Know-How and patents are often licensed together.

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Know-How can also be licensed on its own. 

 

Some examples:

 

In the life sciences:

 

• diagnostic test that is not eligible for a patent because of prior use (but there is still scope for licensing the test to service providers)

• Know-How license component of a Material Transfer Agreement by which biological material such as cell lines, antibodies, proteins, reagents, and mouse models etc are transferred for commercial use.

 

In the physical sciences:

 

• process for electrowinning a metal in soluble form

• manufacturing catalyst for a small industry, too small to warrant the cost of patenting.

 

In information technology:

 

• algorithms (which by themselves are unpatentable) to be implemented by a computer program to be developed by the licensee.

 

 

Tension #1: Royalty Rate

 

There are always royalty tensions in a license. The licensor seeks to maximise the royalty rate. The licensee seeks to minimise it.

 

 

Tension #2: Royalty Term

 

The duration that royalties are paid in a patent license is customarily until the expiration of the licensed patent.

 

But what of a Know-How license, which unlike a patent has no expiration date as such? How long should royalty obligations last when Know-How is licensed?

 

The licensor will want royalties for the longest duration it can negotiate.

 

The licensee will want to minimise royalties for the shortest duration it can negotiate.

 

Theoretically, Know-How could remain out of the public domain forever. If so, can a licensor expect to receive royalties forever?

 

Know-How could enter the public domain a short period after the license is signed. The licensee will want the royalty obligation to end as soon as that happens. In that case the duration that royalties are paid could come to an end in a short period of a few years, or even a shorter period of a few months.

 

Addressing both these possibilities, a Know-How License will specify that the duration of the royalty obligation will be until the Know-How has entered the public domain, with the onus being upon the licensee to demonstrate that.

 

 

Tension #3: Maximum Royalty Duration

 

But there is another dynamic. New knowledge resting on the shoulders of the preceding knowledge, a licensee will be concerned that after a period of time, the licensed Know-How is likely to be independently developed by competitors, and used by competitors behind closed doors, so that its use cannot be detected. This is particularly so in the case of Know-How related to manufacturing processes.

 

To be able to compete with those competitors, the licensee will argue that it should be assumed that the Know-How has been independently developed by its competitors after an agreed number of years. This could be agreed to be five years, ten years, twenty years, or any other duration that the licensor and licensee negotiate.

 

The Know-How License might therefore provide that the duration that royalties will be paid is from the date of the license until the first to occur of:

 

1.     the Know-How entering the public domain, and

2.     the expiration of the agreed number of years.

 

A licensor will want the agreed number of years that royalties are paid to be maximised. The licensee will want them to be minimised.

 

The term of the license however, that is the period that the licensee can use the Know-How, would be perpetual. This is because it is not known whether the Know-How has in fact entered the public domain, it is only assumed that it has for the purpose of bringing royalty obligations to an end, but without affecting the licensee’s right to continue to use the Know-How.

 

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Tension #4: Balancing an upfront payment or license fee with royalties

 

A Know-How licensor will often want:

 

1.     A non-refundable up-front payment or license fee

2.     with or without royalties.

 

The licensor will want the up-front payment or license fee to be the largest amount that it can be. The licensee may not want to pay any such fee, or if prepared to do so, will want to minimise it.

 

The licensor will probably even be prepared to sacrifice some or even all the royalties, preferring to receive a predictable large non-refundable up-front payment or license fee, to the unpredictable royalties with their uncertain duration.

 

Royalties can be brought to an end if the Know-How enters the public domain before the agreed number of years of the Royalty Term is reached.

 

That risk to a licensor diminishes the larger the non-refundable up-front payment or license fee, which is partly in lieu of royalties. The risk is even eliminated if the royalties are totally capitalised into the up-front payment or license fee.

 

On the other hand, the licensee will resist paying any non-refundable up-front payment or license fee at all.

 

Any such payment is a sunk cost. If the Know-How enters the public domain six months after the license is entered into, and the up-front payment or license fee was agreed by reference to a 10 year agreed maximum royalty duration, the licensee is severely disadvantaged. Conversely, the licensor is generously advantaged.

 

As a rule, licensees prefer to back-end load payments under a license. That is, to pay royalties, based on income received from the sale of products or use of the IP.

 

Conversely, licensors like to front end load the license, with non-refundable up-front payments, resisted by licensees because these payments are not sourced from income arising from the use of the licensed IP, but from other unrelated income sources.

 

The up-front payment or license fee serves another purpose: it is the price that the licensor wants for granting the license in the first place, while at the same time having the effect of reducing the back-end royalties.

 

The last tension therefore is the licensor’s desire to maximise the front-end payment or license fee, sacrificing royalties, and the licensee’s desire to minimise, or even avoid it.

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