Background and Foreground Intellectual Property

In commercial transactions, especially high-tech commercial transactions, there is usually a section of the parties’ contract devoted to what IP rights the buyer obtains in the deal. Most of the time, the rights are limited to use of the IP in the product, as the product is intended to be used. However, standard contracts from buyers are increasingly trying to expand their rights.

To begin with, the parties will come to the bargaining table with their own IP. At the very least, the manufacturer will have an IP it can use, and/or has independently developed. Sometimes the buyer will have its own IP often related to implementing its product specifications. This is known as “Background Intellectual Property,” or “Background IP.”

From this starting point, the parties will negotiate what rights they have to this Background IP. Usually, neither party gives the other party any of its Background IP. The manufacturer has limited use of the buyer’s Background IP to make the buyer’s product, and the buyer has limited use of the manufacturer’s Background IP only to the extent the use is connected with the product being used as intended. That’s it. 

Although sometimes, the buyer will want the right to the manufacturer’s Background IP to manufacture the product itself upon termination of the contract. This is a very rough end-run around an IP Escrow Agreement. Also, buyers may insert language into the contract giving it rights to create derivative works of the IP. Manufacturers should be vigilant to protect against giving rights such as these away. These IP rights are in addition to the intended use of the product. Generally, if a buyer wants rights to IP that are in addition to the intended use of the product, they must pay a premium for these.

Once the parties start doing business together, IP can be created. For example, 1) the manufacturer may improve the product over time, 2) the buyer may contract with the manufacturer to create something new, specifically for the buyer, and/or 3) a manufacturer may have a base product that it adapts or customizes to the buyer’s specifications. This creation of new IP after the parties begin trading is what is referred to as “Foreground Intellectual Property,” or “Foreground IP.”

Whether a buyer is entitled to use the Foreground IP outside of the intended use of the products depends on what is being purchased. It boils down to this – Is the buyer paying for the unrestricted rights to the IP?  That is not often easy to answer, and that is why the contract has to clearly state these rights.

Let’s quickly look at the 3 scenarios, above.

1. The manufacturer has to really be careful about its contracts related to Foreground IP, because any manufacturer improvement to a base product during the term of the contract could fall under a broad definition of “Foreground IP.” If the manufacturer has transferred the rights to Foreground IP to its buyer, it may not be able to sell its improved base product to anyone except the buyer. Also, if more than one buyer has the same Foreground IP rights, then the manufacturer could be in breach of contract whenever it improves its base product. Accordingly, manufacturers must be very careful about the breadth of the definition of "Foreground IP," and limit the transfer of it where appropriate.
2. In the second scenario where a custom product is designed and produced by the manufacturer for the buyer, the manufacturer will likely want to charge a premium for this work because it is likely selling unrestricted Foreground IP rights. If the buyer does not want to pay the premium, the contract needs to clearly state that the manufacturer is free to sell products that incorporate the Foreground IP to third parties.
3. Finally, the most difficult issue is where the manufacturer’s base product is specifically adapted for the buyer’s needs. If a buyer shows the manufacturer how to adapt the manufacturer’s base product to the buyer’s specifications, the buyer will not want the manufacturer using that IP in a product it sells to anyone else, especially a competitor of the buyer. As such, the buyer should own the Foreground IP. However, if the manufacturer is the party that figures out how to adapt its base product, and does not charge the buyer for the adaptation, then the manufacturer should own the Foreground IP. Conversely, if the manufacturer does charge the buyer for the adaptation, the buyer has a good argument that it has purchased the unrestricted rights to that Foreground IP.

In all three of these scenarios the conflict is whether the buyer is buying the Background IP (for which it has little grounds for unlimited title) versus the Foreground IP (for which it has better grounds for unlimited title). The manufacturer will likely think its base product, or Background IP, is what creates value. Thus, to the manufacturer no IP rights outside of the intended use of the product are transferred. Conversely, the buyer may believe that the real value is the IP used in adapting the base product to the buyer’s needs.  Thus, to the buyer since the price is largely for the Foreground IP, the buyer has bought the unlimited rights to the Foreground IP. 

For example, I represent a client that manufactures sturdy, high-tech equipment that can be used in the electrical components of trains, buses, city infrastructure and electrical plants. Its customers come to it with difficult computing problems. My client is one of only a handful of companies that know how to implement these solutions in a product strong enough to handle some rough conditions. Now, in my client’s mind, the real value in the product is the base product. Customization to fit the customer’s needs is just the icing on the cake. However, in the customer’s mind, it could be that it sees the real value as the customization of the base product, and wants to own that Foreground IP, outright. 

As such, negotiations can hit a snag while the parties reassess their principle concepts of the deal. This must be addressed on a case-by-case basis. The business and legal teams must watch out for these issues in the fine print of the contract, and legal must confirm the business team’s intentions to make sure that the contract accurately captures the intent of the parties. Make a mistake, and an expensive IP dispute could erupt. So keep your eye on these principles during negotiation, or the next time you see them could be in litigation.

Should you have any questions about Background and Foreground Intellectual Property be sure to contact our specialist intellectual property lawyers on (UK) +44(0)203 287 9500, (USA) +1(949)431-5438or make an online enquiry here and we will contact you.