Most licensing agreements begin with the best of intentions. However, parties who regularly engage in intellectual property licensing recognize that a substantial portion of licensing deals are likely to “go bad.” In fact, a recent survey by the Licensing Executives Society found that many licensing professionals expect that more than a quarter of all licensing agreements will end up the subject of a substantial dispute.

Given this economic reality, in-house counsel and their clients often struggle with whether to include mandatory arbitration provisions in their licensing agreements. Many companies adopt an “all or nothing” approach toward arbitration provisions– either opting to arbitrate all potential disputes, or refusing to agree to any arbitration provisions. In many cases, however, a more nuanced approach may yield better results.

In certain types of licensing disputes, arbitration can provide faster, cheaper and potentially more consistent results than proceeding in court. In other types of disputes, however, including those relating to the scope or validity of intellectual property rights, arbitration may have few– if any– benefits over traditional litigation, and often has substantial disadvantages. Understanding the practical implications of arbitration can assist in-house counsel in avoiding unforeseen pitfalls that often result from a “one size fits all” approach to arbitration provisions.

Arbitration's Benefits: Perception vs. Reality

Cost and speed to decision are consistently identified as the primary benefits of arbitration. For certain types of disputes, arbitration can provide substantial savings, both in cost and time, compared to litigation. However, a recent survey of general counsel revealed that fewer than ten percent of respondents reported that arbitration provided actual cost savings for their companies. Arbitrations involving legally and factually complex issues– such as questions about the validity of intellectual property rights– are much less likely to produce substantial cost savings. In fact, respondents to a recent survey by Price Waterhouse Coopers (PWC) reported that when it comes to international disputes, arbitration is actually more expensive than litigation.

Similarly, speed to decision is highly dependent on the type of dispute being arbitrated and availability of discovery. The American Arbitration Association has reported that it takes an average of twelve months to arbitrate intellectual property disputes valued at more than $1 million, which is substantially faster than the time necessary to litigate similar disputes in court. Where disputes involve substantial discovery, however, the time to decision in arbitration can be much slower. In fact, respondents to the PWC survey identified speed to decision as the second biggest disadvantage of arbitration– second only to expense.

Limited discovery is one of the primary reasons arbitration may be faster and cheaper than litigation. Unless the parameters of discovery is expressly addressed in the parties' agreement, the rules of most arbitration tribunals allow the arbitrator broad discretion to determine whether to allow discovery. Limitations on discovery may be viewed as a substantial benefit for certain types of disputes, such as those involving the calculations of royalties due under a license. Where a dispute involves the scope or validity of intellectual property rights, however, discovery limitations may be a substantial disadvantage. Few patent holders would welcome the thought of resolving a challenge to the validity of their patent rights without the benefit of conducting any pre-hearing depositions.

Another potential benefit of arbitration is finality. Unless the parties agree otherwise, there is no “appeal” from a binding arbitration. As the Supreme Court clarified in Hall Street Associates v. Mattel, Inc.,the Federal Arbitration Act provides for judicial review of arbitration awards only in limited instances, such as where the arbitrator committed misconduct, or acted with evident partiality. With very limited exceptions, courts cannot overturn arbitration awards based on legal or factual errors. This finality is often cited as one of the primary benefits of arbitration. The “beauty” of this benefit, however, is often in the eye of the beholder. Most prevailing parties would welcome the ability to avoid the cost and delay of a frivolous appeal. In the face of an unfavorable decision on the construction of its patent claims, however, few patent holders would view the lack of an appeal right a benefit of arbitration.

Practical Strategies for Negotiating Arbitration Provisions in Licensing Agreements

Arbitration can be an extremely useful tool for resolving certain types of disputes. But the benefits and costs of arbitration vary depending upon the type of dispute involved. The following strategies can assist counsel negotiating arbitration provisions to maximize these benefits and avoid unexpected pitfalls:

• Differentiate among potential disputes within the licensing agreement. Determine at drafting which types of disputes are best suited to an expedited proceeding such as arbitration and which would be better left to litigation. Key considerations include: the likely financial scope of the dispute; the likely complexity of the dispute (i.e., is the dispute likely to be limited to accounting issues, or involve a complex assessment of the scope of the licensed rights); whether the availability of discovery will yield genuine benefits, or simply add to the cost of the proceeding; whether the dispute has implications beyond the parties to the license agreement; and the importance of preserving the right to appeal. Be explicit when describing the scope of disputes covered by the arbitration agreement.

• Expressly address emergency relief. Generally, emergency relief is not available in ad hoc arbitration proceedings. Accordingly, parties to arbitration agreements who wish to preserve the right to emergency relief must either expressly preserve the right to go to court for such relief, or expressly invoke emergency rules adopted by an arbitration tribunal–such as the American Arbitration Association.

• Expressly address discovery. Aside from the disclosure of actual hearing exhibits, discovery may not be available in arbitration unless provided for in the arbitration agreement. The rules of nearly all arbitration forums allow arbitrators broad discretion when it comes to discovery. Parties wishing to ensure the right to conduct depositions or other discovery should expressly address the availability of discovery.

• Assess risks of cross border disputes. Cross-border disputes present unique risks arising from litigating in a foreign forum, including potential lack of neutrality, participants' lack of familiarity with national laws, a risk of multiple litigation and difficulties enforcing foreign judgments. Arbitration agreements can control many of these risks, but the rules of international arbitration bodies vary widely. Moreover the physical location of any arbitration can substantially impact the procedural rules to be applied. Licensing agreements with potential cross-border impact should reflect a careful consideration of both the arbitration rules to be applied and expressly identify the location of any arbitration.

• Address confidentiality when necessary. Courts handling litigation involving licenses and other intellectual property issues regularly issue protective orders to maintain the confidentiality of sensitive information. Arbitration, however, is a function of contract, and arbitrators generally have only those powers given to them by the party. Accordingly, arbitrators have no binding control over third parties and generally have no continuing powers over the parties after the conclusion of an arbitration proceeding. As a result, an arbitrator has very limited capacity to ensure the confidentiality of sensitive information. Where disputes are likely to involve the disclosure of confidential information, the continuing obligation to maintain confidentiality should be expressly addressed in the parties' licensing agreement.

Read Chris Larus' previous column.

Most licensing agreements begin with the best of intentions. However, parties who regularly engage in intellectual property licensing recognize that a substantial portion of licensing deals are likely to “go bad.” In fact, a recent survey by the Licensing Executives Society found that many licensing professionals expect that more than a quarter of all licensing agreements will end up the subject of a substantial dispute.

Given this economic reality, in-house counsel and their clients often struggle with whether to include mandatory arbitration provisions in their licensing agreements. Many companies adopt an “all or nothing” approach toward arbitration provisions– either opting to arbitrate all potential disputes, or refusing to agree to any arbitration provisions. In many cases, however, a more nuanced approach may yield better results.

In certain types of licensing disputes, arbitration can provide faster, cheaper and potentially more consistent results than proceeding in court. In other types of disputes, however, including those relating to the scope or validity of intellectual property rights, arbitration may have few– if any– benefits over traditional litigation, and often has substantial disadvantages. Understanding the practical implications of arbitration can assist in-house counsel in avoiding unforeseen pitfalls that often result from a “one size fits all” approach to arbitration provisions.

Arbitration's Benefits: Perception vs. Reality

Cost and speed to decision are consistently identified as the primary benefits of arbitration. For certain types of disputes, arbitration can provide substantial savings, both in cost and time, compared to litigation. However, a recent survey of general counsel revealed that fewer than ten percent of respondents reported that arbitration provided actual cost savings for their companies. Arbitrations involving legally and factually complex issues– such as questions about the validity of intellectual property rights– are much less likely to produce substantial cost savings. In fact, respondents to a recent survey by Price Waterhouse Coopers (PWC) reported that when it comes to international disputes, arbitration is actually more expensive than litigation.

Similarly, speed to decision is highly dependent on the type of dispute being arbitrated and availability of discovery. The American Arbitration Association has reported that it takes an average of twelve months to arbitrate intellectual property disputes valued at more than $1 million, which is substantially faster than the time necessary to litigate similar disputes in court. Where disputes involve substantial discovery, however, the time to decision in arbitration can be much slower. In fact, respondents to the PWC survey identified speed to decision as the second biggest disadvantage of arbitration– second only to expense.

Limited discovery is one of the primary reasons arbitration may be faster and cheaper than litigation. Unless the parameters of discovery is expressly addressed in the parties' agreement, the rules of most arbitration tribunals allow the arbitrator broad discretion to determine whether to allow discovery. Limitations on discovery may be viewed as a substantial benefit for certain types of disputes, such as those involving the calculations of royalties due under a license. Where a dispute involves the scope or validity of intellectual property rights, however, discovery limitations may be a substantial disadvantage. Few patent holders would welcome the thought of resolving a challenge to the validity of their patent rights without the benefit of conducting any pre-hearing depositions.

Another potential benefit of arbitration is finality. Unless the parties agree otherwise, there is no “appeal” from a binding arbitration. As the Supreme Court clarified in Hall Street Associates v. Mattel, Inc.,the Federal Arbitration Act provides for judicial review of arbitration awards only in limited instances, such as where the arbitrator committed misconduct, or acted with evident partiality. With very limited exceptions, courts cannot overturn arbitration awards based on legal or factual errors. This finality is often cited as one of the primary benefits of arbitration. The “beauty” of this benefit, however, is often in the eye of the beholder. Most prevailing parties would welcome the ability to avoid the cost and delay of a frivolous appeal. In the face of an unfavorable decision on the construction of its patent claims, however, few patent holders would view the lack of an appeal right a benefit of arbitration.

Practical Strategies for Negotiating Arbitration Provisions in Licensing Agreements

Arbitration can be an extremely useful tool for resolving certain types of disputes. But the benefits and costs of arbitration vary depending upon the type of dispute involved. The following strategies can assist counsel negotiating arbitration provisions to maximize these benefits and avoid unexpected pitfalls:

• Differentiate among potential disputes within the licensing agreement. Determine at drafting which types of disputes are best suited to an expedited proceeding such as arbitration and which would be better left to litigation. Key considerations include: the likely financial scope of the dispute; the likely complexity of the dispute (i.e., is the dispute likely to be limited to accounting issues, or involve a complex assessment of the scope of the licensed rights); whether the availability of discovery will yield genuine benefits, or simply add to the cost of the proceeding; whether the dispute has implications beyond the parties to the license agreement; and the importance of preserving the right to appeal. Be explicit when describing the scope of disputes covered by the arbitration agreement.

• Expressly address emergency relief. Generally, emergency relief is not available in ad hoc arbitration proceedings. Accordingly, parties to arbitration agreements who wish to preserve the right to emergency relief must either expressly preserve the right to go to court for such relief, or expressly invoke emergency rules adopted by an arbitration tribunal–such as the American Arbitration Association.

• Expressly address discovery. Aside from the disclosure of actual hearing exhibits, discovery may not be available in arbitration unless provided for in the arbitration agreement. The rules of nearly all arbitration forums allow arbitrators broad discretion when it comes to discovery. Parties wishing to ensure the right to conduct depositions or other discovery should expressly address the availability of discovery.

• Assess risks of cross border disputes. Cross-border disputes present unique risks arising from litigating in a foreign forum, including potential lack of neutrality, participants' lack of familiarity with national laws, a risk of multiple litigation and difficulties enforcing foreign judgments. Arbitration agreements can control many of these risks, but the rules of international arbitration bodies vary widely. Moreover the physical location of any arbitration can substantially impact the procedural rules to be applied. Licensing agreements with potential cross-border impact should reflect a careful consideration of both the arbitration rules to be applied and expressly identify the location of any arbitration.

• Address confidentiality when necessary. Courts handling litigation involving licenses and other intellectual property issues regularly issue protective orders to maintain the confidentiality of sensitive information. Arbitration, however, is a function of contract, and arbitrators generally have only those powers given to them by the party. Accordingly, arbitrators have no binding control over third parties and generally have no continuing powers over the parties after the conclusion of an arbitration proceeding. As a result, an arbitrator has very limited capacity to ensure the confidentiality of sensitive information. Where disputes are likely to involve the disclosure of confidential information, the continuing obligation to maintain confidentiality should be expressly addressed in the parties' licensing agreement.

Read Chris Larus' previous column.