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Joint Ventures, Partnerships, Licenses and Other Ways for Companies to Collaborate

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Joint Ventures, Partnerships, Licenses and Other Ways for Companies to Collaborate

With the acceleration of the globalization of business over the last 20 years, alliances between companies have become commonplace. These alliances can be from different parts of the world or different ends of a supply chain. Whatever the duration and objectives of business alliances, being able to identify and execute alliance opportunities are keys to remaining competitive in the global economy.

Transcript

- [Instructor] Hi, welcome to joint ventures, partnerships, licenses, and other ways for companies to collaborate, pros and cons of each. My name is Len Garza and I am Founder and Principal Attorney at Garza Business and Estate Law. We're located in Princeton, New Jersey, but we have clients nationwide. We represent family businesses, close corporations, private businesses, business owners, and executives. And we help them get formed properly, structured properly, grow in a healthy and sustainable way and help them plan for exit or the next generation. Alliances between companies are a fact of life and business. These alliances can be from different parts of the world or different ends of a supply chain. Some alliances are short term, some of them last only as long as it takes one partner to establish a beachhead in a new market. and others are basically an engagement agreement that eventually leads to a full merger of two or more companies. Whatever the duration, and objectives of business alliances, being able to identify and execute alliance opportunities are key corporate assets. Today, we'll be talking about a few of the most common ways companies form alliances. Joint ventures, and those can be joint ventures via a contract or agreement, and they can also be joint venture entities where a separate business entity is set up, for example, a partnership, LLC, or corporation. We'll also be talking about license agreements, and important factors to consider, and provisions to consider in those types of agreements. So what is a joint venture? You may hear this term banded out quite frequently in business circles, and there are technical terms for what it actually is, but many people, many non-lawyers actually, when they use the term joint venture may mean it in very layman terms and probably aren't specifically referring to some of the more legal, technical characteristics of what actually constitutes a joint venture. So in general, a catchall term, joint venture is a catchall term for two companies, could be more than two, but two companies teaming up for a specific goal or purpose where there's a definite end to the scope of their work. Now, this is different than a partnership, for example, where a partnership, you could have two or more individuals or companies working together on a long term basis. And that's distinguishable from what we think about when companies are looking at forming a joint venture. Joint ventures are more limited in scope than a partnership, and that's a situation where two or more individuals or businesses are teaming up on, for example, in construction, on a particular development project or in other arenas, maybe distributing some new service or product. When we think about joint ventures on a large public scale, think about examples like Sony and Ericsson. These two companies joined up to manufacture smartphones and other consumer technology. After several years operating in a collaborative capacity, Sony eventually acquired Ericsson mobile manufacturing division. In 2008, NBC Comcast and ABC Walt Disney joined up to create a video streaming application for computers, laptops, and mobile phones. This application became what we now know as Hulu. Barnes & Noble, Starbucks, selling coffee in Barnes & Noble bookstores, this is another example. So these are big public company examples, but joint ventures also happen on a smaller private company scale, so for example, think of a real estate company and they have spare land, but no manpower, equipment, or construction expertise. And then you have a construction company and they do have manpower, labor supply, and expertise in the construction of commercial and residential complexes for housing, for example, but they have no land to build on. So you put the two together, and this is pretty straightforward and pure example of where these two companies could form some type of a joint venture, do business, and realize synergies, and it would be to the benefit of both of them. So generally, what are the advantages of a joint venture? Well, companies could desire to get into a joint venture to have access to resources and markets that would otherwise be unavailable to them. So one example of this is Kellogg and Wilmar International Limited. Kellogg entered into the market in order to expand its presence in the Chinese market to sell cereals and other snack foods to consumers in China. Joining with Wilmar resulted in synergies in a very profitable relationship for both the companies. Wilmar contributed its extensive distribution and supply chain network to Kellogg. Kellogg managed to enter into a new geography, China, with this agreement and relationship. Another advantage of a joint venture is limited upfront investment. In our previous example, it would've been prohibitively expensive for Kellogg to set up its own distribution supply chain within China, where it wanted to go. Instead, they were able to partner up with another company, Wilmar, that already had mature and sophisticated resources that they needed. Without that partnership, it would've been substantially more expensive and very possibly impossible for them to break into the Chinese market, within the same timeframe that they were able to through the Wilmar deal. This allowed Kellogg to accomplish another common advantage of a joint venture. It expedited their time to market, specifically consumer snack foods and cereals to the Chinese market. Another advantage is risk mitigation through partnership, and new path to an exit through an IPO or sale of shares. So talking about risk mitigation through partnership, picture that we have two metal manufacturing companies forming a joint venture to build and operate an integrated mill together. Now, company A focuses on converting ore and producing iron products. Company B operated as an ore extractor as a result of the joint venture. Company A obtained a guaranteed 20 year supply of ore, and mitigated the risk of volatile ore prices. Company B received a guaranteed marketing price for its ore, while receiving high quality, lower cost iron products from company A. So both companies were able to focus on, through this joint venture, were able to focus on different parts of the manufacturing process to be able to mitigate the risks of volatile ore prices and also sale over time of that ore. So what are some of the things we need to consider prior to forming a joint venture? Well, prior to formation, we need to identify the parties to the agreement. Some companies will set up subsidiaries, or they already have subsidiaries, or a holding company affiliated with larger entities, and they want those to be the actual parties to the joint venture agreement. In these situations, consider whether the parent entities should be jointly and severally liable for the liabilities of the subsidiaries or holding companies, or the joint venture itself, or whether the parent companies should provide guarantees for the subsidiaries or holding companies, or the joint venture itself. NDAs, similarly, are critical to restrict the joint venture party's disclosure and use of confidential information revealed during the due diligence process, and restrict them to approve disclosures and uses only. The parties should also contemplate having a term sheet, a letter of intent, also an exclusivity agreement, which could either be a separate agreement or incorporated within the LOI or term sheet. Exclusivity agreements result in a period of exclusive negotiations between the potential joint venture parties, it reassures the joint venture parties that their partner is serious about pursuing the joint venture and will not simply walk away for another opportunity. Term sheets and letters of intent allow more certainty in the material terms of the joint venture before the joint venture parties invest too heavily in due diligence or negotiations. So as we touched on earlier, a joint venture may involve creating a new entity, or it may be a contractual relationship, or it could be a hybrid of both. Due diligence, there are various factors that affect the scope of the due diligence of your joint venture. If you have a prior business relationship with the other joint venture party, that helps in reducing the scope and the length of potential due diligence. Also, whether the joint venture is of perpetual or temporary duration will impact the scope. How will the joint venture be structured? Whether it's a separate entity or it's a contractual relationship, creating a separate entity tends to lengthen and widen the of due diligence. What are the types of assets contributed by the joint venture parties? For example, if there's intellectual property, there would be, or may be, specific concerns and real property, specific concerns as to that as well. Where the parties have had extensive history and prior dealings, there may be very little due diligence required, however, joint venture parties who are relatively new to each other may require more extensive due diligence. If the joint venture parties are competitors, they may want to limit the scope of the due diligence to protect trade secrets and other confidential information. Depending on how long the joint venture is expected to endure, this will also affect the scope of due diligence. For longer term or perpetual joint ventures, generally, this is a broader scope of due diligence focused on the long term value to the joint venture parties. Where it's a temporary joint venture, generally these require more limited scope of due diligence, focused mainly on the joint venture parties' ability to perform under the agreement during the time period, short term liabilities, and viable exit strategies. The structure of the entity will have an impact on the scope as well. If the joint venture is an actual separate business entity, the due diligence will be targeted at the party's operational histories, tax implications, and the joint venture party's asset contributions to the partnership. In contrast, where it is simply a contractual joint venture, usually these arrangements require less due diligence, especially when the arrangement involves little or no equity investment. The contributed assets of both parties will also have an effect on the scope of due diligence. Contributions of different types of assets require different amounts of due diligence, often focused on asset value and transferability. Assets that are difficult to value may require more extensive due diligence, for example, intangible assets, assets where there's no ready market, and illiquid assets. Intellectual property, dealing with technology requires due diligence to ensure that the joint venture parties can adequately understand and use it. All intellectual property requires due diligence to identify any third party claims and determine licensing and sublicensing rights. Real property requires due diligence to determine proper title, ability to sublease, and to identify leans, and encumbrances, and environmental liabilities. Due diligence may result in only minor changes to the joint venture party's expectations, because of revelations during due diligence can be accommodated by altering terms of the agreement and to match the joint venture party's new expectations. However, in some situations, due diligence may reveal information so significant that it leads to the parties abandoning the joint venture. Joint venture structure. Where the joint ventures are contractual, these are simple contractual agreements between the parties, such as a strategic alliance or outsourcing arrangement. The benefits of these contractual joint ventures versus setting up a separate entity are that they're generally simpler to establish and dissolve the joint venture entities, because they require less corporate formalities. The contractual arrangement allows joint venture parties to remain in control of their assets rather than contributing them to a joint venture entity that would then own them. The agreement also reduces costs of regulatory compliance, because joint venture entities may require new and duplicative permits that one of the joint venture parties already owns. A joint venture agreement limits potential director fiduciary duties. A joint venture agreement also stages the development of a future joint venture entity by allowing the joint venture parties to first become comfortable with the joint venture before establishing a more permanent relationship through a separate business entity. And as we touched on earlier, when the parties set up a separate joint venture entity, it's typically in the form of a corporation, partnership, either general or limited, or a limited liability company, LLC. The benefits of setting up a separate business entity for the joint venture are that it makes joint venture business more visible by separating it completely from the joint venture parties businesses. It facilitates future exit for the joint venture parties by allowing sales of joint venture entity interests, as opposed to requiring a potentially cumbersome transfer of several contractual agreements. It can also simplify raising debt or equity capital by providing a convenient vehicle for doing that, it's also an instant vehicle for a public offering, should that become desirable. The entity would also have familiar management, governance, and accounting principles. The separate entity also allows for the joint venture to have employees whose interests are aligned 100% with the joint venture, rather than being employed by each separate entity, and also having resources split with the separate joint venture entity. The parties can also achieve limited liability for the joint venture parties, and they can structure pass-through taxation through the separate entity. Other preliminary considerations include regulatory issues. Identify any regulatory issues with respect to the joint venture and its operations, such as antitrust issues. For example, where the joint venture parties are competitors and export controls. There are also accounting considerations. Will the operations of the joint venture be consolidated into the financial statements of one of the joint venture parties? What controls are necessary to ensure the desired accounting treatment? Tax considerations, is flow through taxation desirable? Will one of the joint venture parties consolidate the joint venture for tax purposes? Consider the need for a tax sharing agreement. Contributed assets, general concerns for all assets. Each asset should be valued, at least informally, so that the size of each joint venture party's contribution can be used to determine share ownership and other joint venture matters. Asset transferability must be evaluated to make sure there are no difficulties contributing them to the joint venture entity. Determine contribution timing, particularly whether they will occur at once or in multiple stages, and establish procedures and valuation methods for later contributions. Consider whether representations and warranties should be made about the assets and whether the joint venture parties should be indemnified for breaching them. For example, the parties may want to ensure that each of them makes representations and warranties regarding title to the assets. As to intellectual property, making representations that the property being transferred does not infringe on the intellectual property of a third party. That all necessary third party consents have been obtained, if required. Also consider whether the joint venture parties will retain any rights in the contributed assets. For intellectual property, will title to intellectual property be transferred, or will the intellectual property be licensed to the JV entity? If licensed, determine whether the license is to be broad and enduring or protective of the licensing party. Relevant limitations include, and we'll get into these later when we go more extensively into licensing agreements, royalties, geographic limitations, time limitations, exclusivity, transferability, and termination rights. Cash, initial cash contributions are often made and compensated with stock. Subsequent cash contributions may be required or permitted. Consider whether the joint venture entity will take on initial debt in the form of loans from joint venture parties or third parties. Foreign assets, foreign assets present unique issues, depending on jurisdiction. We'll also delve more into that in a while. Equity structure, for a joint venture entity, the equity interests of the parties must be determined. What's the percentage ownership of each of the joint venture parties? Will there be any preferred securities? And if so, what are the terms of those preferred securities? Is a non-voting class of incentive equity for employees desirable? The ideal debt to equity ratios should be calculated. Two reasons for this are that it will maximize benefits of carrying debt and minimize the chance of equitable subordination by the courts. What are the future funding commitments by the joint venture parties? Joint venture parties may be required to provide additional capital contributions. There may be mandatory capital calls. This is the act of collecting funds from partners when the need arises. What are the circumstances under which there can be additional mandatory capital calls? Who can call the capital? Under what circumstances? Is there a cap or some other limitation? Is the capital contributed in the form of equity or through a shareholder loan? What are the consequences if a partner fails to provide funding in response to a capital call? Some possibilities include, loss of that partner's governance rights, dilution of that partner's shares, buyout right at a discount or otherwise, withholding distributions to that partner. Carrying an appropriate level of debt may provide tax advantages for the joint venture entity. If there are loans made to the joint venture entity by third parties, they may require guarantees by the joint venture parties. The joint venture parties may want mandatory distributions from the joint venture entity, at least in the amount required to pay their pass-through tax liability. Consider whether special allocations of income, loss, or other items are to be made in different proportions to share ownership. Flexibility is allowed in partnerships and limited liability companies. It's also important to define the scope of the joint venture business. The nature of joint venture business must be specified, including whether the joint venture business is for a limited purpose or whether it's free to expand, and if it is, whether this expansion should require joint venture party approval. Determine whether the joint venture entity will be able to form subsidiaries, or whether it must conduct all business itself. Competition from joint venture parties, consider whether joint venture parties are free to compete with the joint venture for business, or whether they must bring corporate opportunities to the joint venture. Also consider whether the joint venture parties should be allowed to pursue opportunities that the joint venture rejects. Restrictive covenants, consider whether restrictive covenants between the joint venture parties and the joint venture entity are needed, including non-compete and non-solicitation clauses and their durations. Business conducted between the joint venture entity and the joint venture parties. Business conducted between the joint venture entity and the joint venture parties could include, supply agreements, purchase agreements, marketing agreements, licensing agreements, service agreements, leases, and more. If these relationships exist, an important consideration is whether they will change if the contracting joint venture party ceases to own shares in the joint venture or another significant event occurs. Joint venture parties may also consider a right of first refusal before the joint venture can enter into a contract with a third party. Governance and management. Board of directors or a similar body, determine the number of directors and a procedure for their selection. Will a joint venture party have a contractual right to elect directors that stock ownership is diluted? Determine under what circumstances a director can be removed or replaced. If state law allows, consider limiting the joint venture entity directors' fiduciary duties. Special voting rules and fundamental decisions. Will approval by stockholders or a super majority of the board be required for particularly important matters such as a merger or public offering? Deadlock, consider dispute resolution measures to avoid deadlock, especially in two-party joint ventures where the risk is high. Possible measures include arbitration, the right to require dissolution, a put right to sell shares, a call right to buy them, neutral and odd number tiebreaker director. For officers, will officers be selected exclusively by the board or will the joint venture parties have appointment powers? Consider employment agreements for key officers, including possible stock incentives. Other board and management considerations. Consider the process for developing and approving the annual operating and capital plan. What if the parties cannot agree? Is a multi-year plan feasible at the outset? Does a prior plan continue with an escalator? Arbitration or expert resolution. Consider whether the joint venture entity should procure directors and officers insurance. Establish procedures for dealing with board conflicts of interest. Establish who the auditors will be. Establish the nature and frequency of reporting by the joint venture to board members and shareholders. Share transfer restrictions, termination, and exit. Share transfer restrictions. The joint venture parties will usually agree to restrict the ability to transfer their interests in the JV. Often there's a right of first offer or first refusal giving the other joint venture parties or the joint venture entity itself the right to buy the shares before the joint venture party can sell to a third party. Will there be permitted transfers to affiliates, lenders under a pledge arrangement? Tag along and drag along rights. Joint venture agreements often include tag along rights, allowing joint venture parties to participate in any sale of joint venture interest by another joint venture party. These tag along rights provide liquidity for the minority shareholder in a case of a majority shareholder exit. Alternatively, drag along rights require the joint venture parties to participate in a sale of joint venture entity interests in order to eliminate holdouts by the minority shareholders. Termination, a termination right allows a party to cause the dissolution and widening up of the joint venture entity if a triggering event occurs or fails to occur. These events may include deadlock, change of control, breach by a joint venture party, failure to meet specific financial targets. These provisions present several questions. How will the joint venture's assets be distributed? Will the joint venture contract survive the dissolution and a planned exit? This is where temporary joint ventures end after the specified period of time, causing dissolution in winding up. A joint venture party may have the right, either at any time or given special circumstances, to cause a public offering and sell its shares. A majority joint venture party may want a call right that is exercisable beginning at a specified time or upon specified circumstances. A minority joint venture party may want a put right that is exercisable beginning at a specified time or upon specified circumstances. The joint venture may include a buy/sell where each joint venture party has the right to offer to buy the interest of the other, or sell its interest to the other at a specified price. This works best in a 50/50 joint venture where the parties have equivalent financial resources. Joint venture as a partnership, tax considerations. Companies can obtain certain accounting benefits by structuring their joint venture as a partnership. Historically, when a corporation has decided to enter into a joint venture with a third party, the use of the partnership structure to conduct the joint venture has generally not been challenged by the IRS. Thus, the application of the provisions of Subchapter K to the business operations contributed to a partnership have generally not been challenged by the IRS. Note that while a partnership might intend a joint venture to be continued long term over a period of years, it can also relate to a single transaction after which the parties dissolve the relationship. The ability to apply Subchapter K to joint ventures is significant for tax purposes. One of the principle legislative objectives of Subchapter K was to afford the partners of a partnership flexibility in allocating the benefits and detriments of partnership level transactions and of partnership partner transactions among themselves. You can see this objective throughout the provisions of Subchapter K, flexibility offered under Subchapter K. Most of the commercial law benefits of utilizing a corporation is the joint venture entity, such as the limitation on joint ventures liabilities regarding the business conducted by the joint venture, can also be achieved through a partnership by forming corporate subsidiaries to serve as the general partners of the partnership, or conducting the business through an LLP that is taxed as a partnership for federal income tax purposes. On the other hand, significantly different tax consequences can result from utilizing a partnership rather than a corporation at the time of formation, during the operational stage and in connection with the winding up of the joint venture entity. Under the treasury regulations, the check the box regulations, a domestic partnership or LLC with more than one member will generally be treated as a partnership for federal income tax purposes, unless an election is made to treat such an entity as an association taxable as a corporation. Partnerships, like corporations, can issue options, warrants, and convertible securities to third parties that provide rights to acquire interest in the partnership or an affiliate. Partnerships can be structured with multiple classes of partnership interests. In many cases, you can achieve more flexibility in tax efficiency than a corporation issuer. There may be reluctance to issue preferred stock out of corporate joint venture vehicle, because dividends are not deductible, whereas interests on corporate debt is generally deductible, subject to certain exceptions and limitations. Note that in this presentation we do not address the rules of section 163J of the tax cuts and jobs act. The corporate dividend recipient would however, generally be entitled to the benefits of the dividends received deduction under section 243. On the other hand, where a partnership issues preferred partnership interest, the income allocated with respect to such partnership interest is includable in the income of the preferred partner, and as a consequence, effectively results in a deduction to the other partners. Partnership joint venture operations. In general, the taxation of partnership operations evidences the split personality of the partnership as an aggregation of its partners, and as an independent entity. Under Subchapter K, the partnership is treated as a separate entity for the purposes of determining taxable income, and as a conduit for the purpose of taxing such income to his partners. The benefits of this conduit treatment, as well as the flexibility offered by partnerships in allocating tax benefits and burdens can be substantial. A more detailed discussion of Section 704C of the treasury regulations, and the specific benefits and flexibility under those treasury regulations is beyond the scope of this presentation, as the rules are quite detailed and complex. But in general, those rules respect allocations of partnership income, gain, loss, deduction, and credit, if such allocations have substantial economic effect. International joint ventures. The use of joint ventures and hybrid entities in international transactions has grown considerably over the last 10 to 20 years. This is due in part to the US federal income tax flexibility and efficiency offered by these structures. In many cases, entities that are classified as partnerships for US income tax purposes are the preferred vehicles for multinational joint ventures and other foreign operations. Generally, it's tax efficient to structure a foreign joint venture as a partnership for US tax purposes, if the venture will incur a significant amount of foreign income tax, and it's in interest holders, or either individuals, S Corps, or C Corps, that own less than a 10% interest in the venture. As minority shareholders with less than 10% interest, these types of taxpayers are not entitled to the deemed paid foreign tax credit. The deemed paid foreign tax credit is a credit typically permitted for a US taxpayer who has actually paid the foreign tax, but there's an exception to this rule. If a US corporation has a subsidiary, then the subsidiary, rather than the US taxpayer, pays the tax. In this scenario, to avoid double tax on foreign income, the US government allows the US parent to claim a deemed paid foreign tax credit under Internal Revenue Code Section 902. This is a credit for the amount of the dividend the subsidiary actually pays to the parent, that is attributable to the subsidiary's foreign earnings. However, this deemed foreign tax credit is available only to shareholders possessing 10% or more of the shares. Without partnership flow through of the direct foreign tax credit, the foreign taxes paid by the entity become simply a deduction in computing their US tax on income when repatriated to the United States. Even if all the US interest holders are domestic corporations that qualify for the deemed paid credit, structuring the foreign joint venture as a partnership for US tax purposes, permits US corporations that own 50% or less of the venture to obtain a general category income under Internal Revenue Code Section 904D1, for foreign tax credit limitation purposes. Other advantages from the use of a partnership and foreign operations might include, the ability to deduct expenses such as interest in both the foreign jurisdiction and the US, and not be bound by the controlled foreign corporation netting rule, or the soak-up rule. The ability to recognize income or loss currently, or to defer recognition of income or loss, depending on whether the partnership interest is held by a domestic or foreign subsidiary. The ability to create current income recognition and direct foreign tax credits without the payment of a dividend where the partnership interest is held by a domestic subsidiary. The ability to avoid a lower tier foreign subsidiary with respect to which no deemed paid foreign tax credits would be available, more flexibility, and offsetting foreign income and losses than provided by the chain deficit rule, and the possibility of an ordinary loss on the abandonment of partnership operations that might not be available with respect to a comparable stock interest. The use of partnership entities in international transactions, typically isn't encountered when a US corporation enters into a commercial venture in a foreign country, either with a local partner or with an unrelated US or third country corporation. In most cases, the US corporation will have three basic tax goals, minimize foreign taxes on operations of the joint venture, preserve the flexibility to defer US income taxation of joint venture profits, and when joint profits are subject to US income taxation, maximize the utilization of foreign tax credits. A US corporation's first venture into a foreign company may not even be by a joint venture or branch at all, but simply by a license of its technological know-how to third party licensees in the foreign country. In this structure, the US corporation is not actively engaged in business in the foreign country, but rather is a recipient of royalties for the use of its technology in that country. So, the tax issues revolve around whether and how the US corporation is to be taxed in the foreign country with respect to its royalty income from the licenses. Typically the foreign country will impose a withholding tax on royalties paid to the US corporation, although the rate of withholding tax can be reduced and perhaps eliminated by application of an available tax treaty. In order to obtain these treaty benefits, sometimes the US corporation will transfer the technology to a corporate subsidiary located in a jurisdiction which has a more favorable income tax treaty with the country where the technology is being used. However, keep in mind, this type of transfer raises significant issues under section 367 of the code, that states, the jobs act clarifies that any income inclusion under this section is to be treated as a royalty for purposes of Internal Revenue Code Section 904D. Also, the recipient of the royalties in these cases will be a controlled foreign corporation, and the royalties in its hands may be Subpart F income, unless the royalties are derived in the active conduct of a trade or business and received from an unrelated person. Instead of, or maybe in addition to licensing its technology to third party users in a foreign country, the US corporation might appoint a local agent in the foreign country to conduct limited business operations on its behalf in that country. The primary tax issue in this structure is whether the activities of a local agent will be imputed to the US corporation for purposes of subjecting the US corporation to tax in the foreign country of operations. Where an income tax treaty is applicable, typically the local agent will not constitute a permanent establishment of the US corporation in the foreign country of operations where the local agent either is an independent agent acting in the ordinary course of its trade or business, or is not an independent agent, but does not have the authority to conclude contracts in the name of the US corporation and does not process goods or merchandise maintained in the foreign country by the US corporation, the income tax treaty between Japan and the United States is an example of this. To protect further against the creation of a permanent establishment in the foreign country of operations, the US corporation could incorporate a local service company as a subsidiary in the foreign country to employ the individuals such as installation or service people whose presence is required in the foreign country. Alternatively, these people could be furnished and employed by the local agent. Licenses, business success increasingly depends on new technologies and the wise use of intellectual property rights. Often these technologies and intellectual property rights are developed or exploited in collaborative relationships, and having agreements clearly stating each party's rights is absolutely critical. In licensing agreements, license grant provisions are the most important section of the agreement. The other section should revolve around the grant provisions. The goal of the grant provisions is to have clearly understood and complete description of the rights being granted to the licensee. This goal may seem obvious, but I'm routinely asked to review and interpret these types of agreements, and often find this basic requirement has not been met. If properly drafted, the license agreement will address these statutory rights, but it will also lay out the party's intentions in clear and unambiguous language that can be understood by the business and technical people who will be operating under the agreement. It's critical to know the difference between contractual covenants versus the scope of the license. You need to have a clear understanding of the difference between words that define the scope of the license or create conditions regarding the exercise of the licensee's rights, and words that are merely contractual covenants. This distinction is important, because action outside the scope of a license, if within the licensor's IP rights, is infringement of the licensor's IP, and the licensor will have access to the many owner favorable statutory provisions under the IP laws. In contrast, a breach of a contractual covenant may lead only to a breach of contract claim with the need to prove, among other things, the licensor's damages. In addition, a breach of a contractual covenant may not necessarily give the licensor the right to terminate the license grant and prevent the licensees continuing use of the technology. Exclusive licenses, for exclusive licenses, the prudent licenser will need to think through what will happen if it's exclusive licensee does not perform as expected. An inadequate agreement can leave the licensor trapped in a bad relationship with no way to harvest the value of its technology. Ultimately, a licensor is most likely going to need measurable milestones and a performance requirements for its exclusive licensee. These requirements can take many forms, depending on the circumstances, such as minimum royalties, minimum commitments for engineering resources or sales and marketing, or obtaining regulatory approvals by certain dates. The appropriate consequences for failing to meet the agreed requirements also vary depending on the circumstances, but what would generally be one of the following, a damages claim, the licensor's right to make the license not exclusive, or the licensor's right to terminate the license. The last might be appropriate if the licensor is likely to need the ability to utilize a different exclusive licensee. Royalty and financial terms. Royalty obligations should provide a clear description of the licensees activities for which royalties are to be paid, and should be carefully coordinated with the license grant provisions. The royalty obligations can take different forms, depending on the nature of the technology, such as whether it's a machine, a process, or a composition of matter. Royalty structures, royalties can be one time or ongoing, they can include upfront payments, milestone payments, or running royalties based on use of the licensed IP. Running royalties can be based on a percentage of sales revenue, customarily referred to as net sales, a percentage of net profits, or a fixed dollar amount per unit. Basing royalties on net profits is difficult and can lead to disputes regarding overhead and other expenses. Also, the licensing may not want to open its books. If the parties do choose net profits, it's essential that the license agreement contain a clear, complete, and unambiguous methodology for calculating the net profits. Special dispositions, in the normal course of business, a licensee may dispose of royalty bearing products other than by sale at fair market value. The smart licensor will have an agreement that addresses the following, demos, samples, internal use, bundling, package sales, payments in kind, related party sales, promotional giveaways, and loss leaders. Depending on the circumstances, possible ways to address the foregoing special dispositions include, using an assumed price, for example, a list price, setting a fixed dollar royalty amount per unit, for bundled products, pro rata allocations based on list prices, making the royalty a percentage of total bundled product price, or including a floor dollar amount per unit and percentage royalty deals. Ownership of IP options. One option is to create a separate joint venture entity to own the intellectual property that will be created. The entity would then enter into license agreements with third parties and with the joint venture parties as appropriate. Ultimate control of the to be created intellectual property would be subject to the ownership and management structure selected by the parties for the entity. This approach can work well for complicated deals. Another option is that one party owns the intellectual property with broad license to the other party. The parties can allocate ownership all to one party with the IP license to the other party. While this may appear to be unfair, the license grant can be drafted very broadly, so the licensee party often gets everything it needs and wants. This approach can also work well for complicated deals and can be the cleanest and therefore best solution. Another option is that the parties could have joint ownership, however, this is almost always a bad idea, whatever the ownership arrangement, it's important to address IP ownership issues early in the business negotiations, it'll be much more difficult to introduce possible changes to the deal structure in the middle of the process. Joint ownership should be avoided whenever possible. Parties often see joint ownership as a solution to a difficult issue, but it generally does not meet the needs or intentions of the parties and is fraught with unintended consequences. Joint ownership of IP can present multiple problems. First, if the parties merely state that the created IP will be joint owned, that leaves many important questions unanswered for their intentions. Do they expect to take actions to maintain the value that is exclusivity of the created IP? If so, who will file, prosecute, enforce the IP? In addition, who decides whether inventions are maintained as trade secrets or are published through the patent application process? Remember that trade secret value is generally destroyed by disclosure. Joint ownership will also mean that no one owner can grant an exclusive license without the consent of all the owners. Second, in the absence of an agreement among the parties, the default rules governing exploitation and the enforcement of intellectual property vary depending on the type of IP, for instance, US patent law allows each joint owner of a US patent to exploit the patent, which includes both use by the joint owner itself, as well as the granting of non exclusive licenses to others, without permission of the other joint owners. Additionally, there's no duty to share proceeds among the other joint owners. With copyrights, joint owners may similarly use the copyright work itself and grant non exclusive licenses without the permission of the other owners, but copyright joint owners have a duty to share the proceeds with their other joint owners, so what happens with the products such as software that may be subject to both patent and copyright law? Third, to further complicate the matter, the default rules governing exploitation and enforcement also vary from country to country. Joint owners in different countries often have markedly different expectations regarding their respective rights in jointly owned IP, for example, some countries governing rules state that a joint owner needs permission of its co-owners to exploit patents, whereas other countries don't have this requirement. Joint ownership presents significant coordination and incentive problems for the parties. A joint owner of a US patent is not required to share the proceeds from its use or licensing of a patent. This presents an incentive problem. Each joint owner will be motivated to compete with the other owners to offer the best deal to potential licensees and therefore reap all of the benefits for itself. Us patent law presents a similar problem regarding enforcement against infringers. All joint owners must join a suit against a potential infringer, so there can be a competition or race to agree with the infringer not to sue, that is for the joint owner to grant a license and retain the proceeds for itself. Each joint owner will be at the mercy of the others, and one could call this a race to bottom, all because it's easy to grant licenses and reap the proceeds, but hard to sue infringers that are misusing the IP. As collaboration continues to remain popular domestically, as well as cross-border, the importance and challenge to designing and sustaining an effective alliance structure remains, companies can address these challenges with a targeted and well thought out plan and design in the structuring phase, this will mitigate the downside risks and drive the value generated from the alliance. Thanks for joining us, here's my contact information. If you have any questions on anything we've gone over, feel free to reach out to me, mention you saw this program, and I'll try to help you and give you guidance any way I can, thanks everyone.

Presenter(s)

LG
Len Garza
Principal
Garza Law

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