Royalty contracts

Payment of royalties – typical uses

Royalty payments are payments made by a party (Licensee) to an owner (or Licensor) for the right to use their property. Generally, royalty payments are used in the context of permitting intellectual property (copyright/brand/ design rights/trade marks/patents) in various sectors including software, consumer products, fashion, designs, film and theatre, music, book publishing , franchises.

Royalties are payments made by the Licensee to the Licensor for permission/licence to use the Licensor’s property, typically a percentage of revenue generated by reason of the permission/licence.

Royalties in Licence Agreements

The Licensor gives permission to the Licensee under a licence agreement.

License agreements will set out terms such as the length of the agreement, type of product and geographic territory that the Licensee must adhere to. Of course, the royalty payment structure will also be detailed.

Royalties appear in a variety of forms within licence agreements, for example:

  • a fixed fee or percentage of gross sales;
  • periodic payments; or
  • tiered royalties.

In nearly all licence agreements there will be a minimum royalty payment. However, the rate of royalty charged depends upon the type of royalty fee that is in the agreement.

Of course the royalty rate is influenced by a number of factors which includes:

  • the amount of alternatives
  • market demand
  • the level of innovation
  • any exclusivity right
  • the risk factor

Negotiation of the royalty rate will expand beyond the points highlighted above.

Our team are experienced in negotiating contracts and know the key pitfalls to avoid in licences so we don’t waste time researching or playing catch-up. We help you to reach the best commercial deal for your business.

Net sales and Profits

A percentage of net sales is the most common way to measure royalty payments, though it may also be common for parties to suggest a percentage of net profits. Once the percentage is agreed it is multiplied by total net sales to find the royalty payment, however you must be careful to clearly define the deductions that can be included when determining net sales. Deductions might include:

  • Taxes
  • Sales discounts/offers
  • Returns
  • Shipping and other logistical costs
  • Sales commission
  • Marketing, advertising and promotional costs

Royalty payment based contracts

As mentioned above, the form of a royalty payment may differ from one case to the next. However, common themes throughout any licensing or royalty arrangement include; detailed descriptions of the IP to be issued, the scope and limitations on use and more often than not, an earn-out clause. A final consideration is that if you are licensing intellectual property that is essential to achieving a technical standard then you must ensure your terms are fair, reasonable and non-discriminatory – FRAND.

Beware Quantity Discounts

As a final thought consider the scenario where a licensee offers bulk discounts on your products how you might protect yourself. If the licensee is able to count the bulk selling of 10 units as only 1 unit there are 9 other royalty payments you have missed.

In this case it is prudent to include wording in the contract that ensures the sale is counted before the bundling together of multiple units to protect your revenue stream.

Catherine Gannon

Catherine is well known for turning complex problems into solutions. No case is ever easy but she will find a way. In her spare time she runs Gannons a very successful law firm.

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