United States: The Anatomy of a Technology Transfer Agreement

by Barry Evans

While details vary from transaction to transaction, agreements affecting technology transfers contain two essential elements: the sale or grant of a license under the proprietary rights (e.g., the patent rights and confidential information) of the owner of the technology; and a contractual obligation to transfer, (i.e., disclose) confidential information.

Purchase and sales transfers in corporate acquisitions are relatively simple because the sale of patents and the transfer of information take place more or less simultaneously on the effective date of the transaction. Far more complicated are license transactions. These long-term contracts may determine the economic and technological fortunes of the licensor (transferor) and the licensee (transferee) for decades. It is very important to carefully articulate and integrate the license and technology transfer elements of the transaction and to draft tight, unambiguous instruments. The consequences of not doing so may be very costly, and some of the pitfalls include: inadvertently agreeing to transfer too much technology in the future, granting overly broad rights under patents, failing to access a licensee's improvements via a grantback clause and the costs and distractions of litigating unclear clauses.

Before examining how the many clauses in a technology transfer agreement work, it is useful to clarify the distinctions between technology transfer and patent licensing. Technology transfer obligations per se require the disclosure of confidential information in the form of plans, designs, specifications, formulas, data, processes and recipes, (i.e., know-how) and may require meetings between the transferor and transferee over some considerable periods of time. This is particularly so if improvements are to be conveyed. The scope and duration of the technology transfer(s) must be clearly delineated in the agreement.

In contrast, the patent license simply grants the licensee the freedom to practice under the licensor’s patents, the prospective freedom to practice under the licensor’s future patents as may be granted on existing and to-be-filed patent applications and the right to use the confidential technical information actually disclosed to the licensee. The actual license grant language may be a single sentence granting (exclusive or non-exclusive) rights in certain defined patent rights in a certain defined field.

The precision of any technology transfer agreement depends upon the definitions. The definitions identify the patent rights and confidential information being licensed (the "Licensed Rights"), the field in which the licensee may practice (the "Field") and the improvements to which the other party has license and/or technology transfer rights (the "Improvements"). These clauses must be mutually consistent. Also important are the clauses that invoke these definitions and set forth the grant of rights and the obligation to transfer information, the clauses that set out the licensee’s obligation to pay royalties, the license and information grantback clauses and the termination clauses. While technology transfer agreements have many other significant clauses, these issues comprise the essential short list.

The definition of Licensed Rights typically includes a recitation of certain existing patents, patent applications and confidential know-how. The definition should include or exclude, as negotiated, patent applications filed after the effective date of the agreement. A typical definition includes patent applications related to those in existence on the effective date, (i.e., so-called continuation-in-part patent applications filed after the effective date but based on patent applications pending on the effective date).

Prior to the implementation of the General Agreement on Tariffs and Trade (GATT) on June 8, 1995, this clause had the effect of extending the license to rights originating long after and extending even longer after the effective date of the agreement. Now under GATT, patent applications filed on or after June 8, 1995 expire 20 years from their earliest effective filing date. Therefore continuations and continuations-in-part in the Licensed Rights has become far less onerous to the licensor since all such rights must expire no later than 20 years from the effective date of the agreement.

It is relatively unusual, and not in the licensor’s interest, to include "new" patent applications filed after the effective date because to do so would have the effect of extending the licensee’s rights indefinitely. The licensing or not licensing of such newly originated rights is best handled in the improvements clause.

The Field definition serves to restrict the licensee’s practice under the Licensed Rights to a limited product line and/or geographical area and/or market. Extreme care must be given to field definitions or valuable rights may be unintentionally given away. Crystal balls must be consulted to best guess how a particular Field will develop and to assess who among the licensor, licensee, or another licensee can best develop the technology in the Field. Terms and nomenclature must be clear-cut to avoid ambiguity. It may be helpful to include specific examples of activities within and outside of the Field.

This clause is usually short and sweet. Rights (exclusive or non-exclusive) are granted to the licensee under the Licensed Rights to practice in the Field for some specified term. Obviously, the definitions of Licensed Rights and Field are all-important.

Covenants in the agreement obligate the owner (transferor) to disclose (transfer) confidential technical information to the transferee. It is important to carefully delineate the metes and bounds, particularly the time limits for the technology transfer. The detailed information disclosed may be broader or narrower than the scope of the Licensed Rights or the scope of the Field. If broader, it falls to the Licensed Rights and the Field definitions to confine the licensee's activities to the agreed area of practice. The information to be disclosed will usually be incorporated in plans, specifications and data relating to specific products or processes in the Field. Consultation with and instruction of the transferee may also be involved.

As in the initial license grant and information transfer, the grant of rights to practice under the licensor’s future patent rights on improvements and the obligation to disclose these future technology improvements must be carefully and independently considered. Where a license grant is exclusive, the licensor may be willing to both grant future rights and to disclose future improvements within the Field. Where the license grant is non-exclusive, however, the licensor may not be so ready to do either, particularly where the licensor is a competitor of the licensee.

Most critical is the definition of improvements. The definition should be consistent with the definition of the Field. The same terminology and nomenclature as is used in the Field definition and elsewhere in the agreement should be used. Examples of what is understood by the parties to be an improvement, and what is not, may be helpful to avoid ambiguity.

For example, in a process license, should an improved catalyst be included as an improvement or are improvements limited to process conditions? In the license of a pharmaceutical, should a newly-found therapeutic indication be included within the definition? These questions and others must be addressed at the outset.

Once the definition is established, the separate considerations of granting a license under patents covering these improvements and transferring information about the improvements may be considered. Technology transfer agreements should have separate improvement license grant clauses and improvement information transfer clauses. The grant of patent license rights to improvements may include new patent applications filed well after the effective date of the agreement. A common device is to grant licenses under improvement, but only insofar as those improvement patents are dominated by the original Licensed Rights. A separate issue is whether the licensor is obligated to make disclosures of its new confidential information to the transferee and for how long and for what consideration. These clauses may affect the rights of the licensor/transferor to receive royalties and technology transfer payments for years after the effective date of the agreement.

The technology transfer officer must consider the basic conditional nature of a license grant in structuring the payment clauses. A license does not, without more, compel the licensee to use the technology or to make payments if it does not use the technology. Moreover, the licensee is specifically empowered by law to challenge the validity of the licensed patents. Therefore, any payments that are to be made unconditionally should be stated as such (e.g., by characterizing them as guarantee payments). Where a valuable information transfer accompanies the license grant, the guarantee payment should be substantial.

All other typical license payments -- for example, minimum royalties, milestone payments and running royalties -- are conditional, that is, they depend upon the licensee’s intent to use and/or actual use of the licensed and transferred technology. Even where covenants in the agreement require the licensee to diligently develop the technology, the licensor/transferor may only have a right of termination of the license if the licensee does not make the required payments.

A long stream of running royalties is obviously in the licensor’s interest. For that reason, licensors seek to tie the payment of royalties to the use of any of the Licensed Rights, in particular to the use of confidential information where no patent has issued, even after the confidential information has inevitably entered the public domain. There is no legal impediment to structuring the running royalty clause to obligate the licensee to pay royalties on confidential information in perpetuity, even where the information enters the public domain. (Warner-Lambert Pharmaceutical Company, Inc. v. John J. Reynolds, Inc. 178 F. Supp. 655, (SDNY) 1959). But a well-advised licensee/transferee will seek a declaration in the agreement that a paid-up license to the confidential information is granted as part of the license grant and the technology transfer.

Where patents are licensed, it is settled that the royalty obligation may not be extended beyond the expiration of the patents. (Brulotte v. Thys Co., 379 U.S. 29 (1964)). And where patents and confidential information are licensed, unless the licensor clearly structures the clause to distinguish between the patent royalty and the confidential information royalty, such that there is a royalty reduction upon patent expiration, a royalty obligation extending beyond patent expiration will not be enforceable. (Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979); Pitney Bowes, Inc. v. Mestre, 701 F.2d 1365 (11^th Cir. 1983)).

The royalty obligation can, of course, be extended and made essentially evergreen by granting rights to patent applications filed after the effective date and by granting rights to information developed after the effective date -- assuming of course that such rights and information are used by the licensee. The latter will also require ongoing information transfer. Whether ongoing obligations are worth the additional royalties depends upon the economic and technical circumstances of each case.

Licensors are also well-advised to remember that the emergence of new or alternative technologies may prompt a licensee to abandon, or, if it has the right, to terminate the license long before the patents expire. This may also happen, for example, if the claims of the licensed patents do not cover the licensee’s activities or if patents are not issued on licensed patent applications. This is an incentive for the licensor to maximize up-front payments.

Grantback clauses bring up the same considerations already discussed -- but with the parties' roles reversed. Where the licensee/transferee is expected to develop the transferred technology, it may be important for the licensor/transferor to access the improvements for its own business purposes. The definition of the license rights to be granted back is important as is the definition of the field in which the licensor can practice the licensee's improvements. Often the licensor is licensed to use the granted back rights outside the Primary Field granted to the licensee. Separate consideration must be given to the terms and conditions of the actual information transfer by the licensee to the licensor.

The excitement, sense of accomplishment and good will that attend the conclusion of a technology transfer agreement may last for years. However, frequently, they do not. After the technology has been transferred and up-front payments have been made, any number of factors can derail the relationship between a licensor and a licensee. These may simply be the normal difficulties encountered in developing a new technology, changing technical and economic pressures on the licensee or legal difficulties confronting the licensor in perfecting the Licensed Rights. Often, cultural differences, language problems or just plain human nature may be the cause. It is a virtual certainty, however, that an ongoing obligation to pay hefty royalties will rankle the licensee as time passes with the idea: what have they done for me lately? This is particularly true if its recent contributions to the technology are perceived to be more valuable than the licensor’s earlier technology transfer.

For these and other reasons, the drafter of the technology transfer agreement must pay close attention to the termination clauses and build exit strategies into the agreement that make the most out of what may become a difficult situation. Many technology transfer agreements permit the licensor to terminate only in the event of a "material breach". But, unless material breach is a defined term, the parties may find themselves in court litigating whether or not an event of alleged breach that has taken place is or is not material. It is therefore to both parties’ advantage to recite in the agreement at least those events and circumstances that are believed to be material.

Where the happening or non-happening of an event is still subject to interpretation -- for example, was the licensee diligent in developing the technology or not -- the licensor may still find itself in court after an unsuccessful attempt to unilaterally terminate the agreement. A useful approach is to set unambiguous standards measured in expenditures, revenues, units of production, royalty payments or the like so that the occurrence of the event defined as a material breach cannot be reasonably argued by the licensee when it happens or does not happen. Carrying this notion further, it may be advantageous for the licensor to establish several different minimum levels of the licensee’s expected performance. This may be a "low" level of running royalties, which if not paid, sets up the licensor’s absolute right to terminate even though a higher, but more ambiguous level of performance, may or may not arguably have been reached.

The licensee may also articulate precise events which are deemed to be a material breach. These may include, for example, failure of the licensor to transfer certain information and failure of patents to issue. Since the licensee is in a better position to simply abandon the license, its rights to terminate the agreement are not as critical.

Technology transfer agreements are complex, long-term arrangements between proprietors and users of technology. While clairvoyance is helpful, at the very least, substantial care should be given to the negotiation and drafting of the license and information-transfer terms so that the agreement can fairly serve the needs of the parties as technology and markets change.

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.