FAR 31.205-37—Royalties and other costs for use of patents.
Plain-English Summary
FAR 31.205-37 addresses when royalties and patent-related costs are allowable as contract costs, and when they are not. It covers royalties on patents, amortization of the cost of purchasing a patent or patent rights, the requirement that the patent be necessary for proper contract performance and applicable to contract products or processes, and the specific disallowance triggers: Government license or free-use rights, invalidity, unenforceability, and expiration of the patent. It also addresses reasonableness concerns when royalty arrangements are not the result of arm’s-length bargaining, including royalties paid to affiliates, royalties paid under agreements made in anticipation of a Government award, and royalties agreed to after award. Finally, it limits recovery when the patent was formerly owned by the contractor and points readers to advance agreements under FAR 31.109. In practice, this section is about preventing the Government from paying patent charges that are unnecessary, inflated, or already covered by Government rights, while still allowing legitimate intellectual property costs that are truly needed to perform the contract.
Key Rules
Royalties can be allowable
Royalties on a patent, and amortization of the cost of purchasing a patent or patent rights, are allowable if the patent is necessary for proper contract performance and applies to the contract products or processes. The cost must be tied to actual contract use, not merely to a general business benefit.
Government rights bar payment
A royalty is not allowable if the Government already has a license or the right to free use of the patent. Contractors should not charge the Government for rights the Government already possesses.
Invalid, unenforceable, or expired patents are excluded
Royalties are not allowable if the patent has been adjudicated invalid, administratively determined invalid, considered unenforceable, or has expired. Once the patent no longer provides enforceable protection, the basis for the royalty charge disappears.
Reasonableness must be scrutinized
When royalties arise from less-than-arm’s-length bargaining, the contracting officer must carefully assess reasonableness. This includes royalties paid to affiliates, royalties negotiated in anticipation of a Government award, and royalties agreed to after award.
Formerly contractor-owned patents are capped
If the patent was formerly owned by the contractor, the allowable royalty amount should not exceed the cost that would have been allowable had the contractor retained title. The contractor cannot increase recoverable cost simply by transferring ownership.
Advance agreements may help
FAR 31.109 encourages advance agreements where appropriate. These agreements can reduce disputes by establishing in advance how patent royalties and related costs will be treated.
Responsibilities
Contracting Officer
Determine whether the royalty or patent cost is necessary, applicable to the contract, and otherwise allowable. Scrutinize reasonableness where the royalty is not clearly arm’s-length, verify whether the Government already has rights to use the patent, and consider whether an advance agreement is needed to avoid later disputes.
Contractor
Substantiate that the royalty or patent amortization is tied to contract performance and applicable products or processes, and show that the amount is reasonable. The contractor must also disclose any facts affecting allowability, such as Government license rights, patent expiration, invalidity, unenforceability, affiliate relationships, or post-award royalty arrangements.
Agency/Government
Assert and document any existing license or free-use rights in the patent, and rely on those rights to prevent improper royalty charges. The agency should also use advance agreements when patent-cost treatment is likely to be disputed or complex.
Patent Owner/Licensor
Provide the contractual basis for the royalty and support the scope of rights being licensed. If the licensor is affiliated with the contractor or the agreement was made in contemplation of a Government award, the licensor should expect heightened scrutiny of the royalty amount.
Practical Implications
This section often turns on documentation: contractors should be ready to prove why the patent is needed, what rights are being licensed, and how the royalty amount was set.
A common pitfall is charging royalties for patents the Government can already use for free or under an existing license; those costs are not allowable.
Another frequent issue is inflated or questionable royalty rates in related-party or post-award agreements, which may be reduced or disallowed as unreasonable.
If a patent has expired or been found invalid or unenforceable, the royalty basis is gone, even if the contractor continues to pay under a private arrangement.
Advance agreements under FAR 31.109 can save time and disputes by locking in treatment of patent royalties before costs are incurred.
Official Regulatory Text
(a) Royalties on a patent or amortization of the cost of purchasing a patent or patent rights necessary for the proper performance of the contract and applicable to contract products or processes are allowable unless- (1) The Government has a license or the right to a free use of the patent; (2) The patent has been adjudicated to be invalid, or has been administratively determined to be invalid; (3) The patent is considered to be unenforceable; or (4) The patent is expired. (b) Care should be exercised in determining reasonableness when the royalties may have been arrived at as a result of less-than-arm’s-length bargaining; e.g.,royalties- (1) Paid to persons, including corporations, affiliated with the contractor; (2) Paid to unaffiliated parties, including corporations, under an agreement entered into in contemplation that a Government contract would be awarded; or (3) Paid under an agreement entered into after the contract award. (c) In any case involving a patent formerly owned by the contractor, the royalty amount allowed should not exceed the cost which would have been allowed had the contractor retained title. (d) See 31.109 regarding advance agreements.