ISSUES TO CONSIDER: INTELLECTUAL PROPERTY (“IP”) LICENSING AND MANUFACTURING AGREEMENTS

Agreements or contracts for the license and/or manufacture of products which have a significant component of intellectual property have unique features, as well as provisions or features which are common to all contracts. Because even the provisions which are common to all contracts may take on unusual characteristics where intellectual property is involved, it is worthwhile to walk through a checklist of the whole contract, thinking in advance of problems and bargaining positions. Getting as many key points into the drafts of the agreement early in the process saves trying to bargain for them later, when every request becomes a kind of ‘bargaining chip’ (if you have to ask for X at the end of bargaining, which you should have included earlier, that gives the other side more leverage to request the inclusion of Y, which you weren’t so inclined to give.)

  • Who are the parties? This most fundamental question in any contract is easily overlooked. Are you forming an entity like a limited liability company (LLC) or ‘S’ corporation for purposes of your business interests? Is it formed yet? Is there an operating agreement, if it’s an LLC? Who are the members? If you are protecting intellectual property rights, does the entity which is being formed have those rights, or do you still hold them personally? If you haven’t determined the entity yet, or haven’t identified all the equity participants, then make sure the agreement you sign gives you the right to introduce the new entity without making a new contract.
  • Identify what your company does. A broad defining statement of what your company does, what tangible or intangible assets it holds, what it sells, how it adds value, is helpful. Later on, if necessary, it will be easier to demonstrate that ‘little x’ is your intellectual property if you say at the outset that ‘big X’ is something that you do or sell or hold. Whether or not you hold patents or trademarks or have nationwide rights to ‘big X’ (whatever it may be), at least as far as the parties to this contract is concerned, ‘big X’ and all its sub-components, like ‘little x’ are yours, just because you said so in writing.
  • Be specific about what you are licensing, marketing or making, and what you are not. Don’t be vague. What are the products? How is the product marked for identification – whose name is on it? Who owns new products, who has the responsibility to present the products, who markets them, who manufactures them? What happens if the other party to the deal doesn’t perform – can you step in? If you don’t perform, can they step in? Who are the customers that each party is responsible for – is it the whole world? Are there any carve-outs to the customer responsibility, access, or right to sell to? (A developer may have made initial marketing efforts to a small group and wishes to retain that group as a customer). What happens if there is a dispute about whether something you develop later is one of the new ‘products’ or not? Who has the web site – and what can the other party, or you, put on the web site? Do you have approval rights for what is displayed on the website? How are the promotional materials for the developed products marked or identified?
  • What are the limits on the IP license in terms of time, assignment, geography? Generally, forever is too long in contracting, but sometimes one party to a contract has sufficient bargaining power to get a ‘forever’ license or right. If you are granting a license, make sure there are some performance parameters the other party has to meet, although they can be worded ‘as commercially reasonable efforts’ to at least avoid the licensed party sitting on its hands. If you are receiving the license, make sure that you can meet the performance obligations and have contracted for some recourse or flexibility to deal with unexpected events or setbacks. Assignment (as in the other party assigning its obligations to a third party) is closely related to contractual performance, because obligations, once assigned may be harder to monitor or enforce once the obligation for performance is in the hands of a third-party assignee. Try to retain some control over to whom, how, when and whether the party you are contracting with gets to assign its obligations to another entity. Geographic limitations to the scope of activity/responsibility are very important in some contexts, particularly where non-compete provisions are entailed. Marketing responsibility may be divided into distinct ‘target groups’ – there may be restricted periods in terms of marketing to these groups, and milestones identified to extend or renew those restricted periods.
  • Where is the financing coming from? If money is changing hands at the beginning of a business activity, identify from whom it comes, to whom it goes, what its purpose is, and whether the money is a loan or an equity investment. Get something in writing with a signature accompanying any early loan (‘seed money’) or investment. Make sure the contract identifies how past loans/investments are being accounted for. Cash flow is everything to a new business and few new businesses are capable of generating an adequate amount of their own operating cash requirements at first. Even if the business barely breaks even, how will you pay your mortgage and buy groceries? Anyone lending directly to a new business venture typically has both bargaining leverage and demands specific concessions or rights. Often, lending to an IP developer is personal, based on the entrepreneur’s personal financial statement or assets, such as a home equity line of credit, loans from relatives (or more dangerous still, credit card financing). Sometimes the entity being formed has a working partner and an investing partner. (If you are reading this, you are probably the working partner). Working out the business terms with your lender or lending partner, prior to entering into contracts with another party, is at least important, and maybe essential. Your financing partner or lender’s requirements will substantially affect the deal you can enter into.
  • How do you get paid from business operations? How does the money flow? If you want to irritate a judge, take an agreement into court for enforcement which is vague about payment terms. Know exactly what and when you get paid, so clearly that you can explain it to a stranger in two minutes. Then write it down so it can be incorporated into your agreement. There is a great deal of natural optimism flowing at the outset of a new business, and it can blind people to the inevitable bumps and obstacles of organizing and operating a profitable business. Take seriously two different scenarios, and contract explicitly for both: (1) the business is making money – who gets it, how much and when (get specific – vague intentions to re-invest everything in the business do not cut it); (2) problems arise and the business is not making money – how and when can you back out, and what assets, tangible or intangible, do you back out with? If you’ve granted an IP license and the other side is not performing its marketing duties, are there mechanisms to explore the problems that are arising, e.g., meet and discuss, or a right to monitor the effort of the licensed party, or informal mediation? If you are responsible for manufacturing, does the contract have mechanisms in it so that you can incorporate into your pricing structure unexpected costs?
  • Who pays for, and who has rights to, further IP developments? This is where Intellectual Property contracts really differ from more standard types of manufacturing contracts (although the IP language may be boilerplate in many contracts, if nothing new is being developed, the boilerplate language is rarely discussed or invoked). One of the characteristics of intellectual property is that it is somewhat of a ‘moving target’ – the ideas that make it valuable continue to be developed. Critical issues are: (1) Who is doing the developing, (2) who pays, (3) who owns and markets, and (4) who profits – as the product evolves.
  • Sales support and requested product changes. It may be challenging to try and negotiate in advance the responsibility for responses to ultimate customer questions or requests for product support or product modification. At least the contract can draw up some broad lines of responsibility. At the end of the negotiation, the parties ought to be able to say with clarity who pays for free samples, who visits the customer for training, who visits the customer for troubleshooting.
  • Warranties. Representations and warranties are part of almost every commercial contract, but IP contracts have reps and warranties that are more significant than the customary boilerplate. When you license intellectual property, you are representing that you own the intellectual property free of liens or other ownership claims; there are no known non-frivolous claims of infringement or misappropriation, or any patents, trademarks or other intellectual property rights that you are infringing; that your act of licensing the intellectual property rights will not conflict with or infringe upon the rights of any third party. The contract should identify who is responsible for defending against infringement claims from others, and what rights the other party to the contract has in connection with such defense.
  • Terminating the Contract. As noted earlier, all contracts should have some definite term, even if that stretches to twenty years. There should be some provisions for earlier termination and ‘back out’ rights and/or conditions, but these are very much dependent on bargaining power. Before either party backs out or invokes its rights under a termination provision, there ought to be provisions for written notice of an alleged default, and an opportunity to cure to alleged default. Even after a breach of contract, which permits the non-breaching party to step in and assume the duties of the breaching party, contractual provisions for reinstatement of the breaching party can be negotiated. Sometimes the most difficult negotiations are over the right to cure a manufacturing problem, especially where the nature and scope of the alleged default is completely speculative at the time of contracting. Promising to fix an off-shore manufacturing or shipping problem in a short period of time can be unrealistic, and creative negotiation may be necessary to protect each party’s interests.
  • Confidentiality and Non-Disclosure. The handling of confidential information is included in most commercial contracts, including IP contracts. The common law of many states, including Pennsylvania, provides that confidential information cannot be disclosed to third parties. What constitutes confidential information depends on individual circumstances, but marketing plans, pricing, outstanding bids, customer, mailing and telephone lists, manufacturing methods which are not generally known, etc., generally qualify. What constitutes the intellectual property which is the subject of the contract ought to be identified clearly, and the confidential information which exists should be protected by the customary language found in many contracts. At the beginning point in contract negotiations, both parties are motivated to protect confidential information, so negotiations on boilerplate language are not usually at issue. The contract may identify specific third parties who have already received some confidential information, and make an exception for those third parties from the general duty of non-disclosure to third parties.
  • Indemnification. Indemnification issues can be complex. Generally, indemnification means one party (the ‘indemnitor’) is acting as a kind of insurer for another party (the ‘indemnitee’), in connection with certain events. In any contract, generally there are often indemnification provisions whereby one party indemnifies the other for losses arising out of willful misconduct or negligent acts. Who gets indemnified and for what is often a function of bargaining power. Frequently smaller businesses, in order to do business with a large business, agree to indemnification provisions that resemble somewhat a mouse indemnifying an elephant. In the IP context, a party who has IP of some sort and is licensing it to another party for marketing purposes should expect to be indemnifying the ‘marketing party’ against losses or claims if it should turn out that the IP rights being licensed were successfully challenged. Depending on the size and economic resources of the parties, the licensing party may be responsible for legal defense in the event of an allegation by some third party that some part of the IP license infringes on the IP rights of that third party.
  • Insurance. In most manufacturing contracts, shipping terms and insurance work in a complementary fashion. At some point, the parties agree that the manufacturer is going to relinquish shipping responsibility, title and all associated costs, including insurance costs, to the party receiving the manufactured products. In some product development scenarios, the cost of insurance may require special negotiations, or the parties may agree to self-insure because the cost is prohibitive. Costs associated with product development and manufacture can be very sensitive where a market is being developed ‘from scratch’ for an entirely new type of product. There is no easy answer when products, methods or markets are ‘out of the box’ and the usual approaches to insurance costs don’t work. Negotiating flexibility on ‘who bears the risk’ may be essential to making the deal work.
  • Other Expenses. The contract should identify which party is responsible for various expenses such as website development, product samples, travel costs associated with sales calls or product support, etc. Which of those expenses can be built into the cost structure of the product, and which are part of one of the parties’ general overhead, ought to be examined and can be negotiated.

The foregoing list of issues is representative, not comprehensive, and nothing contained herein should be construed as advice from attorney to client. The best advice I can give is to obtain competent legal counsel to assist in all aspects of the transaction. Try to ‘think it through’ with your attorney, in advance of the problem areas. Negotiating solutions in advance may save enormous amounts of time, energy and money later on. A deal that has to be done in a hurry or it will fall apart generally isn’t a good deal at all.