Determining a royalty rate

Determining a royalty rate is the exercise of setting the remuneration due for the exploitation of an intellectual property right, most often in the form of a percentage applied to a base, such as the net turnover generated by the products covered. No legislation imposes a method in contractual matters, since setting the royalty falls within the parties’ freedom. The question nevertheless arises in various legal contexts, each with its own requirements, from licence negotiations to transfer pricing, and from FRAND licences to compensation for infringement.

Methods of determination

The comparable licences method relies on the rates applied in agreements concerning similar technologies, markets and terms, which presupposes having access to such agreements and adjusting them for the differences observed. Income-based methods start from the expected profit from exploitation and divide it between the parties according to their contribution. Certain rules of thumb, such as the one that reserves a flat share of the operating profit to the licensor, are widely criticised as arbitrary. For standard essential patents, the top-down approach first sets the total royalty burden a product can bear before dividing it among the holders.

Adjustment factors

The rate depends on the exclusivity granted, the territory, the field of use, the remaining term of the titles, their resilience to an invalidity action and the stage of development of the technology. The choice of royalty base matters as much as the rate: even a low rate applied to the price of an entire product may amount to remunerating elements unrelated to the invention, hence the search for the value specific to the patented feature. The accumulation of royalties owed to several holders on the same product, known as royalty stacking, must be anticipated to preserve the economic viability of the product.

The royalty rate in litigation

In infringement matters, the court may, as an alternative and at the request of the injured party, award a lump sum that may not be less than the amount of royalties that would have been due had the infringer requested authorisation to use the right. This reasonable royalty in damages is not the same as the contractual rate, since courts may take account of the absence of negotiation and the benefits derived from the infringement, which may justify an increase. The demonstration relies on comparable licences, economic expert reports and the defendant’s accounting records.

Key points

The royalty rate results from a negotiation informed by economic methods, none of which is imposed in contractual matters. The choice of base matters as much as the rate itself. A file of comparable licences should be built, each adjustment justified and this documentation retained, as it will serve both in dealings with the tax authorities and before a court hearing a claim for damages.

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This glossary entry is general in scope and does not constitute legal advice.

Dhenne Avocats handles FRAND licences, standard essential patents and contracts bearing on patents, in advisory work as well as in litigation.

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