Licensing Agreement: Everything You Need to Know
A licensing agreement is a deal between the owner of a patent, brand, or trademark and someone who wants to use the patented or trademarked goods and services. 13 min read
Updated June 28, 2020:
What Is a Licensing Agreement?
A licensing agreement, or license agreement, is a deal between the owner of a patent, brand, or trademark and someone who wants to use the patented or trademarked goods and services. The license grants permission to the licensee and includes stipulations. The licensee must honor these guidelines. One of the rules in the licensing agreement is usually a financial arrangement to pay for use of the license.
What Are the Elements of a Standard Licensing Agreement?
Most licensing agreements have standard clauses to cover the issues that arise most often in licensing negotiations. These clauses include the following:
- Contract length: A licensing agreement has a start date and an end date. One party usually prefers a longer contract than the other. Thus, renewal rules are also included.
- Dispute resolution: This is a standard clause that discusses terms in the event of disagreement between two parties. These resolutions frequently spell out whether the parties will settle a disagreement in a court or in arbitration. Arbitration is growing more popular because it's faster and cheaper.
- Exclusivity: Some licenses have more value when only one organization can use the innovation. Licensees will pay more for an exclusive license. The licensor must decide whether the innovation will make more money with one exclusive license or several non-exclusive ones.
- Inventory issues: The licensor may demand that the licensee stock a set volume of products in exchange for the licensing agreement. The contract should include explicit language to address inventory issues.
- Minimum sales requirements: The licensing agreement may require the licensee to meet certain sales goals in order to keep the license. The reverse can also be true. In that case, a vendor can get out of the agreement if sales fail to match the minimum terms of the agreement.
- Oversight: A licensor must protect its brands, trademarks, and innovations. Giving a license to other parties is dangerous because their actions could damage the brand. To guard against this, the agreement can call for oversight of products. A lack of quality control would be cause to break the agreement.
- Quality control: As a second aspect of oversight, the licensing agreement might call for the licensee to prove that their facilities and products honor the standards of the contract.
- Patent applications: In the fast-moving technology field, many companies arrange licensing agreements without formal patents in place. A provisional patent application is enough to get a license. In such cases, the licensee will pay significantly less until the United States Patent and Trademark Office (USPTO) grants an official patent. Sometimes this never happens.
- Payment amount: This is the most important part of a licensing agreement. The vendor agrees to pay a set amount in exchange for access to the license. The payment amount is what gives value to the innovation.
- Payment schedule: Rather than make a single payment, most licensees agree to pay a fixed or variable amount at set dates. The payment may depend on sales criteria, causing fluctuation in the payment amounts. Any failure by the licensee to provide a scheduled payment is a breach of the agreement.
- Renewal rules: The agreement will include language about the steps each party must take for a timely extension of the contract. To streamline future negotiations, many licensing agreements include language that will extend the length of the deal by default.
- Returns and allowances: Many licensing agreements involve physical products. The language must account for customer returns and damage to products during the delivery process.
- Royalty rates: Some licensing agreements include a revenue split agreement. A licensee will pay a percentage of the revenue from each sale of the licensed product(s).
- Royalty calculations: The agreement must explicitly state the royalty rate. It also must show how the licensee will make the royalty calculations and which products are eligible for licensing. Without this language, the parties could wind up in court or in front of an arbitrator. Someone almost always feels like the money isn't split fairly.
- Sub-licensing: A licensee often wants the right to sub-license the innovation to additional parties. The licensor generally agrees to this, since they get additional payments thanks to the other licenses. The licensing agreement should state the revenue shares for these situations. Note that a licensor may refuse sub-licenses because they want to maintain the exclusivity of the innovation.
- Territorial agreements: With more than 100 countries participating in global commerce, licensing is complex. A licensee must decide whether a product will have the same or more value in other countries. If the answer is yes, the licensee will ask for access to the license in multiple territories. Licensors obviously charge more for multi-territory licenses.
Some of these laws give automatic coverage to the owner of the intellectual property. In other instances, such as patents, the process to earn protection is complex and requires specific actions from the inventor. A person must know their intellectual property rights before creating any licensing agreements.
What Are the Checklist Items for a Licensing Agreement?
- Arbitration: Many businesses choose not to sue over disagreements. Instead, the licensor and licensee agree to settle disputes via arbitration. This section of the agreement states the rules about how arbitration will work. It settles matters such as the location and type of arbitration.
- Assignment provision: In many licensing agreements, the licensor asks for the right to assign licenses to other parties. This happens in non-exclusive license agreements. The language of this section spells out what rights the licensor and licensee have with the license in question.
- Auditing: Many licensing agreements base payments on royalties. With a financial incentive in play, one party may not act honestly about sales. The auditing section prevents this issue. It states how an unhappy party can audit the books.
- Confidentiality: Most companies use some sort of non-disclosure agreement (NDA) these days. When they don't, the licensing agreement needs this clause. The confidentiality section must say which parts of the license are secret. This clause is also a good place to strengthen an NDA if it's weak.
- Considerations: This section covers payment issues. Factors such as royalty calculations and annual payments need inclusion. This section is important in exclusive licenses in particular. Otherwise, the licensor may get less money than expected.
- Definitions: Basic agreements rarely use definitions since they're short and simple. Complex agreements need more language. Some of it gets confusing. The definitions section clarifies the terms in the licensing agreement.
- Diligence: Getting an exclusive license is a big deal. The inventor only makes money from one source. As such, the inventor is taking a risk. This section makes sure that the licensee does everything possible to earn money, too. That way, the licensing of the intellectual property will lead to royalty money for the licensor. Basically, the diligence section guarantees that the licensee tries hard.
- Export rules: Some licensees import and export licensed products and intellectual property across borders. This clause must state how the licensee should follow the rules of the applicable countries in question. Export rules are especially important in military contracts.
- Favored nation status: Licensees don't want to overpay. This clause protects them against paying more than other parties for the same license. The language usually states that the licensee only pays what the party paying the smallest amount pays. Still, other factors like upfront fees and royalty schedules make comparisons difficult. The only way to know for sure whether a party pays more is through a pure cash transaction.
- Force majeure: Sometimes, an unexpected event ruins the basic understanding of a licensing agreement. For example, a building fire could ruin a manufacturing business. This clause states what happens in such extreme situations.
- Improvements: An innovation is fluid. Someone might notice a way to make it better. When that happens, the licensing agreement should say what the rules are. Both the licensor and licensee are capable of improving the innovation. The licensee could feasibly change the invention enough that the new version is worthy of a patent. The licensing agreement must say who has the rights in such situations. Other factors along these lines also need precise language.
- Infringement: This section has to address several potential issues. A previous licensee could infringe on the intellectual property. The current party also could after the licensing agreement expires. The infringement section lists how to handle such problems. It also shows how penalty payments work. If the licensor and licensee are both victims of infringement, the clause should list the percentage split on penalties.
- Inspection rights: Some inventions are processes and products. The use of these licenses comes with expectations of standards. The licensor should write an inspection clause into the agreement. That way, the licensor can check to see that the licensee is using the license the right way.
- Intellectual property: Many licensing agreements cover more than one piece of intellectual property. This clause must say which properties are okay to use. It also must list the specific types of intellectual property involved in the agreement. An inventor may own a patent on something that includes additional intellectual property. The agreement should state whether the licensee has the right to use this property.
- License restrictions: Inventors are understandably protective of their licenses. When they sell the rights to these innovations, they want to keep some control. The restrictions section lists what rights the licensor maintains. It also discusses how past and future licensees will impact the current agreement. Nonprofits and universities should also reserve rights. That way, they can still use a license even if they sign an agreement with a licensee.
- Parties involved: The licensor and licensee add information such as legal names, contact details, and addresses.
- Rights and privileges: The granting of a license is a risk for both parties. The licensing agreement should explain what the licensee can do with the license. It should say whether the license is exclusive or not. It should also discuss whether the licensor gets to use the license or cedes all rights to the licensee. The territory of the operating license and terms of the agreement also need clarification. Finally, the agreement should note whether the licensee can sub-license the invention. The contract must include all of these details. Otherwise, a dispute is likely.
- Schedules: This is the master list of all sections that the licensing agreement covers. A person can read the schedules section to find information easily. Doing so is quicker than reading through the full document. When an agreement needs changes, people find that it's easier to modify the schedules section than the rest of the document.
- Termination: This part of the agreement states the terms that will end the contract. Each party should have the right to end the agreement in some situations. This section should spell out what those are. It should also list explanations as to why a party would want to terminate in such situations. The termination clause also must cover whether a party must pay penalties for ending the agreement.
- Warranty: This is similar to any other warranty that you'd get with a purchase.
A few other issues fall into the category of basic boilerplate language. Examples are:
- Country of Law: This clause simply states which country's laws will act as the basis of the licensing agreement.
- Integration: This section proves that the current agreement is the primary one for the license.
- Language: Some agreements involve multiple languages. The document shows whether one language is enough. If not, the language must have the same translation in all others. Incorrect translations can lead to misunderstandings and lawsuits.
- Modifications: This clause states the rules about agreement changes. The parties may have the right to alter it verbally. Alternatively, the contract can require that they make any changes in writing. The modifications section should cover individual sections if some but not all changes require written proof.
- Notices: This part is the payment section. It lists the schedule and any rules about payment. It also covers notices about payment changes.
- Signatures: This section is where both parties type and sign their names. It should include the typed section since many personal signatures are hard to read.
What Are the Types of Licensing Agreements?
Intellectual property licensors use three main types of licensing agreements. They are:
- Exclusive license: A licensee who gets this license is the only one who can use the intellectual property. Even the licensor cedes rights to the license during the length of the agreement. This type of license costs the licensee much more.
- Non-exclusive license: A licensee has the rights to use the intellectual property. The licensor also has the option to sell it to others, though. Non-exclusive licenses have the greatest number of licensees. That's because many licensees have the right to use the same intellectual property.
- Sole license: The licensee has the sole right to the licensing of the intellectual property. The licensor also keeps the right to use it. This is similar to an exclusive license. It's more favorable to the licensor, though. This type of license usually costs more than a non-exclusive one but is cheaper than an exclusive license.
What Issues Does a Licensing Agreement Cover?
A licensing agreement can cover any or all of the following issues:
- Service mark
- Trade secret
Which Parts of a Licensing Agreement Are Most Important?
From a business perspective, the licensor has almost all the power in a licensing agreement negotiation. This party owns the brand, trademark, or invention that someone else wants. The licensor has control over usage of the innovation. Anyone who wants it must agree to the licensor's terms.
During the negotiation, the licensor should focus on the following:
- Price: The main purpose of innovation in the business world is to make money. The licensor can and should hold out for the highest possible financial agreement. Many licensees will want to add a mechanism to base the license cost on actual sales, which is reasonable.
- Exclusivity: Having the only license to an innovation is a major competition advantage. For example, think about a wireless innovation that increased download speeds by a factor of ten. The wireless service that purchased an exclusive license for this technology would dominate the market. The licensor could probably make more money by licensing the technology to everyone, though.
- Rights: In most instances, a licensee will ask for full rights to a license. Whether the licensor grants this privilege or not depends on the situation. A licensee could use the rights to do research internally that could lead to further innovation. This advance would negate the value of the licensor's innovation. For this reason, the licensor should limit license rights as much as possible.
The royalties from a licensing agreement are usually 6-10 percent. It does vary depending on factors like the quality of the intellectual property and the licensee's experience and need.
Some licensors don't expect royalty guarantees in contracts. Others demand them. A licensor should always try to get the most money possible at the start of the licensing agreement.
Another form of protection is to base extensions on royalties. A licensor will expect the licensee to pay a set amount over time. If that happens, the licensee gets to renew the agreement. If it doesn't, the agreement automatically ends.
What Are the Largest Areas of Concern With a Licensing Agreement?
With so many areas of negotiation for a licensing agreement, anything can cause problems. That's especially true if the attorney who writes the licensing agreement uses language that's too broad. Still, four areas are the most likely causes of a licensing agreement dispute:
- Net sales: Since money is what matters the most in a licensing agreement, it's often the biggest sticking point. Many agreements focus on a percentage of gross revenue. The language matters, though. A licensee should want concessions for returns and allowances. These sales should come out of the gross revenue calculations.
- Royalties: Any royalty calculations must have transparency. Both parties should have the ability to calculate expected royalties over time. Then, the language of the agreement should include contingencies if the sales aren't as strong as expected. A mechanism must exist to protect the spirit of the agreement about royalties.
- Guaranteed payments: Most licensing agreements include minimums. The licensor will get at least this much on the scheduled date regardless of sales figures. Since different accounting practices can impact the registered date of a sale, the language must specify how to calculate revenue above the minimum. An unhappy licensee could also sue over guaranteed payments, claiming that the licensing agreement payments are too expensive.
- Quality control: The licensing agreement must state expectations for products and services. It should also detail methods to verify that the licensee honors the agreement at all times. Even a single quality control failure can do massive damage to a brand.
What Are the Dangers of Not Making a Licensing Agreement?
The main areas of concern are the same for licensor and licensee. With an agreement, both parties have an understanding of how to approach intellectual property. Without one, the parties face the danger of lost time and money plus the frustration of a failed business negotiation.
When Would Someone Use a Licensing Agreement?
Think of the situation from the perspective of a clothing manufacturer. Brands like professional sports teams, music artists, and movies all add value to a shirt.
A licensor would want to manufacture goods that use these brands. The licensor would want payment for the license. The license agreement is how the two parties work out a deal that benefits both parties.
What Is an End User Licensing Agreement?
The End User License Agreement (EULA) is one of the most important documents for a software developer. This agreement gives the user the ability to use the product. In exchange, the user agrees to honor any restrictions listed in the EULA.
The reason for the EULA is that a piece of software is effectively a rental. Even a permanent purchase of the product doesn't give the user ownership of the product — just unlimited usage of it. Without the EULA, the user could take the ideas of the software and use them in ways that would damage the licensor.
An EULA has interesting acceptance terms. Legally, a person accepts an EULA by breaking the plastic surrounding the software product. To avoid accepting the EULA, the person must return the unopened package to the licensor. In the digital era, licensees must agree to terms online before downloading digital products for personal usage.
How Can a Person Create a License Agreement?
Hiring an attorney is the best way to handle any type of contract. A person or organization can create a general purpose license agreement by following a few steps, though. Just keep in mind that a broad agreement can cause problems in court cases and arbitration hearings.
The steps for making a license agreement are as follows:
- Download a template for a licensing agreement.
- Choose your role as the licensor or licensee.
- Define the license(s) in the agreement.
- Decide whether the license is exclusive or not.
- Settle the matter of fees and payment schedule.
- Add a renewal date and rules.
- Fill in the appropriate blanks in the licensing agreement.
Given the details above, anyone can see that licensing agreements are complex. The safest strategy is to post your legal need in the UpCounsel marketplace. The attorneys at this site have plenty of experience writing licensing agreements that fit anyone's need. Whether you're a new inventor or represent a growing business, UpCounsel's lawyers can protect your interests and help you grow your brand.