Reach-Through Royalty License Considerations

In a typical patent license, a royalty is consideration paid on the sales of a product that is covered by the licensed patent, where the royalty is usually a percentage of such sales. In the case of the license of a drug or other technology discovery tool patent, however, the royalty is occasionally a percentage of the sales of the drug or other technology product found using the patented tool. This is a so-called “reach-through” royalty, since the royalty is not based on sales of the patented tool, but rather, “reaches-through” to the sales of the drug or technology product found by the licensee using the tool, notwithstanding the fact that the discovery tool patent does not cover such drug or technology sales.

As reach through royalties are set up to be paid based on drugs or technology that are not covered by the licensed patent, and often for time periods after the underlying discovery patent has lapsed, the patent and license is open to charges of patent misuse as such a license structure covers activities outside the scope and temporal boundaries of the patent. Upon a finding of patent misuse, regardless of the basis for that finding, courts will refuse to enforce affected license agreements against the licensees victimized by the misuse, and will refuse to enforce the misused patents against any person, including third parties who are not individually affected by the conduct that gave rise to the misuse. In other words, a single act of patent misuse results in the denial to a patent holder of all judicial remedies related to the misused patent. It is therefore critical that any license that has a reach-through royalty structure is crafted carefully to avoid any challenge of the license as creating a misuse of the licensed patent.

While there is not a great deal of jurisprudence on reach-through licenses settling all validity concerns that exist due to patent misuse jurisprudence, there have been a few decisions that have provided guidelines that indicate that such licensing schemes are enforceable if drafted and negotiated properly.

Guidelines for a proper reach-through license

1. There should be some nexus between the discovery tool patent and the product on which the reach through royalty is based.

a. For drugs, it is normally the case that the drug was discovered, at least in part, by using the licensed technology.

2. The royalty structure is not coerced and is a mutually convenient structure of measuring the value of the licensed rights

a. On whether there is coercion, courts look to whether the licensor has offered another viable alternative to pay for actual use during the license negotiations outside of the reach through option, so the reach-through option is looked upon as a choice by the parties, and not a “take it or leave it” proposition.

i. Therefore consider offering licensee other payment alternatives to consider and not just a reach-through option during negotiations. These can be terms that are highly favorable to the licensor, but still should have some rationality. .

b. If a reach-through royalty structure is used, I recommend including “mutually convenient” language in the license such as “…as further consideration for the grant of the license to licensee, and to provide a convenient means for measuring the value of the license, licensee agrees to compensate licensor based on sales of future [products] sold by licensee”

3. The temporal nature of the licensed activities that give rise to the royalty based product must happen during the term of the licensed patents. There should be some termination date on running royalties owed.

a. So for a drug discovery tool, the drug must be discovered using the patented tool while the patent on the discovery tool is still valid, if you want to ask for royalties on sales of the discovered drugs after the discovery tool patent has expired.

The jurisprudence on these issues is still evolving and courts look to the totality of the circumstances when looking at patent misuse under such provisions. Legal counsel should be consulted when drafting such provisions to obtain a more definite analysis on the validity of the provision, given the entire factual circumstances of the license and license negotiations.