Technology licensing – 5 tips for avoiding ‘oh dear’ moments

Posted by Julia Murray

Image by Alex Proimos

There’s no secret formula for negotiating successful technology licence agreements. But it’s not always the ‘big ticket’ items – such as liability caps and termination rights – that cause licence agreements to come unstuck. As the following five pointers demonstrate, the old adage about preparation still holds true.
1. Identify and communicate your ‘must haves’

The only thing worse than realising an ‘oh dear’ moment is reporting it to the Board (or the shareholders)! There’s simply no easy way to answer the question: ‘why did you let this continue for so long?’. Having a well-formulated business case before commencing contract negotiations is critical to avoiding this career-limiting scenario. It’s also important that you communicate your 'hot-button' issues to the licensor early on. So, for instance, if you can't accept anything less than a full indemnity against third party intellectual property infringement claims (as is often the case with public sector entities that are bound by model contracting policies), then you don’t want this issue to bring the whole deal unstuck after six months of negotiations. Similarly, if you anticipated having a certain period of exclusivity in a defined market, you don’t want to find out six months into a 10 year contract that your exclusivity arrangements only captured specific iterations of the licensed technology.

2. There’s nothing quite as satisfying as a tax refund

Needless to say, security of payment is a key issue for licensors. And it’s for this reason that licensors often seek to shift liability for taxes to their customers. While many customers are prepared to accept this general position, it’s a good idea to obtain expert tax advice to uncover any significant tax liabilities (or windfalls!). This is particularly important if you’re dealing with overseas licensors, as GST and royalty withholding tax may become an issue. If you’re well advised, you may find that that your liability to pay royalty withholding tax rate can be reduced. Similarly, liability for GST can be affected by the medium by which the licensor’s technology is delivered, or even the place where the agreement is executed. Get it wrong, however, and you may find yourself paying more tax than you've budgeted for.

3. Flexibility begets success

Parties tend to have diverging philosophies when it comes to negotiating licence terms. For example, licensors may seek to lock customers into licence terms that are as granular as possible, often specifying the numbers and categories of authorised users and hardware. However, for licensees, these limitations not only create administratively onerous monitoring obligations, but may also set the scene for "fee creep". Therefore, if you want to future-proof your licence agreement, it’s best to negotiate more flexible terms at the outset. Paring back prescriptive obligations around authorised users and designated hardware is a good place to start. Similarly, you may wish to incorporate broad sublicensing rights that allow you to engage outsourced service providers or permit your customers to host their own instance of the licensed technology. It’s also good practice to include contractual options and pricing formulas to accommodate future developments, such as shifts from user-based licensing models to enterprise-wide arrangements; anticipated changes in applicable law; or expected future iterations of the licensed software or technology.

4. Two’s a partnership, three’s a takeover

Technology companies are particularly liable to takeovers, and so it’s worth thinking about the scenarios in which you'll want to pull the pin. Takeovers don’t always spell catastrophe, but they do signal change – and this may be for better or for worse. And if those changes sound in redundancies, new strategic directions or different corporate culture, licensees may have good reason to be concerned! While the general response to a licensor takeover is to ‘suck it and see’, there are a number of contractual mechanisms that can be used to protect a licensee’s interests. These include:

• prohibiting change of control events without the licensee’s prior consent (which can be given subject to various performance-related undertakings from the acquirer);
• insisting on a parent company guarantee; and
• conferring express termination for cause rights if the licensor is acquired by a competitor of the licensee.

5. Along came a third party product…

It's common for technology solutions to incorporate a suite of third party products, including commercial-off-the-shelf (COTS) software, hardware and communications equipment. These are usually priced separately, and can add considerably to the overall cost of the licensed solution. Often, however, the full extent of third party components is not apparent until the negotiations (or even the contract delivery) is well progressed. Avoid nasty surprises by insisting on a full breakdown of third party products and costings upfront, and ensure that these disclosures are supported by appropriate warranties. Licensees will also need to consider whether they prefer to have a direct contractual relationship with third party vendors or are happy for the licensor to manage third party contracts. And while it's inevitable that the list of third party components will change over time (particularly for long term arrangements), it shouldn't change without your consent.

Careful consideration of these (and other) issues prior to engaging with the licensor may help smooth the negotiation process - and lead to a more optimal result.

Partner: Paul Kallenbach