Nexus: sublicensing

Sublicensing considerations in software contracts

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Sublicensing has become increasingly prevalent against the backdrop featuring a diverse IPR spectrum that subsists in a licensed work, a variety of business models and use cases (internal use, production/testing environment, (non)commercial use, etc.), complex organisational structures of the involved entities, multiple proprietary interests, geographical scope and so on. Sublicensing may carry the risk of diluting the value of the licensed work, but it also has the potential to increase the licensor’s return. Skilful drafting of head licences and sublicences is key in avoiding potential pitfalls.

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Licensor’s considerations

The licensor is usually the primary originator (not necessarily the owner!) of the licensed/sublicensed work. The Licensor’s major concerns relate to safeguarding the proprietary and commercial interests stemming from the work, including adequate compensation and control of the use of work. These concerns are usually addressed either by a sublicensing approval mechanism or pre-emptive sublicensing restrictions embedded in a head licence.

Approval may problematic because: (i) it involves carrying out due diligence and vetting the respective sublicensee, which may not always be feasible; and (ii) it shifts the burden of compliance monitoring from licensee to the licensor; and (iii) unless qualified or conditioned, it effectively “signs off” on the sublicensing arrangement, which may in certain circumstances mean a waiver of a right to dispute its validity or scope.

Pre-emptive sublicensing restrictions are more common and may include such provisions as:

(i) A requirement of a written sublicence, whose terms are consistent with the original licence (licensor may require a copy of each sublicensing agreement, or even include a model sublicence agreement within the head licence);

(ii) The Licensee’s full liability for the acts or omissions of a sublicensee or, alternatively, licensee’s joint and severable liability with its sublicensees for any breach of the licence. The licensee should be required to furnish the licensor with notice if it becomes aware that the sublicensee has breached the sublicence agreement;

(iii) An acknowledgement by the licensee that a breach of the sublicence is treated as a breach of a licence. The licence agreement may include the licensor’s right to enforce a sublicence (see also Contracts (Rights of Third Parties) Act 1999, which creates exceptions to the usual rules on contract privity and licensor can rely on such statutory rules to impose obligations directly against sublicensee);

(iv) Audit rights for the licensor, which may be the licensor’s only way to verify that the sublicensed work is not misused and/or infringed and that royalties are adequately calculated;

(v) Regarding the effect of sublicence termination: (a) Does the licensed work have to be returned or destroyed at termination?; (b) When the original licence terminates, does the sublicence terminate in tandem or does it become a direct licence (see VLM Holdings, where the High Court held that the sublicence survived the termination of the head licence, causing the licensor to be in breach of a separate licence of the same software that it had granted to a third party on an exclusive basis).

It is in the licensor’s interest to ensure that the sublicence is not granted to a competitor. Licensor may want to place express restrictions on the third parties that may become sublicensees, such as a limitation to only allow it for parties having a direct contractual relationship with the licensee, only to affiliates of the licensee, only to a specified number of third parties or only to parties preapproved by the licensor. Another approach is to restrict sublicensing by listing types of companies, or even specific entities, to which no sublicence can be granted.

The licensor’s compensation may take different forms and methods: (i) equally shared royalties; (ii) an upfront lump sum; or (iii) per each sublicensed copy. Special attention must be given to those arrangements where the licensee receives a cross-licence from its sublicensee.

The licensor should always seek the availability of equitable remedies in both licensing and sublicensing agreements, because the infringement of digital works can proliferate virtually instantly and on a very large scale. If the parties decide to include an arbitration clause, the licensor should ensure that an exception is included to allow for injunctive relief.

Licensee/sublicensor

The licensee/sublicensorwears both licensor and licensee hats being the middleman, having a direct contractual relationship with both the licensor and sublicensee.

First, the licensee has to consider whether the agreement with the licensor needs to contain a right to sublicense. If so, it is important to expressly state such right, because implied sublicensing might not be possible or at least uncertain, depending on a jurisdiction and licence exclusivity. Blanket prohibitions on sublicensing can be particularly problematic where the licensor or licensee is part of a group of companies.

As explained above, in most scenarios the licensor will want to limit and restrict sublicensing or condition it on an express, prior written approval. If the licensor’s approval to sublicensing is mandatory, licensee should require that such consent can be withheld only on a reasonable basis and not arbitrarily.

If the licensor chooses to impose express restrictions and limitations on sublicensing, a licensee, in turn, should ensure that these limitations are clear, specific and broad enough to allow for all intended sublicensing scenarios. The licensing clause (and sublicensing permission) should be explicit regarding licence exclusivity, geographical application, term and licensed rights, including:

- The right to make a reasonable number of copies to fully exercise all rights under the licence agreement (including for backup and archival purposes), adapt, customize, configure, extend, localize, translate and/or enhance;

- Permit licensee’s third party contractors, agents and outsourcers to install, use and access the work (directly or remotely);

- Move or transfer software licences from any device or platform to any other device or platform;

- Install and use the licensed software for development, testing, disaster recovery and high availability purposes and, as needed, to migrate to new versions.

Further, the licensee should seek the following: (i) A warranty (coupled with an indemnification) from the licensor that the licensed product does not infringe or misappropriate the IPR of any third party and does not include any unauthorised materials or information; (ii) that the licensor has all the necessary rights to license the work and to allow subsequent sublicensing thereof (including the right to grant further sublicences, if applicable); and (iii) that no claim is pending or threatened against the licensor or its suppliers alleging that the licensed product infringes the IPR of any third party.

Sublicensee’s perspective

The sublicensee’s primary concern is to ensure the full enjoyment of the licensed product without incurring any liability arising from the acts of the upstream licensors. Understanding what obligations are being imposed within the licensing chains with multiple tiers tends to be a complicated endeavour.

In a perfect world, the sublicensee should seek a warranty from the licensee/sublicensor that no IP claims are pending and the licensee/sublicensor has all necessary rights to grant a sublicense for the use as anticipated in the sublicensing agreement. If there is a claim, the sublicensor should be required to indemnify for any claims arising from such technology, even if sublicensor is not the one who developed it and undertook no due diligence. It is important for the end user, because there may be no other recourse due to absence of privity with the original licence.

However, if the middleman is a reseller/paying agent/mere conduit, the sublicensee may not have any leverage to negotiate sublicensing terms, which are usually simply passed down from the original licensor. But, at the very least, sublicensee should seek to specify that its rights are not contingent on the licensor’s receipt of payment from the reseller and that payment in full to the reseller is deemed to be payment in full to the licensor.

The sublicensee may want to consider entering into a stand-by licence with the licensor pursuant to which upon a termination of a head licence, sublicensee would receive a direct licence from the licensor. Sublicensor should be asked to contractually commit to good faith cooperation with sublicensee’s effort to obtain stand-by licence agreement.

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Why Do People Sublicense: Let Me Count the Ways

By 0x000216

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This Kat will begin with a one-sentence muse. The ultimate challenge in writing about IP is

trying to say something categorically meaningful about how IP plays itself out in that most elusive of places, "the real world." This has once again become acute as this Kat works on an article on one of his IP fascinations--sublicensing. In particular, we have been wrestling with the question of "why do people engage in sublicensing"? We can discourse about how to define sublicensing, what is its legal rationale and what are its most distinctive contractual elements. But all of these considerations rest on the fact, as this Kat's anecdotal experience confirms, that the sublicensing of IP rights is a wide-spread phenomenon. If so, how can this Kat get its "IP paws" around that most simple of questions--"why do people engage in sublicensing"?. As with so many deceptively simple questions, the answer is both multi-layered and multi-faceted. Set out below is our first feline stab at offering an answer.

1.The licensor and licensee may be seeking additional revenues for exploitation of the licensed intellectual property rights. What better way to do so than to share in sublicence royalties.

2. The exclusive licensee may not be easily able to meet its minimum royalty payments, but sums reasonably received from the sublicensee will likely enable the licensee to do so. (Separately, of course, the question then remains--What is meant by an "exclusive licence" when the exclusive license grants a sublicence?)

3. In a version of the foregoing, the licensor may from the outset set a high minimum royalty payment for the licensee, secure in his belief that the licensor will be able to identify and manage a successful sublicensee in the territory.

4. By providing for a sublicence, the sublicensee may seek to fulfill market demand that
the licensee is itself unable to satisfy on its own.

5. The sublicense may be necessary to meet customers’ requirements for second sourcing of a product manufactured under the IP right. Here, the impetus comes from the downstream actor, namely the ultimate customer, concerned to protect a reliable supply of the licensed product.

6. The licensor may not itself exploit the IP rights or arrange for exploitation by third parties on a contract manufacturing basis. Instead, all exploitation will take place by the sublicensee under the supervision of the licensee.

7. In a specific instance of the foregoing, the structure of the commercial relationship with the licensor may be such that it is intended that only the sublicensee(s) are intended to exploit the IP. This is especially so in franchise arrangements, where the franchise is often structured to provide for a master franchisee in the territory, which does not directly operate any licensed units, but rather manages a chain of franchisees/sublicensees.

8. The grant of a sublicence may be required to resolve a legal challenge to either the licensor or licensee, such as where there is a competition law concern that the licensee enjoys a dominant position. The presence of a sublicensee may allay this concern, provided that the sublicence is made between unrelated parties.

This is this Kat's initial list. Has he missed anything obvious? To remind you--the task is to create a comprehensive list for that most challenging of questions--"why do people enter into a sublicensing arrangement."

Two Riffs on Sublicensing

By 0x000216

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Can there be a topic in IP licensing that is more neglected than sublicensing? When this Kat was asked to prepare a talk on the topic a half-decade ago, he was surprised -- no, he was stunned -- at the paucity of both relevant secondary literature and instructive judicial discussion (especially, sorry to say, in the UK). While we all intuitively know that the practice of IP sublicensing is common, it is so very difficult to find useful guideposts, both in concept and in practice. This ranges from a lack of consensus on the legal justification for sublicensing to a list of the recurring commercial circustances in which sublicensing takes place.

Since that talk, this Kat has taken a particular interest in the subject, and he is always on the lookout for new uses for the sublicensing arrangment. During the last year, he has encountered two recurring situations of particular interest.

In the first, the licensor, licensee/sublicensor and sublicensee are all part of the same corporate group and are directly or indirectly under the same ownership. The ultimate intended user of the licensed right (say software) is the sublicensee, but it is the licensee that has the most substantial ongoing commercial activities (especially if the licensor is an IP-holding company) Under such circumstances, what are the most efficient arrangements to enable the licensee to maximizze its tax position, taking into acount the deduction for the payment of the royalty to the licensor, on the one hand, and receipt (or imputed royalty income) from the sublicensee, on the other? How different are the considerations when the licensor is not a mere IP-holding company but has fully-fledged operations? Depending on the answer to these considerations, the very locus of the various entities to the licensing arrangement may differ.

In the second, the licensor provides a platform intended for customers of the licensee
which includes, as a central part of it, use of the licensor's IP. The licensee itself makes no use of the licensed IP right. Rather, it merely serves as a legal conduit (what sometimes is characterized in a license/sublicense agreement as a "pass-through" license) by which the right to use the IP is granted to the licensee's customers. Indeed, if the platform is online, the licensee may not even provide the sublicensee customers with the software or the like and, in principle, the licensor could provide the customers with the software directly.

Here, the interest of the licensor is to bring the licensee into the set of contractual arrangements with respect to the licensed IP right, whereby the licensee will ultimately be responsible for the management of the use of the IP rights by the customers (including collection of payments, a portion of which is then remitted to the licensor). All the licensor wants to do is "clip the coupon" from revenues received from customers, and leave all of the rest (including liability for customer conduct) to the licensee.

Readers' comments on these, or other sublicensing scenarios, are welcome. Indeed, for those of you who cannot get enough of sublicensing, this Kat will be delighted to share his work-in-progress PowerPoint on the topic. Just let him know by email here, using the subject line 'Sublicensing'.

Nexus

Sublicensing considerations in software contracts

Why Do People Sublicense: Let Me Count the Ways

Two Riffs on Sublicensing

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