line searching of issued patents at the Web site of the U.S. Patent Office at http://www.uspto.gov/web/menu/pats.html . A close analysis of subsequently issued patents helps identify those companies who might have developed and patented improvements over the earlier issued patent of a licensor and which, upon closer review, may actually reveal the need for a license from the licensor to use the improved technology described or claimed in the subsequently patented improvements. Insofar as an improvement patent can be developed over patented technology, presuming the improvements made to the same are novel, the U.S. Patent Office will in fact issue improvement patents even though making, using or selling a product covered by such improvement patent may require a license or assignment from the owner of the rights of an earlier issued patent. In other words, the earlier issued patent can constitute a dominant patent with respect to later issued patents or improvements for the same technology. The listing the dominant patent as one of the references cited in the prosecution of the improvement patent can therefore alert the patent owner or licensor of the dominant patent as to the fact that improvement patent relates to technology so closely related as to have been cited by the U.S. Patent Office as a relevant reference.

Once the foregoing steps have been completed, it would be advantageous to draft a business plan for the purpose of clarifying the overall strategy of the licensing procedure to be adopted, the potential advantages and disadvantages from the same, concluding with an indication of a potential economic returns on the basis of the initial investigation conducted and the evaluation of the enforceability of the patents owned. Appropriate steps can then be taken to contact potential licensees for the purpose of making them aware of the availability of the license under the patents or by advertising in journals and the company's brochures and Web site that the patent owner is willing to license or assign the rights to the patented technology. In those situations in which it is readily apparent that a competitor is infringing, consideration can be given to the forwarding of a cease and desist letter for the purpose of bringing this matter to the attention of the infringer while specifying the identity of the infringing product as well as providing the infringer with a copy of the patent or patents being infringed so as to serve as proper notice of infringement.

[2] When to Consider Licensing Trade Secrets

The licensing of know-how has gained in significance with respect to both domestic and foreign technical assistance situations. The Uniform Trade Secrets Act (UTSA)[3] has defined a trade secret as follows:

"Trade secret" is information, including a formula, pattern, compilation, program, device, method, technique or process, that:

(i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtained economic value from its disclosure or use, and

(ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

As with patent licensing, trade secret licensing has distinct advantages and disadvantages. The advantages include the ability to leverage business resources. Hence, by adding licensee's resources for a particular business operation to its own operation, a licensor can enter markets that it otherwise would not have hoped to serve. This is particularly true for a small firms and start-up companies who do not have sufficient personnel to utilize a trade secret nationwide, or more particularly worldwide markets. Upon granting others the right to market and distribute products which include the company's trade secrets, it is possible to enter geographic or product markets otherwise unreachable. As a result, a company can more readily enter certain markets otherwise closed to it and can increase market penetration through complimentary products. The licensing of such trade secrets may also make valuable the licensable patents of such company and can make them more readily licensable to those who desire the trade secret information of the patent owner. The net result of the foregoing is that additional revenue can be derived from patents or trade secrets that are otherwise kept in-house and not licensed to others. There is also a possibility that by making such trade secrets available for use, an opportunity will present itself with respect to cross-licensing of trade secrets for patents of other companies that might be useful to the owner of the patent. Through negotiations, this can also permit one to have access to improvements in the technology, even if generated by companies other than that which held the patent. The foregoing also serves to enhance the trade secrets and trade name of a company licensing the trade secrets and can also permit the owner of the trade secret to select business partners and form valuable alliances within their industry or to branch out to other industries seeking their trade secret information.

It must of course be recognized that certain disadvantages can result when licensing trade secrets. First and certainly foremost is the loss of exclusive control over the trade secret information. While confidentiality of the trade secret information is typically one of the conditions under which the trade secret information is passed to a licensee, if such trade secret information is not properly monitored, marked and otherwise kept secret by the licensee, there is a clear potential for loss of said trade secret information to third parties. Licensing of the trade secret information also can serve to establish a competitor with respect to commercialization of the trade secret information and can result in greater public recognition of the licensee as compared with the licensor.

[3] When to Consider Licensing Both

It goes without saying that licensing of both patents and trade secrets is often necessary to fully exploit the generation of revenue from both the patents and the trade secrets, since the licensee is often interested in both in order to make certain that the license will generate the maximum benefit to the licensee. This is readily understandable when one considers the fact that, oftentimes, valuable trade secret information is not included in a patent granted and that there is a certain amount of know-how, show-how and other types of information available only based upon the frequent consultation with the inventors or other knowledgeable individuals of the licensed and patented technology. It is for this reason that licensees often request that, in addition to a patent license, a license is requested from licensor regarding the trade secrets or know-how of the inventors or those knowledgeable in utilizing the licensed technology so as to make certain that patented technology is properly used and that such obtains its full potential for the licensee. In other words, technical complications often arise when an apparatus or method licensed under a patent is attempted to be used by a licensee. The licensee would benefit from knowing under a trade license agreement what experimentation had been done in the past and what had been found to be the most advantageous structure or method to use, even though precise details of the same were not explained in the patent application resulting in the patent. In view of this, licensees often recognize that the trade secret information regarding a patented invention can save a significant amount of trial and error and set-up time to maximize the commercial benefits of the patented technology.

In view of the foregoing, it is often beneficial to the licensor to suggest that a license agreement incorporate both patent and trade secret rights, so as to thus constitute a hybrid agreement, or to alternatively separately license the trade secrets and to make available the nonpatented information within the knowledge of the owner of the patent and its employees who have become familiar with the use of the patented technology. Thus, consulting fees can result and the relationship between the licensor and licensee can be further strengthened by the cooperation between the two. Further future cooperation can result in improvements being developed by the licensor or licensee and, under the proper circumstances, additional license agreements with respect to such improvements can be negotiated to the mutual benefit of both parties. Of course, on the contrary, such relationship may become less desirable over a period of time since it may strengthen the licensee as a possible competitor. This may also be the situation where a license is granted only in settlement of a suit by the licensee such as in an action to invalidate the licensor's patent or in any situation in which licensing is done reluctantly, or where the situation is such that the degree of future cooperation between the licensor and licensee is unknown or is unpredictable at the time the license for the patent is initially granted. Under such circumstances, if the situation changes subsequent to granting of the license for the patent alone, the licensor can always later grant a license for the associated trade secrets.

§1.02 Types of Licenses

[1] Exclusive, Nonexclusive and Other Variations

Intellectual property licenses are contracts which are interpreted and construed under the law of contracts and are interpreted in substantially the same way as any other contract. In patent licenses, the patented grant gives the owner the right to exclude others from the enjoyment of the patented subject matter and thus, the license serves as an understanding on the part of the patent owner not to assert his right to exclude others against the licensee, if and when the licensee practices the invention. In the field of patents, a license is typically either an exclusive license or a nonexclusive license. An exclusive license includes a requirement on the part of the licensor not to enter into any similar agreement with any other party, or to assert the right to use the patent on its own behalf. To remedy patent infringement, a civil action in a federal court is permitted under the patent law.[4] To the extent that licenses are involved, reliance upon U.S. patent law is not the exclusive remedy since the agreement may provide further specific additional remedies such as a liquidated damages provision or a right to terminate the agreement due to default. However, it is to be understood that if the licensee terminates the agreement and is subsequently threatened with an infringement suit, the licensee has the opportunity to file a declaratory judgment action for obtaining a judgment with respect to the invalidity of the patent.

While exclusive and nonexclusive patent licenses are the most commonly known in use, other types of licenses are found in the field of intellectual property. These include a sole license, a shop right, a label license and a franchise license. In addition, oral licenses, electronic licenses, implied licenses, compulsory licenses in foreign countries, and licenses which arise by the sale of a patented or unpatented article or by estoppel exist. Additionally, computer software, shrink wrap licenses and click wrap licenses have now come into existence, and compulsory licenses exist in some countries and require licensing of local industries if patent protection is granted, in addition to judicially imposed licenses. Trademark and copyright licenses also are of great importance as well as multimedia licenses.

An exclusive license precludes licensor from granting other licenses and the grant of such license bars the licensor from practicing the invention unless the licensor has specifically reserved the right to do so. If the licensor retains the right to practice the licensed subject matter, such licenses are often referred to as a "sole license".

A nonexclusive license is, in effect, an agreement by the licensor not to sue the licensee for infringement of the intellectual property rights being transferred. Such nonexclusive license is also normally not transferable by assignment to any other party by the licensee and, unless otherwise expressly provided for in the agreement, a nonexclusive licensor may practice the invention or authorize others to do so on behalf of the licensee. The nonexclusive licensor may freely license others, or may tolerate infringers. As a general rule, the nonexclusive licensee does not have the right to sue for infringement whereas if an exclusive license is granted to the licensee, this would typically be permitted, as provided for in the agreement.

A label license is a license which can be granted under either patented or unpatented products. These label licenses typically require labeling of the patent number on patent products.[5] For unpatented products used in a patented process, the label indicates that the process for use of the product as claimed in an identified patent.

A franchise license differs from a normal patent license in that the bundle of rights transferred directly affects the image of the franchisor and the degree of control imposed by the transferor is correspondingly greater. A franchise license allows for the expansion of business through independent franchise operations and is a significant recent event in U.S. business.

An express license is a contract whose terms have been stated with specificity and which usually appears in a written agreement. However a license can be an oral license. Oral licenses may, however, be void or unenforceable if they violate the Statute of Fraud provision of the jurisdiction in which the contract is made. Disputes of this type arise more frequently in connection with oral (parol) licenses which are not to be performed within one year. The existence of terms of an oral license must be proven in court by a preponderance of evidence.

Electronic licenses have evolved as a result of the impact of computer technology which has provided easy access of e-mail and the Internet. The result is the establishment of a new type of contract which often appears on a computer screen and invites acceptance by clicking on the acceptance symbol on the computer screen. As with oral licenses, these electronic contracts may create problems under a state's Statute of Frauds law. This area of contract law is presently evolving and raises complex issues which have not yet been addressed by many states. However, the Virginia General Assembly enacted a law of this type on March 14, 2000.[6]

Implied licenses can result from the conduct of parties where no written agreement has been signed. A license to make, use or sell patented invention can arise by implication from the acts of the patentee or one acting for the patentee. It is also possible for a patentee to allege that the conduct of an infringer was such as to imply acceptance of a license. However, the existence of an implied license ultimately is determinable based upon the intention of the parties and the scope of such license depends on the circumstances surrounding the creation of such license. A determination as to whether a license will be implied depends on whether the patent owner under the circumstances is estopped from asserting infringement. An implied license can arise from the sale of a patented or unpatented article. In particular, the authorized sale of an article, patented or unpatented, whose sole use is in the practice of a patented combination, process, etc. authorizes, absent negotiations, an implied license under the patent which covers the sole use. The implied license, however, will only last for the life of the component.[7]

An implied license may also result by estoppel. Conduct by the owner of the patent which induces the person who uses the invention to place himself or herself in a situation where they must suffer injury, unless such right to practice the invention is conceded, will be regarded as implying such right.[8] Whether the activities of the patent owner comprise a gratuitous license, or one for a reasonable royalty, will depend upon the specific circumstances under which the license arises.

An implied license can also result from an implied negative covenant appearing in an agreement. More particularly, where a license is drafted so that the granting clause is not coextensive with the full scope of the patent (i.e., quantity, field of use or territorial restrictions), if the activities of the licensee exceeds the grant, the question arises as to whether the licensee has breached an implied covenant not to invade the nongranted part of the patent. Some courts have held that there is such an implied negative covenant but other courts have chosen not to do this.

In addition to the above-noted definition of an exclusive license as meaning that the licensor will grant no future licenses, unless it retains a sole license, an exclusive license also normally defines whether the licensee is entitled to file suit for infringement of the patent license or to require the licensor to do this upon proper notification. The granting of an exclusive license normally also involves certain other terms and conditions, the most important of which is often the ability of the licensor to obtain a higher royalty than would otherwise be necessary for a nonexclusive license. This recognizes the fact that, unless the licensor has obtained a sole license, the licensee will be the sole source of revenue under the patent. It is for this reason that certain additional terms and conditions, such as a best efforts clause[9], is often found in exclusive license agreements so as to make certain that the licensee exercises its best efforts to commercialize the invention. As a result, if an acceptable exclusive licensee can be determined, it may be beneficial to sign such an agreement if this provision is included. However, the terms of the agreement should be such that if best efforts are not demonstrable or if certain thresholds of performance are not met, the licensor should retain the ability to terminate the agreement due to the default of the licensee and seek either a better exclusive licensee or to proceed with the granting of multiple nonexclusive licenses.

Nonexclusive licenses permit the licensor to grant further licenses, as desired, and thus a nonexclusive license is normally considered as being a mere agreement by licensor not to sue the licensee for infringement in exchange for a lower royalty than would otherwise be obtainable under an exclusive license. The licensor can freely license others, or may tolerate infringers with the result being that, should either event occur, the licensee's rights are not violated in any way. The general rule is that a nonexclusive licensee does not have the right to sue for infringement and cannot assign its right to others without written permission from the licensor.

A cross-license normally results where, for example, both parties of a prospective license agreement have patent rights which the other party wishes to acquire. Upon cross-licensing, each party to the agreement may operate without being charged with infringement of the patent rights of the other. Depending upon the value of the patents rights involved, an agreement of this type may be concluded by exchange of a license and a cross-license may, if needed, be accompanied by payment of royalties. However, in some instances, no payment of royalties would be needed such as, for example, where it is anticipated that the value to each of the parties to the agreement will be substantially equal. Cross-licenses frequently arise for the purpose of unblocking technology of each party so that each can produce the same without the threat of litigation. A potential drawback in cross-licensing, however, is the fact that such may violate U.S. antitrust laws. While cross-licensing alone presents no inherent legal difficulties, a potential problem arises if the effect of the cross-license effects competition such as aggregation of patents in the same field, often resulting in the legality of the agreement being questioned. However, unrestricted cross-licenses have, in general, been approved by the courts[10]. A high percentage of cross-licenses have, however, been judicially challenged under the Sherman Antitrust Act, especially where an adverse effect on competition results.

[2] License vs. Assignment

A license is generally recognized as having the legal effect of waiving a right to sue or prosecute the licensee for conduct that, absent the license, would be actionable. Thus, a patent license is a waiver by the patent owner of its right to exclude the licensee from making, using, selling, offering for sale or importing the claimed invention. The term "assignment" is one that normally implies as defined in Black's Law Dictionary as a transfer or making over to another of the whole of any property, real or personal, in possession or an action, or of any estate or right therein[11]. In patent terminology, however, the meaning of assignment has been given a special and lasting meaning in the Supreme Court decision of Waterman v. MacKenzie[12].

The distinction between a license and an assignment is primarily of importance in the field of taxation and in the determination of which party has standing to sue for infringement of a licensed patent. As a general rule, payments made for an assignment of a patent must be capitalized by the assignee and may be taxed as capital gains to the assignor. Royalties paid under a license, however, are deductible business expenses of the licensee and comprise ordinary income for the licensor. With respect to standing to sue for infringement, the Federal Circuit has held that determination between assignment and license requires the court to determine the intention of the parties and examine the substance of what was granted[13]. In summary, a patent right may be transferred by assignment or license, an assignment comprises a transfer of the right to exclude others from making, using or selling, and a license comprises a waiver of that right. As can be readily understood, the transfer of the right to sue for infringement is an important aspect of an assignment.

It is to be further understood that an assignment may be defined as a transfer in writing of (a) the whole patent, including the exclusive right to make, use and sell the invention throughout the United States; (b) an undivided share of that exclusive right; or (c) an exclusive right under the patent within and throughout a specified part of the United States[14]. Assignments having full legal effect are required to be in writing and recorded in the U.S. Patent Office[15]. Oral assignments and unrecorded written assignments convey only equitable title inter partes[16].

The primary significance of the determination whether a particular transfer constitutes an assignment or license is focused on the ability to bring suit for patent infringement[17]. An assignment (or an exclusive license in many cases) gives the transferee the right to sue for infringement, since title to the whole or an undivided part of the patent is deemed to have passed[18].

§1.03 Determining Compensation

[1] Royalties

A great deal has been written concerning the paramount issue of proper determination of compensation for licensing or assignment of patent rights, including a determination as to the royalty base (i.e., unit of measurement on which a royalty is payable) and the royalty rate. The royalty rate is the formula by which compensation is paid to the owner or licensor of the patent rights. In determining the proper setting of royalty rates, complicated mathematical analyses have been proposed which typically require extensive data concerning the commercial activities of perspective licensees but which usually provide insufficient marketplace considerations. While the assignee or licensee wishes to maximize the compensation derived from the royalties, the following factors are relevant to this determination:

(1) the strength of the patent.

(2) the availability of competing technology.

(3) the cost of developing the invention and obtaining protection of the same.

(4) the savings or profit to be realized.

(5) the cost of bringing suit for infringement.

(6) type of license being granted by including the availability of grant backs, production against unlicenced infringement, exclusivity, etc.)

(7) negotiating costs.

(8) the desirability of establ