Center for Advanced Study & Research on Intellectual Property

 

CASRIP Newsletter - Fall 1997, Volume 4, Issue 3

Actual Royalty Rates inPatent-, Know-How- and Computerprogram-License Agreements

by Dr. Michael Gross, Attorney atLaw, Munich, Germany

I . More and more companies aretrying to improve the use of their technical and legalresources.The economic conditions and the growinginternationalization of companies effect an increasing importanceof the exploitation of know-how and intellectual property rightsby license agreements.When drafting license agreements, a majorproblem is quite often determining what constitutes a„reasonable" royalty.

1. Where can we find royaltyrates? In Germany only two publications of 1955 ( author:Lüdecke) and of 1977 (author: Fischer), and some indications inseveral publications exist. (1 please see Stumpf/Gross, TheLicense Agreement,7.edition, Heidelberg 1997, page 86 withfurther references).

Recently three judicial decisionsincluded royalty rates. Particularly well known is theTchibo/Rolex case. (Tchibo is a German chain store that sellscoffee and other goods). Tchibo sold imitation Rolex watches.Thecompetent court, and at least the German Federal Supreme Court, (2 ) obtained expert opinions. The expert , who gave his opinionto the German Federal Supreme Court , said that a royalty rate of12.5% - 20% of the net sales price would be fair and reasonablein general. In the case at hand, the expert decided that a rateof 12,5% would be fair and reasonable. The expert gave thefollowing reasons for the rate of 12,5%: the wide circulation ofthe Tchibo watch; only a single event for a short time (10 days);and the prestige of the Rolex trademark. The expert had comparedthe above average rate (12.5%) with the „normal"royalty rates in German industry ( 1%-10%).

Another decision of the GermanHigher Regional Court in Stuttgart (3) ruled on the followingcase: the license agreement (field of use : special machinery)provided a down payment of 225,000 Deutsche Mark, which had to bepaid within 2 weeks subsequent to the signing of the licenseagreement, a royalty of 6%, and a minimum license of 50,000Deutsche Mark/year. If the licensed patent applications werel notgranted, licensees would not be obliged to pay royalties. Paidroyalties would have to be refunded. The down payment would nothave to be repaid.

Another case was decided by theGerman Higher Regional Court in Düsseldorf (4) with thefollowing facts: a royalty of 4% for a trademark license of asoftware distributor.

2. These royalty rates are nottypical for all businesses, but rather depend on differentfactors. The analysis always requires a case by case decision. IfLüdecke and Fischer (5) drew the conclusion that firm formulasand fixed numbers do not exist, this conclusion can be confirmed.Stumpf/Groß (6) listed more than 160 examples of valuationcriterias. The wide range of criteria disclosed the numerouspossibilities to find reasonable royalties. At the same timethese criteria revealed that the listing of royalty rates failedto 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 carefuldrafting 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 duerespectively what scope should be appropriate ? Is the downpayment chargeable and/or refundable ?

a) In Germany, there exists theso-called „Law Relating to Inventions Made byEmployees." This law determines that inventions made byemloyees belong to them . Only by a special act and in conjuctionwith a special remuneration can they become the property of theemployer. The remuneration for the invention can be calculated bythree methods. The most usual method to caculate the inventor´sremuneration is the so-called „license analogy." Theinventor receives a certain percentage, based on the net salesmade by the employer, of a reasonable royalty. Number 10 of theso-called „remuneration guidelines" (added to the LawRelating to Inventions Made by Employees" ) providesexamples for reasonable royalties:

Electronics 0.5 - 5 %

Machinery 0. 33 - 10 %

Chemical 2 - 5 %

Pharmaceutical 2 - 10 %.

b) Another valuation methodinvolves the „Georgia Pacific Factors:"

The 15 factors of Georgia-PacificCorp. V. United States Plywood Corp. are as follows (thereasonable royalty is determined by a hypothetical negotiation!):

(1) Royalties for the patent insuit;

(2) Rates paid by the licensee foruse of comparable patents;

(3) Nature and scope of thelicensee, exclusive vs. non-exclusive, restrictions as togeography etc.;

(4) The licensor´s policy withrespect to licensing its patents;

(5) Commercial relationshipbetween the parties;

(6) Effect of selling the patentedproduct on the ability to sell other products;

(7) Duration of the patent and theterm of the license;

(8) Established marketability ofthe product made under the patent;

(9) Advantages over old modes ordevices;

(10) Nature of the invention andthe benefits;

(11) Extent to which infringer hasused the invention;

(12) Portion of profit that iscustomary to allow for use of the invention;

(13) Portion of the profit thatshould be credited to the invention as distinguished fromnon-patented elements or improvements added by the infringer;

(14) Opinion testimony of experts;and

(15) The amount that a willinglicensor would have agreed to accept, and that a willing licenseewould have agreed to pay at the time the infringement began.

The German Courts make use offactors which are quite similar to the Georgia PacificFactors.There are two interesting publications of Rogge (11) andMellulis (12), who are judges of the German Federal Supreme Court(13). Another interesting publication is „Factors AffectingRoyalty Rates" by McGavock, Haas, Patin. This publicationpresents the results of a survey covering licensing practises,business strategies and factors affecting royalty rates (14).

3. Quite often, royalties willalready be fixed in R & D agreements.The contractors want tocalculate the project costs and the costs resulting from such anR & D project in advance. On the other hand, there are noproject results prior to the start oof the project. There is noidea, if there will be any project results which could beexploited at the end of the project. Another question will be,what value these results could have.

At the very least, there is a highrisk for the investor. The contractor treis to minimize the risk.However, the question is: why should the parties fix royaltiesprior to the beginning of an R & D project? Nobody knows ifthere will be an invention, what value the (potential) inventioncould have. and which factors will be relevant for thedetermination of royalties.

An example shall be given toclarify the positions of the parties of an intended R & Dagreement: if there are contractor`s and/or contractee`sintellectual property rights (e.g., patents, copyrights,know-how) prior to the R & D agreement, which value do theseintellectual property rights have? Is the new know-how dependenton the old know-how? Is there a depedence or an interdependenceon the old know-how of one or of both partners to this R & Dagreement? Will this question be relevant to a dependence orinterdependence on patents? How does this situation affect thedetermination of royalty rates? What scope of license fee shallbe applicable? Should there be a down payment in addition toroyalties (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 (howmany installments)? What shall be the percentage of the downpayment and when will the down payment be due?)? Shall the downpayment be paid subsequent to signature of the R & Dagreement, or subsequent to signature of the license agreement,or at the start of production or when the licensed product isfirst put on the market? Shall the royalties be refundable (inpart)? Who shall pay the costs for patent applications, themaintenance of patents (old and new patents of the parties of theR & D agreement)? Who shall bear the costs if both partieswant to apply for project-patents in different countries? Shallminimum licenses be paid ? And if so, at what time? What is theaccounting period for minimum licenses in connection with theaccounting period for royalties per unit/%-royalties? Shall theminimum license be chargeable? At what time? For which period?Shall the minimum license be only chargeable to the royalties perunit/ %-royalties and /or to the down payment?

4. It is rather difficult and moreor less impossible to offer reasonable solutions for allcontingencies. A solution could only be presented in theindividual 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 onlysome examples of many possible varieties. Contractual decisionscan only be made in individual cases.

II. The second part of thispublication 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 anylonger (e.g., because of bankruptcy, termination (withoutnotice), new state of technology, new markets, etc.).

1. At first sight the 328 licenseagreements include 82 patent licenses and 61 mixed patent/knowhow licenses. However, most of the patent licenses have beensigned in combination with R & D - agreements. In many cases,consultancy agreements (transfer of know-how by„heads") had been signed in combination with patentlicenses. At least more than 2/5ths of the examined agreementswere mixed patent/know-how licenses. Particularly striking is thefact that 126 agreements were computer program licenses. Thiscorresponds to a percentage of 38.42 % of all agreements examinedby the author.

2. The agreements included a lotof modern technologies like gene technology (2 licenseagreements) 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 havebeen signed in the following fields of use:

simulation, methods of calculation(e.g., packaging, logistics, R & D), environmentalengineering, ecological balances, control (e.g., robotics,production lines ), diagnostic, data compression, analysis ofprocesses in factories, medical applications, graphics, databases, transputer, lexicographical data. Only 6 licenseagreements (4 exclusive and 2 nonexclusive ) included sourcecodes.

The 118 agreements included 8exclusive and 110 nonexclusive licenses. There is only 1 crosslicense. 70 agreements were related to a company/ a group ofcompanies/a place of work. In 79 cases, the licensee had to pay asingle fee from 200 Deutsche Mark - 100,000 Deutsche Mark. 6agreements provided %-royalties. The scope of the %-royaltiesshowed a range of 10 % - 75 % of the net sales. The definitionsof net sales were varying as the case may be. In 5 cases, theparties agreed on royalties per unit. 11 agreements included adown payment in addition to a royalty per unit or a %-royalty. 1agreement included a minimum license. 8 agreements providedgraduated discounts with regard to royalties. In some cases theparties agreed on „zero-licenses" (e.g., licensesbetween R & D organizations and/or universities).

328 agreements included 2 crosslicenses (1 patent and 1 computer program license).

The licensees paid down paymentsfrom 5,000 - 50,000 Deutsche Mark. Computer program andpatent/know how licensees were particularly likely to make downpayments.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 refundableto royalties (per unit /%).

3. Another problem is thatlicensees who settle disputes with infringers try to circumventthe licensors, or in other words, try to avoid the payment ofroyalties, which they received as damages from infringers. Theauthor has been involved in 2 such cases (the clients were thelicensors). The damages of the respective royalties to be paid tothe licensors amounted to 17,000,000 and 30,000,000 DeutscheMark. The license agreements provided very clear and unequivocalconditions. The problem of the licensors was that, in each case,they were private inventors and they would never have had themonetary power to sue the licensees for damages (= royalties). Inone case, the licensor had already published his victory over theinfringer (background: the licensor saw the possibility to backthe shareholder value!). In the other case, the CEO who hadnegotiated with the licensor had already told his board ofdirectors that he would „win"! In both cases, thesolution was as follows: both licensors (inventors) receivedpayments for their support during the infringement proceedings!One licensor received, in addition, a consultancy agreement ofthe licensee to accelerate new R & D work. At least, thesolutions were based on negotiation and mediation.

4. Recently joint inventions haveplayed, and will continue, to play a role which is and will bevery important when exploiting IPR. In Germany, joint inventorshave the duty to immediately and completely notify any serviceinvention made by them to their employers in writing. Eachemployer has the right to declare an unrestricted claim (of thepart) of the employees‘ invention within a 4-months-term. Bythis action, the the employer will become the owner of thisinvention. However, he is only the owner of the (part of the)invention of his(!) employee.

If there are two joint inventorsof two companies, the companies have to declare unrestrictedclaim (of the part) of the invention to their inventors.Subsequent to this action, both companies have to negotiate thedetails of an exploitaion of the joint invention. Which partyshall apply for a patent ? In which countries? Which party shallbear the costs for the application, the maintenance and othernecessary steps? Who shall exploit the invention? Both parties?Shall both parties exploit the invention in different fields ofuse exclusively, or shall only one party exploit the invention,or shall both parties exploit the invention on a nonexclusivebase?

Twenty-six (7.93%) agreements ofthe 328 agreements examined from 1992 – 1994 exploited jointinventions. According to German law (§§ 741 et seq. of theGerman Civil Code), each party to a joint invention has thepossibility to exploit the joint invention as a whole. However,if one co-owner is interested in granting licenses to thirdparties, he is only entitled to grant licenses upon prior consentof the other co-owner. This situation can be changed by invidualagreements between the co-owners of the joint invention.

How did the partners of the 26agreements solve the basic legal problem of the German CivilCode? Five agreements provided the grant of licenses upon priorwritten consent of the co-owner . Fifteen agreements provided anexploitation without the prior written consent of the co-owner.In 3 cases, only 1 partner had the possibility to exploit thejoint invention.. The other co-owner only participated in costsand turnover. In 2 cases, one partner exploited the jointinvention in a defined field of use, and the other partnerexploited the invention in another field of use. In one case, onepartner exploited in a defined field of use, and both partnersexploited together the joint invention in all other fields ofuse. In 12 cases, costs will be charged against royalties onceper 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 importantimbalance between costs and royalties. Most of the agreementsprovided a a sharing of costs and royalties on a 50 % - 50% base.

Last updated 4/27/2012