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Securing Diligence Obligations in Early Stage Licensing
Every licensor seeks to include diligence obligations in the license terms.
Diligence obligations are obligations upon a licensee that the licensee must be diligent in commercialising the licensed intellectual property.
Diligence obligations can take many forms, for example:
Identifying milestones along the commercialisation pathway, and requiring them to be achieved or reached by the licensee by specific dates or timeframes, such as milestones dealing with:
completing R&D or product development
clinical and regulatory achievement
producing a prototype
manufacturing a satisfactory pilot plant and production plant
granting a sub-license in a key market
Requiring minimum expenditure on
(a) R&D, or
Requiring minimum sales to be made, generally, or in particular markets.
These are just a few examples. Licensors and licensees can be quite inventive in formulating diligence obligations when negotiating their license.
A licensee’s failure to comply with those obligations might indicate technical obstacles. But they might also be the result of a licensee’s less than diligent efforts to commercialise the licensed intellectual property.
A licensee may have funding for only its top three ranking projects, and the licensed technology may rank fourth. A licensee may have developed, or licensed in, competitive technology which is more profitable. A licensee may intentionally not commercialise, having sought the license for no other reason than to make sure that the technology was “put on the shelf”.
In each case, the result of an underperforming or non-performing licensee is that the licensor receives no financial return, or inadequate financial return.
Where the licensor is a research organisation its mission of its research outcomes benefitting the community is not achieved.
Where the licensor is a start up company, its investors may not get a return, or may get an inadequate return.
Diligence obligations are therefore critical. Failing to comply with diligence obligations, ultimately, must lead to the termination of the license so that the licensor can license an alternative licensee.
However, the earlier in the stage of development a technology is, the harder it is to negotiate diligence obligations.
The earlier the stage of development of a technology, the higher the risk for a licensee, and the greater the speculative nature of the licensee’s investment into the licensed technology. Correspondingly, the greater the licensee is resistant to diligence obligations, or just simply refuses to entertain any diligence obligations.
The later the stage of development of a technology, the lower the risk for a licensee, and the lower the speculative nature of the licensee’s investment, if speculative at all. In fact, the risk is greatest to a licensor, which having a market ready or near market ready technology, has the greatest to loose in the case of an under-performing or non-performing licensee.
But however early the stage of development of the technology, and however resistant a licensee might naturally be to diligence obligations, some type of diligence obligations should be able to be negotiated.
Research organisations not uncommonly need to license their research outcomes at an early stage. Start up companies may need to partner and license at an early to intermediate stage. SMEs may need to license to help underwrite the risks of development.
They may need a licensee to fund national phase patent expenses, and so will need to secure a license well before national phase commences. They may not have the financial capacity to take the technology beyond the research phase or early development phase, and into the trial, prototyping, and market ready phases. Or, they may not have the specialist skills or the resources to take their research outcomes into the development, trial, prototyping and market ready phases.
Even a technology at the earliest stage of development should be able to be licensed with some diligence obligations.
A licensee that seeks to be granted a license, even of the earliest stage technology, must intend to do something with it in the short to intermediate term. Whatever that may be should be able to be formulated into milestones for that immediate to intermediate term.
Diligence obligations can be the hardest part of a license to negotiate, and the earlier the stage of development of the technology, the harder that task is. But diligence obligations are also critical, and the most important obligations that a licensor seeks to secure from a licensee.