One-sided contract term of the day (3)

We continue our series highlighting IP Draughts’ “favourite” one-sided provisions in contracts.  These provisions are often found in contracts where there is an imbalance of power between the parties, and where the party with the power (let us call him the “Patron”) seeks to reduce a sometimes theoretical risk by imposing it on the other party (the “Supplicant”).

Today’s one-sided term is:

If any withholding tax is levied on the Payments, then Supplicant shall increase the sums paid to Patron so that the amount received by Patron after the withholding tax is deducted is the full amount Patron would have received if no withholding or deduction had been made.

This term differs from some of the others in the series in a number of ways.  First, it is focussed on an IP issue, or rather an IP tax issue – withholding tax.  Some of the other terms in the series could be found in many types of commercial agreement and are not specific to IP transactions.

Secondly, the presence or absence of the term doesn’t depend entirely on who has the bargaining power, although this has a part to play.  Instead, the use of such a term seems to reflect practice in particular industry sectors.  Thus, IP Draughts sees the term used frequently in software supply agreements, but very rarely sees it in biotech licence agreements.

What is withholding tax?

Many countries’ tax laws, including those in the UK, start from the assumption that where IP royalties are paid, tax should be deducted by the payer (ie the licensee) from the amount of the royalty, and paid to the tax authorities in the licensee’s country.  The net amount, less the tax, can then be paid to the licensor.  In some situations, reliefs and exemptions may be available that allow the payment to be made gross, ie without deduction of tax.

It is important to stress that what is being deducted is an advance payment of the licensor’s tax.  Typically, basic rate income or corporation tax (the name varies between jurisdictions) is deducted. Thus the licensee is acting as an unpaid tax collection agent for tax that has nothing to do with him.

While this tax system may be unfamiliar to many people, you may be more familiar (at least in the UK) with the fact that, on an interest-bearing bank account, your bank deducts basic rate income tax on interest payments, and sends you a certificate of tax deducted at the end of the year.  You include this certificate in your annual income tax submission and the tax authorities take it into account when calculating the tax due.  Essentially, the deduction at source of tax on interest is the same system as applies to royalty payments, and for that matter dividends on shares.

This withholding of tax at source is commonly known as withholding tax.

Deduction of tax on royalties at source can cause several problems for the licensor.  If he is not a taxpayer, or is not a taxpayer in the licensee’s country, it may be difficult for him to recover the tax, or (even if he can recover the tax) he may suffer a short-term cash flow disadvantage.  If he is a taxpayer in another country, he may find himself being taxed twice on the same income in two countries.  This is known as double taxation.

To mitigate the effect of double taxation, most countries of the world have entered into bi-lateral double tax treaties with most other countries of the world.  The terms of those treaties vary, but over time as they are periodically renewed, many are being redrafted to conform with an OECD model.  This is gradually removing some of the quirks of some of the treaties.  For example, while many treaties allow 100% relief from basic rate tax in the licensee’s territory if certain conditions are met, some of the treaties with Far Eastern countries have historically allowed only 50% relief.  During the 1990s, IP Draughts was involved in helping a UK biotech company that was prejudiced by the fact that the UK:Japan treaty only allowed 50% relief.  IP Draughts understands that the latest UK:Japan treaty allows 100% relief from withholding of tax.

Typically, to obtain the relief, the licensor must obtain evidence from the tax authorities in his home territory showing that he is a taxpayer in that territory.  That evidence is given to the licensee, who shows it to the tax authorities in the licensee’s territory and seeks permission to make the royalty payments gross, ie without deduction of tax.

Addressing the withholding tax risk

In biotech licence agreements (to take one of the examples given earlier), IP Draughts has typically seen wording such as the following:

The Payments shall be made without deduction of income tax or other taxes charges or duties that may be imposed, except insofar as the Licensee is required to deduct the same to comply with applicable laws.  The Parties shall cooperate and take all steps reasonably and lawfully available to them, at the expense of IP Owner, to avoid deducting such taxes and to obtain double taxation relief.  If the Licensee is required to make any such deduction it shall provide IP Owner with such certificates or other documents as it can reasonably obtain to enable IP Owner to obtain appropriate relief from double taxation of the payment in question.

The above wording provides that the parties will try to avoid withholding of tax, but ultimately if the licensee is required to deduct tax he may do so.  This is a tax issue for the licensor and ultimately, in the above wording, the risk is borne by the licensor.

The “one-sided” wording quoted at the beginning of this piece takes a different approach.  It requires the licensee to “gross up” the amount of the payment so that, after deduction of tax, it is the same amount as was originally agreed to be paid.  With this approach, the risk is passed to the licensee.

Who bears an individual risk in a contract is ultimately a matter for commercial negotiation, and the answer to this question may be affected by industry practice and the relative bargaining power of the parties.  In some cases, the risk may have been factored into the price.  It is for the parties  to decide what deal terms they want to agree, and IP Draughts claims no superior knowledge to tell them differently.

Standing back from market practice, though, it does seem strange to IP Draughts that a licensee should have to bear a risk that he cannot control, and where the nature of the risk may depend on the structure of the licensor organisation (eg whether he has a trading subsidiary in the licensee territory that can offset the tax against profits) and its current tax status.

IP Draughts’ scoring for extremeness: 6/10

Let specialties be drawn between us: Shakespeare on contract drafting

IP Draughts has just returned from watching a very entertaining production of Taming of the Shrew by the Royal Shakespeare Company at Stratford upon Avon.

The lawyer in IP Draughts couldn’t help picking up on a couple of lines in the text.  After hearing that Kate’s father will give a generous dowry if Petruchio marries her, Petruchio declares:

Let specialties be therefore drawn between us,
	That covenants may be kept on either hand.

See Act 2 Scene 1 lines 126-7.  Black’s Law Dictionary (seventh edition) confirms at page 320 that specialty is an old name for a contract under seal. As IP Draughts has previously commented, the modern name in English law for a contract under seal is a contract executed as a deed.  Thus Petruchio is asking for a pre-nuptial agreement to be drafted in the form of a deed.

Regrettably, IP Draughts’ knowledge of English matrimonial law in 1590 (the year Taming of the Shrew was written) does not extend to the legal formalities for a marriage settlement.  This article provides an interesting summary, but IP Draughts cannot vouch for its accuracy!

The second line quoted above refers to the parties entering into mutual covenants.  Covenant is, of course, the traditional name for an obligation in a contract under seal.

The only other legal point to be gleaned from the lines quoted above is that Shakespeare uses the traditional term “draw” for the writing of a contract.  The modern term is “draft” (or draught), which may be considered a back-formation from draw.  Occasionally, case reports still quote judges (see paragraph 28 of the judgment at the previous link) as saying that a contract is “not well drawn”, meaning that it is badly drafted, but IP Draughts considers that usage to be so old-fashioned that it can only be viewed as pretentious.

IP Draughts’ better half (let us call her the Draughtatrix) scorns IP Draughts’ focus on legal technicalities, when there is so much more to enjoy in the play.  “You need to make it bawdy”, she said.  IP Draughts’ response is to say: Act V Scene 2, lines 147-190.

When should researchers be allowed to copy others’ work?

Academic research has its own standards when it comes to drawing on another person’s work.  Plagiarism is considered a terrible sin, at the high end of the scale of wrongdoing.  Lack of attribution is a serious matter, in the middle of the range of indictable offences.  Misspelling another researcher’s name in credits is a minor misdemeanour (but may be viewed seriously by the aggrieved party).

These standards are quite separate from questions of copyright law, and IP Draughts has observed that academics sometimes disregard IP issues when conducting research and producing academic papers.  For example, IP Draughts has come across numerous instances of computer programs that have been written by academic staff without giving any thought to IP infringement.  This issue sometimes comes up when the academic department wants to commercialise the software.

When challenged as to how the software was written, some academics airily respond that the ideas behind the software are original to them, and that they arranged for a junior colleague to do the coding, caring little how that coding was done.  Was the junior colleague an employee of the university?  Possibly not.  Did he or she have a written contract with the university?  Possibly not.  Did he or she incorporate routines into the software that they found on the internet?  Quite possibly – it would have been a waste of time and money to reinvent the wheel.  Was any of this internet software subject to open source licence terms and did the programmer click on an “I accept” button when they downloaded it?  Quite possibly, you would need to ask them.  I’m sorry I’m late for another meeting, but hopefully you now have all the information you need.

This attitude of carelessness about IP issues may result, in part, from a belief that IP laws allow use of the IP for the purposes of research.  It is certainly true that both patent and copyright laws have exceptions that allow limited categories of research to be conducted without infringing the IP.  But the scope of those exceptions is not as all-encompassing as academics like to think, and anyway the extent of the exceptions varies considerably between countries.

This topic has come into IP Draughts’ mind as a result of the UK Government’s current Consultation on Copyright.  Sections 7.68 to 7.83 of the document consider the current exceptions in UK copyright law for research and private study, while sections 7.84 to 7.99 focus on data mining, which is not currently permitted under UK copyright law.

Private study

The Government raises three points on the research exceptions.  First, it proposes to extend the research exception to all type of copyright work, including sound recordings and films.  At present, partly for historical reasons, it applies only to literary, dramatic, musical and artistic works, and certain published editions.  The Government considers that the current law is inconsistent and prejudices research in the humanities.  IP Draughts agrees with this view and hope the law will be changed on this point soon.

The Government’s second topic relates to access to electronic copies of works in libraries.  The consultation paper points out that the UK is permitted by Article 5(3)(n) of the EU Copyright Directive to introduce an exception to copyright, to allow use of electronic copies on “dedicated terminals” in libraries for the purposes of research or private study.  To date, the UK has not introduced such an exception.

IP Draughts is uncertain how useful such an exception would be.  According to Article 5(3)(n) it applies only to “works and other subject-matter not subject to purchase or licensing terms”.  In IP Draughts’ experience, electronic copies of copyright works are usually, if not always, sold subject to licensing terms which restrict the use that the purchaser can make of the work.  Can any reader comment on how useful this exception would be, and whether it has proved useful in any other EU country that has introduced the exception?

We'm gotten a good load of data for you today, sir!

Finally, the UK Government focuses on the subject of copying complete works for the purpose of “data mining”.  It proposes to introduce a further exception in UK copyright law to allow such copying by academic researchers.  This new right would be based on the permitted exception under Article 5(3)(a) of the Copyright Directive.  It seems that the Government would also like to introduce such a right for commercial research, but recognises that it is not permitted to do so by the Copyright Directive.  Therefore, it proposes to explore with its “European partners” how to develop the legal framework in relation to commercial data mining.  In other words, a change in EU law would be required before this objective could be achieved.

IP Draughts predicts that this last point may be the most controversial of the three, as illustrated by the recent Meltwater litigation.

One-sided contract term of the day (2)

We continue our series highlighting IP Draughts’ “favourite” one-sided provisions in contracts.  These provisions are often found in contracts where there is an imbalance of power between the parties, and where the party with the power (let us call him the “Patron”) seeks to reduce a sometimes theoretical risk by imposing it on the other party (the “Supplicant”).

Today’s one-sided term is:

Clause X does not prevent the Patron from taking proceedings relating to a Dispute (“Proceedings”) in any other court or tribunal with jurisdiction.  To the extent allowed by law, the Patron may take concurrent Proceedings in any number of jurisdictions.

Typically, Clause X states that the agreement is subject to the exclusive jurisdiction of a named court.

Thus the Patron is “having his cake and eating it”.  The Supplicant is forced to litigate in the court named in Clause X.  The Patron can litigate in that court if he chooses to do so, but he also has the option of suing in any other court that is willing to accept jurisdiction.

The quoted clause is taken almost verbatim from a draft agreement that IP Draughts was sent recently.  He deleted the clause when marking-up the draft, the other side accepted the deletion, and no discussion was required.

But why, oh why, was the clause there in the first place?  It gives such a bad impression of aggressive one-sidedness.  The answer is almost certainly that it was in the template that the drafter was using, and he or she did not choose to delete it before issuing the first draft.

The sentiment of this clause is not particularly unusual – IP Draughts has seen similar clauses in a fair number of agreements that he has reviewed over the years.  Usually the clause only appears in agreements where the drafter is in “strongly protective mode” rather than “reasonable, balanced terms mode”.  For example, IP Draughts has seen the clause in many financing and investment agreements.

IP Draughts wonders whether investors realise how bad an impression it gives to the investee company when such one-sided provisions are included in the agreement.  IP Draughts cannot decide whether investors are usually (a) unaware of this impression, (b) a litte uncomfortable sometimes, but guided by their lawyers as to what is conventional and what is needed to protect their investment interests, (c) indifferent to it, perhaps feeling that the investee should not get exercised about “legal boilerplate”, or (d) happy to reinforce the point that they are in charge.  No doubt it varies from investor to investor.

One possibility is that many investors lack experience of commercial negotiations, outside the cocoon of investment transactions, and therefore don’t “get” how important it can be to establish a mutually-respectful “partnership of equals” in commercial negotiations.  And that this extends to the terms proposed in the contract, which are a central part of the structure of that relationship.

Perhaps in some cases the investor’s view is: we just do what everyone else does. We use the same lawyers as other investors, and the same types of documents.  Those documents have developed over many years, and are from a different gene pool to commercial collaboration agreements.  We’re just following market practice.

Perhaps. A similar argument is heard for pay levels in the financial sector, and that argument is now being challenged.

IP Draughts’ scoring for extremeness: 9/10

Three cheers for the manicule

Lord Denning MR was arguably the most important English judge of the twentieth century.  As first-year law students at university, IP Draughts and his fellow student, Andy Livesey, sent Lord Denning a telegram to congratulate him on his 81st birthday, and received a very nice letter in reply.

In the area of contract drafting, one of the more striking of Lord Denning’s judicial comments was about the need for a “red hand” in the margin of a contract, to point to a one-sided contract term.  This comment was made, obiter dictum, in the case of J Spurling Ltd v Bradshaw [1956] EWCA Civ 3.  What he actually said was:

I quite agree that the more unreasonable a clause is, the greater the notice which must be given of it. Some clauses which I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient.

In practice, this comment has not led to a proliferation of marginal manicules (the printer’s name for a pointing hand) in English law contracts.  Lord Denning’s comment has largely been ignored by contract drafters, and can be viewed as a historical curiosity.  Sometimes, IP Draughts includes a warning statement at the beginning of a set of terms of sale, pointing out that the terms limit or exclude liability.

Manicules have fallen out of fashion, but at one time they were frequently seen in street signs and other public places.  Nowadays, a simple arrow tends to be used.

A beautiful, 1933 edition of Aesop’s Fables, printed by Oxford University Press, used them as a design feature.

In modern typography, the quickest way of finding them may be to look in the Wingdings font of Word.

The closest equivalent to Lord Denning’s red hand in US laws may be the requirement, under Article 2-316(2) of the Uniform Commercial Code, for disclaimers of certain implied warranties to be “conspicuous”:

…to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous.

Conspicuous is defined in Article 2-103 as follows:

“Conspicuous”, with reference to a term, means so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it. A term in an electronic record intended to evoke a response by an electronic agent is conspicuous if it is presented in a form that would enable a reasonably configured electronic agent to take it into account or react to it without review of the record by an individual. Whether a term is “conspicuous” or not is a decision for the court. Conspicuous terms include the following:

(i) for a person: (A) a heading in capitals equal to or greater in size than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same or lesser size; and

(B) language in the body of a record or display in larger type than the surrounding text, or in contrasting type, font, or color to the surrounding text of the same size, or set off from surrounding text of the same size by symbols or other marks that call attention to the language; and

(ii) for a person or an electronic agent, a term that is so placed in a record or display that the person or electronic agent may not proceed without taking action with respect to the particular term.

IP Draughts understands that many US States have adopted these provisions of the Uniform Commercial Code, but is not an expert on this subject and would welcome comments from US readers on how widespread is the adoption of this part of the UCC, and whether any other contractual provisions must be displayed in conspicuous text under US State laws.

In many US contracts, it is common to see disclaimers typed in BLOCK CAPITAL LETTERS, which would appear to comply with paragraph (A) quoted above.  Very few drafters of US contracts make use of the other available methods of making text conspicuous within the above definition, such as use of bold text, or a different colour or font.  IP Draughts would like to encourage US contract drafters to be more creative, and to consider using a manicule.  This method is anticipated by the wording quoted above, which refers in paragraph (B) to “symbols …that call attention to the language”.