This article is a follow-up to a previous article on excluded licensed product sales.
Often in a license agreement, the definition of “net sales” refers to the sales related to the licensed products. This is a term that is separately defined with a language – such as all products “made,” “used,” or “have made” – covered by one or more claims of the licensed patents. Therefore, before one can determine the appropriate net sales subject to royalties, it is necessary to give a careful examination of the licensee’s relevant product line(s) and identification of the products that are covered by one or more claims of the licensed patents. This is particularly important as the licensee expands the portfolio of products that extend, enhance, or complement the patented product that was initially contemplated and commercialized.
In our experience, these subsequently developed products are frequently treated by the licensee as products outside the scope of the licensed patents or convoyed products that are not subject to the royalty calculation. But, are they?
For example, a licensee manufactures and sells a line of diagnostic kits that are used by its customers to monitor manufacturing processes to ensure consistent product quality and increase production yields. In addition to the diagnostic kits, a system is also developed and sold by the licensee to help users extract, process, and visualize the data generated from the diagnostic kit. In the submitted royalty reports, the licensee excluded the following two categories of products:
However, certain facts could be gathered during the royalty audit process that indicate such exclusions are not appropriate. For example, rather than non-royalty bearing convoyed sales, the data-visualization systems might be covered by other independent claims in the licensed patents. Additionally, while the new diagnostic kits are capable of a broader detection range, certain customers may be using them to detect within the range as described in the patented claims.
Do you know whether your licensee excluded any products that it shouldn’t have? The following are some tips that may help answer that question:
Depending on the volume of information and the complexity of analysis, it may be prudent to retain an independent third-party auditor to help perform a more in-depth assessment. Bear in mind that many of the license agreements have a limited look-back period. In the event that these excluded products are determined to be subject to royalties, a delay in tending to these issues would likely result in getting less than what you have bargained for due to the inability to recover underpayment for periods outside of the look-back period.