How to Make a Buck or Two from Licensing Your Trade Secrets

By by Jonathan D. Hurt and Steve McDaniel, Technology Litigators | February 7, 2013

All right, you’ve spent the time and money to create and guard your trade secrets from misappropriation.  Wonderful!  But your business model is at least partly based on others paying you to use your trade secrets.  Perhaps you have a paint formulation or process to produce a modified coating or coating component that would be of value to another company, but you are not in a good position (e.g., lack of sufficient manufacturing or marketing capacity) to maximally exploit the trade secret yourself.  

It is time to license your trade secret – with the caveat that you must take care that your licensee does not intentionally or unintentionally divulge your property.  A prospective licensee will likely want to look under the hood at your trade secrets prior to opening up their billfold.  All the procedures for maintaining secrecy should be incorporated into the pre-negotiation confidentiality/nondisclosure and subsequent licensing agreements, as well as which of your trade secrets will be part of the agreement(s).  The agreement should clarify the licensee should use reasonable safeguards to maintain the trade secret’s security in order to maintain its secrecy, and may include details regarding the security to be implemented, and rights for the licensor to inspect the security measures.

A licensing agreement, rather than expressly including the trade secret, can define the trade secret by reference to materials in prospective or previous (e.g., pre-negotiation agreement) communications, and such communications may be electronic or written materials, or simply visual and oral disclosures when the trade secret is “know how” rather than, say, a specific formula.  Think of a PowerPoint presentation with no text and you doing a lot of talking.  However, this can create the problem of an “I told the licensee the trade secret” versus “no you did not” argument if things go south.  A confidential written summary of the visual/oral disclosure should be made within an agreed upon time period to avoid this issue.  Alternatively, though less theatrical, only written disclosures may be defined in the licensing agreement as being the trade secret.

The nuts and bolts of the license should clearly delineate that ownership title to any physical materials, such as prototypes, documents, equipment, etc. that are used to communicate the trade secret are the property of the licensor.  Further, prohibitions on uses of the disclosed material may be included with the descriptions of the grants of the license.  

A clause of explicit acknowledgement by the licensee that the licensed material is a trade secret should be included.  As part of the license, other non-trade secret information, such as publically available know how, confidential information, etc. may be included.  Clauses can be added to receive payment for this information (e.g., training on use of equipment) and/or to retain confidentiality of the supplemental materials.  Additional clauses should cover indemnities, warranties and license termination conditions.  In other words, the standard legal stuff.

Once the licensee possesses your confidential (e.g., trade secret) information, there is a danger that this information will be used by them just by being part of their nontangible knowledge base.  A licensee may seek an exclusion clause regarding paying royalties for work produced from use of this non-tangible information called “residuals.”  In short, it is difficult to restrict people from using the base education you have given them from developing other ideas and thus products.   What has been seen can never be unseen!  However, what happens if the licensee improves upon your trade secret?  It would be very desirable, regardless of the presence or absence of a “residuals” exclusion clause, to have a clause clarifying that any improvements using the trade secret are the property of the licensor, regardless of whether the trade secret itself should lose its trade secret status during the licensing period.  Conversely, what if the licensee already possesses the trade secret you disclose, independently discovers it, or unrestrictedly obtains it from another party, or the “trade secret” was already publically known (i.e., not a trade secret)?  A clause excluding such information may be desired by the licensee, if they are well represented.   The licensee typically will extend such a clause to exclude the trade secret when it becomes public from sources other than the licensee, but, as described below, you may want to keep the time frame for receiving royalties to extend beyond that point of time.

In the best situation, trade secrets can be unknown to others indefinitely, and thus retain their value for a potentially endless period of time.  Some secret processes for manufacturing have been maintained without competitors reverse engineering or independently rediscovering them for decades, providing tremendous competitive advantages in certain fields.  In most cases, a trade secret will ultimately become publically available. 

But what you really need to think about is how much are your trade secrets worth to the licensee.  Be aware that a license may last longer than the trade secret remains secret to competitors.  And, if the licensee had done a great job capturing market share, the profits to you can still be rolling long after the all the competitors try to capture market share with knock offs.   A classic example was the case of the formula for Listerine.  Way back in 1881, Dr. J.J. Lawrence licensed the formula to another party with no time limit.  Though the royalty was later reduced and the rights of the agreement assigned to a different party, the agreement remained open ended in duration.  In the 1950s, the licensee tried to end royalty payments on the basis that the formula had been publically disclosed decades ago, and thus was no longer a trade secret.   But the court ruled that the contract still remained valid though the secret was discovered by the general public or a third party, and that the formula provided a “head start” to the licensee in the field that was of “incalculable value” over the years.  You may notice Listerine is in fact still occupying sizable shelf space in drug and grocery stores 80+ years after the formula was published.   The take home message:  licensing agreements should be based on the profits engendered from the technology embodied in the trade secret rather than the date secrecy may, unfortunately, be lost. 

The real meat and potatoes value of your intellectual property often is in your trade secret rather than a patent portfolio, and you should not forget that in determining the licensing royalties.  Though your patents may cover related materials, and must include the “best mode” of practicing an invention as of the date of filing the patent application (i.e., a previously held trade secret = the best mode), often after the patent application’s filing date new trade secrets such as substantive refinements and improvements or spin off technologies are developed.  These additional, non-patented trade secrets often have the most real world licensing value as part of your trade secret portfolio.   Further, patents must disclose the best mode, but not the worst mode (please do not give the patent office any ideas, OK?).  Working know how of what not to do - the technological dead ends - can be of tremendous competitive edge value in accelerating development of a technology by showing a licensee where not to waste resources in bringing a product to market.  Trade secret licenses have the additional advantage of being able to obtain royalties on global use, while a patent license is limited to the national jurisdiction that the patent has issued, the metes and bounds of the claims and the patent’s limited lifespan.
In the best of worlds, if you do your licensing agreement right, your trade secret license can make you money on a potentially unending commercial future of a technology.
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