Avoiding Trademark Licensing Pitfalls

Successful trademark licensing enables both licensor and licensee to grow their businesses by taking advantage of the synergy between their companies.  The trademark owner benefits by expanding the reach of its brand, increasing brand recognition and generating a royalty stream.  The licensee benefits from the brand’s selling power, resulting in increased sales.

The blueprint for a successful licensing relationship is the license agreement.  Ideally, the agreement should clearly set forth the parties’ expectations and the procedures by which they will conduct their relationship.  Some of the issues that should be carefully negotiated and drafted with precision include:

The Scope of the Grant:  Often, too little attention is paid to the wording of the license grant.  It is in the licensor’s interest to define narrowly and with precision the goods or services that will be covered by the license, particularly if the license is exclusive.  In an exclusive license, the licensor may have a legal
obligation not to allow the licensed mark to be used by another to the detriment of its exclusive licensee.  Therefore, in addition to a narrowly drawn grant clause, the licensor will want to expressly reserve the right to use or license others to use the mark in connection with goods and services that are distinct from, although competitive with, those within the scope of the exclusive grant.

 The licensee, on the other hand, is likely to want a broad grant that not only covers its core goods and services, but also gives it the right to expand its use of the trademark to new product lines.  It will also want at least some protection from competition.  The parties need to come to a clear understanding of exactly what rights the licensee is getting, how much exclusivity it will have, and the extent to which the licensor will remain free to exploit the trademark in fields that may viewed as competitive with the licensee.  This understanding should then be memorialized with precision in the license agreement.

Quality Control:  Trademarks operate as designators of source that give consumers the ability to predict the quality of the goods or services they purchase.  In the eyes of the law, a trademark licensor who does not monitor and control the quality of its licensees’ goods or services is seen to be abandoning its trademark.  Without adequate quality control, the agreement may be deemed a “naked license” that results in a loss of the licensor’s trademark rights. 

To avoid this, every trademark license should include quality control provisions that apply both to the licensed goods or services and to all packaging, advertising and marketing materials that use the trademark.  Additionally, the license should provide workable mechanisms by which the licensor can monitor the licensee’s compliance. 

To ensure quality, the licensor may want to have the right to approve the licensed products as they are being developed, from the earliest 2-D depictions, to prototypes and production samples.  To avoid conflict and confusion, the license agreement should set forth procedures and time frames for the approval process, require that approvals be in writing, and specify whether the licensor’s failure to respond to a submission within a specified number of days shall be deemed approval or disapproval.  Of course, the licensee will want the licensor’s approval rights to be subject to an objective benchmark or, at a minimum, a reasonableness standard.

Termination:  The termination provisions of a license are probably its most important clauses.  Licensors do not want to be saddled with a licensee that is not performing or, even worse, has committed a breach that the licensor views as unforgivable.  Licensees, on the other hand, need the security of knowing that they will not invest heavily in the trademark program only to have it taken away from them precipitously.  These competing interests need to be carefully balanced in the termination clauses of the license.

The typical contractual termination clause allows a party to terminate the agreement on notice if the other party commits a material breach, provided that the defaulting party fails to cure its breach during a specified period following the effective date of the notice. This works for the run-of-the-mill breaches that may occur in a licensing relationship.  In agreeing on the length of the cure period, the parties need to seriously consider the types of breaches that may occur, the damage that will result if the breaches are not promptly cured, and the time and effort that a cure will take.

In addition to this right to terminate on notice, however, the parties may also want the right to immediately terminate the agreement, without giving the other party an opportunity to cure, in the event of a breach that renders the relationship no longer sustainable.  For example, a licensor may want an absolute right to terminate a licensee that repeatedly fails to pay its royalties on time, infringes the licensor’s mark, or becomes subject to a government recall of the licensed products because of safety, health or other risks to the public.  If the license is tied to a film release, sporting event or other time-sensitive occurrence, either party may want the right to terminate the license if the other does not adhere to the anticipated time-table for the coordinated program.  During contract negotiations, these types of scenarios need to be carefully considered so that termination provisions that give the parties needed protection can be incorporated in the license.

Warranties and Indemnification:  These are another crucial area of concern.  The licensee will want the licensor to stand behind its trademark, warranting that it owns the mark and indemnifying the licensee against claims by third parties who may assert superior trademark rights.  While the licensor may be willing to provide such assurances with respect to its established geographic markets, things get more complicated if the licensed territory includes countries in which the licensor has not clearly established or registered its trademarks.  In that event, the parties need to decide whether the licensee can use the trademark in such markets and, if so, how the risk and responsibility for any resulting trademark infringement claims will be allocated.

Just as the licensee wants the licensor to stand behind its mark, the licensor should ask the licensee to stand behind its products.  Because trademark licensors have an obligation to monitor the quality of their licensees’ products, several courts have held that they may be found liable for injuries that those products cause. Therefore, the licensor will want to be indemnified against claims by consumers and other who are harmed by the licensed products, and should insist that the licensee maintain adequate product liability insurance that names the licensor as an additional insured.

Infringements:  The license agreement should clearly delineate whether the licensor, licensee or both have the right to pursue infringers, how the cost of pursing infringers will be borne, and whether any sums recovered from an infringer will be maintained by the party bringing suit or divided between licensor and licensee.  Because the validity and priority of the licensor’s trademark may be attacked in an infringement suit, it may want to retain the exclusive right to pursue infringers as well as the right to elect not to do so in a given case.  The licensee, on the other hand, will want the licensor to commit to actively police its mark so that counterfeits and infringing products do not cut into its sales.  Absent agreement, the licensee may have a legal right to share in the proceeds of any recovery obtained by the licensor from an infringer.  To avoid disputes, how such proceeds should be divided, if at all, is best addressed in the license agreement.

In licensing, as in so much else, an ounce of prevention is worth a pound of cure.  While the economic advantages of a licensing relationship can be great, it is essential that sufficient attention be given to the parties’ license agreement at the outset to minimize conflict, liability and unwelcome surprises.