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American Bar Association

ABA Section of Business Law

Volume 12, Number 6 - July/August 2003

Passing it on
Beware new ground rules, new hazards
    By Jim E. Bullock

The technology license can be a complex mesh of masterfully crafted, borderline-run-on sentences that press the envelope of grammatical correctness, weaving numerous clauses and cross-references into a roaring confluence of business and legal issues, meticulously outlining specific and intricate details with the precision of NASA technology.

Or, it can be simple.

Either way, there are five basic issues to address:

  • What is the duration and nature of the license?
  • What are the access and transferability rights granted by the license?
  • What are the permitted uses and restrictions established by the license?
  • What ownership rights are granted and reserved by the licensor?
  • Are there hidden terms in the license?
And — just like key ingredients for a fine soufflé or the star players on a championship basketball team — these five issues form the core foundation of the license grant. With all of the privileges or responsibilities surrounding the use of the technology hinging on the license grant, these five issues determine to what extent the licensee may use the technology and are, therefore, critical to the success and usefulness of the technology license.

The duration and nature of the license grant — This is the initial issue to address, for it affects the value, both to the licensor and to the licensee, of the other elements of the license grant by determining for how long the licensee may use the technology and whether other entities may use the technology (including the licensee's competitors).

For how long will the licensee have the right to use the intellectual property? If for a finite period of time (such as five years), then the license is a "term" license; at the expiration of the term, the licensee's right to use the intellectual property expires, and the licensor is free to license it to others or charge the licensee additional fees for continued use of the intellectual property.

On the other hand, a "perpetual" license continues unending absent an intervening event canceling or terminating the license (such as the licensee's material breach of the license restrictions).

Whether the license should be perpetual or term is a product of the practical use(s) of the technology, the licensor's business model, and the respective negotiating leverage of the licensor and the licensee. However, the parties must set the duration; otherwise, it will be set for them (that is, copyright law will apply a default license for the duration of the underlying copyright, 17 U.S.C. §203; but, under the Uniform Commercial Code, §2-309(3), the license without a term may be terminable at will with reasonable notice).

If the licensee will have sole use of the technology to the exclusion of other potential licensees, then the licensee is receiving an "exclusive" license to use the technology, and the licensor is surrendering its ability to license the technology to other parties — including the licensee's competitors — for the duration of the license. Moreover, an exclusive licensee has standing to bring an infringement suit against unlawful use of the technology by another (in other words, the exclusive licensee need not rely on the licensor to vindicate a violation of its exclusive use of the technology). 17 U.S.C. §201(2), 501(b); see also Prima Tek II, LLC v. A-Roo Co., 222 F.3d 1372 (Fed. Cir. 2000) (a licensee holding all substantial rights has standing to sue for infringement).

If the licensor reserves the right to license the technology to other parties, then the license is a "nonexclusive" license. The licensor can maximize the potential revenue value of the intellectual property by granting numerous licensees the right to use the technology; and the licensee may be only one of many entities using the technology (including its competitors). Unless the license declares its exclusivity in writing, the license is a nonexclusive license. See 17 U.S.C. §204; 35 U.S.C. §261.

Access and transferability rights — This element of the license grant defines who may actually use the technology by determining who will have access to the technology and whether the license will be transferable to another.

Who may use the licensed technology? Only the licensee's employees? Or may the licensee's contractors, or other agents, access and use it? May the licensee outsource its use of the technology (that is, hire another company to use the technology on its behalf)? A license may be "personal," permitting use only by the licensee (that is, its employees); or, the license may allow the licensee to grant access to the technology by other parties, such as its agents.

Typically, licensors want to limit access rights to the specific licensee as a means of protecting its financial interests in the technology (such as reserving the right to charge additional license fees for additional access) as well as protecting against dilution of its trade secrets in the technology. Therefore, if the licensee requires access beyond its employees — for example, contractors that help maintain or operate the licensee's business or third- party outsourcers — the licensee should negotiate these broader access rights.

A licensor also should be careful to balance the permitted use (discussed below) with the access rights it grants or else face creating a much broader license grant than intended (for example, a license to the licensee and "its agents" for the licensee's "business purposes" may be broader than a license to the licensee, alone, for its "internal purposes").

A "nontransferable" license is simply that — the licensee cannot assign or otherwise convey the license to any other party without the licensor's consent. The opposite is, of course, a "transferable" license, which the licensee may freely assign or convey to any other party.

Indeed, the licensor may limit transferability further by precluding "a transfer by merger, acquisition or consolidation, or operation of law." Thus, for example, if the licensee later divests the division using the licensed technology, it must obtain the licensor's consent for the divested entity to continue using the licensed technology following its merger into the acquiring company.

Whether the license should be "transferable" or "nontransferable" depends, among other things, on the parties' respective needs and the particulars of the business arrangement. The licensee may want the right to assign or otherwise convey the license rights to another entity (for example, to a subsidiary or an asset-holding company for tax purposes).

However, the licensor may oppose any transfer of the license as a means of protecting its intellectual property rights in the technology (that is, protecting against loss of its trade secrets or limiting the risk of unlawful copying) or protecting other interests in the technology (for example, preventing the transfer of the license to another party absent payment of additional consideration to the licensor).

Unless the license grant specifies otherwise, by default it may be nontransferable (the copyright law provides that a license to use a copyright is nontransferable, unless otherwise agreed. 17 U.S.C. §117(b)).

Some transactions may even include a hybrid of transferable and nontransferable license rights. In an original equipment manufacturer agreement (OEM), the license may permit the OEM- licensee to sublicense the licensor's technology to the OEM- licensee's customers but expressly forbid the OEM-licensee's transfer of the original license grant to any other party.

Permitted uses and restrictions in the license — This portion of the license grant — the permitted uses and restrictions — is the core component of the grant, for it determines what rights to the technology are granted. It pulls together the "duration and nature" elements with the "access and transferability" elements by defining the "what" that the licensee can use for the duration of the license and to which the licensee can permit access (or can transfer).

This portion of the license grant answers the basic question: What may the licensee do with the technology? The issue in drafting this portion of the license grant is which of the licensor's exclusive rights will the licensee get to use? Under copyright law, the copyright owner enjoys the exclusive rights to make copies, prepare derivative works, sell and distribute copies, and perform and display the work publicly. 17 U.S.C. §§107-122. And, under patent law, the patent holder enjoys the exclusive right to exclude other parties from making, using, offering to sell or selling, or importing into the United States a patented invention. 35 U.S.C. §271(a).

The license can include any or all of these rights and can be as defined or narrowed as the parties agree. For example, it may grant the licensee a limited ability to copy the technology but not to make derivative works or distribute the copies. It may grant the right to "perform" the technology but not publicly. And it is a good idea for the license to state whether it includes the right for the licensee to use future releases or versions of the technology.

The bottom line, however, is that this section defines what use the licensee may make of the technology. If a use is not granted, it is precluded (S.O.S. Inc. v. Payday Inc., 886 F.2d 1081 (9th Cir. 1989)). A licensee commits an act of infringement if it makes use of the technology outside the license grant. See General Talking Pictures Corp. v. Western Electric Co., 305 U.S. 124 (1938) (J. Brandeis, "[a]ny use beyond the valid terms of a license is, of course, an infringement...").

In addition to these elements of "use," the license grant should set the "scope" of the permitted use — in what manner, or for what purposes, may the licensee use the technology? The scope of the license typically ranges from use limited to that strictly benefiting the licensee only to use limited to benefiting other parties only.

At one end of the spectrum, some licenses permit only "internal use" or use for the licensee's "internal business purposes," thus permitting the licensee to use the technology solely for the benefit of the licensee and not other parties. For example, the Neiman Marcus department store chain may license database software from Oracle and point-of-sale (POS) software from Ariba Technologies to help it monitor variances between its warehouse inventory levels and trends demonstrated by its POS data, but the license may not permit Neiman Marcus to provide the same POS/inventory tracking for other companies — in other words, Neiman Marcus could use the software only for its "internal use."

At the other end of the spectrum, some technology licenses are OEM licenses permitting the licensee to embed the licensed technology within different functionality, distribute the combination to end users, and provide support for the end users but not permitting the licensee to use the technology for its "internal use."

Cellular telephones are an excellent example of the OEM license. The phone's physical components may be constructed by Motorola or Nokia, for example, possibly incorporating licensed technology from other companies. Then, software is licensed — let's assume, from Sun Microsystems, Microsoft or IBM — and loaded into the hardware. Then, the phone is distributed by cellular services companies such as Sprint or AT&T Wireless (who may embed even more software, some or all of which it may have been licensed from an OEM licensor, depending on the particular service plan purchased by the end user).

Between these two categories lie variations — for example, the third-party administrator-licensee may require a license that permits it to use technology for the benefit of other parties as well as its internal, corporate purposes (for example, the back office bookkeeping company that administers payroll for various companies as well as itself).

Alternatively, the service provider-licensee may require a license that permits it to use the technology to provide a specific service to other parties, thus permitting these parties indirectly to use the licensed technology via the service provider's technology without actually permitting the end user directly to access the licensed technology (for example, Internet service providers may license the use of technology to help them provide e-mail, e-calendar and Internet access services to its customers).

This section can be as narrow or as broad as the parties agree given their respective leverage and needs and the particular use(s) of the technology.

Additionally, this section may set specific restrictions on the licensee's ability to use the technology. Here a licensor may restrict the licensee to using software only in object, or binary, code (that is, the 1's and 0's only computers and Stanford doctoral students can understand). Or, an OEM licensor may restrict the distribution of the licensed technology unless it is deeply embedded as an integral, indivisible — perhaps indistinguishable — element of the licensee's technology.

The licensor may restrict the licensee's ability to uncover the trade secrets inherent in the technology by precluding the licensee from reverse engineering, decompiling or disassembling the licensed technology. The licensor could restrict the licensee to a specific number of copies, users or installations of the licensed technology. This portion of the license grant, too, is flexible to suit the parties' needs and objectives.

Creation and reservation ownership rights — This portion of the license is so important to the respective rights of the parties that it often commands its own subsection distinct from the license grant. Here the licensor may grant the licensee the right to modify, enhance (or improve), or create variances of the licensed technology. This is also called creating "derivative works." 17 U.S.C. §101. Absent a license to do so, the law reserves to the licensor the exclusive right to create derivative works. 17 U.S.C. §106(2); 35 U.S.C. §271(a).

In those instances where the licensee is granted the right to make derivative works, this section should define who owns them. Unless the derivative work is considered a work- made-for-hire (work prepared by an employee within the scope of employment) or a specially commissioned work (a special category of work designated as "work for hire"), ownership of the derivative work is vested in the party creating it. 17 U.S.C. §101; Hi-Tech Video Prods. Inc. v. Capital Cities/ABC Inc., 58 F.3d 1093 (6th Cir. 1995). Therefore, if the licensor wishes to own derivatives of its technology, the licensor either should not grant the right to make derivative works or should seek to retain ownership of derivative works as a "work for hire."

This portion of the license can have a serious long-term effect on the parties' business. For example, the licensor that permits the licensee to own derivative works may find itself precluded from including certain functionality in later versions of its technology, due to the licensee's ownership of the derivative functionality. Likewise, a licensee that does not obtain the right to create derivative works may find itself unable to develop specialized functionality that it needs for its intended use of the technology unless created by the licensor. In that case, it may find its competitors obtaining the same or similar functionality in later versions of the technology. Thus it is evident why this portion of the license is so important and why, in some cases, it can be the subject of lengthy and intense negotiations.

Hidden terms and unintended consequences in the license — This element of the license grant best can be summarized in two words: due diligence. That is, due diligence in identifying hidden license terms or unintended consequences in the license grant or in other portions of the license agreement. After all of the effort in crafting the perfect technology license grant, some license agreements may contain terms that can, intentionally or unintentionally, undo some of the hard work. These are items which, alone, may appear unrelated to the license grant but do affect it as part of the overall license agreement.

For example, some licenses may be subject to payment of certain fees, while others are effective separate from the payment of fees (for example, on signature or on acceptance of other terms).

If effective on or subject to payment of fees, the licensee's use of the technology may be precluded until, frankly, its check clears the bank, so to speak (indeed, in the wake of the technology industry's "dot-bomb" era, some licensors may not consider that to be such a bad provision), and missing an installment or royalty payment could terminate the licensee's right to use the technology.

Both licensors and licensees should be aware of the effect of terminating the overall license agreement on the duration of the license grant. An agreement may provide that termination of the agreement will not terminate the license or that even a perpetual license is coterminous with the agreement in which the license is granted.

Spotting hidden terms and unintended consequences requires a focused eye, and a little experience can go a long way. The prudent business lawyer is best served by looking at the totality of the license agreement while working on the individual parts.

Each of these five issues contributes to the success and usefulness of the license grant. Trouble in any one of these five areas can have a damaging effect on either the licensor's or the licensee's rights — or both. But, when properly addressed, these five issues form the core of a strong license grant, which is critical to the success of the technology licensing transaction.

  • Use easy-to-read, concise sentences rather than Cirque de Soleil grammatical acrobatics in drafting the license grant.
  • Don't be too tricky. It's preferable that both the licensor and the licensee understand the license grant. Moreover, it is important that a reasonably prudent person could understand the license grant (particularly shrinkwrap and clickwrap license agreements) in the event the license lands on a judge's desk for interpretation. Make sure each party is given a reasonable opportunity to see and review any terms to which it will be held.
  • There are certain terms fairly standard in the industry: "perpetual," "term," "nonexclusive, nontransferable," "personal," and "internal use." If other terms are to be used, be sure the term either is defined in the license or is readily understood in the industry.
  • http://library.lp.findlaw.com/intellectualpropertylaw.html — Findlaw.com contains links to helpful articles on licensing as well as general intellectual property law topics.
  • http://www.ucitaonline.com — Uniform Computer Information Transactions Act (information on the proposed uniform computer software licensing terms based, in part, on UCC Article 2).
  • http://www.lesi.org – Licensing Executives Society International, an organization of persons interested in technology licensing; links to newsletters and journals.

Bullock is senior counsel at Sun Microsystems Inc., in Dallas. His e-mail is jim.bullock@sun.com.

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