Biotech licences are very often lengthy contracts running to
30, 50, 70 or more pages. This reflects the fact that the
licences are usually long-term, worldwide and exclusive
arrangements involving products of strategic importance to at
least one of the parties.
Many topics must be covered in the contract for it to
effectively form the basis of the parties' relationship.
Two of the most important topics are the licence grant and the
royalties. The parties are well-served to devote their maximum
attention and thought to these clauses, since they will in
large measure decide whether the parties receive the benefits
they expect from the relationship.
This article considers some issues for licensors and
licensees when structuring royalties on sublicensing revenue to
licensees from the licensed technology.
Biotech licences very often charge royalties on 'net
sales' by the licensee and its sublicensees. Net sales are
typically defined as the gross invoice price of the products
less any deductions that effectively reduce the selling price
(e.g., discounts or returns) and any extraneous charges (e.g.,
insurance, duties or shipping). This royalty structure
effectively creates a carrying charge on the products that must
be collected on sales by both the licensee and its
sublicensees. So long as the net sales royalties constitute a
satisfactory return to the licensor, any other financial
arrangements the licensee may make with its sublicensees are of
no importance to the licensor.
The royalty situation becomes more complicated when the
licensor also wants to share in the total revenues (from all
sources) its licensees may make from the licensed technology.
This is the case with profit-sharing arrangements, which have
become more common in the biotech industry.
In these broader revenue-sharing arrangements, licensors are
concerned that their licensees will make earnings from the
licensed technology that fall outside what is royalty-bearing
under the licence. Indeed, their licensees may actively devise
ways to find such non-royalty-bearing revenues.
In addition to licence fees, milestone payments and
royalties received by licensees, licensors will want the
royalty provisions to cover 'all other consideration'
received in connection with the 'licence, sublicense,
assignment or transfer of rights' with respect to the
licensed technology, as well as all 'other operating
income' received with respect to the development and
commercialization of the licensed technology. To guard against
licensees avoiding royalties by taking non-monetary
consideration, licensors will want the royalties to also
capture the fair market value of any non-monetary consideration
Though these types of clauses protect the licensor, they may
be problematic to licensees who do not want to pay royalties on
certain technology development or commercialization
arrangements with their partners.
One such arrangement is where the licensee sublicenses the
technology to another biotech or pharmaceutical company, and
receives back a research and development contract. Licensors
will want to capture the research and development revenues to
the licensee as monies earned from the licensed technology.
However, with research and development activities come
expenses, so licensees must be careful to ensure the
royalty-bearing revenues are their research and development
profits, and not their gross income from the research and
Another arrangement that licensees may use with sublicensees
are equity investments in the licensee by the sublicensees.
Licensees will typically want to ensure these equity
investments are not captured by the royalty provisions of the
licence. Licensors may resist this exclusion, however, since
these investments may be done based on valuations that are very
favourable to the licensee. The investments are really just a
mechanism to either fund research in the licensee or to pay for
the technology sublicensees.
McCarthy Tétrault Notes:
These examples illustrate the level of detail that needs to
be considered in structuring royalty arrangements in biotech
licences to ensure a fair bargain that protects both
parties' interests. Lack of attention to royalty terms when
negotiating biotech licences is a recipe for future disputes,
due to the many ways — both closely related and
not-so-closely related to the licensed technology —
that licensees can make returns from licensed
The content of this article is intended to provide a
general guide to the subject matter. Specialist advice should
be sought about your specific circumstances.
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A recent Saskatchewan Court of Queen's Bench decision allowed a court-appointed receiver to sell and transfer intellectual property rights free and clear of encumbrances, finding that a license to use improvements of an invention was a contractual interest and not a property interest.
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