By: Larry Schroepfer
There’s a provision in license agreements (and many, many other agreements for that matter) that’s often relegated to the “boilerplate” at the end of the document, and it’s whether either or both parties can assign their rights under the agreement to third parties. Sandwiched somewhere between “Severability” and “Entire Agreement”, this clause often says simply, “neither party may assign its rights under this Agreement without the other party’s consent”.
But this one doesn’t belong in the boilerplate. Particularly in a licensing context, there are potentially serious consequences attached to whether the licensee can or cannot assign.
From a licensor perspective, it wants to be able to control who is practicing its patent or technology, and the terms (financial and otherwise) under which the licensee is doing so. Just because the licensor is willing to license a startup or small niche player doesn’t mean that it would be willing to license its biggest competitor. Nor does it mean that it would extend the same terms if it did decide to license the competitor. So the licensor wants to prohibit the licensee from assigning the license or otherwise engaging in any transaction under which a third party acquire rights to the patent/technology.
From a licensee perspective, the ability to assign, at least in connection with an acquisition by a third party, can be absolutely critical. Particularly with a startup or small company, unless it is one of the fortunate few that are capable of going straight to IPO, its “end game scenario” assumes that it will be acquired at some point.
So a prudent licensee will ask for the right to assign the agreement in connection with an acquisition of its assets and business to which the licensed patent/technology relate. But the licensor is frequently unwilling to grant this kind of carte blanche, because it really doesn’t solve the licensor’s problem when it comes to the identity of the acquirer.
So what do you do? Here’s a few thoughts:
- The most common “solution” is to add a provision that says licensor’s consent to assignment or other transfer cannot be unreasonably withheld, and everybody thinks the situation’s well in hand. But they’re wrong: this solves nothing. If the licensor withholds consent and takes the position that its refusal is reasonable, the licensee’s only recourse is to sue (or arbitrate if the agreement includes an ADR clause), but there is no acquirer in the world that is going to wait around until this dispute slowly grinds through the legal process. While it’s true that the licensor could be liable if it wrongfully withheld consent, in the absence of wrongful intent, this claim is difficult to sustain, and it doesn’t put the pieces back together again for the licensee in any event.
- One solution is to grant the licensee the ability to assign to an acquirer, but limit the scope of the license in that situation to only the product volume that the licensee sold prior to the acquisition (plus, perhaps, some reasonable increase to account for “organic” growth). This allows the acquisition to go forth and the licensee to continue “business as usual”, but if the acquirer wants to substantially expand the license to additional products or volumes that are orders of magnitude more than what the licensee sold, it will need to come back to the licensor and negotiate for those rights.
- A variant of this approach is to provide that the license remains in effect only so long as the licensee continues as a separate subsidiary (or, perhaps, separate business unit), and that it only covers sales by that subsidiary/business unit. This would not, however, fully protect the licensor if the acquirer substantially “ramps up” the business. I’ve sometimes seen provisions covering both product volume limitations and separate entity requirements, which goes a long way to limit the effect of an assignment or change of control from the licensor point of view, but which the licensee and its acquirer may find too restrictive.
- If the licensor is particularly concerned about the license “falling into the hands” of its principal competitors, one approach is to generate a blacklist of companies to which the license would not transfer if they acquired the licensee. Conversely, the agreement might include a whitelist of companies to which the license could transfer, but to no one else. However, a note of caution: before resorting to this approach, the parties should check with antitrust/competition counsel, since this could be problematic, particularly in the EU.
- Finally, a friend and astute business person whom I respect used to talk about reducing problems to “problems that can be cured by the payment of money”. Applying that approach here, the parties could agree to a “Change of Control Fee” which would be payable if the licensee were acquired. There are various ways to fix the amount of this fee — it might be a simple negotiated lump sum, an amount based on the acquirer’s size, an amount based on the sales volume of licensed products, or doubtless other criteria. The point is that a potential acquirer would know right up-front how much it had to pay for rights under the license, and could take that into account in determining whether to buy the licensee (or how much to pay for the licensee).
One other point: I have seen many, many otherwise astute lawyers who don’t seem to understand that if the stock of a company is purchased by a third party, there is no “assignment” of the agreement, and therefore a simple clause that says the licensee may not “assign the agreement” doesn’t work. Sometimes people think they are solving this problem by including any assignment “by operation of law”. This might cover a merger, but if all that happens is that the stock of a company changes hands while the license remains in that company, there is no assignment of anything, whether by operation of law or otherwise. So if the licensor really wants to restrict disposition of the license if the licensee is acquired, it needs to go further and address the consequences of the licensee’s “Change of Control” (as appropriately defined to include stock acquisitions) in addition to “Assignment”.
This Bulletin is not intended as legal advice. Readers should seek professional legal counseling before acting on the information it contains.