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.

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  • “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

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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


BOTL II

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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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License Agreements: BOTL (Be On The Lookout)

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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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License Agreements: Aim for Fairness — But Words Have Meaning

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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


License to Kill (Your Business)

Licensing represents an opportunity for a fashion brand founded on one or a small number of product lines to stretch into almost any clothing, jewelry, beauty or accessories category—and beyond.  Moving into a broad range of products and services has been an especially successful strategy for luxury brands.  Consider that Ralph Lauren started as a maker of men’s neckties and that Hermès began as a maker of harnesses for carriage horses.  Although you sometimes hear the saying that, “No one ever got rich licensing a brand,” licensing can be a useful, even necessary tool to build brand awareness among both old and new classes of customers.  When you leap into categories that have specialized production requirements, unique distribution methods or simply just high barriers to entry—consider timepieces, fragrances and eyewear—licensing is about the only sensible way to make it happen.

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But what is a legal article without a warning about pitfalls?  (Just as designers are paid to create and merchants are paid to awaken and satisfy customer desire, lawyers are paid to worry.)

  • For the licensor, a key concern is that its licensing agent or licensees themselves may prove unmotivated or unable to bring the brand’s image to new product lines.  A licensor can find itself devoting an inordinate amount of time to servicing the product development needs of its licensees—to the point that, in extreme cases, the licensor can start to feel as if it is working for its agent or licensees.  On the other hand, licensees’ successes may kindle the temptation to over-license, risking dilution of the brand.
  • For the licensee, pitfalls can include disapprovals of products by the licensor that result in missed shipping dates, lost markets or revenue, confusing or incomplete branding direction or support (especially after a change of control at the licensor), and all the potential dangers that come from devoting your business to enhancing the goodwill of someone else’s brand.

Any one of those concerns can cause serious—and in extreme cases terminal—problems for participants in the licensing game.

In subsequent posts, we will review the ins and outs of licensing in more detail.  As with a good story, where the art is in the telling, with a good license, the art is in the drafting.

Credit:  Alan Behr