Sub-Licensing: Controversies Around Step-In Rights 


Introduction

When a licensee grants a sub-license, apart from the usual need for the licensee to obtain the licensor’s prior written consent (which is not to be unreasonably withheld) the other major issue is how to deal with Step In Rights. This can sometimes be controversial. 


What are Step in Rights ? 

Postulate: 

  1. a licensor grants a license to the licensee for the unexpired duration of the licensed patent 
  2. the licensee grants a sub-license to a sub-licensee for the same duration, the unexpired duration of the patent 
  3. one year later, the licensee breaches the license, and the licensor terminates the license 
  4. the patent will expire in 15 years time. 

What is the position of the sub-licensee ? Does its sub-license continue, or is it terminated as well? 

A licensee cannot grant any greater rights than the licensee itself has. A term in a sub-license which purports to continue the sub-license after the license from the licensor is terminated is ineffective.  

A sub-license being entirely dependent on the licensee’s license continuing, and coming to an end if the licensee’s license comes to an end, the sub-license will want to address this in some way to ensure that its licensed rights continue. 

It does this by having Step In Rights. 


Sub-Licensee’s perspective on Step in Rights 

A sub-licensee will naturally want to “step in” to the licensee’s “shoes”. That is, the sub-licensee will want to have the original license to the licensee, re-issued to the sub-licensee, as a new license, on the same terms as the original license. 

In this way, the sub-licensee “steps in” to the original license in substitution for the now terminated original licensee. 

This will ensure the uninterrupted continuation of the sub-licensee’s licensed rights. 

This would be achieved at the time of entering into the sub-license, by the sub-licensee requiring an additional agreement between the sub-licensee, the licensee, and the licensor, providing for these step in rights. 

It is only by having this 3-way agreement, to which the licensor is a party, that the sub-licensee can enforce its step in rights against the licensor. 


Licensor’s perspective on Step in Rights 

A licensor may however have a different perspective.

Postulate: 

  1. the original license to the licensee provides for a royalty rate of 5% 
  2. the licensee grants a sub-license for a royalty rate of 7%. 

The licensor may not have any concerns with step in rights as such. But the licensor will realise, as well as the sub-licensee realising: 

  1. if the sub-licensee steps into the licensee’s position, the sub-licensee will experience a windfall, by having a reduction in its royalty rate from 7% to 5%, and 
  2. if alternatively the licensor steps into the licensee’s position, it will be the licensor that experiences the windfall by having a royalty increase from 5% to 7%. 


Resolving the controversy 

Obviously, the sub-licensee will prefer to step into the licensee’s position, and the licensor will prefer to step into the licensee’s position. 

How should this controversy be resolved? There may be significant amounts involved, given the unexpired duration of the patent. 

The licensor might have an attractive argument that it makes more sense for the licensor to step into the licensee’s position, rather than the reverse. 

The original license may have been granted without a field limitation, operating worldwide. However, the sub-license may have been granted a license in a field, and a territory other than the whole world. If the sub-licensee stepped into the licensee’s position, it would now be exercising licensed rights beyond its field, which might be beyond its capability, as well as exercising worldwide rights, which similarly might be beyond its capability. 

Given those factors, it might be argued that the proper way of dealing with step in rights is for the licensor to step into the licensee’s position, and that this universally should therefore be the position. 

But of course the matter is highly negotiable. At the time of seeking consent to the grant of the sub-license, the sub-licensee might have the superior bargaining position, since only it might be able maximize the commercial opportunity to benefit the licensor. Or, the licensor may have the superior bargaining position, since its consent to the sub-license is required, and it may be obliged to consent (because there are no reasonable grounds to withhold it) but it is not obliged to agree to step in rights. 


Improving the Licensor’s position 

The licensor’s position, at the time that consent to the sub-license is sought, is therefore unpredictable. 

To improve the licensor’s position, rather than waiting to deal with this issue when consent to the grant of a sub-license is sought, the licensor could deal with it in the original license, providing that it will be the licensor that will step in to the licensee’s shoes, and not the reverse, and that the licensor would be entitled to withhold its consent to a sub-license if the reverse was sought. 

This being a term of the original license, the licensor is likely to be in a stronger position to resist the reverse being sought in the event of a sub-license.