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Stacking, Packing and Pending Application Patent License Royalty Provisions
Practical Law Legal Update 6-577-3805 (Approx. 5 pages)
Stacking, Packing and Pending Application Patent License Royalty Provisions
by Practical Law Intellectual Property & Technology
| Published on 12 Aug 2014 • USA (National/Federal) |
A discussion concerning certain royalty provisions in a patent license. Specifically, the discussion addresses royalty stacking and packing and royalties payable for pending patent applications and how these provisions could affect the overall royalties payable under a patent license.
The royalties that the licensee pays for a licensed product may significantly impact the commercial viability of that product and potentially the licensee. Therefore, counsel should always evaluate the magnitude of the royalties payable under the license. This typically entails considering:
- The circumstances of the licensing transaction.
- The industry in which the parties operate.
- The particular patented technology to be licensed.
- How that technology affects the commercial viability of the licensed product.
These considerations could raise important issues that affect the magnitude of the royalties, such as whether:
- The patented technology is incorporated in a product that:
- includes various components or features that may also be separately patented by third parties; or
- is sold as part of a kit or other combination of products.
- At the time the parties sign the patent license, the licensed patent asset consists only of a pending patent application.
Counsel must understand these issues to effectively represent the client in various patent licensing transactions.
Royalty Stacking
A company seeking to commercialize a product incorporating patented technology should consider whether it may need to enter into royalty-bearing patent licenses with multiple patent owners. This often occurs for products that incorporate multiple technologies, such as electronic devices. If multiple licenses are required, the multiple royalty obligations could be significant and prevent the company from successfully commercializing its product.
A patent licensee therefore often seeks to minimize this risk by including a royalty stacking provision in each of its license agreements covering the licensed product. This type of provision typically allows the licensee to reduce its royalty obligations to the licensor by a certain agreed-on amount under certain situations where the licensee enters into a license agreement with a third party concerning other patents that cover the licensed product.
For example, the licensee can request that the agreement either:
- Allow it to reduce a portion of the royalties it must pay to the licensor if it has to pay royalties to third parties.
- Include a ceiling for all of the stacked royalties on the licensed product. If the total stacked royalties exceeds the ceiling, each of the licensors has its royalties reduced on a pro rata basis so that the total royalties owed to the licensors are no more than the ceiling.
However, a royalty stacking provision is contrary to the licensor's desire to maximize its licensing revenue. As a result, a licensor typically seeks to either:
- Prohibit royalty stacking provisions altogether.
- Minimize any reduction of its royalties due to a royalty stacking provision.
Where a royalty stacking provision is unavoidable, the licensor can consider limiting royalty reductions by allowing them only where any of the following occur:
- The licensee's need to pay a royalty to a third party is based on an opinion of counsel acceptable to both parties, or a court order.
- The third-party patent claims broader subject matter that dominates the narrower claimed subject matter of the licensor's patent, for example, where the third-party patent claims a device and the original licensor's patent claims a particular material for the device.
- The third-party patent covers a commercially essential feature of the product.
In addition, if the parties agree to a ceiling for the total stacked royalties, the licensor should consider imposing a floor below which its royalties would not fall.
Royalty Packing
In addition to a royalty stacking provision, where the licensed product is sold as part of a kit or as a component of or otherwise in combination with other components or products, the licensee should seek to base the royalties on the net sales price of the "smallest salable patent-practicing unit" (see LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67 (Fed. Cir. 2012). Otherwise, the licensor could be compensated for non-infringing components if the licensee pays royalties on the net sales price of the kit or combination. On the other hand, the licensor will likely insist that the licensee should pay royalties based on the net sales price of the kit or combination if it can successfully argue that the patented technology drives demand for the kit or combination (see LaserDynamics, 694 F.3d at 67 - 68).
Both the licensor and the licensee should identify the smallest salable patent-practicing unit of the kit or combination and whether the entire product should instead be the royalty base to ensure that the royalties payable under the patent license are:
- Aligned with the requirement under 35 U.S.C. § 284 that royalties should be reasonable in light of the patented technology.
- Based on economic and factual foundations that reflect the patented technology's economic value in the relevant marketplace.
This should lead to royalties that:
- Fairly compensate the licensor.
- Provide the licensee with a reasonable opportunity for the licensed product's commercial success, which should also be in the licensor's best interest.
Royalties for Pending Patent Applications
If, at the time the parties enter the license agreement, the licensed patent asset consists only of a pending patent application on which no patent has yet issued, the licensee may seek to do either or both of the following to limit its financial obligation before the patent issues:
- Eliminate the payment of royalties altogether or lower the royalty rate or amount until a patent issues with a valid claim covering the licensed product.
- Limit the time period when royalties are payable before a patent issues.
However, the licensor may seek to rely on provisional rights under Section 154(d) of the Patent Act (35 U.S.C. § 154(d)) as a basis to obtain royalties before the issuance of a patent. Specifically, a reasonable royalty may be obtained under a published patent application:
- From anyone who:
- makes, uses, offers to sell or sells the invention claimed by the published patent application; or
- uses, offers for sale or sells in the US or imports into the US products made by the process claimed in the published patent application.
- Where each of the following conditions is met:
- the patent application has been published;
- the person has actual notice of the publication; and
- the invention claimed in the published patent application is substantially identical to the invention ultimately claimed in the issued patent.
In addition, the licensee may agree to pay royalties before a licensed patent issues where the licensee obtained access to licensor confidential information that helps the licensee commercialize the licensed product. In this situation, the amount of any royalty payable for know-how or other unpatented technology before the patent issues should be less than the royalty payable during the term of the patent (see Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979)).
For sample provisions addressing a variety of patent royalty issues and drafting guidance, see Standard Documents, Patent License Agreement (Pro-licensee) and Patent and Know-how License Agreement (Pro-licensor).
For more information on patent licensing generally, see Patent License Checklist and Practice Note, Patent License Agreements.