By: Scott Hervey
Brand licensing transactions can be structured in a wide variety of ways. However the fundamental purpose remains the same; to give a third party the right to benefit from the goodwill and economic value associated with an established mark. Regardless of the structure of the transaction, there are key deal terms that all brand owners need to consider in all licensing transactions.
1. Consider Equity. Most licensing transactions take the form of a contractual relationship whereby the brand owner (licensor) grants the licensee the right to use a brand for a specific purpose in exchange for a royalty. Although this arrangement is fine for most instances, in certain circumstances it may be more advantageous to the licensor to take a different approach. For example, the licensor and licensee can form an entity and then have the entity enter into a license agreement with the licensor, which has certain advantages. First, if the venture is one that lends itself to possibly being acquired by a third party, by virtue of having an equity position, the licensor can participate in the purchase or any other liquidity event. Obviously a license agreement could also be structured to protect against a licensor not participating in the sale of the licensee. There are however other good reasons to consider running the transaction through an entity.
In a license agreement, a licensor has the right to access certain information pursuant to an audit provision. Traditionally, the scope of information is limited to the books and records of the licensee related to the calculation of royalties payable to the licensor and only for the past two years. However, an equity holder in a California entity has certain inspection rights that may be greater than the scope of documents reviewable under the audit provision in the license agreement. Shareholders and LLC members have the statutory right to examine certain books and records of the company in which they hold ownership interest. California Corporations Code section 1600 governs the inspection rights of certain shareholders in corporations, while Section 17106 governs the inspection rights of LLC members. Although all inspection requests must be for a purpose reasonably related to the interest of that person as a shareholder or a member, as the case may be, the scope of documents accessible are broader than the scope of documents accessible pursuant an audit provision in a license agreement.
Additionally, controlling shareholders and managing members owe certain duties to minority shareholders and members. These duties, which at a minimum include the obligation to act in the best interest of the company and impose fiduciary obligations, are likely greater than the contractual obligations imposed in an ordinary license agreement.
2. Require Performance. Regardless whether the license is exclusive or non-exclusive, it is best practice to require the licensee to meet certain performance requirements. Some may think that a performance requirement is not necessary for a non-exclusive license agreement because the licensor is free to enter into other licenses. However, there is an opportunity cost to not being able to grant an exclusive license. A licensor who has granted a non-exclusive license that is underperforming may be forced to pass on an otherwise potentially lucrative arrangement because it cannot grant an exclusive license.
3. Protect Against Self Dealing Through Affiliates or Sub Distributors. Sub distributors play a vital role in the exploitation of licensed product. However, cautious counsel for the licensor should protect against the chance that a licensee will use a sub distributor (who most likely will be an affiliate) to siphon off a lion’s share of revenue. One way to protect against this is to require licensor approval over all sub-license arrangements. I also like to include the following provision which requires that the economic terms of any sub-license be fair and reasonable:
The parties acknowledge that Licensee utilizes sub-distributors for certain territories outside of North America and Licensee shall be permitted to sublicense the rights herein solely to its sub-distribution partners. If Licensee enters into an agreement with an affiliated company for the sub-distribution of the Licensed Products or any of the rights hereunder whereby the sub-distributor is entitled to receive a fee, Licensee shall establish fair, just and equitable licensing fees and arms-length terms in such dealings which shall be created on a reasonable and empirically justifiable basis.
4. Representations and Warranties. A representation and warranty provision is standard fare for any contract, and such a provision is also included in licensing transactions. In addition to standard representations and warranties, a licensor should always require that the licensed product be manufactured in compliance with all laws and regulations, not contain material that is toxic or otherwise hazardous or unsafe, and will not be inherently dangerous as long as the licensed product is used in compliance with the instructions on the label for each product. The licensor can also require the licensed product to meet certain other factors that are important to licensor, such as environmental impact. Not only is this important to ensure that the licensee intends to manufacture a quality product, but it is also an opportunity to convey certain ethical concerns that may be of importance to the celebrity or brand. The licensor should require the licensee to insure that all sublicensees meet these same qualifications
Licensee shall exercise reasonable diligence with respect to representations and warranties from each approved sublicensee concerning the manufacture, sale and marketing of any Licensed Product and shall terminate all licenses with respect to any approved sublicensee in the event that such approved sublicensee or the manufacturer of any Licensed Product engages in any activity that may, in Licensor’s good faith determination, adversely impact the goodwill in the Licensor Properties or otherwise subject Licensor to public disrepute or criticism.
If the licensed products are to be manufactured in a foreign nation or are an apparel product, the licensor should specifically require that the licensee and all sublicensees comply with laws and regulations concerning fair labor standards in connection with the manufacture of all of licensee’s products and not just the licensed products.
Licensee represents and warrants that the operation of its business (including without limitation the manufacture, promotion and exploitation of Licensee’s products (including, without limitation, the Licensed Products) shall in each instance be in accordance with all applicable national, state, provincial, local and municipal laws, orders and regulations and the standards and guidelines established by any recognized industry or trade organizations relating to human rights and labor standards.
5. Termination. Aside from the right to terminate the agreement in the event of an uncured material breach, licensors chose licensed property consists of consumer-facing brands need to have the ability to get out of a license arrangement in the event of a negative public relations incident involving the licensee, the licensed products or anything else that could taint the licensor’s brand.
Licensor may terminate this Agreement following 10 days written notice to Licensee and the opportunity to cure (if curable) if the Licensed Products, Licensee’s use of Licensor’s Marks, or Licensee’s acts or omissions may damage the goodwill and/or reputation of Licensor or Licensor’s Marks, as determined in Licensor’s sole discretion.
6. Avoid Liability for False Endorsements. Celebrity licensors are routinely asked to promote, market and support the sale of the licensed product. In such situations, counsel for the licensors should require prior approval over all forms of advertising and promotion, including social media activities (tweets, Facebook posts, blog posts, etc.). Counsel should specifically be on the lookout for claims or statements the licensee wants the licensor to make that push the bounds of truthfulness. Statements by the licensor that he/she uses the licensed product when in fact he/she doesn’t or that the licensor experienced certain results when he/she didn’t, will subject both the licensee and licensor to liability. Additionally, requiring the licensor to promote the licensed product during personal appearances (i.e., talk show appearances) or in social media without a disclosure of the relationship between the licensor and licensee may also be problematic for both licensor and licensee. Where I represent a celebrity in those circumstances (and also in sponsorship or endorsement engagements) I always require the licensee warrant that they will comply with the FTC “Guides Concerning the Use of Endorsement and Testimonials in Advertising.”
Each licensing transaction presents its own facts and circumstances and there are numerous other terms and provisions that can be used to protect a licensor’s best interest.