We should pause here. Sugarman and Mencino’s argument rests on the idea that a certain method of patent management leads to a finding that licensing income is related to a university’s exempt purposes:
- use with greatest possible public benefit
- widest possible dissemination and use
- emphasizes public benefit over profit-making
These requirements are not equivalent to “owning everything and licensing very little of it, and what is licensed is licensed exclusively with upfront fees, milestone fees, royalties on sales, royalties on sublicenses, share of settlements and judgments, and the like.” These requirements are not equivalent to “licensing terms commonly used in industry.” The mandate, to avoid federal tax issues, is to be distinctly different from industry-standard licensing terms, which presumably are formed to accommodate pursuit of profits (and that somehow, by an invisible hand, the public will benefit from profit-seeking). One would have to demonstrate practices that meet this mandate across the patent management program: what inventions are encumbered by the program, how inventions are made broadly available, a showing that these efforts indeed promote use with the greatest possible public benefit and widest possible dissemination, and especially demonstrate that license agreements emphasize public benefit over profit-making.
This last piece is particularly troublesome. Sugarman and Mancino emphasize that neither the university or its inventors should license other than with a “need for income.” But what about a licensee–a company that will have a profit-motive and therefore will act with a “need for income” because that’s baked into its corporate genes? This is where the university’s management of each license matters–the structure of the deal, the nature of the effects on the public, and the nature of the benefit to the university–quite apart from how the university uses any income it receives.
Consider some possible signs that a university has conducted its licensing program to achieve widespread use or dissemination for a public benefit, not for profit-making:
- acquisition of inventions is voluntary (inventors want university to manage)
- most inventions are licensed non-exclusively, royalty free
- where royalties are charged, they are “reasonable” and not monopoly-based
- licensing is non-discriminatory
- university licenses to a standard or to create a standard
- exclusive licenses do not preclude research and public uses
- exclusive licenses have limited terms, after which everyone has access
- exclusive licenses have incentives to price low to achieve widespread use
- exclusive licenses limit monopoly pricing and discriminatory sublicensing
- exclusive licenses require socially responsible practices
- university gives up income to achieve a societal effect
Most present university patent management programs cannot demonstrate anything on this list. Their ownership of inventions is compulsory and most inventions remain unlicensed. Of those that are licensed, most are exclusively licensed for all rights, so that no one can make or use the invention other than by purchasing a product, which often is never produced. Exclusive licenses are on “industry standard terms” rather than terms that show an emphasis on public benefit over profit to the university. To give up income to achieve a societal effect is held to be a sign of “weakness” or “incompetence” in a university licensing office–especially by some trustees and wealthy university donors and boosters who would rather see the university wheeling and dealing in the venture capital marketplace, where they imagine there are hundreds of millions to be made with university patent positions. And those folks are right, in a way, since there have been hundreds of millions dollars made–once every few decades per university, and at the expense of all the other things that have been prevented from circulating in order to feed the venture capital beast. In short, most–not all–university licensing operations are entirely non-compliant with Sugarman and Mancino’s description of what connects patent management to a university’s exempt purposes.
Making the connection between royalty income and tax exempt purposes is much easier if the patent management is not done by the university at all and inventors are directed to work with external agents, such as a research foundation not operated by the university. In that case, if the external agent is a nonprofit, it is that nonprofit’s exempt purposes that are in play, not the university’s. That’s a different issue, then–the inventors are not part of the nonprofit operation, so they can be paid without question. The agent acquires patent rights in an arm’s length deal, so consideration is perfectly normal. The income is directly related to the nonprofit agent’s exempt mission of managing inventions, so we’re good there. There are still issues, of course, but not as many, and most not involving the university because it is, as the idea goes, “passive” in the activity. It allows inventors to decide when to patent, it allows inventors to choose an agent to deal with, it allows inventors to structure that deal with the agent, and it lets the agent do its thing with patenting and licensing. In return for this passivity, it receives a share of any upside from licensing. When the university gets interested in agent practices, it is to ensure that inventions are broadly available to the public, pricing is reasonable, and that societal benefits take precedence over possible university income.
As Sugarman and Mencino observe, if a university does not want to navigate the tax issues, it should use an external agent:
But it was just this external agent network of invention managers that university administrators dismembered after Bayh-Dole. Apparently, they realized that they could navigate the tax issues without the need for external agents. Or perhaps they realized that it didn’t matter–that they could do most anything they wanted and befuddle tax authorities, so long as they made a show of connecting patent licensing to the university’s exempt purposes, such as by stating an intent that patent management should have a public benefit–you know, attracting risk capital to research inventions or providing new products for public benefit or developing the economy–even if most of this never happens. And in general it appears to be true–the tax officials don’t appear to care, or care but don’t know enough to see how the system works, or don’t have the political clout to go after what university folk are prepared to defend when threatened.
Sugarman and Mancino then work through the distinction between licensing a patent in the form that an invention has taken in exempt activities (such as research conducted in the public interest) and adding a development step. If a university contributes to the development of an invention, it may cross the line and produce unrelated business income:
We might consider, then, practices by university officials in starting faculty-led companies and hosting those companies in university facilities on the expectation that they will develop inventions into commercial products (or develop themselves into a fat turkey company to be acquired by a hungry big company, at which time all will give thanks). Here are practices that do not appear to be “necessary for dissemination of the results of research”:
- licensor sponsors research in inventor’s lab at licensing university
- university hosts startup company licensee in university facility
- university contributes funds to develop the invention
With regard to licensing, Sugarman and Mencino offer these guidelines:
Further, the university should seek to license the patent on a nondiscriminatory basis; it may grant exclusive rights, preferably for only a limited period, but in such cases it should be prepared to demonstrate that the granting of such exclusive rights constituted the only practical way to utilize the invention for the benefit of the public.
I am willing to bet that most university patent licensing programs fail this test. Exclusive licenses are granted routinely for the entire term of the patent, no effort is made to license a patent on a nondiscriminatory basis and certainly not non-exclusively (unless the invention arises in sponsored research, and then the sponsor typically gets that non-exclusive license–but there, the license is not non-discriminatory–it’s a sponsor’s privilege (just as it is with the U.S. government)). I expect virtually no university licensing office can demonstrate that exclusive licenses are the only practical way for an invention to be used for the benefit of the public. Exclusive licenses may be the best way to extract the greatest value from a patent on a research invention–but that’s not the standard that Sugarman and Mencino set forth.