A detailed article on sublicensing terms and strategies appears in the September issue of Technology Transfer Tactics. To subscribe and access the complete article, or for further subscription details, click here.

With myriad ways to go about sublicensing and the potential for the complications involved spoiling a license agreement, university TTOs may put off the question entirely and wait until the issue is forced by a sublicense request. Or they sometimes will establish sublicensing terms up front that seem simple and straightforward, but which actually hinder revenue opportunities.

The better path is to carefully consider sublicensing terms when establishing the initial licensing agreement and craft a deal that works for both parties, say several leaders in tech transfer and intellectual property law. There is no one set of terms that will work well for every deal, they say, but there are ways to home in on terms that protect the university’s interest without creating undue burdens on the licensee.

Sublicensing terms can vary widely because each licensee’s business model will dictate how important it is to have sublicensing terms and what those terms should be, says K. Lance Anderson, JD, member and deputy CEO with the law firm of Dickinson Wright in Austin, TX. He represents licensees and universities, and he previously worked in tech transfer from the university side.

When a faculty member forms a start-up, there is a good likelihood that company will sublicense the IP to others, Anderson explains. But if the IP is licensed to a large, well-established company that is utilizing it for its own products or services, sublicensing may never occur, he says.

“Sublicensing doesn’t matter until it matters. And then it matters a lot,” Anderson comments. “There can be a lot of money at stake and universities want to protect themselves.”

Many licensors don’t allow any sublicensing, notes Michael D. Hobbs Jr., JD, partner with the Troutman Pepper law firm in Atlanta. There can be some loss of control in the process with a sublicensee and they often want a direct, exclusive contractual relationship with the licensee, he says.

However, sublicensing can be critical to the financial considerations of a deal, allowing the licensee to make money without which it can’t pay the amount of royalties the university wants.

In those cases, the sublicenses usually contain a clause that the licensor is a third-party beneficiary to the sublicense agreement and has the right to step in and take legal action in the event of a breach by the sublicensee, he says.

In some cases, the licensor and licensee may not negotiate a standard sublicense, but rather approve agreements on a case-by-case basis. This carries with it uncertainty for the licensee as it may spend the time and effort to negotiate a sublicense only to have it rejected by the licensor, Hobbs says.

When it is necessary to establish sublicensing terms, Anderson says there are two basic models – pass-through and revenue sharing. With the pass-through model, the royalty established with the licensee is replicated with the sublicensee. If the university earns 5% of sales with the licensee, it will earn the same amount from the sublicensee.

A pass-through model protects the university by assuring that a start-up doesn’t just become a broker for licensing the IP, depriving the university of its proper revenue, Anderson explains.

In the other option, revenue sharing, any revenue the licensee earns is shared with the university in a specific way. Often these deals are structured so that the university gets a bigger share when the licensee gets a sublicense quickly after the original license is signed, without having done anything to add value to the IP, Anderson says. The thinking is that in that case the licensee is just acting as a broker and did not earn the revenue by improving the IP, he says. The university commonly may get 50% of such a sublicense’s revenue.

“But if I go and commit resources and time, obtaining regulatory approval, that figure may go down,” Anderson says. “Universities have to be careful with this revenue sharing model because ultimately it can dilute their position when the sales happen. If you do a 10% revenue share with the licensee and they do a 5% royalty on the sublicense, then the university is getting [only] 0.5%.”

That was a common problem in the earlier days of tech transfer when contract terms had not evolved enough to anticipate such dilution, Anderson says. A university would license IP to one company with a 5% royalty, and that licensee would immediately sublicense it to a closely related affiliate or subsidiary company at a 5% royalty, allowing them to sharply reduce the royalty owed to the university.

After universities caught on to those shenanigans, the pendulum swung in the other direction and they started favoring the pass-through royalty model, Anderson says. But that introduces the risk of making it too difficult for the licensees to do anything profitable with the IP, which cuts into everyone’s revenue, he says.

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