Four key terms in a Licensing Agreement
Image by mohamed Hassan from Pixabay
By Faith Sing and Jonathan Tan
This article was originally published on 7 June 2021 on Biotech Connection Singapore’s website.
In our previous article for Biotech Connection, we discussed some basic concepts with shareholders’ agreements – an essential agreement when spinning out a biotech company from a university. Here, we look at another key agreement – the licensing agreement.
A licensing agreement is a contract between a university that owns intellectual property (IP) and a biotech start-up that is formed to develop products based on that IP. Without a licensing agreement, the biotech start-up would not be able to commercialise and use the IP in any form.
There are incentives for universities to enter into licensing agreements with start-ups. Firstly, the licensing of its IP can create additional revenue streams for the university. Secondly, universities seek to promptly license their IP to start-ups with the hope that their technology can be commercialised in an appropriate time frame, as newer and improved technologies might emerge and render the IP irrelevant. Thirdly, the commercialisation of IP can help to boost the reputation of the university, by being known to enable ground-breaking and innovative products to reach consumers.
In this article, we look at four key terms to consider if your biotech is preparing to enter into a licensing agreement with a research university.
One. What is the scope of the licence?
The scope of a licence will generally cover the following:
- What IP is being licensed: The licence should specify the patent and other IP that is being licensed. This agreement will usually refer to “Patent Rights” and “Technical Information” or “Know-how”, the scope of which will be defined in the definitions section of the agreement.
Do note that it is sometimes possible that the technology developed by the university is insufficient for building the desired technological product. What you need from the university might extend beyond the patent. The non-patentable confidential information and technical know-how remain a useful part of commercialising your product and running your business.
- Is the licence exclusive: The licence given by the university may be exclusive or non-exclusive. In the case of a non-exclusive licence, the university retains the right to license the same IP to others.
On a similar note, the agreement could be structured such that part of the relevant IP may be licensed to your biotech exclusively and some other parts non-exclusively. For example, a patent for a particular drug might be exclusive, while a patent for the drug delivery system might be non-exclusive.
- In what “field” you may “use” the IP: The right to use the IP is usually limited to specific fields; for example, the treatment of muscular dystrophy or the treatment of stomach cancer. The “Licensed Field” or “Field of Use” will usually be defined in the definitions section.
It is important to focus on, not just the breadth of the definition, but on how that term is used throughout the licensing agreement.
- In which “territories” you may “use” the IP: This refers to the geographic boundaries or jurisdictions in which the IP may be used under the licensing agreement. This may be “worldwide” or limited to certain jurisdictions or other geographic boundaries.
An important way of resolving disagreements on commercial terms or upfront fees (see section 2), would be by narrowing the “territories” in which the licence applies. When the licence granted by the university is an exclusive one, the university is likely to seek exceptions so that they can continue to use the licensed IP for academic, research and educational purposes, including rights to publish research.
Two. What payments or other benefits will the university receive?
Payment terms may be structured in a number of ways.
- initial upfront payment – the university may seek a simple upfront payment from the licensee to recover its expenditure for its research costs. A biotech seeking to obtain the licensed IP from the university may agree to an initial upfront payment to demonstrate its interest in the licensed IP. While this payment may be a relatively small part of the total sum the university hopes to gain from a licensing agreement, it may serve as an important differentiating factor for a university when deciding between multiple biotechs bidding for the same IP.
- annual licence fees – like the initial upfront payment, the requirement of annual payments ensures that there is a minimum revenue stream for the university from the licensed IP. This fee acts as a disincentive for the licensee, to prevent them from “sitting on” or “hoarding” the licensed IP. One consideration is that the annual licence fee should be greater than a token sum so the licensee does not simply “shelve” the licensed IP.
- milestone payments – a university may require payments to be made as the biotech reaches certain milestones. Some examples of milestones are (1) when certain government approvals are obtained or (2) when the biotech completes certain phases of clinical trials.
- royalty payments from sales – annual royalty payments or its variants are the main way in which the university reaps the fruits of its investment in the licensed IP. The true worth of the licensed IP will always be unclear at the outset. There may be many reasons for its value to fluctuate and many of these have nothing to do with its scientific value. A royalty agreement that increases or decreases with the level of sales of the final commercialised product allows both university and biotech to avoid a hard discussion on valuation of the licensed IP initially.
- equity issue – a university may ask for equity or shares in the biotech instead of or in addition to cash payments under the options above. Like royalty payments, the value of the equity in the biotech will be dependent on the success of the commercialised product. This is akin to obtaining a share in the profits (rather than sales) of the commercialised product along with the benefits and risks of a shareholder. An issue of equity is a potentially useful option for cash-strapped biotech start-ups, although from the university’s perspective, it will, like all investors, want to consider carefully the arrangements surrounding their investment.1
Three. What are the development plans and milestones?
The licensing agreement may contain a provision which requires the licensee to develop products based on the licensed IP. This provision in the licensing agreement may be expressed in different ways. For example, this provision could be phrased as an obligation on the part of the licensee to use “commercially reasonable efforts”, “best efforts”, “reasonable efforts”, or “diligent efforts” to develop products based on the licensed IP. Whilst these expressions may sound similar, the different expressions reflect different degrees of effort which the university may require the biotech to put in to develop the product. The university and biotech may negotiate to agree to an expression that both ensures that the biotech works with sufficient effort to create a commercial product with the licensed IP and prevent the overpromising of results as success may be uncertain.
Some agreements go into greater detail by requiring licensees to follow a development plan and achieve certain milestones within a set timeframe. Some of the milestones include reaching certain phases of clinical trials and achieving the first commercial sale.2 In effect, the licensee is obliged to reach certain milestones (or at least do its best to) and honour milestone payments to the university. If the licensee is unable to meet the milestones, the licence agreement may be terminated by the university.
The agreement may also contain a clause for the parties to collaborate to resolve situations where milestones are not met. For example, a clause may provide that:
- the biotech company must give advance notice of the issues that may affect the company’s ability to meet the required milestones;
- the biotech may consult with the university to come up with a plan to achieve the milestone or an amended milestone agreed to by the university; and
- the biotech and the university must work together in good faith.
Four. When does the agreement end and what happens upon termination?
All agreements should be clear on when they end. With licensing agreements, this is an area where a licensee might want to pay closer attention because the circumstances of termination and consequent obligations may differ.
At its simplest, there is likely to be a fixed date. The length of the agreement could either be an agreed period from the date of the agreement or on the expiration of the last patent related to the licensed IP.
There are likely to be provisions allowing the parties to terminate the licence early. The university will want to terminate where the licensee is in breach of the agreement. This could be the case when a licensee has failed to develop the licensed IP or if the licensee is in financial strife. Similarly, the licensee would not want to continue making licence payments if the university is in breach, although oftentimes, there are few obligations on the university.
One important aspect to deal with would be the management of relevant IP when the licensing agreement is terminated early. The university might want a right to the new IP developed by the licensee and not just a right to the university’s original IP. This would allow the university to pick up where the biotech has left off and continue developing the product. In this case, the biotech may want a degree of compensation for use of its developed IP.
On the other hand, dragged shareholders may complain that this means they potentially end up with nothing for their shares after a forced sale if the liquidation preference waterfall applies to a drag-along too.
The agreement may also provide for the following rights upon termination:
- The licensee may have the right to dispose of its stocks of products based on the licensed IP.
- The university may require cooperation from the licensee for an interim period, allowing the university to continue development or sales after termination.
The four key terms discussed in this article are only a subset of important terms in a licensing agreement. There are many more terms worthy of a discussion in great depth due to the complexity of this topic. We have barely scratched the surface regarding the nuances in the ways the terms above, and other terms found in licensing agreements work. These can vary and be drafted to deal with both jurisdictional differences and different commercial positions.
1 See for example our article on the 101s of shareholders’ agreements. You may also refer to the section below on “Further reading”.
2 Note that this interacts with the concept of “milestone payments” discussed above and termination below.
We thank Brendan Sieow and Shainan Hora for their valuable feedback and patience in editing various versions of this article.
You may wish to read up on the 101s of shareholders’ agreements as well. The shareholders’ agreement is a key agreement you may want to put in place in parallel with establishing a new company.
Shareholders’ agreements can contain reasonably complex concepts that you may want to review a few times. They are not always accessible, possibly because business and shareholder relationships are not always straightforward.
Read more on shareholders’ agreements (SHA):
- board and shareholder control provisions – 3 key control concepts for a SHA
- transfer of shares provisions – 5 key concepts on transferring shares under a SHA
- board control provisions – 5 key options for board provisions in a SHA
- pre-emptives on transfers – 5 key options for pre-emptives on transfers in a SHA
- drag along rights – 5 key points on drag-along rights in a SHA
- reserved matters – 5 key considerations for a reserved matters list in a SHA
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