Licensing: Four Key Provisions That Should Be Considered In Every License Agreement.
What Is A License
Technically speaking, a license is a grant of permission by a holder of a certain right, to another, to use or enjoy such right that the other party would otherwise not have the right to enjoy.
To better understand what a license is and how it works, simply think back to your days as a kid when you had a favorite doll or truck. Do you remember when your best friend or sibling wanted to play with that toy, but you didn’t want to give it up? You probably let your friend or sibling play with the toy for a certain limited amount of time, under certain conditions – for example, they couldn’t braid the doll’s hair or play with the truck in the mud - and maybe in exchange they let you play with their favorite toy. Essentially, that’s how a license works, with the exception that now the toy is a lawfully recognized right in real estate, certain intellectual property or maybe a technological work.
Licensing provides a way for an owner of some right to continue to possess such right while allowing another to use that same right in return for some form of payment or consideration and subject to certain agreed-to terms and conditions.
Once the parties to a licensing deal have ironed out the basic terms of their arrangement, they should memorialize those terms in writing, by drafting a formal licensing agreement. The length of the agreement will often depend on the complexity and structure of the arrangement. However, the four key provisions discussed, below, are terms that should be considered every time a licensing agreement is drafted.
#1 License Grant
Admittedly, it is unlikely that the license grant, or the language actually granting the license of rights from the licensor to the licensee, will be absent from a licensing agreement. This point is more about the content of the provision and the accuracy and preciseness with which the provision in the agreement is drafted.
Often, authors of licensing agreements miss the mark when trying to capture what rights are actually being licensed as part of the agreement. They will often draft the license grant too broadly or too narrowly, which could potentially harm the parties involved and could promote disputes between the licensor and licensee.
The actual license grant should be very carefully crafted with great forethought. The grant language should delineate precisely which rights the licensee is to be granted. For example, where certain rights to a copyrightable work are being licensed and the licensor and licensee intend for the licensee to have, only, the right to publicly display the work, for example, it would be incorrect to simply say that the licensee “may use and enjoy” the work. This language is vague and overly broad and does not accurately capture exactly what the licensor and licensee agreed to. This could result in the licensee actually receiving greater rights than what was originally intended by the parties.
The agreement should also specify where and how the rights may or may not be used, the length of the term during which they may be used, and any and all other limitations on use to which the parties agreed.
#2 Consideration or Payment
Often, payment for the license will be in the form of a flat fee and/or royalties. However, there may be no consideration for certain reasons or consideration may be in another form, such as the license of certain rights held by the licensee, to the licensor.
Royalties can be calculated any number of ways, but are most often based on a certain percentage of either gross or net sales stemming from the use of the right that is being licensed. The parties should specify in the agreement, with great detail and accuracy: (i) if royalties are to be paid; (ii) how the royalties are to be calculated (gross or net sales with a detailed definition of the applicable term); (iii) how often the royalties are to be paid; (iv) to whom the royalties should be paid; (v) how they are to be paid and within what time period they are to be paid; and (vi) what remedies are available if they are not paid in timely fashion or at all.
#3 Quality Control & Audit Rights
Quality control is a crucial licensing deal term. Because the licensor is maintaining possession of the licensed object and it still holds value to the licensor, any harm done to the object will likely cause immediate and direct harm to licensor. Going back to the example, above, if your friend cuts your doll’s hair off and then hands it back to you, the doll has lost significant value. It will never be the same.
For that reason, the licensor will often want to establish quality standards with which the licensee is to comply, within the license agreement as well as the remedies that are available to licensor in the event of a breach of such quality standards.
In connection with a well-drafted quality control provision, a licensor will likely also want to have audit rights. Audit rights refer the licensor’s right to “check in” on the licensee from time to time and ensure that the quality standards are being met and that the payments to be made under the license are being made accurately and timely. Typically, there are limitations to the licensor’s audit rights so that the licensor does not become a nuisance or a burden to the licensee. For example, the licensor may have to give a certain period of notice to licensee before performing such an audit and/or may only have the right to perform an audit a limited number of times per year or other defined time period.
Indemnification essentially means that the indemnifying party, or the party that agrees to indemnify you, will compensate you for any loss or damage that you incur as a result of their actions. In a licensing agreement, both parties may agree to indemnify each other in the event that something they have done has harmed the other. For example, the licensor may agree to indemnify the licensee if licensor licensed rights to an infringing work and licensee was harmed because of that. A licensee may agree to indemnify the licensor if the licensee misused the rights licensed to them, which resulted in harm to licensor. Whether indemnification is mutual or unilateral, in the favor of only one party, will often depend both on the nature of the relationship and the relative negotiating leverage held by the parties.
Depending on the value of the agreement, sophistication of the parties and the potential for harm under the agreement, indemnification provisions can be drafted concisely or can be quite lengthy, addressing issues like, in the event of litigation, which party will be in control of the defense of the case, which party has the right to select legal counsel and which party pays for the legal fees involved.
In conclusion, the parties to a licensing arrangement are already ahead of the game when they reduce their agreed to terms to writing. However, that is not the end of the process. The agreement should be a well-drafted document, comprised of terms which are the result of great forethought. While there are many additional provisions that should be in a well-drafted licensing agreement, the four provisions referenced above are ones that should be considered each and every time such an agreement is drafted.