Why smart corporate IP strategies need licence on transfer

Despite the advent of inter partes review and other patent reforms, non-practising entity (NPE) patent litigation remains a challenge and a cost to corporations. The vast majority of patents asserted by NPEs originate with operating companies, and patent sales to NPEs remain one of the key aspects of corporate patent risk today. Traditional strategies for addressing patent risk – such as patent cross-licensing, so-called patent ‘détentes’ and defensive aggregation – are proving insufficient.

While a rigorous corporate cross-licensing programme can mitigate risk from patent sales by counterparties, patent cross-licences are a significant strategic decision, making them impracticable or undesirable in many cases. Similarly, a patent détente between two operating companies which elect not to conclude a cross-licence can leave one party exposed if the other sells its patents to an NPE.

Further legislative and judicial reforms are needed to curb abusive NPE litigation. However, there is also a role for private market solutions to address the residual patent disaggregation risk of operating company portfolios. In particular, an emerging licensing model – licence on transfer (LOT) – is specifically tailored to address this disaggregation risk, while minimising many of the strategic and practical impediments of portfolio cross-licences.

We believe that the LOT concept is an important, flexible tool which could serve as a key element in a corporation’s patent transaction strategy. LOTs are gaining momentum, in the form of both multilateral networks and bilateral agreements. However, they remain a largely niche tool and have not yet obtained broad recognition or acceptance. Many remain unfamiliar with LOTs or have little experience negotiating their terms or evaluating them. This article surveys the potential roles a LOT can play in a corporation’s patent strategy, examines different implementation approaches (including bilateral and multilateral LOTs) and discusses some of the key considerations for the negotiation of terms.

Figure 1. No licence is effective unless and until a party sells a patent covered by the LOT

Figure 2. Transfer of a LOT patent to an NPE triggers the LOT licence

What is a licence on transfer?

A LOT is a licensing agreement which is tailored to address patent disaggregation risk – that is, the risk arising from assertions when the patent is no longer controlled by its current owner. Potentially implemented in a number of ways, the beneficiary of a LOT receives a licence to a patent which is designed to protect it from claims of infringement after sales or transfers of the patent. Unlike a traditional patent licence, a LOT is not designed to provide the beneficiary with protection against infringement claims while the patent holder itself retains ownership. Rather, a LOT licence is triggered only upon a patent sale or transfer. LOTs usually focus on transfers of patents to NPEs, which lack product businesses and are therefore invulnerable to infringement counter-claims, which is otherwise a common means to mitigate exposure as part of a company’s response to a patent lawsuit. However, when an NPE purchases a patent from a party which is subject to a LOT, that patent remains subject to the pre-existing licence, providing the counterparty company with a defence which can be raised should the patents ever be asserted against it (see Figures 1 to 3).

Traditional patent licensing also addresses patent disaggregation risk, since a typical licence would run with any patents sold and bind any subsequent acquirer. However, by focusing just on those patents that a company has decided to divest, the LOT presents some potential advantages over traditional cross-licensing.

Figure 3. Result of a LOT transfer to an NPE

First, LOTs can increase transaction opportunities. In some cases, companies are unable to reach agreement on a traditional patent cross-licence because of concerns about patent exhaustion, competitive products or other reasons. However, because LOTs are targeted only to patents that companies have sold, those concerns are largely obviated. In other words, even if a company is unwilling to grant a licence to a counterparty itself (eg, due to a competitive concern), it is much less likely to have a competitive concern over patents that it has decided to sell at its own discretion. Indeed, companies are unlikely to sell patents which are strategically important or competitively sensitive in the first place, so a LOT licence would never apply to them.

Second, LOT agreements tend to be shorter and simpler than traditional licence agreements. In traditional patent licences, companies must often negotiate fields of use and other provisions critical to protecting their business interests with respect to their own patent portfolios. In LOTs, parties are often willing to provide broadly scoped licences because the agreement will affect transferred patents only.

Third, many organisations may be comfortable entering into LOTs on a cashless basis, eliminating one of the most contentious issues in a licensing negotiation.

Finally, negotiations regarding LOTs are generally more efficient and require fewer senior resources than a traditional cross-licensing agreement, given their limited scope and strategic implications.

Industry attempts to find transactional solutions to NPE litigation risk have focused on the purchase of patents by defensive aggregators before they can be sold to NPEs, which then grant licences to their participating members and release the patents back to the market. Not-for-profit AST and for-profit RPX are two examples of such organisations. While the buy-to-license or subscription defensive models have an important role in mitigating NPE risk, LOTs can offer an advantage over them by addressing the patent disaggregation risk of an entire portfolio in a single transaction rather than potential repeat purchases of portions of that portfolio as they are sold off and then asserted over time. LOTs also intervene as a preventative measure before patents are divested and asserted, which has the potential to lower transaction and other costs as well.

One challenge to LOTs is that their actual value is difficult to quantify. A LOT does not resolve present patent risk, but future patent risk if and when patents are sold. If a party to a LOT never sells any patents, the counterparty never receives any benefit. Further, it is impossible to know whether the patents which will actually be sold will be relevant to your business or will be asserted against you in the future. Based on these uncertainties, some find it difficult to prioritise negotiating a LOT over other activities. Nonetheless, as more companies become familiar with this tailored licensing tool and the value of mitigating future patent disaggregation risk becomes apparent, we believe that LOTs are likely to become more prevalent and may even become considered basic IP corporate practice.

Multilateral or network LOT concepts

Although the concept of a LOT is not new – Intel has some LOT agreements which date back to the 1990s – the rise of several industry groups employing a networked form of a LOT has fuelled a fresh surge in attention. Each of these groups harnesses the power of LOTs, combined with network effects, to deliver increased value to those that join the network.

LOT Network

The LOT Network – a non-profit organisation founded in 2014 by Google, Canon, Dropbox and several other technology companies – is probably the best known of these initiatives and currently has nearly 90 members. Companies which join sign a uniform agreement whereby they grant a royalty-free perpetual licence under their patent portfolio to everyone else that joins the LOT Network covering those other members’ activities which occur anytime on or after the transfer of a patent of the granting member to a patent assertion entity. Participants also pay a small annual membership fee to defray the costs of the LOT Network’s operations.

As of the time of writing, the LOT Network claims that members enjoy LOT protections for over 585,000 patent assets worldwide. This structure may be attractive to companies seeking to maximise the number of patent assets under which they have LOT protection. However, if a company is unwilling to enter into a LOT with certain counterparties (eg, certain direct competitors), an open network presents challenges, because new membership is open and would be beyond its control.

Additionally, the decision to join the LOT Network has a permanent effect on a member’s patent portfolio. Once a company joins the LOT Network, it can withdraw, but its then-existing patents remain bound by the LOT commitment, providing remaining members with greater certainty and protection. However, withdrawal results in an asymmetric position for the withdrawing party because it results in the loss of any LOT benefits for the withdrawing company, other than for patents actually transferred to a patent assertion entity before the withdrawal.

Freedom

Freedom – a network launched by Askeladden LLC, a subsidiary of the Clearing House, on behalf of various financial institutions (but open to all industries) and administered by RPX Corporation – has similar aims to the LOT Network. Once again, those that join agree to provide a benefit to other members with respect to patents that are transferred to NPEs. However, there are some differences in approach with regard to the structure of the licence grant, as well as some other issues. For example, participants in Freedom can withdraw from the network at defined intervals, upon which their non-divested patent assets are no longer subject to the LOT. This feature may be attractive to companies which would like to enjoy the benefits of a networked LOT solution, but are uncomfortable making a commitment which would permanently bind the patents it owns while it is a member (as in the LOT Network). Additionally, Freedom has no membership fees.

RPX Open

RPX Open, another network administered by RPX with over 30 members (including Intel), uses the LOT concept differently. RPX Open focuses only on increasing transparency in the patent secondary market, without requiring the grant of a licence to transferred patents. A long-stated concern of many is that patent sales to NPEs occur privately without the patents being more broadly marketed to potential operating company buyers.

Companies which join RPX Open agree to provide at least 45 days’ notice to the network before agreeing to sell a patent portfolio to an NPE. If a member fails to provide such notice before selling to an NPE, the patent is subject to an automatic licence (LOT) benefiting the other members. This notice period is intended to give other RPX Open participants, including RPX itself, the opportunity to speak with the selling member about alternatives to an NPE sale. Nothing obliges members to have such discussions or consider alternatives.

With its emphasis on transparency instead of automatic free licences upon transfer, RPX Open (unlike the LOT Network and Freedom) has the potential to attract as members even those that may wish to retain the freedom to sell patents to NPEs.

Each of these networked approaches is designed to provide members with efficiencies as a result of network effects, reliance on uniform terms which are generally not negotiated and outsourced administration. An individual member executes only one agreement with the LOT administrator and need not enter into discussions with any other particular member of the network.

Bilateral LOTs

In addition to these more publicly visible networked implementations of LOTs, companies may implement a LOT as a simple contractual arrangement with a counterparty. Much like traditional cross-licensing, bilateral LOTs can be an effective tool for generating long-term defensive protections for a company by creating, essentially, a custom LOT network. In a bilateral LOT, two companies agree that if, and only if, either of them sells a patent, the other will receive a licence under it. Typically, bilateral LOTs will apply to a defined category of patents, such as patents sold within a certain period (eg, three to five years), or patents with a filing date on or before a specific date (eg, three years after signing), regardless of when sold.

Unlike the networked LOT alternatives, bilateral LOTs require negotiations with each specific counterparty. While this could be less efficient than a networked LOT option, it has potential advantages. Crucially, with bilateral LOTs, a company can target LOT discussions to those counterparties which would most benefit it. Each company must evaluate its own patent exposure in light of the major holders of patents that might threaten it. If the members of a network include (or are likely to include) some of those major patent holders, joining it can deliver proportional benefits. However, if they do not, then the benefits may be limited, unless and until a major holder joins. Some major patent holders may never elect to join a LOT network. By contrast, in practice, many members of a multilateral network may not own patents in significant numbers, may have no history of transferring patents or may not be in an industry segment that is germane to the operations of a company considering joining. To keep costs low, the network’s administrative organisation may be limited and, as a practical matter, may be unable to cater to specific efforts to develop the membership to suit any individual company’s interests.

Today’s shareholders are keenly aware of the value of patents as a corporate asset and companies continue to explore patent sales as a way to capture return from their investment in building patent portfolios. In fulfilling their responsibilities to shareholders, IP professionals are routinely expected to demonstrate how they obtain appropriate value in exchange for the value of the patent licences they grant or the patent transfers they make. For companies with large, strong portfolios or patent sales programmes, bilateral LOTs may provide an effective tool for striking a proper balance between one’s duties to the company’s shareholders while operating a patent sales programme which does not exacerbate the issue of NPE patent litigation.

Bilateral LOTs may be able to reach companies interested in mitigating NPE litigation risk but which, for whatever reason, are uncomfortable or unable to join a networked approach. In a bilateral LOT, only the direct parties enjoy the benefits of the LOT commitments. No third parties may elect to obtain the benefits of the LOT without the consent of the original parties. Further, parties to a bilateral LOT are free to adjust the agreement’s terms to suit their particular interests and needs. These may include terms driven by their corporate structure, corporate procedures, flexibility for withdrawal, scope of patents that they wish to commit or other strategic considerations. With bilateral LOTs, two parties can negotiate and tailor the LOT framework to address those needs in a way that a networked solution does not allow.

We believe that the corporate community is best served by embracing the LOT concept as something broader than any specific implementation of it, and that networked LOT solutions and bilateral LOTs are both credible options and can be complementary tools. Members of networks may be able to expand their coverage by engaging with co-travellers through bilateral LOTs and companies which cannot obtain management approval to join a networked solution may avail themselves of the benefits of a LOT bilaterally.

Considerations in a LOT

Before discussing some of the key elements of a LOT, it is worth stating the obvious: the rise in interest in LOT agreements is recent enough that the concept and the various methods of implementing it have yet to be tested in litigation. Additionally, constructing a document that deflects the risk of patent disaggregation but does not, like a traditional cross-licence, grant immediate immunity from infringement in the absence of a triggering transfer requires craft and precision. The sometimes unanticipated way in which US courts have interpreted transactional structures as they have broadened patent exhaustion law can leave some uncertainties as to whether they will respect the boundary lines in a LOT. This task is complicated if lawyers also seek certainty (where none, in fact, may be available currently) that their selected LOT structure will survive bankruptcy proceedings or be effective with respect to patents transferred to NPEs indirectly by subsequent owners of the LOT-encumbered patents.

Despite some legal uncertainties, many companies on the cutting edge have adopted a spirit of practicality to LOTs, especially where no monetary payments are associated with the agreement. A LOT agreement is likely better than none at all for protecting against disaggregation risk. More than one structure can accomplish the core purpose of a LOT, even if an organisation might have a preference for some over others. In time, we will certainly see case law directly interpreting LOTs and practitioners will modify their practices in light of any new clarity about how courts will likely construe the agreement’s terms. Regardless of how a court ultimately adjudicates questions about a given LOT structure’s effectiveness, its presence may dissuade an NPE from investing in the acquisition and assertion of an encumbered patent in the first place, knowing that it will face additional hurdles to prevailing than it would with patents not subject to a LOT.

Key elements

Turning to the key elements of a LOT, one of the first decisions that a company needs to make is which patents will be subject to it. Given the LOT’s purpose, most companies will want to have it cover the full portfolios of each signatory and its subsidiaries owned during the term of the LOT or otherwise meeting some objective criteria (eg, a priority date on or before a specified date). It is possible to craft a bilateral LOT which would include only patents covering specific technologies, but this is less common. Companies still developing their comfort levels with LOTs might lean towards a shorter term or capture period, coupled with auto-renewal of that period if neither party opts out before the renewal.

Duration of LOT commitment

Companies must also decide for how long they are comfortable making the LOT commitment. Given the LOT’s purpose, most parties will likely want the licences to transferred patents to endure for the life of those patents. In the context of LOTs, duration also focuses on whether a patent, once made subject to a LOT, remains so regardless of when the triggering transfer occurs (ie, once tagged, always tagged), or whether the triggering transfer must also occur during a specific timeframe for the licence to take hold. The approach that a company pursues will depend on the level of future flexibility it wishes to preserve related to patent transfers. A company which wants to hedge its decision might opt for a specific term, coupled with auto-renewal concepts.

Triggering transfers

Next, companies must decide what transfers of patents will trigger a licence. Some parties may prefer the clarity of a transfer trigger – perhaps because they do not envision ever having a patent sales programme or business divestiture where patents would be a key value driver. We expect companies to find the most common ground with an NPE transfer trigger, recognising the potential value of the licence defence that a LOT provides to deter frivolous litigation and aggression by an NPE buyer. Other tools – such as a strong, well-developed portfolio from which counter-claims could be made – can help to encourage reasonable behaviour by an operating company purchaser.

Special case: business divestitures

One consideration is whether a traditional business divestiture (eg, the sale of a division or business line) would trigger a LOT, as opposed to a specific patent sale. This is less likely to be a concern if the trigger is limited to transfers to NPEs, as NPEs are not typically acquirers of major business operations. However, in a LOT which triggers upon any transfer to any third party, it is likely more important for a company to have developed its viewpoint on the appropriate interplay between its LOT philosophy and its business divestiture practices.

A LOT results in a non-exclusive encumbrance on transferred patents, like the traditional cross-licences that a company may already have, so there will be no adverse impact on its freedom to operate. Likewise, a company acquiring a divested business needs to consider whether the presence of a LOT could affect its reason for making the purchase, which is likely to be the case only if the divested patents are material to the competitive advantage of the divested business and the beneficiary of the LOT licence happens to include a divested business competitor.

In these contexts, companies might consider seeking exceptions to the definition of ‘transfer’, which would exclude certain bona fide business divestitures. However, such an exception can call into question whether the LOT is worth doing if a counterparty becomes concerned that application of the exception will not be rare or may provide opportunities to avoid the purpose of the LOT by characterising patent sales as business divestures.

Licensed field

As discussed earlier, because a LOT’s impact is limited to patents which are transferred, as opposed to those retained, the licences provided via LOTs potentially can have extremely broad fields of use (ie, any product and service). Even so, it would be unsurprising for companies to insist on some level of clarity that the products and services covered by the licence are those of the licensee, to avoid concerns (particularly with a networked LOT solution) that parties may structure arrangements with the purpose of extending the benefits of a LOT to the products of a third party which has not agreed to provide a corresponding LOT benefit under its portfolio (eg, patent laundering).

Licence grants

The licence grant structure of a LOT can be implemented in a surprising number of variations. Some LOTs seek to optimise clarity that the agreement affects only patents which ultimately are transferred and which do not grant immunity prior to a triggering transfer. These tend to adopt a structure where the licence is expressly granted only under transferred patents and effective only immediately before the triggering transfer.

Other LOTs may optimise for as much clarity as is feasible under bankruptcy law (which is inherently limited, given the existing case law) that the LOT would survive with respect to transfers made in bankruptcy. These tend to emphasise the present and effective nature of the grant. For some companies, bankruptcy clarity may be a higher priority in a networked LOT solution, where value proposition rests more on offering access to portfolios of a wide range of companies, including start-ups and small companies, where bankruptcy concerns may loom larger than in the context of a bilateral LOT between two well-established companies.

Change of control

Traditional patent licences and cross-licences often devote substantial energy to addressing what effect a change of control of a counterparty should have on each party’s licence rights. Predicting the future is difficult and such provisions are often necessary to reassure companies that they will not regret the licence arrangement five or 10 years down the road.

By definition, in a LOT, all of the licences providing immunity to the acquired party’s business at the time of acquisition are under patents that the licensor no longer owns. As such, the approach to change of control in a LOT should be much simpler, likely focusing more on whether licences should continue to take hold for any patents transferred in the future (for the acquired party or both parties) than attempting to rescope the licence rights related to transfers which have already taken place.

Familiarise and reap benefits

Thinking ahead to the next move is important for strategists seeking to mitigate defensive patent risks for enterprises. The LOT concept can be an important, flexible tool in a corporation’s patent transaction strategy toolkit. Those who take the time to familiarise themselves with LOTs and their various implementations will be best positioned to reap the benefits that they have to offer.