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Pitfalls in Licensing Arrangements Association of Corporate Counsel

November 4, 2010

Richard Raysman

Holland & Knight, NY

Software Licensing Generally

• Licensing is a serious economic issue for both the Licensor and Licensee.

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Disputes – Four Corners of the Agreement

–  Non-transferable vs. transferable

–  Non-sublicensable vs. sublicensable

–  Non-exclusive vs. exclusive

–  U.S. only vs. worldwide

–  Irrevocable vs. term of years

–  Internal use only

–  Available for third-party access

–  Source code vs. object code

–  Scope of license

–  Permitted uses

–  Confidential

–  No open source software

–  Right to modify

–  Right to copy

–  No reverse engineering

–  Permitted use only by the

Terms in license agreements have meaning:

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Common Thread in Disputes

• Ambiguous clause in agreement

• Time period of several years before a claim is made

• Delay in enforcing rights

• Notice of non-compliance

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Two Sides to Every Story

Licensee

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Licensor

The Licensee (Important Product for Use in Its Business) • Integrated into Licensee’s business processes

• Most licenses are not unrestricted

• Need to comply with scope of use

• Termination risk

• Pricing

• Expansion into new areas

• What are the Licensee’s needs (e.g. customer use, affiliates, third-party access)

• Plan ahead

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The Licensor (Revenue Stream)

• The licensor can be assertive.

• The licensor performs the audit.

• The licensor gives notice of non-compliance.

• The licensor gives notice of termination.

• The licensor objects.

• Actions depend on what the license agreement says –  Ambiguities in agreement are exposed in most disputes

–  After purchase: review of license agreements

–  Effect of delay in enforcing rights

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Course of Conduct

N.Y. U.C.C. §1-201(3):

"Agreement" means the bargain of the parties in fact as found in their language or by implication from other circumstances including…course of performance….”

N.Y. U.C.C. §2-208(1):

“Where the contract for sale involves repeated occasions for performance by either party with knowledge of the nature of the performance and opportunity for objection to it by the other, any course of performance accepted or acquiesced in without objection shall be relevant to determine the meaning of the agreement.”

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Notable Licensing Terms Leading to Disputes – Grant of License

• Grant of License [Exclusive] Licensee. Upon and subject to the terms and conditions herein set forth, Licensor hereby grants to Licensee the exclusive worldwide right and license to make, use, sell, and offer for sale, or to otherwise enjoy, commercialize, and exploit, the Invention via the Internet only. Licensor hereby expressly retains all other rights in and to the Product.

Sublicenses. Licensee shall have no right to grant any sublicense to exercise any right in the Product without the express written authorization of the Licensor; EXCEPT that Licensee shall have the right to authorize individual users or groups of users to use the Product via the Internet.

For Non-Exclusive License (a) Subject to the terms and conditions set forth in this Agreement, LICENSOR grants to LICENSEE, and LICENSEE accepts, a non-exclusive, non-transferable, non-divisible right and license under the Licensed Patents, Licensed Products and Licensed Services, without the right to sublicense to others, to make, use, sell, offer to sell, or import the Licensed Products and Licensed Services in the Licensed Territory.

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Notable Licensing Terms Leading to Disputes – Grant of License

• Important considerations –  Restrictions on assignments and sublicensing. A licensor may or

may not permit a Licensee to sublicense to one of its subsidiaries or assign rights to a third-party.

–  Limiting the scope to patent rights. A Licensor should typically make clear that the license does not grant the Licensee a right to use the Licensor’s copyrights or trademark or service marks, or Internet domain names and the goodwill associated with them without authorization.

–  Field of use limitations. A Licensor may want to prohibit the Licensee from selling the patented technology in certain forms or types of devices or products. For example, in the case of software code, a Licensor may want to limit the Licensee’s use to certain designated equipment of the Licensee.

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“Irrevocable” License

Nano-Proprietary Inc. v. Canon Inc., 537 F.3d 394 (5th Cir. 2008) •  This case arose from a patent license agreement that granted the

defendant Canon and its subsidiaries a nonexclusive license to the plaintiff’s television display patents. •  The Licensee paid a onetime lump sum of $5,555,555.55 and received a

“fully paid-up, worldwide, royalty-free, irrevocable, perpetual, nonexclusive license (without the right to sublicense)” that “shall continue in full force and effect until expiration of the last to expire of the licensed patents. •  Subsequently, the Licensee signed a joint-venture agreement with a

third-party.

•  The Licensor sued the Licensee claiming that it materially breached the agreement by sublicensing its patents to the joint venture and by tortiously interfering with the Licensor’s prospective business relations (specifically, its prospective license with the joint venture).

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“Irrevocable” License

Nano-Proprietary Inc. v. Canon Inc., 537 F.3d 394 (5th Cir. 2008)

•  The district court found that the joint venture was not a subsidiary of the Licensee because the Licensee did not hold a majority of voting stock and, alternatively, because the court declined on equitable grounds “to recognize a corporate fiction” designed to evade the Licensee’s obligations.

• After the lower court ruling, the Licensor informed the Licensee that it was terminating the agreement. The Licensee disputed the Licensor’s right to terminate and also did some corporate restructuring such that the joint venture was now a subsidiary.

• At a subsequent motion hearing, the lower court found that the joint venture in its original form was not a subsidiary of the Licensee and that the Licensee had materially breached the agreement because creating the joint venture was an attempt to sublicense its rights to the Licensor’s patents, causing damage to the Licensor. The lower court found the termination of the agreement was effective and the $5.5million payment could be retained.

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“Irrevocable” License

Nano-Proprietary Inc. v. Canon Inc., 537 F.3d 394 (5th Cir. 2008) •  The appeals court reversed the lower court's ruling that the licensor could

terminate the agreement, given the licensee's material breach. The court found that even assuming that the Licensee breached the agreement, the Licensor could not recover the additional damages it sought, i.e., damages in relation to the value of a prospective license to the joint venture.

•  Regarding the right to terminate, the court held that under New York law, a licensor is not entitled to terminate an "irrevocable," "perpetual" patent license agreement, notwithstanding a material breach, but may sue its licensee under any available form of relief.

•  The appeals court found that based upon the unambiguous meaning of "irrevocable," the license agreement could not be terminated without rendering the parties' intent superfluous and contravening the established rules of contract interpretation. The appeals court also affirmed the dismissal of the Licensor’s tortious interference claim, finding that the Licensor failed to present evidence of a reasonable probability of either an impending business relationship or contractual relationship.

•  Thus, as the court stated, a party to a license agreement is not entitled to terminate the license when it contracts for an irrevocable and perpetual license, unless there is specific language that allows for such an action.

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Notable Licensing Terms Leading to Disputes – Royalties

• Royalty (a) LICENSEE agrees to pay simultaneously with the execution of this Agreement and every year thereafter on the anniversary of the Effective Date of this Agreement, a non-refundable annual advance royalty payment of $xx,xxx. Such payment shall serve as an advance payment for all royalties to become due and owing pursuant to section 3(b) herein during the then subsequent twelve (12) months of the term.

(b) LICENSEE agrees to pay LICENSOR a royalty of _____ and one-half percent (x.5%) of Gross Revenues. Such royalties will be applied against the advance paid for the twelve-month period in which such Gross Revenues became due until such royalties due in such twelve-month period exceed the amount of such advance for such twelve-month period, at which time such royalties will be payable monthly, no later then thirty (30) days after the month in which such royalties become due.

(c) LICENSEE shall pay interest to LICENSOR at a rate of the lesser of (i) ___ percent (x%) per annum over the current U.S. federal discount rate and (ii) the maximum permitted by law, on any and all advance or royalty amounts that are at any time overdue and payable to LICENSOR under this Agreement, such interest being calculated on each such overdue amount from the date when such amount became overdue to the date of actual payment thereof.

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Notable Licensing Terms Leading to Disputes – Royalties

•  Important considerations

– The definition of what constitutes “Gross Revenue” and description of allowable revenue set-offs

– The right to an accounting or audit

–  Provisions for minimum royalty payments or minimum sales targets

– Often royalty rates do not deviate far from industry standards for a particular technology and a Licensor may find it difficult to set a higher royalty rate than is common in that sector. Royalty rates will of course deviate between exclusive and non-exclusive licenses.

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Payment Terms

Madison River Mgmt., Co. v. Business Mgmt. Software, Corp., 387 F. Supp. 2d 521 (M.D.N.C. 2005)

 A number of courts have held that payment terms are covenants where permission for use precedes payment, forming a contract, but not a copyright infringement claim.

 In Madison River, the licensor alleged that the licensee made excessive use of the licensed database without payment. The agreement provided: "[i]f [the licensee] exceeds the number of licenses purchased[,] [the licensee] has 30 days to remit payment for the actual number of licenses used."

 The court found that the grant of the license was not conditioned upon payment for the excess use and that the license essentially granted permission for the excess use and then required payment for it.

 Defendant’s remedy does not lie in copyright, but in breach of contract.

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Payment Terms

• Varying forms of payment

–  Licensing fees can be based upon the number of users, the licensee’s systems and hardware, maintenance and tech support, access to upgrades and new releases.

–  Support can vary by vendor…just telephone or tech support ; additional fees for new releases or versions, etc.

–  The fees can be a monthly or regular charge, or an up-front fee for a paid-up perpetual license.

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Notable Licensing Terms Leading to Disputes – Improvements

• Improvements

It is agreed that any if LICENSEE or any of its employees or officers shall make any inventions, improvements, modifications, updates and/or further develop any Licensed Products or Licensed Services which is covered by the scope of any of the claims of the Licensed Patents, shall be promptly disclosed to LICENSOR such information and LICENSOR will have the exclusive right, title and interest to any patentable inventions. The LICENSEE agrees to cooperate in assisting the LICENSOR in pursuing any patent applications it elects to file.

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Notable Licensing Terms Leading to Disputes – Improvements

• Important considerations

–  Whether the Licensor gains ownership of independently developed improvements or derivatives to the licensed technology or whether the Licensor is only granted a perpetual, royalty-free cross-licensee in the Licensee’s improvements.

–  Whether the Licensee is entitled to any improvements developed by the Licensor during the term of the license without paying any additional royalties.

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Notable Licensing Terms Leading to Disputes – Territory

• Territorial Division – examples

“Territory shall mean the entire world”

“Licensed Territory shall mean all countries where there are Licensed Products”

“Territory shall mean the United States of America, its territories and possessions”

“The software used in any jurisdiction outside the Territory or imported into any jurisdiction except in compliance with all applicable laws of the Territory….”

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Notable Licensing Terms Leading to Disputes – Territory

• Important considerations

–  Limited territory can allow Licensor to select a Licensee that is knowledgeable to the local market and responsive to regional trends in selling the licensed products or services.

–  Territorial limitations on the area of sale or potential customers invariably affect the royalty rate paid by the Licensee.

–  The definition of licensed territory may grow over time when patent rights are granted in new jurisdictions.

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Notable Licensing Terms Leading to Disputes – Best Efforts

•  Best Efforts

Licensee to Use Best Efforts. Licensee agrees to use its best efforts to promote and sell by any and all appropriate means the Invention to third parties, and agrees to offer the Invention for such use within six months of the date of the execution of this Agreement.

Insufficient Performance. In the event that Licensor, in his sole discretion, determines that Licensee's efforts to promote the Invention pursuant to this paragraph are not sufficient, or that Licensee's sales of the use of the Invention are not sufficient, Licensor shall so inform Licensee in writing; and Licensee shall within sixty (60) days from the receipt of such writing cure such deficiency to the satisfaction of Licensor, or this Agreement shall be, at Licensor's sole option and upon written notice to Licensee, terminated.

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Notable Licensing Terms Leading to Disputes – Best Efforts

• Important considerations

–  Often the clause is tempered by use of the terms “reasonable” best efforts, or “subject to reasonable business judgment or customer demand.”

–  Depending on the technology and nature of the transaction, the best efforts clause may set a date for promotion and sale of the licensed product to the public.

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Representations on Performance

Market America Inc. v. Google Inc., 2010 WL 3156044 (D. Del. Aug. 9, 2010)

•  The plaintiff entered into a license agreement with the defendant for e-commerce related, enterprise search applications, allegedly based upon certain pre-contract representations about the software’s capabilities to handle a certain volume of search requests. Subsequently, the plaintiff experienced service disruptions using the software.

•  The court found that the software license agreement lacked provisions requiring the defendant to deliver a particular system with a specified capacity and contained limitation of liability provisions that disallowed liability for representations not included in the agreements in explicit terms.

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Representations on Performance

Market America Inc. v. Google Inc., 2010 WL 3156044 (D. Del. Aug. 9, 2010)

•  The license agreement contains liability provisions stipulating that: Google does not warrant that the operation of the Software will be "error-free" or "uninterrupted"; "the product and services provided by Google and its Licensors are otherwise provided 'as is'"; "Google does not warrant that the product or any portion thereof, [is] error or bug free"; and "Google and its Licensors assume no responsibility for the proper installation and use of the product."

•  The court concluded that such limitations precluded contract claims based upon allegedly underperforming software.

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Scope

Experexchange, Inc. v. Doculex, Inc., 2009 WL 3837275 (N.D. Cal. Nov. 16, 2009)

 A software developer licensed its product under a non-exclusive license allowing the licensee to incorporate the software into a specific standalone program. However, from the outset, the licensee transmitted royalty reports to the licensor that listed multiple products incorporating the software, yet the licensor did not notify the licensee that it was exceeding the scope of the license until litigation commenced eight years later.

 In the interim, the licensor continued to accept royalty payments for those products, repeatedly renewed the license agreement, and encouraged the licensee to incorporate the software into additional products.

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Scope

Experexchange, Inc. v. Doculex, Inc., 2009 WL 3837275 (N.D. Cal. Nov. 16, 2009)

 The court granted the licensee's motion for summary judgment dismissing the licensor's copyright and trademark claims. Among other reasons, the court found that the licensor's copyright and trademark claims were barred by laches due to the unreasonable delay in bringing suit. The court found that the licensor had constructive notice that the licensee was incorporating the software into unauthorized products and that the licensee would suffer prejudice as a result of the delay, given that during the past eight years it expended resources into developing products in reliance of its presumed right to use the licensed software.

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Real Life Examples

• Licensor licensed engineering technology in a ten-year exclusive license for a territory of 20 countries

–  Licensee integrated technology into its business

–  Right to sublicense was ambiguous

–  Over five years, the licensee entered into three small sublicense agreements, which the licensor knew about

–  Licensee entered into large sublicense agreement

–  Licensor claimed non-compliance and terminated

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Real Life Examples – Ambiguities • Licensor had Beta development with its customer

–  Product that licensor intended to roll out to its other customers

–  Professional services agreement stated that modifications to the Beta product were a work-for-hire that was owned by customer

–  After development, customer claimed ownership not only of modifications but of underlying software

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Real Life Examples

• Licensor licensed financial software to a bank. The software was integrated into the bank’s customer operations.

–  Bank elected not to take a source license

–  Licensor provided source code anyway

–  License allowed third-party contractors access to the source code

–  Five years later, the licensor elected to claim non-compliance with agreement

–  Licensor terminated the agreement

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