Terminating international licensees for non-performance

Everything seems to be going well. Your exclusive licensee is developing the licensed IP into a commercial product, and updating you regularly on progress. Then it all goes quiet. The information flow dries up and your calls to the licensee are not returned. Months pass by, and still no word. You learn that the licensee is in the middle of a strategic review, in which some development projects are being scrapped or slowed down. But there is still no news on whether your development project is being actively pursued.

You dust off the licence agreement and take a look at the performance clause. There is a general obligation to develop the IP into licensed products using “commercially reasonable efforts”, and a target date for selling the first commercial product, which is still a couple of years away.

Your lawyer advises you to write a formal letter to the licensee, asking for information about performance. After some delays, the licensee replies, asserting that they are actively developing licensed products, and citing a development spend of several hundred thousand dollars per year. You are very doubtful about this assertion, which doesn’t seem to tie in with what you have seen and heard. You wonder whether they have indulged in some creative accounting.

You decide to give notice of breach for non-performance.  You notify the licensee that unless he remedies the breach, you will terminate the licence.  The licensee writes back denying breach, and provides further information on performance.

You are still not convinced and you have heard through back-door channels that your project is being scrapped.  The next thing you hear is that the licensee has been acquired by a multinational company.  The licensee informs you that there will be a further strategic review in which the new owner will decide which projects are to be pursued.

In the meantime, you have another potential licensee expressing great interest in taking a licence.  They would replace the existing licensee.  The commercial representative of this company tells you that the current licensee has certainly abandoned your project, but isn’t ready to admit it.

Your lawyer advises you that you probably have a right to terminate, but it is difficult to predict how the court will interpret the “commercially reasonable efforts” obligation, and if the licensee refuses to accept the termination you could be involved in very expensive litigation that could take years.  Meanwhile the life of the licensed patents is ticking away.

The new licensee in the wings is showing great enthusiasm to take a licence, although the discussion so far has been with a mid-level commercial manager and your lawyer advises you that the licensee is unlikely to take a licence whilst a dispute with the current licensee continues.

What should you do?

Clearly there are both commercial and legal aspects in this question, and there is probably no easy solution.  You are a small company, and you don’t have the appetite for litigation with a multinational company.  You may have to wait until the further strategic review is complete and then try to negotiate an agreed termination with the current licensee, assuming that the outcome of that review is as you expect.

There are a couple of things you could have done, or tried to do, when the licence agreement was being negotiated.  You could have included in the agreement development milestones with dates, with a right to terminate if any of the dates is not met.  But past experience tells you that the licensee would probably have pushed back on the dates, either by making the dates later than you would have liked, or by making them subject to the “commercially reasonable efforts” qualification rather than absolute dates.  At the time you granted the licence, you were convinced that the licensee was going to be very active in developing licensed products, were under pressure to get the deal done, and you didn’t hold out for strong development milestones.

Another step you could have taken would have been to include a contractual mechanism for deciding whether the licensee had complied with its performance obligations.  We have often included a mechanism in licence agreements that enables the licensor to refer this issue to an expert, who would decide this issue in a limited time frame based on documents.  This mechanism is intended to be quicker and cheaper than litigating the issue, and to provide legal certainty to the parties.

Name check: the mechanism arose partly from discussions I had in the 1990s with Jonathan Gee (then a technology transfer manager; now a senior investment executive) and with Matthew Warren (then a junior solicitor; now a partner at Bristows).

The mechanism is made more palatable to licensees by providing that, if the expert decides that the licensee has not been diligent in performance, the licensee has 6 months to put the failure right.  Only if the licensee still fails to perform can the licensor terminate.  The detailed wording of the mechanism can be found in our published templates, eg Precedent 8(c) in Drafting Agreements in the Biotechnology and Pharmaceutical Industries (OUP, looseleaf, 2008 onwards).

American Arbitration Association

In our experience, European licensees are usually willing to accept this type of mechanism, but US licensees are not.  We don’t know why there is such resistance in the US.  We have speculated that it may be simply unfamiliarity with the mechanism, or a tendency in US agreements not to refer technical questions to experts.  However, we have been successful in persuading US licensees to refer questions of non-performance to expedited arbitration, eg under the American Arbitration Association’s rules (see section E of their commercial arbitration rules, dealing with expedited arbitration, here).  In practice, this solution has been an acceptable compromise on several occasions.

(Other arbitration bodies have similar rules, eg see the WIPO expedited arbitration rules here, but we haven’t studied whether these rules would provide a sufficiently quick and inexpensive solution).

In practice, effective management of defaulting licensees may require a combination of legal and commercial steps.  The importance of active monitoring of licensee performance, eg through formal audits and regular, scheduled meetings with the licensee, cannot be over-emphasised.  Contractual mechanisms, including those described above, may also assist the licensor to ensure that its technology is actively commercialised by its licensee.

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