Category Archives: Contract drafting

Post-expiry royalties: what’s the problem?

weirdThere are some weird terms in US licence agreements. Let’s leave aside the general peculiarities of US contract wording. Examples such as “indemnify, hold harmless and defend”, “represents, warrants and undertakes”, “successors and assigns”, and a host of other excrescences, appear in many types of commercial agreement and not just IP licences. Instead, let’s focus on wording that deals with the duration of royalties in licence agreements. This issue came into sharp focus last week, with the decision of the US Supreme Court in the case of Kimble v Marvel Entertainment, LLC.

More on that case later. The general issue, in the US and internationally, is whether it is appropriate to require a licensee of IP to pay royalties after the IP has expired, been revoked, or otherwise ceased to exist. A generation or two ago, there seemed to be a consensus among legislators and the courts that it was not appropriate. This attitude could be seen, for example, in:

  • the US Supreme Court case of Brulotte v Thys Co, a 1964 decision that was discussed and followed in the Kimble case linked above. In Brulotte, the court decided that a contractual obligation to pay patent royalties after the patents had expired was “unlawful per se“.
  • the UK Patents Act 1977, which included a provision in section 45, since repealed, that: “Any contract for the supply of a patented product or licence to work a patented invention, or contract relating to any such supply or licence, may at any time after the patent or all the patents by which the product or invention was protected at the time of the making of the contract or granting of the licence has or have ceased to be in force, and notwithstanding anything to the contrary in the contract or licence or in any other contract, be determined, to the extent (and only to the extent) that the contract or licence relates to the product or invention, by either party on giving three months’ notice in writing to the other party.”
  • the 1984 EC Block Exemption Regulation for patent and know-how licences, which black-listed a provision whereby: “the licensee is charged royalties on products which are not entirely or partially patented …without prejudice to arrangements whereby, in order to facilitate payment, the royalty payments for the use of a licensed invention are spread over a period extending beyond the life of the licensed patents …” Recital 22 to the Regulation clarified that this spreading of payments referred to “spreading payments in respect of previous use of the licensed invention” – ie use during the period when the patents were in force.

A possible solution to this issue is to grant a mixed patent and know-how licence, in which royalties can be charged for use of know-how in circumstances where there are no patents, eg because they have expired or not been applied for in a particular country.

While this solution may work in many countries, there has clearly been a strand of opinion that, in the USA, a more nuanced approach to royalty terms is required. It seems to be thought by some that the licence agreement should state separate royalty rates for use of patents and for use of know-how. Presumably this makes it easier to show that there is no disguised patent royalty after the patents have expired. This approach is consistent with a comment from Kagan J in the Kimble case. She said:

That means, for example, that a license involving both a patent and a trade secret can set a 5% royalty during the patent period (as compensation for the two combined) and a 4% royalty afterward (as payment for the trade secret alone).

IP Draughts has seen some very strange royalty terms that try to finess this issue, eg providing separately for X% for use of patents and another royalty of X% for use of know-how, but stating that for as long as both patents and know-how protect the product, only the patent royalty applies. After the patent expires, only the know-how royalty of X% applies. Hey presto, X% applies both before and after the patent expires! IP Draughts has severe doubts about the effectiveness of this type of legal engineering.

More conventional, in IPDraughts experience, is a clause that sets the royalty at X% and reduces it to 50% of X in any country where there is no valid patent.

Ley lines

Ley lines

IP Draughts’ impression is that economists and competition (or in the USA, antitrust) authorities are no longer as concerned about post-expiry royalties as they once were. For example, the European Commission’s 2014 Guidelines on Technology Transfer Agreements state, at paragraph 187:

Notwithstanding the fact that the block exemption [for technology transfer agreements] only applies as long as the technology rights are valid and in force, the parties can normally agree to extend royalty obligations beyond the period of validity of the licensed intellectual property rights without falling foul of Article 101(1) of the Treaty. Once these rights expire, third parties can legally exploit the technology in question and compete with the parties to the agreement. Such actual and potential competition will normally be sufficient to ensure that the obligation in question does not have appreciable anti-competitive effects.

Kimble

In Kimble, the parties had settled patent litigation on terms that the inventor, Kimble, assigned a patent to Marvel in return for royalties. The parties set no end-date for the payment of royalties. Some years later, Marvel “stumbled across Brulotte” and sought and obtained a declaratory judgment that it could cease paying royalties at the end of the patent term. On appeal, the Supreme Court upheld the award of the declaratory judgment. In passing, one wonders how such a defective settlement agreement could have been drafted. Presumably the parties were advised in their patent litigation and settlement negotiations by lawyers who held themselves out as specialists in US patent law.

The majority of the justices in Kimble appeared to recognise that the current thinking of economists (and therefore antitrust authorities) does not object to post-expiry royalties. As the majority judgment put it:

A broad scholarly consensus supports Kimble’s view of the competitive effects of post-expiration royalties, and we see no error in that shared analysis.”

However, that consensus was irrelevant, according to the majority, as the issue before them was one of interpreting statutory patent law, and not antitrust law. The Supreme Court was bound by the principle of stare decisis to follow the decision in Brulotte. If the case had been properly considered as an antitrust case, they might well have been prepared to decide Kimble differently.

IP Draughts found this part of the Kimble decision surprising. Though he has no expertise in US laws, he had always understood the general issue, at least as it is understood in the UK and Europe, to be one of competition (antitrust) law.

The 3 minority justices in Kimble also saw things differently. They commented that the earlier Brulotte case “was an antitrust decision masquerading as a patent case”.

stare decisisGood old stare decisis. IP Draughts remembers being taught about the English version of the rule in his first term as an undergraduate law student, in 1979. Courts are sometimes bound by earlier court decisions on points of law. The English rule is not so constraining as the US one, it seems. The UK House of Lords (now the UK Supreme Court) simply announced in 1966 that it would no longer consider itself bound by its previous decisions.

IP Draughts is left feeling perplexed by the decision in Kimble. It is concerned only with a narrow point on the duration of patent royalties. But on that narrow point, US licensing practice and to some extent (because of the strong, international influence of the US) non-US licensing practice, is frozen in time by the opinions and decisions of an earlier generation of US judges. It matters not whether the decision is based on statutory interpretation or antitrust laws, the practical effect is the same.

Practitioners advising on licence agreements that have a US element to them must consider carefully how the royalty duration is expressed. Many of IP Draughts’ licence agreements provide for royalties to be paid, on a country-by-country basis, for the longer of (a) the duration of the licensed patents, or (b) in the case of know-how, for a period (often 10 years) from the first commercial sale of licensed products. At first glance, this would appear to address the issue. What is troubling IP Draughts is whether the agreement needs to go further, in light of this US case law, and have separate royalty rates for patents and for know-how, as some US templates for patent licence agreements seem to prefer. Readers – do you think this is necessary?

 

 

 

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Drafting standard terms – a thankless task?

tsncsOne of the many tasks that a commercial lawyer is asked to perform, is to draft or revise standard “terms and conditions”.

Definitions

As an aside, the expression “terms and conditions” (or the shorter “ts and cs”) is probably best avoided in a legal setting. The phrase has become part of business jargon, where it is shorthand for standard contractual provisions, such as those which a business seeks to apply to its sales or purchases. As with some other business jargon (eg “due diligence” or “partner”), commercial usage has become a little detached from the original legal meaning.

In traditional English law usage, a condition (sometimes known as a promissory condition, to distinguish it from a contingent condition, such as a condition precedent) is an essential term of a contract, breach of which entitled the other party to terminate the contract. By contrast, a warranty, or term, of the contract, is sometimes understood as a less important provision, breach of which entitled the other party to claim damages but not terminate the contract.

In IP Draughts’ view, this traditional distinction (which is used, for example in the UK Sale of Goods Act 1979) has outlived its usefulness in modern contract drafting practice. Most modern contracts specifically address when a party can terminate for the other party’s breach.

Using the expression “terms and conditions” as a commercial shorthand for standard contract provisions is unlikely to cause legal problems in most situations, but IP Draughts prefers to avoid using legal terminology in this way.

Drafting the blighters

blightOccasionally, IP Draughts is instructed to draft, or update, a client’s standard contract terms. He is currently working on a project to draft standard terms for use by a medical research charity when funding research at universities. Although he has been doing similar work for about 30 years, he still finds it a difficult task to do well and efficiently.

Part of the problem lies in getting clear instructions from the client. They sometimes have a vague idea that they would like their terms to be updated or checked by a lawyer. But they are not intimately aware of why each of the present terms has been included. Sometimes, a term is so “bespoke” that it wouldn’t have occurred to IP Draughts to include it, if it were not already present. No-one in the client organisation knows why it is there. But who is to take responsibility for deleting it from the new standard terms? IP Draughts may have to spend time in discussing its potential implications, the risks associated with deleting it, and so on. This might not be a good use of an expensive lawyer’s time.

A further issue is how to price the task. Should allowance be made for the discussions referred to above? This might result in a price that is difficult for the client to accept.

Who should be doing the drafting? IP Draughts is aware that in many firms, reviewing standard terms is a task for a trainee or junior solicitor. This has the advantage of a low hourly rate, but how good is the review going to be? It is likely to be a desk-based review rather than one that considers the commercial needs of the business.

tell me whyIn the project on which IP Draughts is currently working, he quoted with explicit assumptions, namely that the client wanted simple, standard terms that IP Draughts would base on one of his templates, and that he could ignore the client’s existing terms which are rather detailed and complex. However, the senior executive who agreed the price and the assumptions is not the same person as the manager who has operational responsibility for agreeing terms with universities. The manager, understandably, wants to understand why IP Draughts’ terms are different to those she is used to working with. This has resulted in many hours being spent in discussing the existing terms and the implications of removing the protection given by those terms. IP Draughts’ budget for this project has turned out to be too small.

There is no major deal in the offing, as there would be when drafting a contract for a transaction. So, there is no commercial context in which to assess the value of a lawyer’s contribution. It is human nature that clients tend to undervalue the lawyer’s contribution in drafting standard terms.

IP Draughts doesn’t have an answer to this conundrum. Do readers have any suggestions?

 

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Contract drafting and the limits of textual analysis

meaningGood contract drafting can be compared to good writing, as a play or TV drama can be compared to real life. One is a focussed, concentrated form of the other. Discuss.

Modern contract drafting uses the general principles of good writing and adapts them to the peculiar requirements of a commercial agreement. Some of the general principles work well for contracts. To communicate clearly, it is best to use modern language, write in short sentences, be direct and avoid ambiguity. This works for contracts as it does for an instruction manual for consumer goods, or an article in the The Times.

Contracts are less interesting, from a literary viewpoint, than many forms of writing. A contract sets out legally-binding obligations that the contracting parties have agreed. It is, in effect, a “shopping list” of promises. Some of the writing techniques that are used in other forms of communication have no place in contract drafting. For instance, contracts rarely use techniques that show off the author’s literary creativity, or try to persuade the reader of a political opinion, or demonstrate empathy. Equally, some of the techniques for good contract drafting are unlikely to be found in general writing. In contracts, the drafter should be painstaking to avoid internal ambiguity: he should use the same word or phrase in different parts of the contract to express the same meaning. This can sometimes result in a stolid “feel” to contract prose, which a writer in a different genre might avoid by varying the words used.  In some respects, contracts read like computer programs: it is important to be mathematically precise and accurate; very little credit is given for style.

If best practice is followed, a contract should only have one meaning. If the meaning is clear, there should be no scope for disputes arising over interpretation. But this logical conclusion fails to take account of human nature. Disputes over the meaning of contracts can arise for many reasons, including:

  1. The drafter didn’t make the meaning clear.
  2. The parties didn’t understand the meaning, even though it was clear. Perhaps there was wishful thinking on the part of the parties, or they didn’t have the same powers of linguistic analysis as the drafter.
  3. The parties chose not to understand the meaning, because it was not in their commercial interests.

When disputes over the meaning of contracts arise, they sometimes end up in court. The judge has the final say on what the contract means. If the contract is clearly written, the judge should follow that clear meaning and decide the case accordingly. But referring a question of contractual interpretation to a court creates further uncertainties, including:

  1. The drafter didn’t make the meaning clear (see above).
  2. The drafter did make the meaning clear, but the judge didn’t understand the meaning – he didn’t have the same powers of linguistic analysis as the drafter, and didn’t have as much experience of drafting contracts as the drafter.
  3. The judge was influenced by how other courts interpreted the meaning of the same or similar words in earlier contracts.
  4. The judge adjusted the meaning to do justice in the case. This is a larger subject than strict textual analysis, and may be affected by considerations such as which party acted badly, or whether the parties’ conduct modified the terms of the contract. IP Draughts recently discussed this point with a senior commercial judge. The judge’s reaction was that judges are expected to do justice in the case, so this factor will always be present. This led IP Draughts to wonder whether disputes over contractual interpretation would be better decided by an arbitrator, particularly one who had extensive contract drafting experience.

justiceSome experienced contract drafters, and IP Draughts includes himself in this category, would like contracts to be interpreted according to their linguistic meaning, particularly when they are well-drafted and the meaning is clear. This can be viewed as the engineering or computer programming approach. However, not all people think in this way or follow this approach when faced with a contractual dispute.

IP Draughts is not sure what is the best way of dealing with these issues. Ken Adams would like the courts to hear expert testimony when interpreting contracts. IP Draughts is unsure whether this would significantly increase the quality of contractual interpretation. It would probably work well if Ken is chosen as the expert, but if not him, who? In many cases, it might just add another layer of expense to the dispute, with rival experts arguing – as in the case referred to in the last link- over the significance of an Oxford comma.

 

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Do no evil …drafting

Four_wise_monkeysEarlier this week, Google invited us to sell them our patents. In their words, “the Patent Purchase Promotion is an experimental marketplace for patents that’s simple, easy to use, and fast.”

Apparently, selling your patents (but only your US patents) to Google will ensure that the patents don’t end up in the hands of “patent trolls”. All transactions are to be handled in a standardised way, using a Patent Purchase Agreement whose terms can be found here. In FAQs that accompany the promotion, Google declares:

…we aren’t going to negotiate with anyone. You set the price, we set the terms, and if things work out, we get you paid by the end of summer.”

Others have commented on whether you should take Google up on their offer, eg see this article: Google Says Trust Us and Sell Us Your Patents. (IP Draughts has just mis-typed this in a Google search, and found some web pages on the subject “Google Says Trust Us and Sell Us Your Parents”, which is quite a different promotional opportunity.)

Google asks us to remember that:

…this program is an experiment (think of it like a 20 percent project for Google’s patent lawyers)

And they emphasise that:

There’s some fine print that you absolutely want to make sure you fully understand before participating, and we encourage [you] to speak with an attorney.

So, what does this attorney think of the fine print?

The drafting of the Patent Purchase Agreement is so “experimental” as to make IP Draughts suspect that the promotion is not serious. It shows signs of being a rush job, performed by incompetent staff. Let’s be slightly charitable and say that the patent department didn’t have time to involve the legal department in the drafting. IP Draughts suggests a new research project for Google’s “patent lawyers”: learn how to draft contracts. Note to IP Draughts’ staff: if you ever draft something as terrible as this document, you won’t have a future with the firm. Yes, it really is that bad. Let’s take a few examples. Each one on its own might not be a sacking offence, but cumulatively they amount to gross misconduct.

  • the missing “not”

Agreement NonTransferable. The Seller may assign or otherwise transfer this Agreement, or any rights or obligations under this Agreement, to any third party without the prior written consent of Google.

  • the missing sentence

Governing Law; Venue/Jurisdiction. This Agreement will be interpreted, construed, and enforced in all respects in accordance with the laws of the State of California, without reference to its choice of law principles to the contrary. Seller irrevocably consents to the jurisdiction and venue of the courts identified in the preceding sentence in connection with any action, suit, proceeding, or claim arising under or by reason of this Agreement.

  • cutting and pasting text from another document. Badly. Eg section 5.1, which refers to the “Delivery Date”, or section 5.2 which refers to the “Closing” and the “Closing Date”. In all of these cases, IP Draughts suspects that the defined term “Effective Date” may have been what the drafter intended to use, if he had taken the time to clean up the draft.
  • double definitions, and confusion over whether the defined term should be “Seller’s Patent” (section 1.1) or “Seller’s Patent(s)” (section 2). This mental confusion results in some horrible phrases, such as “any of the Seller’s Patent”.
  • misuse of defined terms, eg section 6.6, which should refer to “Seller’s Patent” not “the Patents”
  • turgid or error-strewn drafting, eg:

…necessary or desirable for effecting completely the consummation of the transactions contemplated hereby

…represents and warrants to Google as follows that as of the Effective Date and as of Closing

  • use of the future-perfect tense (for goodness sake) and multiple verb pile-up:

Upon the Effective Date, Seller …shall have caused its Affiliates to sell, assign, transfer and convey to Google …

  • incorrect cross-references, eg section 7.2 cross-refers to section 3.4, which doesn’t exist.

The above examples focus on mistakes and the very worst kind of drafting. The document also contains plenty of examples of drafting that IP Draughts considers to be unacceptable, but not quite as bad as in the bullet points above. In the following examples, the point that (most) concerns IP Draughts is highlighted in bold text:

restrictions and encumbrances including without limitation any pledge, charge [etc] …or other restrictions and encumbrances (collectively, “Restrictions and Encumbrances”)

The Seller’s Patent has never been found invalid …

NEGLIGENCE (WHETHER ACTIVE, PASSIVE OR IMPUTED) … FOR COVER OR FOR ANY INCIDENTAL…

And there are plenty more.

There are also points of substance in the agreement that should concern any seller. Some of these indicate half-baked thinking on the part of the drafters, including the ridiculously elaborate warranty in section 6.3 which provides that, in respect of any licenses that the seller has previously granted under the patent:

…each such license is nontransferable (except solely in the context of acquisition of the respective licensee and in that case, the scope of each such license or rights in the Patents is limited to the activities of the licensee prior to the acquisition)

Or the provision that the seller can inform its existing licensees that it has sold the patent “provided that the Seller shall not identify Google”.

In its FAQs and other documents describing the promotion, Google emphasises “simplifying the process”, “better experiences for sellers”, “removing complications”, and “keeping it simple”. Yet the core document of the transaction fails to live up to these ambitions. This just doesn’t make sense. IP Draughts’ conclusion is that Google isn’t serious about this exercise, and that it has been dreamt up as a PR stunt on short notice. Either that, or Google’s competent contract drafter(s) didn’t get the memo.

 

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