What is a Manufacturing Licence Agreement?
Manufacturing Licence Agreements are, as the name suggests, agreements that provide for a party with valuable intellectual property rights for the manufacture of goods to grant a licence over such rights to another party to manufacture, sell and/or market the goods. These rights will typically be in the form of a registered patent, industrial design or copyright (in the shape of the goods), but the protection afforded by unregistered designs, trade marks, trade secrets or know-how is also often of relevance . Manufacturing Licence Agreements are used regularly in the commercial environment by large businesses to leverage the investments of third parties in the manufacture of the goods, to enable the large business to focus on its core activities, or to develop new and rich distribution channels. The objective of such agreements is to permit the efficient and cost-effective manufacturing of goods, which the large business can market and sell, which ultimately leads to a higher return on the investments made by each of the parties to such an agreement.
From a legal perspective, such agreements introduce a number of issues which will require consideration and clarification in order to deal appropriately with each party’s expectations and obligations.
Key Components of a Manufacturing Licence Agreement
A manufacturing licence agreement will typically set out the following key components: The licensee and licensor are the typical identifications at the top of all agreements. The agreement may then be followed by recital clauses or ‘whereas’ clauses, which are designed to provide information on both parties, such as their names and addresses. This section of the manufacturing licence agreement can also be used to describe the product that is the subject of the licensing deal. The scope of rights will include what rights are granted. The parties may grant one another exclusive or non-exclusive licences. An exclusive licence means that a licensee has exclusive rights over the use of the licensed material or technology in a certain territory, and the licensor cannot use it in that territory. A non-exclusive licence relates to the right under the patent laws of a state, such as the UK, to sell or make an invention without infringing the rights of the current patent holder. The duration of the manufacturing licence is an essential component for the parties to consider as this identifies how long the agreement will operate and when a licensee or licensor can opt-out of the terms. For example, a manufacturing licence can be set for a certain number of years, giving a licensee the option to renew at the end of the agreement or the licensor the right to gradually increase royalties every year. It is also important for the licensee to consider the duration of the agreement, for example if the manufacturing licence agreement is linked to a patent that has an expiry date. In our next section, we consider how the terms of an agreement can be varied by a waiver, such as a waiver of compliance.
Legal Aspects and Compliance
When drafting a manufacturing licence agreement, it is essential that the parties take into account all of the relevant legal considerations to which their agreement may be subject. These may include securities regulations or foreign transfer pricing laws, although are likely to be of an intellectual property nature. This section therefore deals with a number of points of potential non-compliance that need to be considered.
Legal qualifications – For compliance with contractual provisions in many countries, the following qualifications apply: Finally, where a manufacturing licence agreement is for technology to be used in more than one country, for compliance with foreign law it should be clarified which jurisdictions govern the export of products and whether a particular export control certificate is required.
Licences and Registrations – It is increasingly common for laws of individual countries to require licences or registrations of foreign IP and technology in order for a party using that IP or those technologies to be able to enforce rights to that IP and/or those technologies in that country. In addition, for the technology to qualify for any tax concessions it may also need to be listed in a schedule to a law specific to that technology. If an appropriate licence or registration has not been obtained, it may not be clear whether the agreement is enforceable as a whole or whether the agreement needs to be amended to include provision for a late application.
Negotiation Tips and Strategies
Negotiating the terms of a manufacturing licence agreement is a critical step towards ensuring a mutually beneficial balance of rights and obligations. Mutually held interests of each party include maintaining quality control of the manufactured products, the supply of raw materials, delivery timeframes and repurchase of the manufacturing facility upon expiry of the licence agreement.
Consider these general strategies when negotiating agreement terms:
Select what is market – This means a clear understanding of key terms that are "market", compared to the licensor’s risk profile and aligned with the commercial goals of the licensee. This will provide flexibility in negotiations and help ensure agreement terms are powerful enough to safeguard the licensor’s interests.
Always consider the cost of non-agreement – What is the potential cost to you if the negotiation fails? This will vary depending on several factors, including potential lost sales to competitors, lost market share and potential adverse impact the transaction will have on your key suppliers.
Research your counterpart – Consider your counterpart’s position carefully before the negotiation process commences. What are their goals, priorities and objectives? Where could they be flexible?
Choose the timing of negotiations – Be strategic about when negotiations take place, perhaps at specific times of the week or month. Choosing the right time can put you in the best position to achieve a desired outcome.
Foster a collaborative business relationship – Find an agreement model that supports a long-term business relationship and advances everyone’s commercial objectives. The parties are likely to be more flexible if an agreement is perceived as strengthening a collaborative business relationship.
Use an experienced commercial solicitor to assist you in negotiation strategy early in the process.
Benefits of Manufacturing Licence Agreements
Manufacturing licence agreements provide a number of advantages for both the parties.
Advantages for licensors
A licence agreement will provide wider access to the market. The licensor can expect to increase its market share and maximise profitability. Using an experienced licensee who knows a particular target market can be a cost-effective way of entering into that market. A licence agreement enables the licensor to focus its efforts in its own area of expertise, while the licensee focuses on what it does best. Licensors require royalties in order to earn revenue from the works they licence. The fee rate can be based on a number of factors, including the volume of units sold, the sales value of the units, or a flat payment per unit or per annum (with or without a minimum guarantee). The principle of sharing revenues rather than one party bearing all of the costs of production can be attractive for many licensors, particularly where they wish to minimise their production and distribution costs .
Advantages for licensees
A licence agreement will provide the licensee with the opportunity to earn additional profits that would not have been available if they had not entered into the licence agreement. A manufacturer who wants to produce a product should be able to do this more cheaply than if they used a third party manufacturer, due to the economics of scale gained from a greater production run. The licence fee will be lower than the market price of the product. The licensee will benefit from being able to produce and sell competitively priced items. The licensee will generally benefit from using the inventor’s intellectual property rights. Filing patent applications, for example, can be expensive if the invention is novel in several countries. It can cost around $200,000 to file international applications in up to 50 countries. With a licence agreement in place, the costs of protecting and maintaining the right can be shared with the licensor.
Challenges and Practical Solutions
While clear definitions of scope from the outset can help reduce the risk of disputes arising later on, it is virtually impossible to predict every challenge that may arise over the course of a manufacturing licence agreement. An agreement that may have been advantageous for one party when entered into may become disproportionately burdensome down the line. A key part of ensuring the longevity of a successful manufacturing licence agreement is being able to respond to unexpected challenges that arise during the period of performance.
In recognition of this reality, many manufacturing license agreements include means of amending the agreement by mutual consent or by pre-determined conditions. However, many times life requires that the parties take on a more adversarial tone. In these situations it may be possible to address issues arising in a manufacturing licence agreement through another form of dispute resolution.
A classic example: the cost of goods to be supplied under the manufacturing licence is pegged to a list of inputs to be provided by the licensor. The inputs may be indirect inputs – such as wire or circuit boards – or direct inputs like specific programming or labelling. Over time, the cost of those inputs may materially fluctuate (in either direction), or even become unavailable, leaving either party unhappy with the terms of the original manufacturing licence.
While a formal contract amendment or a discussion of renewal or renegotiation may grant the greatest flexibility, they also involve the greatest outlay of time and cost. Alternative dispute resolution, which includes mediation, conciliation and arbitration, may be used to find a quicker, more cost-effective solution to problems that arise under a manufacturing licence agreement.
Mediation and conciliation are premised on the understanding that the parties to a dispute would prefer to resolve the issue in such a way that both sides are satisfied. Mediation and conciliation are similar in that they do not yield a determination of wrongdoing by one party or another. Instead, they seek to find areas of common ground that allow the parties to move forward cooperatively in finding a solution.
Arbitration, which is less frequently used in commercial negotiations but important to note, is a type of alternative dispute resolution that allows an independent third party to offer a determination of wrongful conduct by one party or another. While that unilateral determination may be legally binding on the parties, it is not legally binding on the court system unless ordered by a judge. In such cases, the courts are still involved in deciding whether to enforce the decision reached in arbitration.
A recent example of ADR can be found in a manufacturing licence agreement between US chipmaker Intel Corporation and rival Advanced Micro Devices (AMD), which both produce semiconductors and semiconductor systems. At the centre of their dispute were manufacturing process patents and packaging designs that both companies claimed gave them a competitive advantage in the marketplace: specifically, a cell technology developed by AMD that could be used more efficiently to manufacture chips for others. AMD wanted compensation for infringement of that technology, while Intel wanted to protect its extensive patent portfolio.
By using an alternative mechanism to court, the two companies were able to informally settle their dispute without the hassle of a prolonged legal battle. As part of the agreement, AMD received a cash payment and shares in Intel, and agreed to drop 220 legal claims it had brought against the company.
Successful Manufacturing Licence Agreements: Case Studies
When it comes to creating successful manufacturing licence agreements, companies must be clear on their objectives and the key aspects of the agreement that will lead to a win-win situation for both licensor and licensee. For example:
Case Study 1: Fostering Innovation
Company B wanted to expand its manufacturing capabilities without investing in new facilities and without losing control over product design. Company A licensed intellectual property to Company B with the goal of negotiating the most favourable terms for the "non-exclusive" manufacture of the products. While Company B presented a robust case for exclusivity, through negotiations, Company A concluded that its best future lies in licensing multiple manufacturers, thus incentivising innovation. The new licence agreement included tiered quarterly royalty rates based on production, sales targets and productivity. The gradual step-up royalty rate incentivised Company B to improve the quality of their output, not just the quantity.
Case Study 2: Ensuring Quality Control
In addition to being the lead designer of a successful children’s toy, Company Z was an experienced consultant who specialised in the niche market of child-oriented products and components. Lack of research into the market led Company Y to conclude that it could reach a wider audience by producing the toys on a larger scale and by purchasing materials from different suppliers. The first batch of the new toys was a lot less successful than had been projected and much of it never sold. Although the design rights for the toys were held by Company Z, the majority of its work was completed prior to the initial launch, Company Y would be liable for the losses or damages incurred under the terms of the manufacturing licence agreement. While Company Y’s shareholders were furious, the manufacturing licence agreement limited Company Y’s liability to no more than the royalties paid to Company Z.
Lessons Learned
Both case studies provide important lessons about the drafting of manufacturing licence agreements. Among them:
These examples illustrate how different factors—including contractual obligations, knowledge sharing and the quality of the end product—impact the overall value of a manufacturing licence agreement.
Emerging Trends in Manufacturing Licence Agreements
As technological advancements continue to accelerate, the future of manufacturing licence agreements will likely evolve alongside them. With the rise of Industry 4.0 and the Internet of Things (IoT), manufacturers will increasingly rely on data-driven decision making, predictive analytics and digital tools that were not widely available even a few years ago. Manufacturers may seek to incorporate such technologies within their business model to support more efficient, reliable and scalable manufacturing processes.
Manufacturers and licensors will be well-advised to focus on the parameters of such technologies when drafting new manufacturing licence agreements. The types of technologies a licensee or licensor may require should be clearly defined in such an agreement. Above all else, licensors will be wary of what information is accessible by the licensee. The outcome of such efforts could be a dual-tiered licensing structure, whereby a licensor retains full rights over more technologically advanced tools, and licenses the same tools in a limited capacity to its licensees .
Additionally, creating a pre-agreed royalty or profit-sharing structure regulating any additional technologies and products that are developed using those tools may encourage collaboration between the parties to the manufacturing licence agreement and align their interests. This short-term approach will likely lead to long-term exclusivity in the development of new technologies by ensuring that the zeal of the licensor and licensee remain aligned.
Finally, manufacturers and licensors will need to be cognizant of the changing market dynamics as a result of a combination of emerging economies and globalisation. Such developments will have a dual impact on manufacturing licence agreements, because the regulation of such agreements, as well as their enforcement, are tied to the various jurisdictions in which the manufacturing activities take place. Accordingly, understanding the governing law in each jurisdiction should inform all licensing strategies, and careful and informed drafting should ensure that each party understands their obligations under the agreement.