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Scenario: Company A is a design agent and owns a vessel design (Company A's Intellectual Property) that has not been built and that Company B is interested in proposing as it's solution for an anticipated DoD opportunity as a prospective prime contractor. Company A has no patent, and has not filed for a patent for said vessel design, but is requiring Company B to enter into a license agreement including royalty payments to use Company A's vessel design based on a percentage of the price for each vessel constructed and sold to the Government. I am assuming the contract, or CLINs, under which the vessels will be constructed will be fixed price incentive, which may have some bearing on what clauses and provisions may be included in the solicitation concerning.

It is my understanding that license agreements with royalty payment terms for the use of a design that has no design patent do exist, but it is not clear to me if the Government would deem such royalty payments to be proper and deem the associated costs to the prime contractor to be allowable if there is no patent. FAR 31.205-37 seems to only address royalties in the context of when there is a patent. FAR 27.202 mostly refers royalties in the context of when there is a patent.

So the question is, would the royalties paid to Company A by Company B be deemed proper and the costs deemed allowable despite there being no patent for the vessel design?

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8 hours ago, JKRAU2003 said:

So the question is, would the royalties paid to Company A by Company B be deemed proper and the costs deemed allowable despite there being no patent for the vessel design?

I recommend you consult with Intellectual property counsel because this area is a slippery slope. I assume your focus is from a government or prime contractor interest. If prior to government solicitation the contracting officer is aware that royalty costs may be included in proposed responses, and it meets other criteria, per FAR 27.202-5, the Contracting office may include FAR 52.227-6 and/or other clauses or provisions in the solicitation. If this first gets noticed through the response to the solicitation, FAR 52.227-6 should then be inserted. Per 27.202-3, the contracting officer may coordinate government positions regarding reasonableness, allocability and allowability of royalty costs and include that in the negotiations. If I was the prime and there were questionable risks involved with such payments by B to A, I would attempt to include a contract clause with A that they insure against an potential unallowability determination by the Government at any time, including post award audits by DCAA. I would like to see A's response to that as well as requesting an opinion from its legal counsel. The responses could reveal useful risk information. Personally, I believe using the word royalty may cause confusion because royalty often associated with a patent. If I were A, I would just call it my profit. Still there may be concerns about the total dollar amount when displayed as a %. 

Edited by Neil Roberts
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I don't think company B should call the cost a royalty in its pre-award cost submission or post-award invoice to the Government -- that term makes people think of patents, and you expressly said there is no patent.  It might be styled as a royalty in the agreement between A and B, but that doesn't make it a royalty for purposes of FAR part 27.  As Neil said, it causes confusion.  But still, the cost is a cost, and should be treated as a cost.

I already gave my answer regarding allowability of the cost, but here_2_help asks a fair question.

To help anyone else who might want to think about this, let me ask two questions--

  • Is this a competitive acquisition, or sole-source?
  • Will certified cost or pricing data be required?

If this is a sole-source acquisition, then the allowability of the cost may be addressed during pre-award negotiations (such as with an advance agreement, FAR 31.109)  rather than leaving it to chance as part of a post-award invoice.

Two last thoughts, following up on Neil's suggestion of an intellectual property attorney --

  1. Will the Government's contract with company B require company B to provide the design to the Government, along with some measure of rights (unlimited rights, government purpose rights, or limited rights, or some other license) to the design?  If YES, will the agreement between A and B allow B to provide those rights? 
  2. Does company B have to warrant the design or the product to the agency?  Will company A have any liability for any design defect, or will company B cover that?  Will company B be allowed to alter the design?  What is company A's liability for company B's alterations?


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