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
When reviewing a license agreement, be on the lookout for provisions, whether boldly set forth in the “Default/Termination” section or sitting innocuously in the body of the agreement, that inappropriately (from the licensee’s perspective) may create potentially uncurable defaults or otherwise end the agreement. Some examples:
- “Licensee shall ensure that if (a contractor or a distributor or a retailer, etc. does/does not …..).” Although a licensee should be responsible for damages to its licensor caused by a third party with which the licensee chooses to deal, should it be subject to termination if one of these third parties fails to act properly? Yet “shall ensure” means that, if the third party acts in a way that violates the license agreement requirements, an uncurable default has occurred. Go for “seek to ensure” or, better, no termination for third party acts if the licensee stops dealing with the offending third party (unless the licensee was aware/involved).
- “Licensee may renew the license agreement if (among other things) it has maintained a performance standard acceptable to Licensor throughout the initial term.” Such a subjective standard could make the option illusory. If a licensor offers an option to renew, generally any conditions should be objective.
- “Licensor may terminate the license agreement if Net Sales on account of sales of Licensed Products to Closeout Accounts during a Contract Year are more than X% of all Net Sales during that Year.” Licensors do not want the licensed business to evolve into a special make-up/closeout account business so, hence, they propose termination as a disincentive. Good reason, but a bit heavy-handed, so long as the licensee doesn’t make a habit of it. (Assuming an 8% royalty rate, it is fair to say that a licensee is not closing out the Licensed Products at substantial discounts to cheat the licensor out of its 8% royalty on the discounted amount, while eating the other 92% itself.)
- “Licensor may terminate the license agreement if there are more than some number of late payments within a Contract Year or even within a period of months (even if no default notices have been sent).” Surely the licensor must have recourse if payments are habitually very late or, more clearly, if a licensee were to keep forcing a licensor to send out notices of default before curing payment defaults, but the words here also would cover a few payments arriving within a few days after they are due. I know – “no licensor would try to terminate” or “no arbiter would side with the licensor” in such a seemingly extreme case, but a line has been drawn in the license agreement. For a remedy as draconian as termination, something more should be required. While not perfect, a “no harm, no foul” window and a notice requirement would serve fairness.
Credit: Jonathan R. Tillem
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When reviewing a proposed license agreement that has been submitted by a potential licensor, Be On The Lookout for provisions that can artificially or inadvertently act to, in effect, increase the royalty rate. Some examples:
- Gross Sales based on the wholesale or list prices rather than the actual invoice price. Is the top line on your invoice always list?
- Unreasonably low caps on deductions permitted in calculating Net Sales. Some caps can be defensible but, if your historical rate of “discounts, allowances and returns” is higher than the cap …
- Quarterly caps on deductions. Some quarters will have disproportionately higher shipments and the others will have disproportionately higher returns. Any cap should be based on annual sales and deductions.
- Quarterly payments of earned royalty in excess of the quarterly minimums. If, as is common, minimum royalties will be paid quarterly in advance and if earned royalties are calculated and paid quarterly as well, the quarterly payments of earned royalty should be computed on the basis of Net Sales during the entire year through the end of the most recently completed quarter, with a credit for all minimum royalties and earned royalty previously paid for that year. (For belt and suspenders aficionados: While the formula accurately reflects the customary agreement of the parties, to avoid all possible confusion, some licensee lawyers will also request a provision to the effect that, at the end of the day, the aggregate royalty due for each year will be the higher of (a) the minimum royalty for the year and (b) the earned royalty that accrues on Net Sales during the year.)
- A chargeback is not an allowance (and, therefore, even though the license agreement may permit deductions for allowances in calculating Net Sales, a chargeback would not be deductible unless the license agreement says it is). The lesson is that a licensee must make sure that it understands all aspects of the definition of Net Sales and that the agreement allows it to deduct all items that it would expect to be deductible. Historically, auditors claiming significant underpayments of royalties are more likely to point to improper deductions than to underreported sales.
Credit: Jonathan R. Tillem
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It can be said that a licensing arrangement is inherently symbiotic in nature, with the good faith efforts and cooperation of both the licensor and the licensee being necessary for success. The licensor provides its trademark, perhaps some degree of design expertise (particularly in the fashion field), and perhaps also brand customer relations and certain advertising and promotional assistance; and the licensee contributes its expertise in the particular industry covered by the license and possibly its customer relations, its organizational structure and capital resources. The resulting relationship, in a very practical sense, is that of a joint venture or a partnership. Although on one level the negotiation and drafting of a license agreement must be approached as an adversarial process, both parties also should recognize that they will be more likely to view their arrangement ultimately as a success if it strikes a balance, on the one hand, between the licensor’s legitimate concerns for the maintenance of its image and quality standards, for the protection of its trademark and for fair compensation for the rights it has granted and, on the other hand, the licensee’s legitimate desire to exploit the rights granted to it in an economically advantageous manner consistent with industry norms in the applicable market segments and without fear of termination if it is performing in good faith. Ideally, therefore, the parties should approach the negotiation and documentation of the license agreement from the perspective that each of them is looking to make the venture a success for both of them and should recognize and attempt to satisfy the other’s needs.
That said, no matter how much the parties aim for “fairness,” there almost surely will be provisions that a licensor perceives as necessary to protect important interests which a licensee considers unfair, unduly burdensome or overreaching. Before proceeding with an agreement, a licensee must remember that words have meaning and a licensor can seek to force the licensee to conform in its performance to what the agreement says. A licensee cannot rely on its business sense (or gut) to assume that a licensor would “never do that,” even if the licensor assures it that the licensor never has done so before. There also can be no great comfort in the thought that the provision might not be enforceable, since the time and cost involved in adjudicating the issue can be enormous, even if the licensee succeeds. If the agreement requires certain conduct or prohibits certain acts, a licensee should assume that those words control and that, if it ignores them and its licensor’s demands for conformance, it does so at its peril.
Credit: Jonathan R. Tillem