CASRIP Newsletter - Fall 1997, Volume 4, Issue 3
Actual Royalty Rates in Patent-, Know-How- and Computerprogram-License Agreements
by Dr. Michael Gross, Attorney at Law, Munich, Germany
I . More and more companies are trying to improve the use of their technical and legal resources.The economic conditions and the growing internationalization of companies effect an increasing importance of the exploitation of know-how and intellectual property rights by license agreements.When drafting license agreements, a major problem is quite often determining what constitutes a „reasonable" royalty.
1. Where can we find royalty rates? In Germany only two publications of 1955 ( author: Lüdecke) and of 1977 (author: Fischer), and some indications in several publications exist. (1 please see Stumpf/Gross, The License Agreement,7.edition, Heidelberg 1997, page 86 with further references).
Recently three judicial decisions included royalty rates. Particularly well known is the Tchibo/Rolex case. (Tchibo is a German chain store that sells coffee and other goods). Tchibo sold imitation Rolex watches.The competent court, and at least the German Federal Supreme Court, ( 2 ) obtained expert opinions. The expert , who gave his opinion to the German Federal Supreme Court , said that a royalty rate of 12.5% - 20% of the net sales price would be fair and reasonable in general. In the case at hand, the expert decided that a rate of 12,5% would be fair and reasonable. The expert gave the following reasons for the rate of 12,5%: the wide circulation of the Tchibo watch; only a single event for a short time (10 days); and the prestige of the Rolex trademark. The expert had compared the above average rate (12.5%) with the „normal" royalty rates in German industry ( 1%-10%).
Another decision of the German Higher Regional Court in Stuttgart (3) ruled on the following case: the license agreement (field of use : special machinery) provided a down payment of 225,000 Deutsche Mark, which had to be paid within 2 weeks subsequent to the signing of the license agreement, a royalty of 6%, and a minimum license of 50,000 Deutsche Mark/year. If the licensed patent applications werel not granted, licensees would not be obliged to pay royalties. Paid royalties would have to be refunded. The down payment would not have to be repaid.
Another case was decided by the German Higher Regional Court in Düsseldorf (4) with the following facts: a royalty of 4% for a trademark license of a software distributor.
2. These royalty rates are not typical for all businesses, but rather depend on different factors. The analysis always requires a case by case decision. If Lüdecke and Fischer (5) drew the conclusion that firm formulas and fixed numbers do not exist, this conclusion can be confirmed. Stumpf/Groß (6) listed more than 160 examples of valuation criterias. The wide range of criteria disclosed the numerous possibilities to find reasonable royalties. At the same time these criteria revealed that the listing of royalty rates failed to answer the following questions:
- What is the royalty base ( e.g. turnover and /or (partial) product and /or (partial) process) ? Do intellectual property rights (invention, patent application, patent, utility model and/or confidential know-how and/or trademarks and/or copyrights (computer programs) exist ? What is the scope of protection ( does the invention only protect a part of a device ?) ? What is the value of the protected part of a product in relation to the total product ? (7)
- What is the price the royalty refers to? We very often see in license agreements so-called „specified terms" like net sales price, price ex works, gross receipts, net receipts and other terms which are apparently specified. However, in German understanding, these „concrete" terms have to be defined to avoid any legal disputes. Which items are deductible ( taxes , freight, dealer discounts, rebates, reimbursements, etc.). If the licensee is entitled to deduct precisely defined items, what is the quantum of these deductions ? Should it be „as usual" or in defined percentages (e.g., 3% dealer discounts)?
The author recommends very careful drafting of the relevant clauses in a license agreement.
Further questions could be:
- What is valid for royalties per unit, royalties for sublicensees and /or minimum licenses? Is there a base for a down payment ( = lump sum/ initial payment)?
When should that down payment due respectively what scope should be appropriate ? Is the down payment chargeable and/or refundable ?
a) In Germany, there exists the so-called „Law Relating to Inventions Made by Employees." This law determines that inventions made by emloyees belong to them . Only by a special act and in conjuction with a special remuneration can they become the property of the employer. The remuneration for the invention can be calculated by three methods. The most usual method to caculate the inventor´s remuneration is the so-called „license analogy." The inventor receives a certain percentage, based on the net sales made by the employer, of a reasonable royalty. Number 10 of the so-called „remuneration guidelines" (added to the Law Relating to Inventions Made by Employees" ) provides examples for reasonable royalties:
Electronics 0.5 - 5 %
Machinery 0. 33 - 10 %
Chemical 2 - 5 %
Pharmaceutical 2 - 10 %.
b) Another valuation method involves the „Georgia Pacific Factors:"
The 15 factors of Georgia-Pacific Corp. V. United States Plywood Corp. are as follows (the reasonable royalty is determined by a hypothetical negotiation!):
(1) Royalties for the patent in suit;
(2) Rates paid by the licensee for use of comparable patents;
(3) Nature and scope of the licensee, exclusive vs. non-exclusive, restrictions as to geography etc.;
(4) The licensor´s policy with respect to licensing its patents;
(5) Commercial relationship between the parties;
(6) Effect of selling the patented product on the ability to sell other products;
(7) Duration of the patent and the term of the license;
(8) Established marketability of the product made under the patent;
(9) Advantages over old modes or devices;
(10) Nature of the invention and the benefits;
(11) Extent to which infringer has used the invention;
(12) Portion of profit that is customary to allow for use of the invention;
(13) Portion of the profit that should be credited to the invention as distinguished from non-patented elements or improvements added by the infringer;
(14) Opinion testimony of experts; and
(15) The amount that a willing licensor would have agreed to accept, and that a willing licensee would have agreed to pay at the time the infringement began.
The German Courts make use of factors which are quite similar to the Georgia Pacific Factors.There are two interesting publications of Rogge (11) and Mellulis (12), who are judges of the German Federal Supreme Court (13). Another interesting publication is „Factors Affecting Royalty Rates" by McGavock, Haas, Patin. This publication presents the results of a survey covering licensing practises, business strategies and factors affecting royalty rates (14).
3. Quite often, royalties will already be fixed in R & D agreements.The contractors want to calculate the project costs and the costs resulting from such an R & D project in advance. On the other hand, there are no project results prior to the start oof the project. There is no idea, if there will be any project results which could be exploited at the end of the project. Another question will be, what value these results could have.
At the very least, there is a high risk for the investor. The contractor treis to minimize the risk. However, the question is: why should the parties fix royalties prior to the beginning of an R & D project? Nobody knows if there will be an invention, what value the (potential) invention could have. and which factors will be relevant for the determination of royalties.
An example shall be given to clarify the positions of the parties of an intended R & D agreement: if there are contractor`s and/or contractee`s intellectual property rights (e.g., patents, copyrights, know-how) prior to the R & D agreement, which value do these intellectual property rights have? Is the new know-how dependent on the old know-how? Is there a depedence or an interdependence on the old know-how of one or of both partners to this R & D agreement? Will this question be relevant to a dependence or interdependence on patents? How does this situation affect the determination of royalty rates? What scope of license fee shall be applicable? Should there be a down payment in addition to royalties (royalty per unit or a a percentage of the net sales)? Shall the down payment be chargeable to the royalty per unit/ %-royalty ? Shall the down payment be paid in installments (how many installments)? What shall be the percentage of the down payment and when will the down payment be due?)? Shall the down payment be paid subsequent to signature of the R & D agreement, or subsequent to signature of the license agreement, or at the start of production or when the licensed product is first put on the market? Shall the royalties be refundable (in part)? Who shall pay the costs for patent applications, the maintenance of patents (old and new patents of the parties of the R & D agreement)? Who shall bear the costs if both parties want to apply for project-patents in different countries? Shall minimum licenses be paid ? And if so, at what time? What is the accounting period for minimum licenses in connection with the accounting period for royalties per unit/%-royalties? Shall the minimum license be chargeable? At what time? For which period? Shall the minimum license be only chargeable to the royalties per unit/ %-royalties and /or to the down payment?
4. It is rather difficult and more or less impossible to offer reasonable solutions for all contingencies. A solution could only be presented in the individual case.The following solutions can be offered:
- no determination of royalties;
- determination of royalties at the conclusion of the R & D agreement;
- the scope of license fees will be fixed with regard to down payment/ royalties per unit/ %-royalties/ minimum licenses and graduated discounts of royalties if necessary;
- if there was „just" a patent application of licensor prior to the commencement of the R & D agreement, a down payment or the payment of installments can be determined (the scope of the down payment can (not ) be determined). The payment of the initial fee (= down payment) can be stipulated at the start of production;
- the crediting of royalties, the demand for the return of royalties and the terms of payment (e.g., the due date of royalties, reports etc.) can be determined at the commencement of the R & D project; and
- the license agreement can be negotiated and determined excepting the actual royalties.
These proffered solutions are only some examples of many possible varieties. Contractual decisions can only be made in individual cases.
II. The second part of this publication deals with the examination of 328 license agreements, which have been drafted/signed by the author from January 1,1988 - September 1, 1994. Some of these agreements do not exist any longer (e.g., because of bankruptcy, termination (without notice), new state of technology, new markets, etc.).
1. At first sight the 328 license agreements include 82 patent licenses and 61 mixed patent/know how licenses. However, most of the patent licenses have been signed in combination with R & D - agreements. In many cases, consultancy agreements (transfer of know-how by „heads") had been signed in combination with patent licenses. At least more than 2/5ths of the examined agreements were mixed patent/know-how licenses. Particularly striking is the fact that 126 agreements were computer program licenses. This corresponds to a percentage of 38.42 % of all agreements examined by the author.
2. The agreements included a lot of modern technologies like gene technology (2 license agreements) and semiconductor technology (1 license agreement).
| Scope | number | % |
| patent license | 82 | 25 |
| know how license | 12 | 3.66 |
| trade mark license | - | |
| computer program license | 126 | 38.42 |
| semiconductor (Protection Act) license | 1 | 0.31 |
| patent/know how license | 61 | 18.60 |
| patent/know how/computer program license | 1 | 0.31 |
| patent/know how/trade mark license | - | |
| patent/computer program license | 1 | 0.31 |
| know how/computer program license | 1 | 0.31 |
| joint inventions (agreements) | 26 | 7.93 |
| patent purchase | 17 | 5.19 |
118 computer program licenses have been signed in the following fields of use:
simulation, methods of calculation (e.g., packaging, logistics, R & D), environmental engineering, ecological balances, control (e.g., robotics, production lines ), diagnostic, data compression, analysis of processes in factories, medical applications, graphics, data bases, transputer, lexicographical data. Only 6 license agreements (4 exclusive and 2 nonexclusive ) included source codes.
The 118 agreements included 8 exclusive and 110 nonexclusive licenses. There is only 1 cross license. 70 agreements were related to a company/ a group of companies/a place of work. In 79 cases, the licensee had to pay a single fee from 200 Deutsche Mark - 100,000 Deutsche Mark. 6 agreements provided %-royalties. The scope of the %-royalties showed a range of 10 % - 75 % of the net sales. The definitions of net sales were varying as the case may be. In 5 cases, the parties agreed on royalties per unit. 11 agreements included a down payment in addition to a royalty per unit or a %-royalty. 1 agreement included a minimum license. 8 agreements provided graduated discounts with regard to royalties. In some cases the parties agreed on „zero-licenses" (e.g., licenses between R & D organizations and/or universities).
328 agreements included 2 cross licenses (1 patent and 1 computer program license).
The licensees paid down payments from 5,000 - 50,000 Deutsche Mark. Computer program and patent/know how licensees were particularly likely to make down payments.Very high down payments were paid in 6 cases (100,000 - 1,000,000 Deutsche Mark -- only in patent/know how licenses). Most of the down payments were not chargeable and not refundable to royalties (per unit /%).
3. Another problem is that licensees who settle disputes with infringers try to circumvent the licensors, or in other words, try to avoid the payment of royalties, which they received as damages from infringers. The author has been involved in 2 such cases (the clients were the licensors). The damages of the respective royalties to be paid to the licensors amounted to 17,000,000 and 30,000,000 Deutsche Mark. The license agreements provided very clear and unequivocal conditions. The problem of the licensors was that, in each case, they were private inventors and they would never have had the monetary power to sue the licensees for damages (= royalties). In one case, the licensor had already published his victory over the infringer (background: the licensor saw the possibility to back the shareholder value!). In the other case, the CEO who had negotiated with the licensor had already told his board of directors that he would „win"! In both cases, the solution was as follows: both licensors (inventors) received payments for their support during the infringement proceedings! One licensor received, in addition, a consultancy agreement of the licensee to accelerate new R & D work. At least, the solutions were based on negotiation and mediation.
4. Recently joint inventions have played, and will continue, to play a role which is and will be very important when exploiting IPR. In Germany, joint inventors have the duty to immediately and completely notify any service invention made by them to their employers in writing. Each employer has the right to declare an unrestricted claim (of the part) of the employees‘ invention within a 4-months-term. By this action, the the employer will become the owner of this invention. However, he is only the owner of the (part of the) invention of his(!) employee.
If there are two joint inventors of two companies, the companies have to declare unrestricted claim (of the part) of the invention to their inventors. Subsequent to this action, both companies have to negotiate the details of an exploitaion of the joint invention. Which party shall apply for a patent ? In which countries? Which party shall bear the costs for the application, the maintenance and other necessary steps? Who shall exploit the invention? Both parties? Shall both parties exploit the invention in different fields of use exclusively, or shall only one party exploit the invention, or shall both parties exploit the invention on a nonexclusive base?
Twenty-six (7.93%) agreements of the 328 agreements examined from 1992 – 1994 exploited joint inventions. According to German law (§§ 741 et seq. of the German Civil Code), each party to a joint invention has the possibility to exploit the joint invention as a whole. However, if one co-owner is interested in granting licenses to third parties, he is only entitled to grant licenses upon prior consent of the other co-owner. This situation can be changed by invidual agreements between the co-owners of the joint invention.
How did the partners of the 26 agreements solve the basic legal problem of the German Civil Code? Five agreements provided the grant of licenses upon prior written consent of the co-owner . Fifteen agreements provided an exploitation without the prior written consent of the co-owner. In 3 cases, only 1 partner had the possibility to exploit the joint invention.. The other co-owner only participated in costs and turnover. In 2 cases, one partner exploited the joint invention in a defined field of use, and the other partner exploited the invention in another field of use. In one case, one partner exploited in a defined field of use, and both partners exploited together the joint invention in all other fields of use. In 12 cases, costs will be charged against royalties once per calendar year. In 13 cases, there was no set-off. In 1 case, the parties aggeed on a set-off if there will be an important imbalance between costs and royalties. Most of the agreements provided a a sharing of costs and royalties on a 50 % - 50% base.
