LICENSOR PROTECTIONS IN AN IMPERFECT WORLD
Most of the risks in any merchandise licensing transaction rest with the licensor. Among the risks facing the licensor are the risk that the licensee will sell products outside of the permitted territory or channels of distribution, will shortchange the licensee in accounting for and paying royalties, will fail to have a sufficient quantity of products available for sale by the designated sale date, or will sell products that do not conform to previously approved samples.
There are various techniques that can be used to manage these risks. However, as is often the case in life, love and licensing, there are no perfect solutions. Some of the techniques typically used by licensors and the shortcomings of these techniques are discussed below:
Exclusive vs. Nonexclusive
Conventional wisdom holds that a licensor should grant nonexclusive rather than exclusive licenses whenever possible. In theory, a nonexclusive license leaves the licensor free to grant additional nonexclusive licenses to other licensees, thus allowing the licensor to bring in additional licensees if the first licensee fails to perform. In reality, however, this practice may not work as planned. A licensee who only receives a nonexclusive license may be reluctant to produce large quantities of products, on the fear that the licensor will bring in other nonexclusive licensees who will cut into the market. Similarly, other potential licensees may be reluctant to enter into a license if there is already one licensee in the market and the potential for others to be admitted as well.
A licensor will generally ask for a guarantied minimum royalty in exchange for granting an exclusive license. A portion of the guaranty may be payable in the form of an advance, but most of the guaranty will become due only if and to the extent that the total royalties paid over the term of the license are less than the amount of the guaranty. On its face, the guaranty seems like a good way for the licensor to insure that it will earn at least a minimum amount from the license. However, problems can arise if the licensed products do not perform as anticipated, and the licensee has no interest in renewing the license. In that situation, the licensee may decide not to honor the guaranty. The licensor will be forced to bring a breach of contract action against the licensee – something that the licensor may be reluctant to do, especially if the balance due on the guaranty is relatively small. If the licensee is particularly obstinate, even obtaining a judgment against the licensee may not be enough to force payment, and the licensor may be forced to take further action to collect on that judgment.
Product Introduction and Sale Deadlines
For many types of products, introduction at an annual or semi-annual trade show is critical to success, and the failure to participate in that trade show may delay the introduction of the product by a year or more. This can be a significant cost to a licensor in terms of lost royalties. In addition, if the product was to be one of many products in a coordinated licensing program, the failure to introduce the product by the designated date may leave a gap in the licensing program, thus harming other licensees and other licensed products as well. Failure to bring a sufficient quantity of the licensed products to market by a designated initial sale date can have similar consequences. The conventional solution to this problem is to specify a deadline for the introduction of licensed products to the trade, and for the commencement of sales. If either deadline is not met, the licensor has the right to terminate the license. However, while termination allows the licensor to severe its relationship with a nonperforming licensee, it does not remedy the problems created by the licensee’s failure to meet the applicable deadline. The licensed products still will not be on the market, and it will likely take another year or more to find a substitute licensee and bring the products to market. By that time, the rest of the licensing program may have run its course.
A licensor who is seeking to establish a coordinated licensing program with several different product lines may require each licensee to contribute to a common advertising fund, or to commit to spending a minimum amount each year on advertising its products. Minimum advertising provisions typically require the licensee to report on its total advertising expenditures at the end of each year. If the amount spent is less than the required minimum, the licensor has the option of demanding the deficiency in cash, or requiring that it be added to the required minimum for the next year. This solution is imperfect in two aspects. First, licensed products and licensing programs often have a fairly short life cycle. Advertising dollars spent at the peak of that cycle may provide a substantial boost to sales; advertising dollars spent after the cycle has hit its peak will often have little or no impact. In other words, shifting the shortfall to a subsequent period or merely getting a check for the amount of actual dollars not spent at the peak of the cycle may not be sufficient to make the licensor whole. Second, as with guaranties, this solution may only be useful if the licensee wishes to continue with the license. If the license is set to expire and the licensee has decided not to renew, or if there is still time remaining in the term but the licensee has decided that the licensed products are no longer viable, the licensor’s only remedy will be to demand the payment of the shortfall. Since the licensee has ended or effectively ended its relationship with the licensor, the licensee may very well choose to ignore this demand, thus forcing the licensor to sue if it wishes to recover any of the shortfall.
Royalties and Audits
Perhaps the most frequently voiced complaint of licensors concerns the underpayment or suspected underpayment of royalties. The first step in addressing this issue is to insure that the license agreement clearly spells out how royalties are to be calculated, including whether or not there are different royalty rates for domestic, F.O.B. and direct-to-consumer sales, and what deductions and credits may or may not be taken into account in calculating the royalty. The second step is to insure that the licensor has the right to audit the books of the licensee. Finally, the license agreement should impose interest on the amount of any underpayment, and should allow the licensor to collect the costs of the audit if the underpayment is substantial. (The typical guideline is a shortfall equal to 5% or more of the amount paid for the period audited.) Unlike the other provisions discussed above, audit provisions can generally go a long way toward solving underpayment problems, provided the licensor is willing to put forth the money and time necessary to conduct an audit.
In most cases, a licensor will want to be credited on the licensed products. Proper credit will assist the licensor in building a reputation among consumers, and may result in more and better licensing deals down the road. Thus a licensor should ensure that every license agreement includes a provision requiring the licensee to credit the licensor, and all credits should be acceptable to the licensor in size and placement.
Most licenses permit the licensee to sell off remaining inventory for some period of time after termination, provided the licensee is in compliance with all of the terms of the license at the time of termination, and provided the licensee continues to pay royalties to the licensor. However, licensees sometimes try to continue post-termination sales beyond the time specified in the license agreement. This may or may not be a problem for the licensor, depending on whether or not there are other licensing possibilities for the property. If the licensor has been unable to generate any new interest in the licensed products, the licensor will probably conclude that the best course of action is to let the terminated licensee sell off its remaining inventory, regardless of how long it takes, provided the licensee continues to pay royalties. However, if the licensor has engaged or is actively seeking to engage new licensees, continuing sales by a terminated licensee may hinder the licensor’s efforts. If the licensee refuses to abide by the provisions of the license agreement and stop sales after the expiration of the sell off period, the licensor may be forced to seek an injunction to force the licensee to cease all such sales.
We live in an imperfect world, and sometimes even contracts do not provide as much protection as we might like. In many cases, the best a licensor can do is obtain protective contract provisions up front. If the licensee acts in good faith, it will honor those provisions, and the licensor will get the deal it bargained for. If not, at least the licensor will have a basis for legal action if it chooses to pursue that route.