Management of royalties received by inventors employed in Hungary

The legal institution of the royalty is something that all innovative companies will encounter sooner or later. The encounter is usually more painful if it comes later. Often, it is only during due diligence in the context of an investment or company acquisition that it becomes apparent that the company did not have an intellectual property (IP) management policy in place to settle the issue of royalties in a reassuring way. This can mean in some cases that the transaction fails. The other typical case is when a royalty claim arises after the employee’s, i.e. the inventor’s, employment has ended; typically, the employee has retired. Such risks can be significantly mitigated if the company takes proactive steps to ensure compliance once the risks have been identified, i.e. by raising IP awareness, by introducing a general IP management policy and by entering into the necessary royalty contracts with inventors on a case-by-case basis. Companies that go down this route often recognise that offering a transparent structure for employees and a fair remuneration rate also gives them a competitive advantage in attracting and retaining talented employees. 

Below, we review the criteria for regulating the remuneration of inventions created by employees and used by employers.

Hungarian legislation

In many countries, the legal concept of a royalty is unknown. In the US, for example, the "work for hire" approach is perfectly legal, which simply means that when someone is commissioned to perform a task, whether in an employment or other legal relationship, the client automatically acquires all IP rights to the result without further payment. This approach is certainly convenient for the client, but there are countries where the law does not allow this. Hungary is one of these countries. 

Hungarian legislation  distinguishes between the concepts of service and employee invention depending on whether the development of the invention can be considered an obligation of the inventor arising from the employment relationship and it regulates the above cases differently. 

For a service invention, i.e. where the development of the invention is an obligation arising from an employment relationship, patent entitlement is vested in the employer, as the inventor's successor in title. In the case of indirect or direct exploitation of a service invention, or even if such exploitation is not carried out to maintain a beneficial market position, the inventor is entitled to a proportionate royalty. Under the Hungarian Patent Act, the remuneration of the inventor may be governed by the terms of the royalty contract.

For an employee's invention, i.e. where an employee has created the invention as a non-employment obligation, the employee has the property rights, but the employer has a non-exclusive and non-transferable right of exploitation in respect of his/her field of activity in return for the royalty. The remuneration of the inventor may also be governed by the content of the royalty contract. The current developments require a wide range of knowledge and, typically, teamwork, so it is increasingly rare for an employee to work on a development within the scope of his/her employer's activities without having received direct or indirect instructions to do so. Therefore, the importance of employee inventions is almost negligible compared to service inventions. 

The rate of the royalty is not defined in the Hungarian Patent Act, neither for service nor for employee inventions, and the starting point for the fee is the licence analogy. The Hungarian Patent Act stipulates that the royalty contract and the related documentation required by this Act should be made in writing and that the parties may deviate from the terms of the royalty agreement by mutual agreement. The Hungarian Patent Act also states that a fixed-amount or a risk-sharing royalty contract may be concluded between the parties for the remuneration of the invention. There are several factors that may influence the level of the proportionate royalty, and it is therefore advisable to include these quantified corrective factors in the invention royalty contract, which may be guided by the opinion of the Body of Experts on Industrial Property (hereinafter the Body of Experts) and by the case law of Hungarian Courts. It is worth mentioning that in Germany, the German Patent Act contains a detailed regulation of the method for calculating the royalty, whereas the Hungarian system allows greater scope for individualised agreement. 

Correction factors for the royalty based on current case law in Hungarian Courts

The criteria to be taken into account for determining the amount of the royalty may vary depending on the specific circumstances of the case, but court decisions on the payment of the royalty and the opinions  of the Body of Experts related to the current decisions can serve as a basis for the development of an IP management policy and a royalty contract for the given case, which can serve as a secure framework.

In the past, the courts used an expert formula to determine the amount of the royalty in dispute, which did not lead to uniform jurisprudence, but did set the essential elements of contracts for royalties, which are described below.

Total net turnover

The total net turnover is the basis for determining the royalty, so it is important to establish what the parties consider to be the total net turnover, i.e. what costs can be deducted from the turnover. On the one hand, the parties may consider the revenue less the amount of the value added tax (VAT) as net sales revenue according to the definition in Act C of 2000 on Accounting (hereinafter the Accounting Act) but may optionally reduce the revenue by other expenses related to the invention and its exploitation, such as duties or costs directly related to the registration and exploitation process. It may be an acceptable concept to deduct as costs only those directly related to the sale and not to adjust the income from sale by costs that are otherwise recoverable. Where appropriate, a revenue-sharing structure may also be applied, whereby the part of the revenue that is predictably necessary to cover the return on utilisation of the invention and a positive operating result, cannot be accounted for as part of the total net revenue, therefore, only the useful result generated by the invention is considered.

Coverage ratio

The definition of the coverage ratio is not defined in the legislation, determining this is a complex technical and economic issue, so if there is a dispute it requires judicial discretion. The coverage ratio is attributable to the total net revenue and can be used to determine the percentage of the business profit of the invention that is generated by the exploitation. For certain inventions, the contribution margin can be determined based on the contribution of the invention to the entire technical process in the technical sense. The principle of value is preferably used to determine the coverage ratio, whereby the coverage ratio, determined as a percentage of the technical contribution, can be further adjusted to reflect the economic importance of the invention, so that it incorporates both the technical and economic importance of the solution. The coverage ratio may be set as high as 100% if there is no functionally equivalent solution to the invention and therefore no substitute.

Licence fee

The licence fee is in practice derived from the net revenue of the licensed products. The licence fee is higher for an exclusive licence than for a non-exclusive licence, and the royalty rate for patent licences is typically higher than the royalty rate for know-how and other solutions. A common starting point for determining the licence fee is the range of fees available in publicly available databases for a given category of industrial solutions. In light of these decisions, the applicable royalty rate for service inventions is currently capped at 50%.

Inventor contribution

In essence, the inventor's contribution is proportionate to the degree of involvement of employer and employee. Several factors may be considered when determining it, including what prompted the inventor to solve the problem. The solution to the problem (i) falls within the employee's job description; (ii) if it is not part of his/her job description, it was subsequently assigned to him/her (by a superior); or (iii) the problem (the problem to be solved) was discovered and solved by the employee himself/herself. Another criterion may be the way in which the task was solved, i.e. to what extent the employee made use of the employer's technical background, procedures, and knowledge generally available in the work environment; or solved the task independently and partially or completely regardless of the technical and economic background provided by the employer. A further criterion may be the job title and/or qualifications of the inventor, which is closely linked to whether the employer can legitimately expect the employee to create the invention on the basis of his/her existing knowledge.

Other issues requiring regulation

In addition, determining the royalty may be affected if the invention was developed by several inventors and if some of the inventors were not involved as employees in the creation of the invention. If the royalty is to be allocated between inventors, it should be considered whether a fixed fee per person (per inventor) is determined in the contract or whether a fixed amount is allocated between inventors as a royalty. In the latter case, if the allocation is based solely on the number of inventors involved, the amount of the royalty may not be proportional to the inventor's contribution.

The case of development of an invention may be questionable when the inventor's original solution or patent is only the basis or starting point for the actual exploitation. It may be expected that the earlier development was essential for the actual exploitation, so that the royalty for the original solution may be determined by an adjustment to reflect this. It can only be decided on a case-by-case basis whether and to what extent the person responsible for the improvement can be considered an additional inventor.

Based on Hungarian legislation, the inventor is entitled to the royalty even after the termination of his/her employment contract, and the inventor's royalty may be inherited in the event of the inventor's death, and it is recommended that these situations be included in the royalty contract.

The payment of a fixed amount as a royalty may be unfavourable for the employee in the case of inventions with a significant impact on profits, as typically the royalty does not comply with the "proportionate remuneration" as defined by the Hungarian Patent Act. In such cases, the introduction of a royalty-based remuneration system is appropriate, which provides inventors with a pro rata remuneration on a continuous basis, depending on the profit generated by the use of the technology.

The scope of inventions that are eligible for a royalty should be defined and categorised, with particular regard to the licensing conditions applicable in each industrial field. Inventions can be divided into technical solutions protected by IP rights and those treated as know-how, the remuneration of which differs in practice. 

In practice, corporate IP policies cover not only technical solutions, but also the rights to individual original works protected by copyright. Most commonly, the source code of software and databases recognised as a compilation fall into this category. Databases created with substantial investment are also protected on a non-copyright basis, but with legal protection. The transfer of these rights and, where appropriate, the remuneration for them, should be regulated in the IP policy, but should not be confused with the remuneration for the invention.
The background legislation of the Patent Act is civil law; therefore, the royalty contract cannot be included in the employment contract, nor is it legal to include the royalty in the salary. 

Conclusion

The Hungarian Patent Act states that disputes over inventions are subject to litigation, but it is best to avoid these disputes, as this Act does not provide for the royalty, and the factors that have developed in case law in the Hungarian Court to calculate the royalty cannot be objectively determined. Such disputes can be avoided by a predetermined remuneration structure which takes into account the specificities of the sector concerned and which can create an optimal situation for both employer and employee in light of the above considerations.