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The Practicality--and Pitfalls--of Reach-Through Licensing in Europe

LONDON - Over the last few years there has been considerable interest in the legality of "reach-through" licences under the anti-trust and competition law regimes in the United States and Europe.


These licences can be a useful model for licensees and licensors to finance the transfer of technology. In principle, reach-through royalty obligations should not present legal difficulties in Europe, although any such obligations do need to be analysed on a case by case basis in light of European Union competition-law requirements. However, in practice, the use of reach-through royalties appears to be on the decline and these obligations are becoming harder to negotiate. 


In the present climate, licensees may find themselves in a stronger negotiating position and, in addition, both licensees and licensors are now more fully aware of the practical disadvantages and uncertainties presented by reach-through royalty payment structures. As a result, trends suggest that licensors and licensees are applying reach-through royalties for enabling technologies on a selective basis and are seeking practical alternatives.


The legalities


Terms of reach-through licensing arrangements allow the licensee to use enabling technology--a database of gene-sequence information, or genetic information documenting a link between the occurrence of a gene and the expression of a particular disease--for which the licensor is paid royalties based on the sale of products that are developed using that technology. 


The end product may fall within reach-through claims included in a licensed patent covering the enabling technology (the validity of which may well be debatable) or may not fall within the scope of any licensed patent at all. Royalties payable on such products are commonly referred to as reach-through royalties.


Arguments have been raised that reach-through royalties amount to a breach of EU-competition law as they can result in the payment of royalties to a licensor who has no IP rights with respect of the royalty bearing product. The primary piece of competition legislation in Europe so far as IP licences are concerned is Article 81 of the Treaty of Rome, which prohibits all agreements that have as their object or effect the prevention, restriction, or distortion of competition within the European Economic Area. Licences of IP rights, and particularly exclusive licences, are often caught by Article 81.


Any reach-through royalty obligations need to be analysed on a case by case basis in light of the provisions of Article 81. No specific decision from the European Court of Justice has considered this point. However, the European Commission's Technology Transfer Regulation sets out contractual restrictions that the Commission deems to be acceptable ("the white list") and unacceptable ("the black list") in IP licences within Europe. Recital 21 of the Technology Transfer Regulation states:


"As a rule, parties do not need to be protected against the foreseeable financial consequences of an agreement freely entered into, and they should therefore be free to choose the appropriate means of financing the technology transfer and sharing between them the risks of such use."


Reach-through royalties are not expressly permitted in the Technology Transfer Regulation's white list or black list. Broad assertions that reach-through royalties are illegal or unenforceable in Europe are, therefore, without foundation. 


While the effect and duration of these royalty obligations need to be considered in the light of Article 81, the Commission's attitude expressed in Recital 21 suggests that reach-through licensing should be permitted.  The Technology Transfer Regulation is currently being reviewed and the Commission is engaging in a period of consultation. It is possible that any revised Regulation may specifically address this point.


The practicalities


At first glance, reach-through licences can offer advantages to both licensees and licensors. The licensee obtains access to useful technology without a significant up-front investment. At the same time, the licensor gains an opportunity to recover its investment and benefit from a regular royalty stream if products developed from the technology are commercially successful. However, a closer examination of these licensing arrangements reveals a number of implications that may reduce their attraction to both licensors and licensees.


Under a reach-through licensing arrangement, the licensor often owns and licenses patent rights that protect the enabling technology. As mentioned above, the scope of the licensor's patent rights may well not cover the products developed from the technology. (Indeed, the validity of reach-through patent claims is open to debate in many jurisdictions.) 


As a result, the licensor's right to receive royalties from the sale of products developed using the technology is purely a contractual right enforceable only against the licensee. Therefore, if an affiliate of the licensee starts to manufacture and sell the same products, the licensor will have no cause of action. 


Licensors also may have difficulty policing their rights to receive reach-through royalties. Most licensees are extremely reluctant to allow a licensor to inspect its research facilities to ascertain how products have been developed. Furthermore, in the UK, the courts are generally unwilling to grant orders for inspection if it believes the applicant is engaged in a "fishing expedition." Therefore, unless royalty-bearing products are agreed between licensee and licensor, the licensor may have difficulty proving that particular products have been developed using its technology, and should be accounted for in the royalty calculation.


A further concern for licensors in the UK is the six-year limitation period for taking action for patent infringement. Given the long regulatory and approval process for new pharmaceutical products, a licensor may not realise until after the limitation period that a licensee has developed a product using the patented technology. If the limitation period has expired, the licensor can rely only on its contractual rights against the licensee for damages, or an account of profits arising from breach of contract.


To be sure, reach-through royalty obligations can often be unpopular with licensees, especially those commonly concerned about the commercial burden of royalty stacking. This is when a licensee develops a product using a number of different licensed-in technologies, and pays royalties for use of each of the different technologies. If reach-through royalties are payable to several licensors, the licensee's ultimate profits from commercialisation of a new product may be greatly reduced.  Obligations of this nature can, therefore, present difficulties in which a licensee wishes to sub-license its rights and a fixed annual fee to use the enabling technology is likely to be preferable. 


In addition, for licensees, there is a risk with a reach-through royalty that a third party will develop a competing product without use of the licensed enabling technology. In these circumstances, the licensee faces a double set-back. Firstly, the competition is likely to drive down prices for the products. Secondly, the licensee will have a contractual obligation to pay royalties on sales of the products, whereas the competitor will not as the product is not covered by the licensor's intellectual property rights.


It is mainly because of these reasons that licensors and licensees are applying reach-through royalties for enabling technologies on a selective basis and are seeking practical alternatives.


Laura Anderson and Kate Bradshaw are attorneys at the law firm Bristows  in London.

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