How to avoid the potential pitfalls associated with licensing agreements Featured

8:01pm EDT October 31, 2011
How to avoid the potential pitfalls associated with licensing agreements

When you sign contracts, how closely do you read them? And how much attention are you paying to the insurance and indemnification clauses that you are agreeing to?

Mike Cremeans, vice president at Neace Lukens, says that too many business leaders don’t take the time to truly understand what comprehensive risks they are committing to when they sign a contract.

“Too often, the details are ignored,” says Cremeans. “C-level people may not have the time or the expertise to look too closely at the insurance and indemnification terms. And, unfortunately, many times, those sections of a contract are viewed as a commodity purchase. However, investing up front to have a contract attorney review the agreement can help you avoid substantial problems on the back end.”

Smart Business spoke with Cremeans about how to make sure you have the insurance required by your licensing agreements and that the agreement adequately constrains your risk to avoid getting burned in a lawsuit.

Before signing a contract, what does a business leader need to consider?

Make sure you understand what the licensor is concerned about. Many times, they include phrases in the agreement that are not defined but that they believe will somehow protect them. So begin by making sure there is a clear understanding among all parties as to what the terms in the indemnity and insurance sections of the contract mean.

Once you have an agreement regarding definitions, you can determine if the licensee has the corresponding insurance coverage and can make an intelligent decision on how to comply with a particular insurance requirement.

How can doing so help in the event of a lawsuit?

Contracts should consider all eventualities. Likewise, insurance and indemnification language should be very clear, in a way that almost settles a claim before it happens. If everyone understands up front the intent and purpose of the indemnity and insurance clauses, that will help prevent a serious error or misunderstanding in the event of a claim.

Too often, leaders don’t have a full, nuanced understanding of their insurance coverages, so when faced with a claim, they say, ‘That’s OK. We have insurance for that.’ Then they realize that the details of their insurance policies don’t align entirely with the language in the license agreement. For example, indemnification sections sometimes do not make an exception for the sole negligence of the licensor. However, many policies provide coverage for contractual liability except for the sole negligence of the other party. It is better to have a clear understanding up front as to what the terms mean and what the policy will cover, resulting in a smoother process.

What language should a licensee watch for in insurance requirements?

Terms such as ‘reasonable and customary,’ ‘adequate,’ ‘sufficient to support the indemnification section,’ etc., are red flags. All they do  is open up problems. This is dangerous, especially if you do not purchase high enough insurance limits. In the event of a large claim, if your limits are inadequate, the licensor can accuse you of not having enough insurance and of being in breach of the agreement. You then have the original insurance claim, along with a potential lawsuit from the licensor.

Unreasonably high insurance limits are another requirement to be mindful of. Many times, the licensor does not understand what insurance limits should apply based on exposure. If you are selling wallets, what kind of bodily injury or property damage could a wallet cause? But if you are selling pharmaceuticals, that carries a different set of potential risks. So if a licensor asks for the same limits of liability on each, that doesn’t make sense.

Also, be aware of indemnification sections that require you to indemnify the licensor for any and all claims, liabilities, costs, etc. No insurance policy covers ‘any and all’ claims because of inherent exclusions and conditions. So the licensee will have a higher obligation under the indemnification section than will be covered by its insurance. Work with an insurance professional who understands how to identify these detailed potential risks and then makes recommendations to help you with the best possible portfolio of insurance products to protect both you and the licensor if you are required to indemnify it.

What should a company look for in an insurance broker?

It is vital to work with a broker who specializes in your industry. A true insurance professional will ask questions, listen intently, and understand exactly what your needs and your risk tolerance are. Then he or she will be in the best position to make good, sound recommendations that won’t break the bank.

Trust, but verify. If you ask, ‘Is everything covered?’ and the broker says, ‘Don’t worry, it’s all covered,’ run the other direction to find another broker. You need to have someone who will force you to think about these issues. Dig into the issues that could potentially put you out of business. Engage your insurance professional and address your concerns and what you are going to do about them.

How should the broker work with other professionals to provide the best coverage?

It is very helpful to have a conference call with the licensor and its attorney, the licensee and its attorney, and perhaps both parties’ insurance brokers. That way you can all discuss the contract language and make certain everyone understands and agrees to the intent, terminology and definitions. We find that qualified insurance brokers bridge multiple disciplines and can oftentimes help translate jargon and facilitate understanding among all parties. Both sides can then decide what terms and conditions are acceptable and come up with a compromise.

A satisfying outcome can be achieved for all when all parties communicate effectively and thoroughly understand the other’s perspective and constraints.

Mike Cremeans is vice president at Neace Lukens. Reach him at (216) 446-3354 or mike.cremeans@neacelukens.com.