Should We Allow the Overleveraging of IP Rights By Contract?

The most distinctive aspect of an IP licence is that it addresses both IP and contractual rights. When the licensor grants to the licensee, and the licensee accepts, the right to use the IP right under specified terms and conditions, the licensee risks a claim of infringement if he exceeds the scope of the grant and he enters into the unlicensed portion of the licensor's IP rights. As well, the undertaking to use the IP right in a specified manner creates a contractual obligation on the part of the licensee, the violation of which gives rise to a claim of breach of contract against the licensee.

This dual nature of an IP licence is well-recognized. Less appreciated, however, is the asymmetry that is created between the scope of the proprietary obligations that exist by virtue of the IP right and the potentially broader scope of contractual obligations that may be created under the licence, subject only to agreement by the two parties. Against that backdrop, an interesting question arises: how do we treat a contractual obligation that exceeds the scope of the IP right being licensed?

An example oft-encountered by this Kat is the provision in a licence agreement involving a trade secret under which the licensee undertakes not to reverse-engineer the trade secret being licensed. Set against this provision is a central tenet of trade secret protection, namely that lawful reverse engineering is permitted. In some countries, the right to reverse-engineer is anchored by statute, in others it is a creature of case law. In either situation, it is well-recognized that the right to reverse to reverse-engineer is part and parcel of the trade secret right. Thus, if the disclosee-licensee is able to reverse-engineer the trade secret without running afoul of some other IP right, such as copyright, the act of reverse engineering is permitted.

Let us assume that the licensee goes ahead and successfully carries out reverse engineering of the licensor's product. The licensor then sues for breach of the licence. The licensee defends by arguing that reverse engineering is permitted as a matter of trade secret law and that the right to do so is a matter of lex cogens in favour of the licensee. This Kat is not sure how such a scenario ultimately plays out.

At a less dramatic level, what is the obligation of the lawyers for the two parties in negotiating a trade secret licence with respect to a provision prohibiting reverse engineering? Do the lawyers for the respective parties have to mention during the course of negotiations that trade secret law permits reverse engineering, or is the ultimate fate of the inclusion of provision simply a matter of bargaining power, leaving the issue of the legality and enforceability of the provision to a later time?

Another example of the potential clash between the proprietary and contractual aspects of an IP licence arises in the context of trade mark consent agreement (lest readers jump on this Kat at this point, I recognize that a trade mark consent agreement is not precisely a licence, but the undertakings created raise similar issues for our discussion.) Even if the underlying dispute involves only registration of the respective marks of the parties, it is the case that the parties will sometimes seek not only to resolve the immediate issues, such as the form of the respective marks and the goods or services to be covered by the respective registrations, but more generally, they will address the terms and conditions by which the two parties agree to use their respective marks. In such a situation, the parties will be tempted to "wrap things up, once and for all", especially if the dispute involves multiple jurisdictions. In so doing, the final form of the consent agreement might include mutual undertakings that exceed the scope of the respective goods and services of the two parties as well to cover territories in which neither party has any enforceable trade mark rights.

Imagine that one of the parties begins to use his mark on goods that lie outside the scope his goods and services under the registration, but that do not fall under the goods and services of the other party. It would seem that a breach of contract claim exists, even if the plaintiff has no claim for trade mark infringement. If this is correct, then the parties, as between the two of them only, have expanded the scope of protection by means of contract. Can the allegedly breaching party nevertheless still defend by arguing that the undertaking is invalid and unenforceable?

This Kat's sense is to say "no". However, if this is the case and the contract claim stands, there is still something a bit troubling by the fact that parties can use a dispute over IP rights IP to leverage their respective rights beyond the scope of the IP rights themselves. The over-leveraging of financial assets, as consensual is it was, proved to be a root cause of our current financial crisis. Should the law take a similarly wary view of over-leveraging when IP licences and the like are involved?
Should We Allow the Overleveraging of IP Rights By Contract? Should We Allow the Overleveraging of IP Rights By Contract? Reviewed by Neil Wilkof on Sunday, September 30, 2012 Rating: 5


  1. Expanding the scope of an IP right by contractual obligations - quelle horreure! Within the EU, that is likely to bring the competition law police running! They don't much like IP generally, and certainly don't like it being expanded. See, for example, the grey-listing of no-challenge clauses under the Technology Transfer Regulation.

  2. No black and white answers here. There is every reason why a party receiving a licence to use IP is indeed in a different position from the rest of the world and both parties might legitimately expect a clearer berth to be given to the conveyed rights than would arise under general law. A licensee of, say, trade mark rights would be in a very strong position from legitimate usage to build reputation in relation to other goods or services, or different brands, in a way that would not be available to those whose use of the registered mark for a registered purpose. The brand values can be "rubbed off" onto other marks or extended to other goods. It may therefore be a legitimate point for the rights owner to agree limits on other activities associated with the mark even if in a third party's hands those activities would be unchallengeable. Similarly, access to trade secrets (and employees and other materials) may make legitimate reverse engineering much easier and the results more readily interpreted, and may increase incentives and rewards for the reverse engineering activity. Again, the licensee is placed in a unique position by a licence. In the licensee's hands, otherwise legitimate activity may acquire extra value and allocation of those benefits by contract can and should be part of the commercial bargain. A rights holder facing a serious risk of being ripped off more effectively by any licensee than by joe public is likely to hold out against licensing, thus defeating what the guidelines to the Technology Transfer Regulation recognise as the procompetitive effects of licensing. The point is that, as with so much in this area, whether in any particular case the overall effects are anticompetitive or procompetitive requires an open mind and an individual assessment.

  3. On a more general thought, isn't this issue inherent to the nature of any license/rental agreement? A property owner has an exclusionary right against everyone in the world, and can license that right to a third party, who now can also have exclusionary rights against the whole world. If we cross license, we now have both leveraged our initial exclusionary rights for greater exclusionary rights against others, however we have done so by giving up a portion of our original rights.

    I think the differential perspective with IP rights can in part be traced to the common distinction between IP rights theoretical effect versus their practical effect. A patent might have an exclusionary right in theory, but be unenforceable economically on its own. If a number of patent holders in this situation use a series of license agreements to create a patent pool there is no theoretical net change in the patent grant, but the practical ability to exclude for each of the pool members against the world at large can be greatly increased.

  4. In the US the K-Dur antitrust litigation seems to be on its way to the Supreme Court after a federal appeal court judged agreements between patentees and generics-makers to 'pay to delay' selling of generics as 'unreasonable restraint of trade'.


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