24 May 2018

How to maximize legal protection when entering into intellectual property licensing agreements in Hong Kong

Written by Barbara Chiu, Crystal Luk and Alfred Yeung

Intellectual property (IP) filings (e.g. patents and trademarks) have grown exponentially in countries such as China, Japan and US in recent years. Upon registration/filings, such registered IP rights can then be licensed to interested parties to use in return for profit via royalty payments. Carefully drafted IP licensing agreements are of utmost importance to govern the terms of the license and the respective rights of the licensor and licensees. 

When such licensing agreements are entered into between a Mainland Chinese party and a foreign international party, a joint venture is often set up to utilize the licensed IP rights in accordance with the agreement. Hong Kong law is one of the favorite choices of law for such agreements. The parties often select Hong Kong law as the governing law, in order to choose a forum which is sufficiently neutral to both parties, and to take advantage of Hong Kong’s reputable judicial system.

Parties to such IP licensing agreements are increasingly favoring international arbitration (as opposed to traditional court proceedings) as the main mechanism of dispute resolution, as arbitration has the advantages of confidentiality, flexibility and finality. In response, Hong Kong has also embraced this additional influx of IP arbitrations by amending its Arbitration Ordinance (Cap. 609). As of 1 January 2018, the new amendment to the Arbitration Ordinance officially clarifies that disputes involving IP rights, including but not limited to disputes over enforceability, infringement, validity, are arbitrable under Hong Kong law.

This article will briefly highlight the common issues of dispute arising from IP licensing agreements and the legal options available for the parties to take in the event of a breach by the other contracting party.

Common issues for dispute arising from IP licensing agreements

(a) Definition of IP rights and scope of licence

Licensors should be as specific and precise as possible in drafting the description of IP rights and the scopes of licence, which may include:

  • duration of licence;
  • exclusivity and non-compete clauses;
  • sub-licensing and assignments etc.

Failure to do so may create difficulties for the licensor to enforce the agreement against the breaching licensee.

(b) Calculation of royalty payments

Failure to pay outstanding royalty payments is one of the most common reasons for dispute. In addition to non-payment, dispute regarding the basis for calculating the payable royalties is also a recurring issue. Parties should therefore clearly stipulate the following fundamental terms on the calculation of royalties in the licensing agreement to minimize disputes:

  • whether royalties should be a fixed sum or calculated based on sales turnover, gross profits or net profits;
  • method for determining the applicable conversion rate etc.;
  • for joint ventures where one party shares its IP rights and the other party injects capital, the division of equity and allowable deductions from royalties should be determined at the incorporation stage of the joint venture

Enforcement of IP licensing agreements

Licensing agreements will often provide where one party breaches the terms and conditions of the agreement, the innocent party shall by written notice request the breaching party to remedy the breach within a stipulated time. Failure to remedy the breach shall usually allow the innocent party to terminate the licence unilaterally and to take appropriate legal action to recover any loss or damages suffered.

In the event of a breach, licensors should immediately take steps to maximize its own protection and to prepare for a potential claim against the breaching licensee, which may include:

  • inform the licensee of its breach in writing;
  • set out their entitlements under the agreement;
  • expressly terminate the licence in writing (if necessary) in accordance with the terms of the agreement; and
  • preserve all records of the licensee’s breach and correspondence between the parties as supporting evidence for potential claims in the future.

Recovering outstanding royalties owed

Where the licensee breaches the agreement (e.g. by failing to pay the royalties due), the licensor may commence legal proceedings against the licensee for any loss and damage suffered, together with interests. The claim for the loss/damage may be commenced either through the appropriate court or arbitral tribunal depending on the agreed dispute resolution mechanisms of the agreement.

The process to obtain a court judgment or arbitral award in these civil claims may take time, depending on uncertain factors such as the grounds of defence, the attitude of the other party, etc. Yet, once the judgment or award is successfully obtained, it can then be used to enforce against the other party’s assets[1].

For breaches which require urgent relief

When issues emerge from the licensing agreement, the licensee will often refuse to provide its books and records for the licensor’s inspection – to prevent the licensor from obtaining evidence of any potential claims. When more serious breaches are committed, communication between the parties may even breakdown completely.

Hong Kong Courts have the power to grant injunctions as an interim measure in legal proceedings (both local and foreign), and in aid of arbitration proceedings, regardless of whether the arbitration is to take place in or outside Hong Kong. As such, irrespective of the method of dispute resolution in the agreement (whether by court action or arbitration), parties can consider seeking an injunction from Hong Kong Courts in some serious and urgent cases where:

  • the damage would be irreparable (i.e. the licensor would not be adequately compensated by a money judgment); or
  • where the licensee’s assets may be dissipated, whether in Hong Kong, PRC or elsewhere.

For example, the licensor can apply to the Hong Kong Courts for an injunction order to immediately stop the licensee from committing the ongoing breach (i.e. infringement of licensor’s IP rights outside of the licence or violation of the non-competition clause) and/or to freeze the licensee’s assets as an interim measure.

However, it should be noted that injunction is a draconian measure. As mentioned above, the Court will allow the application only if the applicant can satisfy the Court that the facts of the case are sufficiently serious and urgent to justify such a powerful order./

Some potential scenarios where an injunction may be suitable remedy include:

  • licensee’s breach of the non-compete clause by setting up a competing entity to sell similar products or services or to divert business based on the IP rights granted under the licensing agreement;
  • dispute between shareholders of a joint venture set up to share usage of IP rights; or
  • unauthorized operation and/or distribution of goods/services which infringes the IP rights by a licensee or third-party.

Conclusion

This article outlines the common issues of dispute arising from IP licensing agreements and the available legal actions in the event of a breach. Careful planning and detailed drafting will offer the best protection to parties to an IP licensing agreement. In the event of a breach, the legal action highlighted above should be considered as soon as possible to prohibit any further wrongdoing and to maximize the recovery of losses suffered.

[1] For more information on the various methods of enforcing a judgments/award against assets located in Hong Kong, please refer to our other article “How to get your money back? Asset Preservation in Hong Kong” at http://www.kwm.com/en/hk/knowledge/downloads/asset-preservation-in-hong-kong-20171130.

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