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IP licensing: Disadvantages to the licensor

30 April 2024

IP licensing: Disadvantages to the licensor

Is licensing in your pipeline? It can be a powerful tool for business growth and expansion, so go ahead. But, says Espie Angelica A. de Leon, be aware of the potential disadvantages that come with licensing and know the steps you can take to address these challenges.

In some unfortunate cases, what two parties in a licensing arrangement believe to be a done deal is exactly that, but with damaging repercussions. The potential licensee approaches the negotiation table with a different plan in mind: stealing confidential technical information connected to the intellectual property being licensed such as technical know-how or trade secrets, or secretly registering the IP as their own. The latter happens when the licensor fails to apply for registration of the IP or does not register the IP within the licensed territory.

After several rounds of negotiations, both parties’ wants and needs have been considered, licensing terms have been finalized and everybody’s happy – or so the licensor thinks. Eventually, the licensor learns about the damage their supposed “licensing partner” has inflicted on them. Truly, it’s a done deal – for the licensee who committed IP theft. As to the licensor, they’re simply done.

IP licensing offers many benefits to the licensor, but it has its share of potential disadvantages. How can individuals and business enterprises planning to license their IP address these pain points before, during and after licensing negotiations?

The disadvantages of licensing

First, let’s enumerate some of the disadvantages, or pain points, connected with licensing.

IP theft is one of them. Actually, it is one of licensing’s most serious concerns.

Another disadvantage is the competitive risks involved. If the licensor grants a license to a competitor or a potential competitor, depending on the nature of the IP, the possibility of the latter having access to proprietary technology that could be reverse-engineered exists. Through reverse engineering, the licensee will be able to develop his own product or service that will compete against that of the licensor in the market.

The licensor also loses control over the use of the IP. Despite the existence of a contractual agreement, when a licensor grants a license to a licensee, the former inevitably relinquishes some degree of control over how the licensed IP is used. “The loss of control can result in the licensed IP being used by the licensee beyond the scope of the license or in violation of the agreed-upon terms,” explained Zunxia Li, a partner at IP March in Beijing.

“Without adequate contractual protection, a licensor risks reputational damage, loss of goodwill and dilution of its brand image or value,” added Natalie Huang, a senior associate at Baker McKenzie Wong & Leow in Singapore.

Aside from losing control over the use of the IP being licensed, the licensor likewise loses control over its quality. To keep their IP’s integrity and value intact, licensors must conduct vigilant quality control. “Poor quality management can tarnish the reputation and dilute the value of the IP. With respect to trademark licenses, inadequate quality control may not only damage brand perception but could also lead to the cancellation of the trademark in some jurisdictions, representing a direct threat to the licensor's brand identity and market position,” remarked Peter Dernbach, a partner at Winkler Partners in Taipei.

Another pain point is the licensor’s dependence on the licensee’s performance. “The financial success and further development of the IP significantly depend on the licensee’s ability to commercialize it effectively. This dependence creates a vulnerability for the licensor, as underperforming licensees can impede revenue generation and limit the potential growth and innovation opportunities associated with the IP,” Dernbach explained.

Licensing to multiple licensees can also be a rough spot as this can increase variations in how the end users experience the IP. When this happens, the IP’s distinctiveness, which is often pivotal to its value, may decrease. As a result, the IP’s competitive edge and market exclusivity decreases as well. 

Legal and compliance risks pose additional challenges to the licensor. “Licensing IP, especially cross-border licensing, often involves complex legal environments from license negotiation to dispute resolution. Failure to adequately address legal and compliance risks may expose the licensor to litigation, penalties, reputational damage and other adverse consequences,” explained Li.

Furthermore, legal disputes may arise between the licensor and licensee or between the licensor and third parties. “For example, if a licensor is obliged to assist the licensee in enforcing trademark rights, the licensor may find itself embroiled in enforcement matters in specific jurisdictions, particularly if the licensee adopts an overly aggressive enforcement stance. Such disputes can exacerbate the licensor’s legal and financial burdens,” shared Dernbach.

Licensing is a management burden, thus an additional disadvantage for the licensor. “Licensors face the operational challenge of managing their IP licenses, which entails monitoring the quality of the licensee’s products or services, ensuring timely royalty payments and preventing unauthorized use of the IP. This management burden can be resource-intensive, diverting attention and resources from other strategic areas of the licensor's business,” Dernbach said.

How to deal with the challenges of IP licensing

There are several ways to circumvent these challenges. Our interviewees advise licensors to take the following measures:

  • Perform an IP audit to identify intangible assets and determine how to structure licensing arrangements.
  • Conduct comprehensive due diligence on the potential licensee. Licensors must do this before entering into any licensing contract. Due diligence includes checking the potential licensee’s past credit history, financial stability, track record in IP compliance, among others.
  • Clearly define the key terms in the licensing agreement. There should be no room for ambiguity where these terms are concerned. Therefore, the licensing agreement must be precise and thorough. “The potential loss of control of the license is a principal drawback in a licensing arrangement. Having a well-drafted watertight license agreement is essential in addressing this risk,” said Jyeshta Mahendran, partner at Shearn Delamore & Co. in Kuala Lumpur.

The terms of the license include the following: what IP is covered; the period, scope and geographical ambit of the license; whether the agreement covers pre-existing IP and/or IP generated pursuant to the arrangement; permitted activities of the licensee; exclusivity; restrictions; the licensor’s and licensee’s respective rights and obligations and whether these include sub-licensing; ownership of IP including ownership rights to improvements to an invention, and goodwill created in the course of the licensing arrangement; royalties; variation to the trademark and get-up during the course of the license; quality control standards.

“Where confidential information is involved, licensors should always ensure they subject licensees to strict confidentiality obligations,” said Lim Ren Jun, principal at Baker McKenzie Wong & Leow in Singapore.

Dernbach also reminded that the terms of the licensing agreement must be flexible as well. “Incorporating reasonable adjustment and termination clauses in the licensing agreement gives licensors the flexibility to respond to underperformance or changing market conditions,” he said.

  • Opt for less disclosure and strict confidentiality.Minimize disclosure of IP information to the licensee and limit the scope of the IP which the licensee can access. It also helps to sign a clear confidential commitment during the licensing negotiation. These, in addition to including confidentiality and non-disclosure provisions as well as IP ownership provisions in the license contract, can help reduce the risk of IP theft. These will also serve as evidence in disputes that may arise later, especially if the license involves know-how and technical secrets.
  • Regularly audit and inspect to ensure quality control. Establishing stringent quality control standards and procedures aren’t enough. This should be followed up by regular audits and inspections to help maintain consistency and integrity in the use of the licensed IP.
  • Take full IP protection. Licensors should register their IP at the outset to protect it throughout the valid term of the licensing agreement. Registration must be comprehensive and timely. Licensors should also monitor the licensee’s use and registration of related IP, etc.

In the case of trademark licensing across borders where the parties operate in regions with different languages, the licensor is advised to secure trademark rights in the relevant foreign languages. Yi-Kai Chen, attorney-at-law at Winkler Partners in Taipei, explained: “For instance, a U.S. company licensing to a Taiwanese distributor should also obtain trademark rights for the Chinese equivalent of their marks, ensuring brand protection across linguistic boundaries. The English marks’ legal safeguards may not fully extend to its Chinese counterpart. Moreover, without this registration, third parties, including the local distributor, could potentially register the trademark in the local language, posing significant challenges to brand control and leading to market confusion.”

  • Avoid contravening anti-competition laws. According to Mahendran, this may ultimately become a disadvantage to both the licensor and the licensee.

Licensing pain points outweighed

“In our experience, the advantages of licensing IP often outweigh the disadvantages,” says Huang.

Chen agreed. “We believe the advantages of IP licensing often outweigh the disadvantages. Proper management and strategic planning can mitigate the above risks and highlight the advantages,” he said.

Huang explained that by generating income through fees and royalties, licensing creates a new income stream for licensors. It also increases revenue without significant capital investment or operational involvement by the licensor

In addition, licensing IP can facilitate a licensor’s entry into a new market. “For example, a licensor can tap into a licensee’s network, experience and contacts to establish a presence in a new market. This would save the licensor time and money, versus building up operations and brand exposure from scratch,” Huang added.

This is especially true when penetrating a foreign market. “For example, an IP owner may license another business to sell its products bearing the relevant trademark in a territory where the owner cannot enter due to restrictions on activities by foreign companies,” said Elisia Engku Kangon, senior associate at Shearn Delamore & Co. in Kuala Lumpur.

The ability to leverage local market expertise is another advantage. According to Chen, licensees often have in-depth knowledge of their domestic markets. And this can work to the licensor’s advantage if he wishes to penetrate that market. “A well-chosen licensee understands the local consumer behavior, market dynamics, regulatory landscape and competitive environment better than an external licensor ever could,” said Chen. “This local expertise enables the licensee to tailor the marketing and distribution strategies to maximize the IP’s appeal and commercial success within the specific market context.”

The licensor will also be able to share the risk of product development, production, marketing and distribution with the licensee, therefore reducing the former’s own financial and operational risks.

Is licensing in your pipeline? Licensing is a powerful tool for business growth and expansion, so go ahead. But be aware of the potential disadvantages that come with licensing and know the steps you can take to address these challenges. And then you’ll be ready for the negotiation table.

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