Category Archives: Contract drafting

Royalty-stacking clauses

When negotiating royalty-stacking clauses, make sure you don't get fleeced!

When negotiating royalty-stacking clauses, make sure you don’t get fleeced!

One of the pleasures of teaching is learning from your audience. This happened in abundance recently when IP Draughts, presently in Australia, delivered his advanced IP licensing course to a group of in-house lawyers and licensing managers. In fact, he delivered the course twice to the same organisation: last Friday to a team in their close-to-Sydney office, and yesterday to another team in their close-to-Melbourne office.

IP Draughts’ knowledge of Australian suburbs has increased greatly, but this posting will focus on legal issues rather than the architecture of Melbourne bungalows, or the surprise felt by a Brit who learns that St Kilda is close to Richmond.

Royalty-stacking refers to the situation where a licensee must pay royalties to multiple parties in order to commercialise a product. The royalties are said to be stacked, one on top of another. A licensee may seek to negotiate a clause in his first licence agreement, stating that if he has to pay a royalty to another IP owner, the royalties payable under the first licence agreement will be reduced. These clauses are known as royalty-stacking clauses.

Two key issues arise when such clauses are negotiated:

  1. In what circumstances will the clause operate. In particular, is its operation limited to the situation where the licensee must obtain the third party licence in order to practise the intellectual property licensed under the first agreement? Alternatively, may the clause apply even where the third party licence relates to “add-on” technology that is not strictly required in order to practise the licensed IP under the first agreement but which is useful for the final marketed product? Usually, a licensor will wish to limit the clause to the first of these alternatives. An example of the latter alternative might be where the first licence is in respect of a pharmaceutical drug, and the licensee combines the drug with a drug-delivery technology, licensed under the second agreement.
  2. What is the formula for making deductions from the first royalty? Is all or only a part of the third party royalty deducted (eg 50%)? Is it deducted from net sales or directly from the first royalty? Is it subject to a cap or floor, eg that the first royalty should not be reduced by more than 50%?

Licence agreements vary significantly in how they address these issues, and not all licence agreements have royalty-stacking clauses. In IP Draughts’ experience, some parties negotiate tailored clauses while others rely on what they perceive to be a “standard” clause, culled from some earlier agreement or templeate.

Whatever the clause says, if enough money is at stake its correct interpretation may be litigated: see the leading UK case of Cambridge Antibody Technology v Abbott, decided in about 2003 (look it up on Google) which concerned a royalty-stacking clause in a licence agreement in respect of the market-leading product known as HUMIRA.

In IP Draughts’ Australian talks, several interesting points came up in discussion that he had not fully considered before. From a licensor’s perspective:

  1. Should the licensee be required to satisfy the first licensor that he needed to take the second licence and that the terms of the second licence were appropriate? Should the first licensor be involved in the negotiation of the second license between the second licensor and the licensee, to ensure that the first licensor is not financially disadvantaged? (IP Draughts perceives a danger that if this is insisted upon, it may make the licensee inclined to put more of the onus on the first licensor to “sort out” third party IP problems.)
  2. Should the first licensor have a right to audit the terms of the second licence to ensure that the correct deductions have been made? How will this be affected by the confidentiality terms of the second licence? Will the second licensee be willing to have the terms of its agreement disclosed to the first licensor?
  3. Do these royalty stacking clauses make the assumption that deductions have to be made from the “first” licence agreement (in which the clause appears)? Are there situations in which it should be the other way around, ie any deductions should be made from the other licence agreement?

To IP Draughts’ mind, these are all good questions, which are not always addressed in negotiations. Readers, what is your experience? Should these clauses get more tailored negotiation than they typically receive at present? How, in your view, should they be structured? Should they be included at all?

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Let’s get rid of the ratchet men

two wayLast week, IP Draughts co-presented a two-day course on clinical trial agreements. With practice-based courses, the discussion becomes interesting, at least for the presenter, when the people attending provide their own insights on the topics being discussed. This happened in abundance last week, and IP Draughts is grateful to all who contributed.

A theme that emerged in this course was whether a company’s template agreements should focus solely on providing maximum protection for the company, or instead should try to provide a balanced set of reasonable obligations on both parties.

What prompted the discussion was IP Draughts taking the class through the terms of a US biotech company’s template clinical trials agreement. The terms were excessively one-sided, giving the company maximum flexibility to tell the investigator what to do or not do.  They seemed to ignore the fact that the investigator has certain responsibilities under EU regulations to be responsible for its own actions and to seek consent from regulatory bodies (eg ethics committees), rather than just dance to the sponsoring company’s tune. It was interesting to compare these terms with the terms that are generally used in the UK, as issued by the Department of Health and negotiated between interested parties. The latter terms are much more pro-investigator, but they also try to address issues of concern to both parties including their regulatory obligations.

The wider issue is whether a company should have standard contract terms that seek to provide maximum protection to the company and largely ignore the interests of the other party. This type of approach is common in some market sectors. In M&A and some financial transactions, it seems that a buyer/investor will often wish to include in the agreement as many provisions as possible to protect its interests and minimise its risks. Or at least, they won’t tell their lawyers to minimise the use of legalistic contract terms, which may amount to the same thing.

This seems to have led to the proliferation of practices that, in other market sectors, can seem ludicrously aggressive and one-sided, eg demanding indemnities in respect of all breaches of warranty, having a party “represent and warrant” (supposedly to give additional remedies in tort as well as contract), and so on. It seems that lawyers in those sectors rarely stand up to their clients and tell them to stop being extreme and to stick to some simple, balanced terms. That just isn’t “done”. A forratchetmer colleague of IP Draughts, a corporate lawyer, called the lawyers who indulged in this type of competitive negotiation “ratchet men”, because they would squeeze out a concession, bank it, then move on to demand another, moving only in one direction like a ratchet mechanism.

In IP Draughts’ world, lawyers are usually “on tap” rather than “on top”. In other words, they are there as a resource but do not usually dictate the structure and agenda of negotiations. In this world, there is pressure to keep contract terms as simple as possible, and not to take extreme positions, because it is not efficient and does not lead to harmonious negotiations. A factor that possibly influences the negotiations is that these contract relationships tend to be long-term and require cooperation between the parties, rather than being a one-off in the way that an M&A deal tends to be.

IP Draughts suspects that some in-house lawyers, influenced perhaps by their training in large law firms, consider it to be their job simply to draft terms that protect their organisation, and that including terms to protect the other party is not part of their brief.

IP Draughts would like to encourage all lawyers to draft balanced documents, and all clients to give clear instructions that this is what they expect. By all means weight them to some extent in favour of your client or your employer, but not at the expense of seeing the other party’s point of view or addressing their legitimate concerns.

 

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Contract drafting: art or science?

volunteerContracts are voluntary. Two or more persons come together and agree to be legally bound to one another to do things, such as make payments, perform work or deliver goods.

Subject to a few basic requirements, the law provides remedies to ensure, or at least incentivise, parties to meet their contractual obligations. Those requirements are of different kinds. There are the technical ones for a contract to exist – offer and acceptance, consideration, requirements for writing, etc. There are the public policy ones – eg obligations to do illegal things are not enforceable. There are a few others “at the margins”, eg occasionally contracts may be void for mistake, while insurance contracts are subject to greater obligations of disclosure than most contracts. There are rules on how to bring a breach-of-contract case and as to the remedies that can be obtained, but they need not detain us here.

where's the beefUsually, these requirements and rules are in the background. They provide a context for parties who enter into a contract, but they are not usually at the forefront of the parties’ minds. Instead, they care about the substance of their obligations to one another – the content of the contract.

English law cares little about that content. It is a private matter for the parties to agree. The law implies certain obligations into the contract, usually only the bare minimum to make the deal work and usually only to deal with points that the parties haven’t thought about and agreed explicitly.

The court’s main roles in a contract dispute are to work out what the parties have agreed (including any implied terms), and then work out whether they have done what they agreed to do. Often, these roles require the court to do two things: (1) identify and interpret the terms of the contract, and (2) decide what the relevant facts are, eg as to their conduct in relation to the contract.

The latter task is often messy and takes most of the time of the court – hearing witnesses, reviewing records etc. At the time of entering into the contract, this messiness is all in the future. Negotiations sometimes seem to assume a strict adherence to the procedures set out in the contract; in practice this rarely happens.

whisperThe task of construing the contract relies more on the analysis of words than the hearing of evidence of who said what to whom etc. Usually. In an ideal world. In reality, the evidence sometimes intrudes and influences the judge in his analysis. Sometimes this is considered necessary to do “justice” in the case. Anyway, judges are not computer programs and are not always consistent in their interpretation of the words used. Whisper it quietly, but some of them are not very good at linguistic analysis.

Yet, it is not a free-for-all. There are some rules on how the contract should be construed. Parties are assumed to have agreed the terms set out in a signed written contract. What those terms mean depends on the words used and how they are interpreted. Words can mean different things to different people. English law is usually interested in what those terms mean to an outsider who has the background facts. In other words, not the subjective views of the parties.

So, when it comes to interpreting contracts, there are some pressures in favour of strict linguistic analysis, and some towards a more human approach that relies partly on how the parties are perceived to have behaved. This makes it difficult to predict how a court will interpret and apply a contractual obligation. It also depends partly on the court. In the past, IP Draughts has challenged a barrister who advised that a County Court would not hold a party to do something within a strict time limit set out in the contract, as a condition of exercising certain contractual rights. Surely the contract was clear and should be enforced by the court, IP Draughts queried. Perhaps you might get that approach from some Chancery judges in the High Court, sniffed the barrister. But not in the County Court. Not on this fact pattern.

There are limits to how far good contract drafting will take you, if your objective is to win in court. But there are other reasons for drafting contracts well. Having clear contract terms may help the parties to avoid a dispute over their meaning, so that they don’t need go to court.

Thus, excellence in contract drafting and excellence as a contract lawyer are overlapping circles in the Venn diagram of commercial life, but they are not identical or even sub-sets of one another. Sometimes, as a lawyer, doing one’s best for a client may involve drafting a contract in a way that could be viewed as sub-optimal from a pure contract drafting perspective. This should never be used as an excuse for shoddy drafting.

So, is contract drafting an art or a science? Viewed as a discipline where clarity, consistency and lack of ambiguity are among the main requirements, it may be more science than art, more like a computer program than a literary essay.  For jobbing lawyers who have to deal with messy realities of life, the scientific approach has its place, but other factors may also need to be considered. These factors may include:

  • being asked to start with a template agreement whose terms have involved over time, and where the client may be both unclear on why some of the terms are present and reluctant to drop provisions that may provide theoretical protection
  • pressure from parties and their lawyers in negotiations, where sometimes it is necessary to keep one’s powder dry for the most important revisions
  • lack of time or budget to improve the drafting to the extent one would like
  • prioritising a favourable interpretation in court over clarity in drafting, if (as sometimes happens) the two conflict, eg by using jargon that one knows the court will understand, even if the parties find it difficult

As conflicting priorities and other human factors intrude into the drafting process, a more ad hoc approach to drafting is likely to be taken. This approach could be viewed as closer to an art form than a scientific process. Whatever approach is taken, the drafting should reflect a set of drafting principles that place a high priority on clarity and accuracy.

 

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A fresh look at indemnities

have a goFollowing last week’s post about indemnities, IP Draughts has had a go at drafting an indemnity clause from first principles, without ‘cutting and pasting’ any traditional indemnity language. His attempt can be found here.

Some points to note:

  1. The core parts of the indemnity are in clauses 1.1 and 1.2. These clauses simply use the term “indemnify” and avoid wording such as “hold harmless and defend”. Instead, the scope of the indemnity is explained in later clauses.
  2. The indemnities are designed to place responsibility on a licensee of intellectual property to indemnify the licensor, except where the liability arises from the licensor’s breach of contractual warranties (in which case the licensor indemnifies the licensee). For example, the indemnity under clause 1.1 would operate if the licensee sells a defective licensed product, his customer is injured and the customer brings a claim against the licensor.
  3. The defined term “Commercialising Entities” broadens the reach of the indemnity beyond that of many indemnities, and IP Draughts is in two minds about this aspect. It might be argued that, as the indemnity covers claims made against the licensee by third parties, it is unnecessary to spell out who those third parties might be, eg by referring to ebaythe indemnity covering use of a licensed product by people far down the supply chain, eg the child of someone who buys a licensed product on eBay from the licensee’s customer. However, an alternative view is that if the indemnity is intended to cover all liabilities that may arise from the use of the product, it is best to be explicit about this aspect. IP Draughts would be interested to hear readers’ views.
  4. The most ‘novel’ aspect of this indemnity clause is probably clause 1.4, which seeks to address questions of interpretation that have probably been the subject of reported cases, as can be seen from the case references in Contractual Indemnities by Wayne Courtney, an excellent book that was reviewed in last week’s blog posting.
  5. Clauses 1.5 and 1.6 address points that are sometimes covered in detailed indemnity clauses. IP Draughts is grateful to his friend and former colleague, Matthew Warren of Bristows, for sending him a very detailed indemnity clause after reading last week’s blog posting, which provided a convenient shortcut to drafting these terms. IP Draughts has filleted most of the ideas from Matthew’s clause but used simpler, and probably less watertight, language. Some points have been omitted, eg an obligation of confidentiality on the indemnifier with respect information learnt from the beneficiary. This point might be covered in a separate confidentiality clause of the agreement. Similarly, if it is intended to give officers and employees personal rights to enforce the indemnity, a separate ‘third party rights’ clause should make this point clear.

Clearly, there is a great deal of detail in the attached wording, even with the simplified wording that IP Draughts has used, and in several cases there are choices to be made by the drafter, eg whether to include an obligation to mitigate losses under clause 1.5(c). There are, no doubt, other points of interpretation and litigation practice that could be addressed.

What do you think of the clause?

 

 

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Filed under Contract drafting, Licensing