One-sided contract term of the day (7): revising commercial terms on breach

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 the Supplicant is in default of any of its material obligations under this Agreement, and shall fail to remedy any such default or breach within sixty (60) days after written notice from the Patron specifically stating that the Patron intends to terminate this Agreement if the Supplicant fails to remedy the default within such time period, then in the Patron’s sole discretion, the Patron may:

(a)   terminate this Agreement; or

(b)   decide not to terminate this Agreement, in which case the Patron’s obligations to meet the diligence standard under Section [ ] shall terminate, and the Patron’s subsequent royalty obligations to the Supplicant under Section [  ] shall be reduced by fifty percent (50%).

A term of this kind might be requested by a prospective licensee in negotiations over the terms of a licence agreement.  There is nothing particularly controversial about alternative (a) above.  Alternative (b) should not be conceded lightly by a licensor.

In IP Draughts’ experience, part (b) is requested only occasionally in licence negotiations and is far being from a standard clause.  IP Draughts has tended to see the clause being requested in high-value technology licence agreements where the technology is close to market, and where the licensee is also requesting various other clauses that would not be seen in lower-value or earlier-stage technology licensing, eg onerous IP warranties and indemnities.

The licensee’s argument for including such a clause is that, without it, he may not have an effective remedy for breach by the licensor.  While he could terminate for breach, he would then lose his licence, and would therefore be shooting himself in the foot.  The position of the licensee can be contrasted with that of the licensor, whose ability to terminate for the licensee’s breach gives a much stronger remedy.

A licensor could respond to such a request in a number of ways.  He could simply state that the clause is draconian and unacceptable, and may give the licensee a windfall benefit that far outweighs any loss suffered as a result of the breach.  In addition, the licensee has a remedy in damages for the breach, so there is an element of double-recovery.

The licensor might go on to point out that it is unacceptable for an exclusive licensee (and IP Draughts mainly recalls seeing this type of clause requested in negotiations over an exclusive licence) to no longer have diligence obligations, while retaining his exclusive licence.  This would enable the licensee to put the licensed technology “on the shelf” and remove the licensor’s ability to terminate for non-performance.  This, too, is draconian.

This last argument has some dangers for the licensor, however, in that it may lead the parties down the road of negotiating a variant on the above clause in which the licensee’s licence is converted into a non-exclusive licence at a reduced royalty rate, or the licence remains exclusive and with diligence obligations, but at a reduced royalty rate.  These “compromises” may also be unattractive to the licensor.

Termination is not always the best solution

Another possible variant would be to refer the amount of the reduction in royalty rates to an independent arbitrator or expert.  But if the parties go down this road, what advantage is there over using arbitration to decide what loss the licensee has suffered from the licensor’s breach and making an award accordingly?

Over to you, readers.  In what circumstances do you think a clause of this kind is appropriate, looked at from an objective standpoint and not as an advocate for one party or the other?

IP Draughts’ scoring for extremeness: 9/10

1 Comment

Filed under Commercial negotiation, Contract drafting, General Commercial, Licensing

One response to “One-sided contract term of the day (7): revising commercial terms on breach

  1. patently

    It rather depends on the remainder of the agreement, surely?

    If the agreement is ridden with traps and pitfalls for the licensor, or has lots of vaguely defined performance obligations that might be ripe for argument, then the likelihood of him being in breach is correspondingly higher, and the risk posed by the clause is likewise serious.

    However, if the agreement is simple & straightforward as regards the licensor’s obligations then a breach by the licensor that remains unremedied after 60 days’ notice is likely to be quite deliberate and significant. A licensor who is willing to do that could be quite a difficult person to deal with. Damages are all very well but suing for them each time the licensor breaches is going to be a bit time-consuming. In that case, having a deterrent against breach is likely to be quite useful in keeping the peace.

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