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Downsides to Assigning IP for Royalties
Normally, royalties are associated with a license. They are amongst the ongoing obligations upon a licensee, in return for the ongoing right under the license to exploit the licensed IP.
Normally also, an assignment of IP has no ongoing rights or obligations, since all the rights upon assignment vest in the assignee, and the assignment is in return for a lump sum payment.
Does that mean that an assignment must be in return for a lump sum payment and cannot be in return for royalties?
Not at all. There is no legal impediment to an assignment in return for royalties.
But, there are some downsides. They arise because an assignment cannot be terminated.
An assignment cannot be “terminated”
A licensor may terminate the license if its terms are breached by the licensee. The licensor’s power to do so deters a licensee from breaching the license terms.
This deterrent effect operates high in a licensee’s mind. It does not want to put at risk its investment under the license, nor the business that the license enables, both of which will disappear if the license is terminated by a licensor as a result of the licensee’s breach.
But this is not so with an assignment, under which the ownership of assigned IP is transferred from the assignor to the assignee. Once the ownership of the IP vests with the assignee, that ownership cannot be “terminated”.
A seller of a car cannot 6 months after the sale “terminate” the sale and get the car back. This is a meaningless concept in the context of a transfer of property. Similarly, a seller of a house cannot 6 months later “terminate” the sale and get the house back. Again, this is a meaningless concept in the context of the transfer of property. So also, the termination of transfer of IP, which is what an assignment is, is again a meaningless concept. IP of course, is also property.
If an assignee has ongoing obligations to the assignor under the terms of the assignment, unlike a license, termination not being possible, there is no deterrent that will ensure compliance with those ongoing obligations upon the assignee.
Unlike a licensee, who relies on the ongoing rights under a license, an assignee, being the owner of the assigned IP, does not need any ongoing rights to the IP from the assignor.
Downside #1: limited options when royalties are not paid
A licensee that does not pay royalties runs the risk of the license being terminated and the licensed rights being lost.
If an assignment of IP is made in return for ongoing royalties instead of a lump sum payment, the failure to pay royalties cannot result in the “termination” of the assignment.
A license has the effect of deterring a licensee from breaching its terms by not paying royalties when they are due. There is no such deterrent when an assignment takes place.
An assignor may sue for damages for the unpaid royalties. But, royalties may have to be unpaid and accrue for a long time before there is economic justification in commencing legal proceedings. In the meantime, the assignor is frustrated by the assignee’s disregard for the agreed terms of the assignment, as well as the assignee’s disregard for the assignor’s demands for compliance.
Downside #2: no more royalties if the assignee liquidates
If a licensee goes into liquidation, generally, the licensor can terminate the license, find another licensee, re-license the IP, and continue to receive royalties from the new licensee.
This cannot be done if IP is assigned. If the assignee goes into liquidation, the IP, being the assignee’s asset, it is treated like all the assignee’s other assets, and is sold to fund payments to creditors.
The assignor has no automatic right to the IP that it assigned. As a former owner of the IP, like a former owner of a car or a house, it has no rights.
Unlike a licensor, an assignor therefore has no opportunity to re-license and obtain royalties from a later licensee.
Downside #3: no more royalties if the assignee in turn assigns
Suppose an assignee, after the assignment, in turn assigns the IP to a new assignee. Who will pay royalties to the assignor now?
The assignee will not be liable for royalties (a payment based on sales) because the assignee is not itself making sales. The new assignee will also not be liable for royalties because there is no contract between the assignor and the new assignee which records such an obligation upon the new assignee.
The result is that sales are made and profits are earned, but the assignor, who was promised royalties on those sales in return for the assignment, receives nothing.
This risk could be lessened by a provision in the assignment requiring the assignee not to re-assign the IP without simultaneously novating the royalty obligations. This would protect the assignor’s right to royalties, because the new assignee will as a result have contractual obligations (under the novation) directly to the assignor.
This however does not prevent an assignee disregarding that provision, and assigning the IP without the novation. While the assignee in those circumstances can be sued for that breach, practically, this is not an option if the assignee has no assets, or has gone into liquidation.
Downside #4: limited options when diligence obligations are breached
Diligence obligations are obligations upon a licensee to diligently commercialise. They are obligations beyond “best” or “reasonable” “efforts” or “endeavours” to commercialise, which generally, are ineffective. (See previous editions of IP Bits What Do “Best Endeavours” and “Reasonable Endeavours”mean? and The Hardest Part of a License to Negotiate - Diligence Obligations - Part 1 , Part 2, and Part 3).
Diligence obligations upon a licensee can take many forms, such as:
1. the achievement of milestones demonstrating the successful progression of the pathway to market
2. achieving a minimum level of sales over defined periods in defined markets
3. the payment of minimum royalties
4. minimum development expenditure
5. minimum marketing expenditure
Under a license, if diligence obligations are not met, ultimately a licensor can terminate the license, and re-license the IP to another licensee, who can successfully commercialise.
Diligence obligations under an assignment cannot result in the termination of the assignment, so there cannot be such a re-grant of rights as can occur when a license is terminated.
While it is true that an assignee that does not meet diligence obligations can be sued for damages, there will be evidentiary challenges, as well as the challenge of the legal expense of bringing proceedings, both of which will deter an assignor.
Do these downsides really happen?
Not often, but regrettably, they do from time to time.
There is no impediment to assigning IP in return for royalties. However, it is because of these downsides that an assignment in return for royalties is uncommon.
More typically, the type of transaction is driven by the type of financial consideration under the transaction:
if royalties are to be paid, rights that can be terminated for non-payment are granted, under a license,
if a lump sum payment is to be paid, with neither party having ongoing obligations to the other, an assignment is appropriate, and
if a lump sum is to be paid by instalments, initially a license is granted, with an assignment taking place upon the payment of the last instalment.