Patent Issues with University Spinouts & High Tech Startups

This article is based on a hypothetical situation that many high tech startups and university spinouts will have.  This article considers the patent issues that a university spinout or high tech startup or should take care of to achieve its business goals successfully.

Hypothetical Situation

Daniel Gold earned Ph.D. in Physics from Harvard.  He was a post-doctoral researcher in MIT nanophysics lab for three years before thinking about a star-up company.  He did his post-doctoral research about graphene.  Graphene is a two-dimensional allotrope of carbon.  Graphene has the ideal properties for building high-speed integrated circuits, especially for broadband radio frequency communication components.  

        The graphene research was funded mostly by NSF (National Science Foundation) for the progress of basic sciences and commercialization of nanotechnologies and partly by DARPA (Defense Advanced Research Projects Agency) for feasibility of grapheme applications in military and homeland security.

        Elizabeth Nichols earned her Ph.D. in Physics from the Johns Hopkins University.  She is a professor in physics and director of MIT nanophysics lab.  She is also interested in joining Dr. Gold’s star-up as a co-founder.  However, she wants to keep her position in MIT as a professor.

        One US patent was issued based on the graphene research funded by NSF.  Even if DARPA also funded the part of the graphene research, the patented invention was from the research outcomes funded by NSF entirely.  Both of Drs. Gold and Nichols were named as inventors for the patent. 

        Drs. Gold and Nichols believe that they can commercialize their graphene research by improving its electrical properties.  Especially, they want to develop ultrafast electronic devices based on the improved graphene for future smartphones.  They propose naming their enterprise, “NanoRadio.”  They have no experience and no funding other than through their families.

        Because of the limited financial resources, members of NanoRadio are going to use MIT nanophysics lab’s research equipments through university-industry research cooperation.  In return, NanoRadio will provide a share for future revenue generation to MIT.  Several researchers from MIT nanophysics lab will also join the collaborate research between NanoRadio and MIT for improving electrical properties of graphene, which was developed at MIT by Drs. Gold and Nichols.

        Drs. Gold and Nichols also want to collaborate with Verizon’s innovation lab for testing commercial potential and prototype product development.  Verizon’s innovation lab develops advanced smartphone devices and systems for its mobile telecommunication networks utilizing its own research outcomes or outcomes from the outside research collaborations.  It also incubates its own spin-offs or outside collaborative start-ups once, a commercial potential for the developed prototype product is verified.  NanoRadio is going to design the prototype chip and Verizon’s innovation lab will integrated the chip into its smartphone testing platform for performance of the prototype chip.  Drs. Gold and Nichols want to promote NanoRadio’s new radio chip technology as a part of next generation wireless standards. 

Issues

Issue 1 Who has the ownership of the patent? Can Drs. Gold and Nichols commercialization the government funded research?

Issue 2 Do Drs. Gold and Nichols need a patent licensing agreement with MIT?

Issue 3 What are the patent issues in collaboration with the MIT nanophysics lab?

Issue 4 Can Drs. Gold and Nichols exploit the patents for financing purpose?

Issue 5 What are the patent issues in collaboration with the Verizon innovation lab?

Issue 6 What are the issues in patent licensing agreements with other parties?

Issue 1 Who has the ownership of the patent? Can Drs. Gold and Nichols commercialization the government funded research?

        Under the Bayh‐Dole Act, MIT can retain the ownership of the patent for the graphene research because Drs. Gold and Nichols’ plan for forming and operating the star-up company, NanoRadio, is well within the requirements of the funded organization to retain IPR (Intellectual Property Right): NanoRadio can promote the commercialization of the results of federal government granted research through university-industry cooperation. 

        The main purpose of the Bayh‐Dole Act is to promote the commercialization of the results of federal government granted research through university-industry cooperation.  The Bayh‐Dole Act was enacted in 1980 and codified in 35 U.S.C. §§ 200‐212.  Before the enactment of the Bayh‐Dole Act, generally the funding agency owned the IPR resulting from the government funded researches, not the funded university.  The critical problem with the IPR ownership of the funded researched by government funding agency is that the government agency cannot fully exploit the outcomes of the funded research, which account for more than 10% of the national R&D expenditures.   The baseline policy in the enactment of the Bayh‐Dole Act is to exploit the outcomes of the funded research fully though the funded university collaborating with private industry utilizing their IPR from outcomes of the government-funded researches. 

        Drs. Gold and Nichols want to commercialize results of their research at MIT that was funded by NSF (National Science Foundation) and DARPA (Defense Advanced Research Projects Agency).  Both of NSF and DARPA are federal research agencies.  Thus, under the conventional research agreement between a university and a federal government agency, all the issues of the commercialization of the research results, especially the issues in the ownership and exploitation of IPR are governs by the Bayh‐Dole Act.

        There is another issue Drs. Gold and Nichols need to resolve because DARPA can be exempt from Bayh-Dole Act, and thus, the funded university may not retain IPRs if the funded research project is directly relevant to weapons or weapons systems developed by the US government.  Additionally, DARPA can limit the disclosure of some information if the results of the funded-research is critical for national security. 

          For IPR ownership issue, even if DPAR funded the part of the graphene research, the patented invention was from the research funded by NSF entirely not from research funded by DARPA.  Furthermore, DARPA specifies in its website through “Doing Business with DARPA (www.darpa.mil)”  that even if funding agency can receive a non‐exclusive, royalty free license for inventions conceived during the agreement under traditional Bayh‐Dole Act approach,  DARPA allows flexibility of an agreement to negotiate IRP.  “Doing Business with DARPA” also specifies that DARPA normally does not acquire any IPR that will block commercialization of technology.  Therefore, DARPA should not object to MIT’s IPR ownership and licensing of its IPR to NanoRadio.

        For DARPA’s limitation of information disclosure issue, Drs. Gold and Nichols need to check whether the funded feasibility research includes some results that our critical for national security.  The best way will be for Drs. Gold and Nichols to consult with DARPA for any information in the research result that might block NanoRadio’s future business activities.

Issue 2 Do Drs. Gold and Nichols need a patent licensing agreement with MIT?

        Because NanoRadio’ commercialization will be based on a cumulative research from the graphene research at MIT, NanoRadio will need to obtain some rights to utilizing the patented invention from MIT.  The patent that was issued based on the graphene research assigned to MIT under the Bayh‐Dole Act can be called as baseline IPR because it is essential to NanoRadio’s research and commercialization of the improved graphene, but was developed before the research collaboration agreement.  Thus, it is necessary for Drs. Gold and Nichols to have a patent licensing agreement for exploiting the baseline IPR fully.  Therefore, Drs. Gold and Nichols will need to consider carefully NanoRadio’s scenario for future business development and licensing policy of MIT for the patent licensing agreement between NanoRadio and MIT.

          Drs. Gold and Nichols’s two possible options for the licensing agreement with MIT are non-exclusive and exclusive licensing agreement.  A non-exclusive license is generally a promise not to sue. Under the non-exclusive licensing agreement, the licensor could have a non-exclusive agreement with other parties, and the licensee gets no rights to later licenses terms. Furthermore, the licensor does not need to provide any promise that he or she would protect licensee’s interests.  For example, if licensee’s competitor infringes the licensed patent rights, the licensor has no duty to bring a lawsuit against patent infringement, which could be a serious problem to the licensee because he or she cannot bring a lawsuit against patent infringement.  Thus, the exclusive license is the right option for NanoRadio because it allows NanoRadio fully exercise MIT’s patent rights. 

        One key point that Drs. Gold and Nichols have in mind is that the licensing agreement should be constructed so that NanoRadio has all substantial patent rights of exclusive license for bring a lawsuit alone without need to join MIT.  In other word, considering all the rights retained by MIT, the issue is whether the licensing agreement did not transfer all substantial patent rights in the licensed patent to NanoRadio.  Examples of lack of all substantial rights for the exclusive licensee cannot bring a lawsuit alone are as follows.

        In Abbott Labs. v. Diamedix Corp., 47 F.3d 1128 (Fed. Cir. 1995), the court held that the exclusive licensee did not have all substantial patent rights because the license was subject to the rights previously granted to the licensor’s other licensees. In addition, the agreement reserved to the licensor the right to make and use products that exploited the patents.  Furthermore, the agreement was not assignable by the licensee without the consent of the licensor.  In Mentor H/S, Inc. v. Medical Device Alliance, Inc., 240 F.3d 1016 (Fed. Cir. 2001), the court found that the exclusive licensee did not have all substantial rights in the patent because the licensee’s failure to take appropriate action against infringers would constitute a breach of the agreement. 

Issue 3 What are the patent issues in collaboration with the MIT nanophysics lab?

       

        Drs. Gold and Nichols need to investigate issues in joint inventing activities and allocating ownership of patents because NanoRadio are going to use MIT nanophysics lab’s research equipments through university-industry research cooperation, and thus, several persons including NanoRadio from NanoRadio and MIT will collaborate.  Possible IPRs from the outcomes during the course of research collaboration are patent, trademark, copyright, and trade secret.  Among the possible IPRs, patents will be the dominant form of IPR for protecting rights to the improved graphene in its electrical properties.  Therefore, Drs. Gold and Nichols need to make an effort to avoid potential pitfalls that could occur by the joint inventing activities and allocating ownership of patents.

Drs. Gold and Nichols should not omit from the patent any person who makes some contributions to the patent claims and also to make sure all such persons assigns to the NanoRadio his or her rights in the patent.  Under the section 116 of 35 U.S.C., if two or more persons produced an invention jointly they can apply patent jointly as joint inventors.  To be a joint inventor, the inventors do not need to work together at the same place or at the same time.  The inventors do not need to make the same type or amount of contribution.  Even the inventors do not need to contribute to all the claims of the patent.  Therefore, Drs. Gold and Nichols should be careful not to omit a person who does some contributions to the patent claims.

        A pitfall of omitting a joint inventor is illustrated well in Ethicon, Inc. v. U.S. Surgical Co., 135 F.3d 1917 (Fed. Cir. 2001).   In Ethicon, Inc. v. U.S. Surgical Co., the invention was made by collaboration of two researches, Yoon and Choi.  However, Choi was omitted as an joint inventor in the issued patent.  The patent was assigned to the Ethicon.  Ethicon sued U.S. Surgical for patent infringement.  U.S. Surgical obtained a license form Choi who should had been joined as a joint inventor of the patent at issue.  The court held that the license was valid because Choi was a joint owner as a joint inventor.

          Figuring out correct joint inventor requires careful considerations.  Under the section 115 of 35 U.S.C., only those who “conceived” the invention are authorized to declare himself or herself as an inventor.  Thus, to be a joint inventor, a collaborator should contribute to the conception of the solution to a problem individually or together.  A possible test for the existence of conception is whether the inventor had a specific inventive idea that one skilled in the art could understand the invention.   A conception that merely suggests a general idea or explains how the invention works cannot be an inventive conception.  Because proof of conception requires corroborating evidence for the existence of conception when dispute occur related to the joint inventor, all new approaches and progress should be recorded and witnessed in laboratory notebook or other log during the course of research collaborations and witnessed contemporaneously or from time to time.

          Joint ownership of patent in the US means an undivided interest in prorate of the full patent rights.  This means that each joint owner can exploit the patent rights without consent of the other joint owners as specified in the section 262 of 35 U.S.C:  In the absence of any agreement to the contrary, each of the joint owners of a patent can make, use, offer to sell, or sell the patented invention within the United States, or import the patented invention into the United States, without the consent of and without accounting to the other owners. For example, one joint owner can provide a patent license to a third party and sharing of royalties without other joint owners’ consent.  On the other hand, one joint owner cannot sue a third party for patent infringement without joining all other joint owners. 

          Joint ownership of patent by NanoRadio and MIT can arise from an assignment by inventors who are participated in the collaborate research from both side.  Because MIT can provide a patent license to a third party without NanoRadio’s consent and NanoRadio cannot sue a third party for patent infringement without joining MIT, Drs. Daniel Gold and Elizabeth Nichols will need to provide alternative options to the joint ownership of patent to avoid the pitfalls with joint ownership in exploiting the patent rights.

        An acceptable option is to assign the full ownership of the patent to one party with some form of license back to the other party.  It may be that one party makes a dominant contribution such as technology, funds, equipment or staff, and has superior means to exploit the patent.  It would be logical to assign the full ownership to that party, who contributed in the research collaboration more significantly.  However, the other party may dispute the relative worth of the other party’s contribution and consider the license-back arrangement unfair.  To avoid potentially disruptive and even destructive dispute, both parties should fully consider and agree at an early stage of the collaboration for the role of each party in the patent assignment. 

Issue 4 Can Drs. Gold and Nichols exploit the patents for financing purpose?

        Drs. Gold and Nichols can allocate the ownership of the patent to a third party financing organization such as venture capital or investment bank.  In this care, Drs. Gold and Nichols can transfer the joint patent ownership to the third party financing organization in return for lump sum investment fund for capitalizing NanoRadio after sharing some amounts of the return capital with MIT.  The third party financing organization, then subsequently, provide an exclusive licensing of the patent right back to NanoRadio in return for some royalties.  (Drs. Gold and Nichols can also exploit NanoRadio’s patents, if the patents are wholly owned, for debt financing using the patents as the collaterals) This kind of patent backed financing model is call ‘patent sale and lease back’ transactions model. 

          Originally, sale and leaseback transactions were applied to tangible assets.  However, its application extended to intangible assets as the portion of the intangible assets increases dramatically in high technology enterprises.  A typical patent sale and leaseback transaction comprises:

(1) transfer of patent ownership to a Special Purpose Vehicle (SPV) for capital;

(2) grant of a patent license by SPV back to NanoRadio for some periods in return for some royalties (usually discounted interest for the initial lump sum payment);

(3) issuance of promissory notes by NanoRadio  to SVP; and

(4)  grant NanoRadio an option to repurchase the transferred patent ownership. 

        The definite advantage of the patent sale and lease back transactions will be a financing for NanoRadio’s operation in its growth phase without losing NanoRadio’ governance in management.  The most significant drawback of the patent sale and lease back transactions is its complexity, which requires expertise over several fields of businesses and laws.  Credible valuation of the transacted patent will be a critical issue for Drs. Gold and Nichols to evaluate reasonableness of the sale price.

        Two most used patent valuation methods that are adopted in the financial industry are the income-based method and market based method.  The income based method values a patent by evaluating the amount of the future revenues that can be generated from the exploiting of the patent.  For NanoRadio’ case, revenue generation potential of graphene chip in the future smartphone market can be a good measure for the future revenues.  A specific difficulty with the income-based method is to evaluate a reasonable discount rate that can reduce a present patent value from the amount of the future revenues during the patent lifetime.  For NanoRadio’ case, average venture capital rates of return on investment to early stage technology can be a good guidance in evaluating a reasonable discount rate. 

        The market based method values a patent by considering the amount of the comparable transaction prices for similar type of patents.  A specific difficulty with the market-based method is to find reliable information about similar patents, which are already actually transacted.

Issue 5 What are the patent issues in collaboration with the Verizon innovation lab?

        Drs. Gold and Nichols want to collaborate with Verizon’s innovation lab for testing commercial potential and prototype product development.  Drs. Gold and Nichols want to promote NanoRadio’s new radio chip technology as a part of next generation wireless standards.  Thus, NanoRadio will need to participate in the standard setting organizations (SSOs) such as IEEE (Institute of Electrical and Electronics Engineers) or 3GPP (Third Generation Partnership Project) and promote its new radio chip technology as a standard during the course of standardization process.  Once selected as standard, the details about the new radio chip technology will be described in the standard specifications.

          Since the SSOs are alliances among would-be competitors, their activities are subject to scrutiny for potential antitrust violations.  Thus, the SSOs adopt self-regulation policies to avoid possible antitrust violations during the course of standardization process.  Especially, every member of the SSOs must disclose their patents which are related to the proposed technologies during the standardization process to avoid the patent hold-up problem as in Rambus, Inc. v. F.T.C., 522 F.3d 456, 469 (D.C. Cir. 2008).  Rambus deliberately failed to disclose about standard related patents to the SSO (Solid State Technology Association) during its participation in SDRAM related technology standardization process. After its technology was adopted as a standard, Rambus tried to license its standard essential patents at allegedly high royalty rates.  If a technology is selected as a standard, anyone wants to produce standard related products should infringe the standard essential patents of the standardized technology. Therefore, one should have a license of the standard essential patents even if the licensor asks unreasonably high royalty rates (hold-up the patent).

          Generally, it is not presumed that holding a patent means its owners have market power in the context of antitrust violation analysis (35 U.S.C. Section 271(d); Illinois Tool Works Inc. v. Independent Ink, Inc., 547 U.S. 28 (2006)).  However, a standard locks in a specific industry because the products should be compatible with the standard specifications.  Thus, holding a standard essential patent can be considered as having a market power because all products compatible with the standard specifications should infringe the standard essential patents. 

To avoid the antitrust issue with the standard essential patents, therefore, Drs. Gold and Nichols should disclose all patents in pending or issued to the SSOs.  If they want to license the patents, Drs. Gold and Nichols must license the patents on ‘fair, reasonable and non-discriminatory (FRAND)’ terms.  Furthermore, Drs. Gold and Nichols should be careful when they try to obtain an injunction from courts for enjoining potential infringers of their standard essential patents.

For details regarding the standard essential patents, please see “Legal & Policy Issues of Standard Essential Patents in ICT Industry.”

Issue 6 What are the issues in patent licensing agreements with other parties?

        In drafting a patent license agreement, a patent license agreement should specify scope and term of license.  The scope must specify the geographic territories because a license without territorial limitation is ambiguous.  Usually the term is the life-time of the patent.   However, the duration of collaboration can be used as the term.  The patent license agreement also should include the assignability and sublicensing right of the patent license.  Without the assignability clause, the licensor can assign benefits (e.g., the royalty stream) to a third party, but cannot assign obligations without approval of licensee.  The licensee, however, cannot assign neither rights nor obligations.  Representations and Warranties clauses should also be drafted carefully.  A representation is a statement of fact that induces a party to enter into an agreement. Because the representation means one party’s statements during the course of agreement negotiations are substantially true, if the statements are not true, the agreement can be rescinded as fraud.  A warranty is a statement that something is true and will continue to be true during the term of the agreement or expressly limited to a period of time.  Thus, the warranties are part of the patent license agreement terms.