A trademark license can be an important tool for a trademark owner, enabling it to derive significant rewards from granting a third party the right to use the mark pursuant to a license agreement.
The License Grant
The license grant is the heart of a trademark license agreement since it defines the answers to the following three key questions: 1. Which trademarks are being licensed and what specific rights relating to such marks are being conveyed? 2. What is the licensee permitted to do with such rights? What is the licensee prohibited from doing with such rights? In particular, what types of products is the licensee permitted to manufacture and sell, in which territories and in which channels of distribution? 3. Is the grant exclusive or non-exclusive?
Territories and Distribution Channels
“Territory” means the geographic area in which the licensee is permitted to sell the licensed goods. It is usually defined on a country-by-country basis. Distribution channels are the permissible categories of buyers from the licensee and/or resellers to the public of the licensed goods. Common distribution channels include mass, mid-tier, department stores, specialty stores, Internet, and catalogs.
One of the most important issues in crafting a license grant is whether and to what extent the licensee will have exclusive rights. Non-exclusive license grants do not restrict the licensor’s ability to grant licenses for like products to other parties. They are the norm in trademark and brand licensing. Exclusive licenses, as the name implies, grant exclusive rights to produce and sell certain products in certain territories and markets during the term of the license. Exclusive licenses may be exclusive against the whole world, including the licensor, or they may exempt the licensor, either explicitly or implicitly.
The License Term
The term of a license agreement is its duration. The length of the initial term, and the licensee’s ease or difficulty in obtaining a renewal term, is largely driven by business considerations. The licensor generally wants a short term with no automatic renewal, so that it can easily replace an underperforming licensee, or obtain better financial terms by engaging a new licensee or by manufacturing the goods itself. The licensee generally wants a longer term with an automatic renewal with few or no pre-conditions, in order to amortize its development costs, and guarantee a longer return on its investment. The license agreement may specify that the term may be renewed only at the consent of both parties, or it may include an automatic renewal provision. Automatic renewal provisions are frequently conditioned upon the mutual agreement of both parties, the exercise of an option to renew by the licensee, or the licensee’s achievement of certain sales or other objectives.
Royalties are the currency of trademark licenses. By far the most common basis for calculating royalties on goods licenses is on a percentage of net wholesale sales, defined as gross sales minus certain agreed deductions (e.g., taxes and returns). The net sales figure is then multiplied by the royalty rate to yield the amount of royalties owing to the licensor.
Minimum Guaranteed Royalties
Minimum guaranteed royalties represent a contractual commitment by the licensee to pay the licensor a certain minimum amount of royalties regardless of the actual amount of sales of licensed products, if any. Advance payments are simply minimum guarantees that are paid at the inception of a license agreement. Minimum guarantees are normally negotiated based on a percentage of expected earned royalties. They are intended to motivate the licensee to diligently promote the development and sale of licensed products in the marketplace, and reduce the licensor’s risk by guaranteeing it a minimum rate of return on its asset.
Approvals and Quality Control
Trademarks operate as designators of source that give consumers the ability to predict the quality of the products they purchase. Without consistency in quality, consumers would tend to be misled, not aided, by reliance on trademarks. A trademark licensor that does not monitor and control the quality of its licensees’ products is deemed to have granted a so-called “naked license” that may result in an abandonment and complete loss of the licensor’s trademark rights. To avoid such an unpleasant outcome, every trademark license agreement must include quality control provisions that apply both to the licensed products, as well as all packaging, advertising and marketing materials relating thereto. Further, the approval provision should provide workable mechanisms by which the licensor can monitor the licensee’s compliance. Licensees will seek to negotiate an efficient and streamlined approval process that minimizes any interference with their business.
Negotiation is Key
It is important to properly negotiate trademark license agreements since there is always a lot at stake. For the licensee, the key risks are financial loss (i.e., minimum guaranteed royalties, investments in product development, and costs associated with the liquidation of inventory), and a loss of reputation with retailers. For the licensor, the key risk is the health and well-being of the brand itself.