Licensing & International Joint Ventures, Merchandising & Technology

This newsletter focuses on licensing issues, including international licensing, merchandising and joint ventures for marketing a variety of products. 
Trademark licenses constitute a common licensing format. Licensing represents a multi-billion dollar business in the U.S., including franchises, merchandising, showing of products in movies, well-known foodstuffs, sports memorabilia and a myriad of other items.

The essence of a licensing arrangement is the license agreement. The licensor should develop a standard format license agreement to present to prospective licensees. The license agreement should cover the several business matters:

1. Identify the IP licensed and the products on which they may be utilized.
2. Define the territory in which the licensee may use the IP.
3. State whether the license is exclusive or non-exclusive.  In an exclusive license, the licensee avoids competition in the product in the territory in which it is selling. The licensor benefits in an exclusive arrangement by working with one successful licensee rather than with several struggling or failing licensees.
4. Specify the amount, the timing and currency of royalties payable by the licensee. Royalties are normally paid as a percentage of sales. There may be an front-end payment which is designed to cover licensor’s costs in setting up the licensee. As a protection for the exclusive licensor, annual minimum royalties are often required.
5.State any required minimum advertising or marketing required of the licensee.
6. Describe the term of the license agreement and any renewal terms.

Licensing permits territorial expansion beyond the licensor’s original territory. The licensor can enter international markets. Licensors unquestionably know their products, their manufacturing and sales techniques in their home territory. However, in overseas markets, this often is insufficient. A licensor typically appoints a licensee with similar skills in the foreign country in order to gain the synergy of combining expertise to succeed in a foreign country.

Licensing valuable trademarks on desirable products in new markets provide several advantages. The licensor preserves its capital when expanding into new territory or new product lines because the licensee typically provides capital to produce and sell the licensed products. A trademark may be licensed for use with products in diverse product categories. The licensor may sell unrelated products without the knowledge required to run new businesses on its own. The licensee pays royalties to the licensor on sales of the licensed goods. The lack of capital investment by the licensor and the royalties from the licensee often provides the licensor a high return on assets. Several legal and business issues and pitfalls arise when expanding into unrelated lines.

International Licensing      
 In the U.S., licensing is a private arrangement subject to few governmental requirements. Many aspects of an international licensing transaction are similar to domestic transactions. Other aspects may vary, including the fact that a foreign license may be based on the laws of another country. In a U.S. licnensing transaction, the license arrangement involves a private contract defined by the agreed upon terms. Foreign licensing may be subject to governmental controls. Governmental approvals may be required to permit the transaction. In a transaction requiring foreign government approval, a basic term which may be controlled is the royalty rate. Typically, permitted rates vary from 1-5% of net sales. The specific rate depends on the products licensed. Other conditions of approval may involve terms such as termination rights, covenants not to compete and choice of law provisions.

There any differences in government monitoring of patent, trademark and copyright royalty rates. Governmental approval and monitoring of royalty rates has become less common. Fewer jurisdictions monitor and restrict royalty rates. There are 3 traditional reasons for these restrictions. First, foreign exchange could be controlled. These restrictions have become less common. During the past 5-10 years, developing countries have not required exchange controls due to the strength of their economies. However, the recent currency and banking crisis in Southeast Asia may cause foreign exchange controls to reappear. Second, local industries may need protection. Third, the local tax base may be sheltered.   High royalty rates decrease local profits and reduce the profits for the local country to tax.

Merchandising refers to the practice of licensing a popular name or character for various ancillary or collateral type products, e.g., Star Wars accessories, San Francisco Giants’replica jerseys. The practice is also known as ancillary product licensing or collateral product licensing. Merchandising has become a huge business in the U.S. and abroad.

Royalty rates range from 6-14 %, depending upon the strength of the property, with domestic royalties averaging between 8-10%. FOB royalty rates may add 2-3 percentage points to the domestic rate. For example, toy products may be sold on a FOB basis so that sales are made directly to the retailer from the manufacturing location (e.g. the Far East. In order to adequately compensate the licensor, the FOB royalty rate is higher than the domestic rate. The toy manufacturer licensee may be required to pay double royalties to the toy inventor as well as to the merchandising licensor.       Property owners typically require the payment of an advance against royalties and minimum royalty payments. Minimum royalty obligations may be guaranteed so that the licensee is obligated to pay the minimum, whether or not it makes any sales.

Quality control provisions in merchandising may be onerous. Stringent quality control provisions often results from the number of reviews required, i.e., preliminary artwork, final artwork, pre-production samples, final production samples, etc. The ultimate product is reviewed before shipment and then periodically thereafter. The rationale is to carefully review each step of the process and ensure that all steps have been taken.

Licensees under merchandise licenses are clearly assuming a degree of risk. Licensees must understand that the license is no guarantee for success and impose a new financial obligations in addition to manufacturing and inventory costs. With respect to motion picture or television properties, licenses are often granted months before the first airing or release of the underlying work. Even after careful planning, licensing programs may fail because of the failure of the underlying motion picture or television series.

A licensee should ensure that the licensor has the right to grant a license by requesting an appropriate contractual representation and warranty regarding ownership and the right to grant a license. There is often an indemnity supporting the representation and warranty in the event of its breach. If the licensor is a major studio or professional sports team, that is typically sufficient. However, if the property owner is a leveraged business, there may be insufficient resources to fund the indemnity. Alternative approaches may include bonds or insurance to fund the indemnity. A licensee should conduct its own due diligence to ensure that the property is owned by the prospective licensor and that the licensor has the right to enter into the license agreement. Licensees undertake their own searches and demand production of the underlying grant documents to ensure that the property owner does have the right to enter into the agreement.

International Joint Ventures & Licensing
The term joint venture covers a wide range of legal forms, including direct equity investments in joint venture entities, formal and informal partnerships, contractual arrangements and strategic alliances. A threshold issue in any joint venture is the choice of an appropriate management structure for control. The joint venture agreement specifies the form of entity, the managerial and organizational structure and the degree of control permitted to be exercised by each of the joint venturers.

Joint ventures have become an increasingly important tool in international business activities in recent years. In many countries, joint ventures with local partners have become the preferred mechanism for foreign investment. Joint ventures offer companies the opportunity to expand operations internationally, allowing the effective penetration of foreign markets through locally produced goods. Local production by joint ventures can offer a means to achieve lower costs and overcome tariff barriers, while satisfying requirements for in-country capital participation imposed by many developing countries. Joint ventures with local parties can also significantly reduce the capital cost and risk of international expansion by offering distribution channels as well as political connections with local governments.

U.S. companies typically use joint ventures when they wish to invest in countries which limit direct foreign investment and require local participation.  Until recently, India and China made it extremely difficult to invest without taking on local partners. In overseas markets, a joint venture partner which has distribution channels and knowledge of the local market should lower the risks and costs of investing.

Technology JV's & Licensing
An IP joint venture involves the transfer or license of technology and related intellectual property from one or both parties to a venture entity.  The terms and conditions of the transfer or license may be set forth in the joint venture agreement or in a separate license agreement.  It is preferable to agree to the terms of the license in a separate agreement because foreign laws may require disclosure and/ or a recording of license terms with governmental authorities.

A license may permit the use of patents, technology, know-how and/or trademarks and trade names by a joint venture. The license must specify the specific products which may be manufactured by the venture, the territories where the products may be manufactured and sold, whether the license is exclusive or non-exclusive, the royalty structure and the terms of termination of the license. The owner of IP licensed to a joint venture needs to consider termination rights, because its goodwill and reputation are closely tied to the joint venture.

The following is a checklist of items to consider in licenses involving joint ventures:

1. Scope of License.
Licenses always need to specify the precise scope of permitted uses of the licensed property. A license to a joint venture must provide in detail a complete description of the permitted uses of the IP, including the goods or services which may be described in an exhibit. Geographical and/or market segment limitations should be set forth, including prohibitions on export, if any.

2.    Description of the IP
The patents, trademarks or other intellectual property which are licensed to the venture must be described. In trademark licenses, a specimen should be attached to the agreement. The joint venture should acknowledge the licensor's status as owner of the IP and as a licensee. The licensee should represent that it will not challenge the licensor's rights in the IP. In trademark licenses, the joint venture should expressly state that no benefits from use of the marks inure to its benefit.

3. Quality controls
The licensor to a joint venture must have the right to maintain and enforce quality control standards over the products of the venture. The licensor should require the right to inspect the premises of the joint venture. Failure to meet quality control and product specifications must be grounds for termination.

4.    Exclusivity/Sublicensing
The license must specify whether the license is exclusive or non-exclusive.  Limitations on the right to assign and sublicense should be clear.

5. Royalties
The terms for the payment of royalties and calculations of such payments need to be exact. The applicable currency should be specified, as well as responsibility for withholding taxes and VAT. 6.    Litigation
The license should state which party is responsible for the protection and defense of the IP and the defense and costs of litigation and other third-party IP claims.  The agreement should be specific in terms of the circumstances under which the licensor may assume the defense. 7.    Applicable Law/Arbitration
The licensor should request that its own laws apply to the construction of the license agreement, although such provisions may not be enforceable in many countries.  The licensor may require compulsory arbitration in a neutral country, if there are concerns about the enforceability of choice of law or consent to jurisdiction provisions. 8.    Termination
The right to terminate the license is paramount to the licensor.  It must be tied to the various obligations of the joint venture, particularly the representations and warranties, the quality control standards and the violation of licensor's IP rights.

A party contemplating entry into an international joint venture should procure the advice of competent local counsel in the country where the joint venture will operate.  The laws vary considerably from country to country and assumptions should not be made based on experience in another country or generalized knowledge.

Because it is often difficult to disengage from the relationship, termination of the venture is one of the most complex issues.  A clear exit strategy should be formulated prior to entering into the joint venture.  Some ventures have had put/call provisions which permit either of the parties to exit the relationship at specified costs.  Valuation issues arise when the put or call is based on cash flows or profits. Summary
A property owner can achieve more rapid business expansion with less resources in terms of finances, assets and manpower through licensing.  Ideally, it combines the licensor’s and licensee’s strengths, making both more successful than either would have been individually.  The licensor provides the goodwill and knowledge through the license and the licensee provides employees, financing to fund the new business and the assets for required plants, offices and distribution facilities.

A licensee must address various concerns before entering into a license.  The licensee must be certain that the licensor has the right to grant the license.  The licensee must protect itself from claims of infringement.  There are various risks if the licensor goes bankrupt or assigns the licensed rights for the benefit of creditors.  There are contractual and other mechanisms available to protect against these risks.

Merchandising provides a method by which a property or mark may enter an unrelated area without any capital investment.  Property owners obtain the dual benefit of broadening their underlying trademark rights as well as receiving royalties.

Many merchandising arrangements are predicated on maximizing revenues for a product with a short lifespan. Most property owners will attempt to keep the terms of such agreements short, e.g., 18 months to 3 years, and do not grant automatic options to renew, although licensees strongly negotiate for such options.  The right may be granted upon meeting a minimum threshold figure for sales or royalties during the then term of the agreement.

In certain cases, there are advantages to a property owner in creating a joint venture instead of a licensing arrangement.  Compensation may be in the form of a royalty or sharing of profits.  There is usually serious negotiation over the definition of profits.  Termination is a negotiated matter because distribution of the assets must be achieved.    Joint ventures are appropriate vehicles when the IP owner desires participation in running a business with other entities.  The owner shares in the revenues and profits of the business which may be much higher than license fees.  However, an investment in a joint venture requires direct involvement in the business and demands greater commitment of resources and management.

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