No Guarantees In Life But Plenty In Contracts

Contract to sign

I was buying yet more consumer electronics of questionable utility (everyone needs a hobby) when the salesman recommended that I take the extended warranty. I told him no. As he was trained to do, he then launched into a grave speech about how badly I would be burned if what he had just sworn was the finest piece of technology in its class turned out to be complete crap—but only after the expiration of the manufacturer’s warranty. I explained, as I always do, that I have consistently refused extended warranties and have already won the bet: if all the consumer electronics of questionable utility that I buy from now until the end of my stay on earth should indeed turn into junk during the term of the extended warranties that I will likewise recklessly decline to purchase, I will have saved so much money from all such prior refusals that I will still come out ahead.

Warranty: In a consumer context, it is often the next most important thing (after the brand itself) that gives a potential purchaser confidence in what he or she is about to buy. In a legal context, however, the word has a more demanding set of meanings attached to it.

The clause we are discussing is typically headed “Representations and Warranties.” There has been some debate on what the distinction between a representation and a warranty might be (outside the context of insurance), if indeed there is one: Some believe that this is another of those situations in which lawyers have two words to describe the same thing and, afraid that one might be found incorrect, shove both of them into their contracts. (That is a form of the legal practice commonly known as “belt and suspenders” drafting.) About the best distinction between representations and warranties that has been made comes from the Section of Business Law of the American Bar Association: “Representations are statements of past or existing facts and warranties are promises that existing or future facts are or will be true.”

The main point is that, whatever you call them, the contractual form of what can loosely be called a guarantee is a statement of facts given for the other party to rely upon in agreeing to the covenants in the contract that govern the relying party’s conduct. If the party providing the warranty misstates the facts, grounds have been given for claims of misrepresentation and for breach of warranty.

In upcoming posts, we will explore the implications of that for agreements in the fashion, accessories and related businesses.

Credit:  Alan Behr


When Just the Licensor is Not Enough

magnifying glass with trademark icon

Companies often place their trademarks in a separate subsidiary or affiliated company. And then, sometimes, rather than being the direct “licensor” of the trademarks, the owner will enter into a master license with another subsidiary or affiliate. Use of a master licensor/licensee structure is appropriate from an operational perspective if the sole business of the trademark owner is to own the trademarks, since it therefore would be unable to provide the services normally required of the “licensor” under any of the various license agreements it hopes will be consummated.

Just as a licensor should require representations from a guarantor of its licensee’s obligations and should seek to bind the guarantor to many of the restrictions imposed on the licensee, sometimes parties receiving licenses (technically, sublicenses) from master licensees will think to ask for various representations from the master licensor/trademark owner, such as those relating to the rights and authority of the master licensee, to the absence of grants of conflicting rights to any third parties, etc., and some of these sublicensees will think to bind the trademark owner to some of the restrictions imposed on the master licensee under the sublicense agreement, particularly in regard to honoring whatever exclusivity rights may have been granted to the sublicensee. But most sublicensees will not think to protect themselves against the potentially adverse effects of changes in the master license agreement itself. For example, if for some reason the master license is terminated during the term of the sublicense agreement, the trademark owner should be bound to substitute itself or a successor master licensee as the (sub)licensor under the (sub)license agreement. And similarly, the customary “binding on successors and assigns” provision of the sublicense agreement should be expanded so that, if ownership of the trademarks is transferred during the term of the sublicense agreement, it is clear that the sublicense agreement is binding on the new trademark owner; and it would not hurt also to bind the trademark owner to be required to cause the new trademark owner to agree that it (or its master licensee) automatically will be substituted as the (sub)licensor under the (sub)license agreement upon the closing of the transfer of the trademarks.

Credit: Jonathan R. Tillem


Don’t Try This In Your Own Home

Fashion designers working together on an outfit in design studio

We have been meditating in these posts (here, here and here) on some of the problems that arise when two or more people start and run a new venture. Many of the issues that arise are common to all businesses, but when it comes to fashion—especially fashion good enough and fresh enough to build a brand from scratch—the question of talent moves to the forefront. Whatever else the business might do, if it is going to succeed, someone involved with it right from the start is going to have to be either very talented or very lucky. (You will soon know if it was just the latter because, as things move along, talent tends to repeat itself and luck does not.) In its simplest form, whether in design, execution or just in knowing how to buy, talent is what you see when inspiration finds a means of expression.

Luckily, like a roast lamb with a robust Bordeaux and a fish salad with a chilled Riesling Spätlese from lovely parts of the Pfalz (just beyond where I own a turnip field with a unique terroir), talent in fashion pairs well with talent in business. It is a paradox of American life that, in a country obsessed with prospering in business, managers are not considered “talent.” But that is exactly what they are. If being able to run a business were not a question of talent, and if it did not require a truly deft intelligence and plenty of self-confidence, artists, philosophers and humanities professors would be running the Fortune 500.

Whether starting up or expanding is the question, however, no one is of greater importance, at least at that moment, than the person known in show business as “the money.” Seed capital can come from the venturers’ pockets (if deep enough), friends and family, crowd funding, banks and others, but as dramatized for effect on television in programs such as Shark Tank, money comes at a price—often one that appears disproportionate to the commitment made. You may well bristle at the thought of surrendering a healthy portion of the equity in your business to someone whose contribution is little more than writing a check, but that person knows all too well that without him or her, your dream enterprise will remain just that. (And think about it for a minute: do you really want that person providing guidance for your fall/winter collection? Maybe it is better if your investor is the strong, silent type.)

So sometimes, when it comes to handing out equity, you have to give until it hurts. On the other hand, mathematics tells us that equity interests can never total more than one hundred percent, so if you shell out ownership percentages in exchange for cash, advice, goods or services, keep in mind that your control ends when more than half the equity belongs to other people.

Whatever you do, always understand this: all divisions of that magic one hundred percent must be carefully documented. You have heard the expression “Don’t try this at home.” That applies double for anything commercial or financial, such as equity participation that has a legal effect. In our experience, few things have been more painful to read than important documents with binding legal effect that were written by non-lawyers who deceived themselves into thinking that they could save the money and do it themselves.

Life is too short to prove to yourself why you decided not to practice law: when legal issues come into play—as they will from day one—it is always best, for the calm and confidence of all, to bring your lawyer into the process. If you are a designer, think of it this way: would you let your lawyer design your wardrobe for you? Turn that around, and now you know why he or she does not want to see you writing your own contracts.

Credit: Alan Behr


Sharpen Your Pencils

Fashion Designers Having A Discussion

We continue now with our reflections, posted earlier (here and here), on the legal and business issues that arise when a fashion business is formed and run by two or more venturers:

You and a colleague have decided to start a new fashion business. It is best to get in writing from the start what it is you intend to do together. A non-binding but useful method is the business plan, which is typically put together to help raise funding for the venture. There is an art to creating a business plan—it has to look earnest and solidly researched, the opportunity made clear and the plan to exploit it both correct and workable. In short, it has to read like an invitation to join in executing a winning strategy. And it should be a good read. (A business plan is, after all, narrowly directed advertising.)

To start, sit down together and write out thoughts about what it is you want to accomplish. You may be surprised with what comes out. We have seen otherwise promising working relationships break up over disputes about direction and vision that could have been detected early on. You may both have agreed that handbags will be your launch product only to find, as you compose your thoughts and turn them into a plan, that you have come to believe that destiny will take you quickly into women’s scarves but that your colleague favors branching out slowly and, even then, straight into small leather goods. You will both want to have all of this buttoned up before you drop the plan onto the desk of a potential investor—or anyone else.

Beyond the business plan comes the need to document organizational responsibilities. These are private matters at first, but because they become part of both legal documents of the company and even the “culture” of your organization, they are of greater long-term importance. For example: in the event of a dispute over that or any other issue, which of you will have final say or what mechanism would you both deem to be fair to resolve the problem and move on? (If your partner is your sister, you can perhaps conference in Mom, but in most new ventures, things are rarely that simple.)

If the form of organization you choose is the limited liability company, you have a clear opportunity to set that down formally all important terms in the grounding document for the company, the operating agreement. If you choose instead to form a corporation, keep in mind that it all starts a bit differently: in the absence of an express written agreement to the contrary, majority rule is the default option. That is, the principal of one share equals one vote applies, and all power goes in the end to whoever, alone or in combination with other shareholders, controls over fifty percent of the voting shares. If no one will have a majority holding, and because you likely will want to have clear rules on more topics than just voting rights, you will be well advised to enter into a shareholders agreement. The operating agreement or the shareholders agreement should deal with all that you mean to make effective about the operation of your business—because, as your lawyer will tell you, an unwritten promise is not worth the paper on which it was not written.

However you do it, the starting point is the same: sharpen your quills and start writing—and keep at it, with counsel and advisors brought in where required—until you have created documents worthy of your best college term papers. The grade of “A” you get as a result will be reflected in the operation of a well-run and profitable business.

Credit: Alan Behr


BOTL III

During the course of negotiating a license agreement, a licensee may propose certain changes that may appear logical and reasonable. However, a licensor should be on the lookout for seemingly innocuous proposals that could impede its ability to operate its business.

Agreement-likeness-blurred

  • “I need a longer sell-off period after termination and the types of customers to which I can sell during the sell-off period [e.g., only closeout accounts] is too limiting.” Agreeing to these requests may not be problematic if no new licensee is in place, but the license agreement must contemplate the possibility that there may be a new licensee; and extended and extensive sell-off rights may make it more difficult to conclude a new license and may increase the pressure to give financial and other concessions to the new licensee. (In a later post, we will discuss the substance of sell-off provisions, including circumstances of termination that could result in a bar to a sell-off beyond the date of a termination of the license agreement.)
  • How much time does a licensee actually need, particularly considering that, for a seasonal business with a typical December 31 contract year/term end, sell-off actually could be starting as early as September?
  • While selling off prior seasons’ inventory should not seriously compete with a new licensee’s business and while closeout accounts may be the only meaningful customers for closeouts, it cannot be good for the licensor’s brand or the new licensee’s business if the former licensee’s products, whether or not they include “basics,” are being offered to the new licensee’s regular customers at the same time that the new licensee’s business is being launched.
  • “I would like an option to renew the license agreement.” While renewal options are quite common, and sometimes may even be offered by a licensor, accepting some common licensee complaints can have unintended consequences.
  • “The date by which I have to exercise the option is too early.” Depending on the length of the term, this could be a fair point, but a licensor must keep in mind that, if the option is not exercised, it will need time to locate, negotiate with and conclude an agreement with a new licensee and the new licensee will need time to develop its initial collection, which, for a seasonal business, will have to go to market well before the end of the current licensee’s agreement. (In a later post, we will discuss the need for provisions in an exclusive license allowing the licensor to engage a new licensee during the term and the new licensee to start business before the end of the term.)
  • “The conditions for renewal are not objective.” As noted in an earlier post, a licensee will want only objective standards when it comes to the conditions it will have to satisfy in order to exercise its option. However, is it unreasonable for a licensor to be able stop doing business with a licensee that, while not technically having defaulted in its obligations, has been a terrible partner and exceedingly difficult to deal with?
  • “I would like a right of first refusal for additional products or countries or trademarks.” A right of first refusal, in effect, requires the licensor to make a deal with a prospective third party licensee and then offer the current licensee the right to match it. There is not much chance that a prospective licensee will be willing to devote the time and expense of negotiating a license agreement in these circumstances. If pressed, giving the existing licensee a first right to try to make a deal with the licensor – a right of first negotiation – is a better, and reasonable, alternative.
  • “I want more countries in my licensed territory.” If a prospective licensee can demonstrate the wherewithal to properly exploit the proposed additional countries, the inclusion of the additional countries is often just a question of business judgment. (There may, however, be legal considerations to be addressed in the license agreement depending on the status of the licensor’s trademark rights in the additional countries.) If additional countries are included, though, a licensor should retain the right to take back countries that the licensee does not exploit adequately; and any such reversion right must be carefully drafted, particularly to take into account that getting back a few countries in a region may not be of any real value to the licensor. (What potential new licensee is going to be interested in a license for a few scattered Asian or European countries if the existing licensee retains the major markets in the region?) A possible compromise here might allow the licensee to keep the entire region if it is appropriately exploiting the major markets in the region, but to lose the entire region if it is not.

Credit: Jonathan R. Tillem

See previously published posts:


License Negotiations – A “WORD” to the Wise

Ask Why

Lately, I have been seeing some licensor counsel sending out first drafts of license agreements as PDFs rather than in Microsoft Word. Putting aside that it is getting easier and easier to covert PDFs accurately into Word, I must ask why. Are they seeking to avoid getting back a markup of their draft? Again, I must ask why. Do they really prefer the good old days when the licensee’s lawyer would send back a 50+ paragraph memo of comments to be followed by hours upon hours of give and take negotiations just to get to round 2?

To me, it is unquestionable that sending or receiving a track change or compare copy saves a tremendous amount of time (and psychic energy) in and within the process of documenting a license, particularly with experienced parties and counsel. (Note to sender – if you do a compare copy, send along a clean copy of the revised draft!) It takes me far less time to do even an overly comprehensive markup than it would to describe all of my proposed changes, with the associated reasoning, in a memo of comments (and this does not even factor in the time saved by effectively eliminating the first round of “live” negotiations). Similarly, as licensor counsel, much less time is involved in reviewing a markup and incorporating the acceptable changes into the draft than in talking through the comments with opposing counsel and then redrafting. Much gamesmanship is eliminated and the truly open issues are set; and, frankly, I have found that, at this point in the process, both lawyers tend not to revisit most items that, in a practical sense, are inconsequential and to focus on resolving larger issues and moving toward consummation. Sort of like seeing the forest!

Credit: Jonathan R. Tillem