Brand Licensing Strategies to Maintain Value and Goodwill By Marc A. Lieberstein and Amit D. Kumar Introduction California and New York vertical price restraints may still 4 Laws in the United States limit and, practically be considered per se illegal. A brand licensor has a verti- speaking, prohibit brand owners from fi xing prices or cal relationship with its licensee, and as such, restraints taking other anti-competitive steps that would ordinarily on the licensee’s ability to set its own resale prices for help them to maintain brand value and goodwill, not to licensed goods are likely to lead to liability for the licensor mention increase revenue. This article addresses practi- in California and New York. cal licensing and distribution strategies that transactional Therefore, it is customary—and advisable—to ex- parties can use, under U.S. law, to maintain brand value pressly state that the licensee is free to determine the and goodwill without crossing the line into illegal price prices at which it resells licensed products. fi xing or unfair competition. Nonetheless, even though a brand licensor cannot Generally, a brand licensor cannot simply dictate dictate the resale price for licensed products, there are resale prices. But it can take other steps to maintain brand strategies available to the brand licensor to protect itself. value and reduce the likelihood that a licensee will en- These strategies include: (1) imposing reasonable controls gage levels of discounting that will harm the brand. over inventory levels of licensed products; (2) employing a royalty structure that reduces incentives to discount and “To rub salt into that wound, since royalty also ensures that the brand licensor gets the benefi t of the bargain; (3) restricting distribution to selected and ap- is often tied to ‘net sales,’ discounts proved distribution channels; and (4) requiring an estab- that exceed what the parties initially lished SRP and that it be communicated to consumers. contemplated deprive the licensor of the financial return it anticipated when Strategy 1: Include Restrictions on Inventory entering into the license.” Levels Manage Forecasts and Inventory Resale price has long been a touchy subject when it One common reason a licensee may opt to sell li- comes to license agreements. A well-crafted license agree- censed products at low prices or to unauthorized resellers ment affords a licensor control over many aspects of a or customers is that the licensee has too much inventory. licensee’s manufacturing, marketing and sales of licensed The licensee needs to pay the factory for the goods, and it products, but license agreements are typically silent needs to turn its inventory into cash to do so. If the licens- about resale prices (or, if they say anything, they may say ee fi nds itself with a relatively large amount of inventory, simply that the licensee is free to set the resale prices). it may have an incentive to try to move it more quickly by The problem is this—deep discounting can hurt the discounting or selling through unauthorized channels. licensor’s brand. When a licensed product shows up To mitigate against this incentive, brand licensors can online with confl icting Suggested Retail Prices (SRP), or employ a set of clauses to require that a licensee provide is heavily discounted, consumers associate the behavior advance forecasting information to the brand licensor and with the brand itself. To rub salt into that wound, since also provide visibility to the licensee’s inventory levels to royalty is often tied to “net sales,” discounts that exceed ensure that such inventory levels are indeed consistent what the parties initially contemplated deprive the licen- with the forecasts. sor of the fi nancial return it anticipated when entering into the license.1 Here is a sample forecast provision: Under federal law, for many years vertical price re- Within thirty (30) days of the date hereof, straints were a per se violation of Section 1 of the Sherman Licensee shall provide to Licensor a Antitrust Act (a “vertical” restraint refers to a restraint twelve (12) month rolling forecast of sales between parties that have a “vertical” relationship in the of Licensed Products by [month/quarter] supply or distribution chain, like sellers and buyers).2 (the “Rolling Forecast”). Licensee shall That changed in Leegin Creative Leather Products, Inc. v. provide an updated Rolling Forecast PSKS, Inc.,3 where the Supreme Court ruled that vertical by the fi fth (5th) day of each calendar price restraints are legal if the restraints satisfi ed the “rule [month/quarter]. of reason.” Notwithstanding Leegin, in states such as Here is a sample inventory provision: 8 NYSBA Inside | Spring/Summer 2016 | Vol. 34 | No. 1 Licensee shall provide Licensor with These provisions should effectively allow the brand a [monthly/quarterly] stock report of licensor to control the inventory from its old licensee Licensed Products in Licensee’s inven- and maintain brand value for its new licensee in the tory (the “Monthly Stock Report”). The marketplace. Monthly Stock Report must refl ect actual inventory levels on the fi rst (1st) day of each calendar [month/quarter] and be “Pertaining to the issue of pricing and provided to Licensor by the fi fth (5th) distribution, licensors need to be aware day of each calendar [month/quarter]. that the minimum guaranteed royalty can Licensee shall cease production of new units of Licensed Products if and when itself become an incentive for licensees the inventory of Licensed Products to engage in expanded, unauthorized exceeds the anticipated sales of Licensed distribution and excessive discounting.” Products for the next three (3) months as refl ected in the Rolling Forecast.5 Strategy 2: Ensure That the Brand Licensor Even with proper inventory management, the licens- Actually Receives Its Anticipated Financial and ee may still have some inventory of licensed product left Goodwill Benefi ts at the end of the term. It is important for brand owners to have the option to take control of this inventory. Brand Use a Minimum Guaranteed Royalty Structure That licensors should include a “sell-off” or “wind-down” Only Counts Authorized, Goodwill Enhancing Sales provision that gives a brand licensor the option, but not Minimum guaranteed royalties are common in brand the obligation, to purchase the inventory at prices which license agreements. Often, licensors reserve the right to are predetermined in the license agreement. Here are two terminate a license agreement for failure of the licensee sample terms that can be used together or separately: to achieve the minimum guaranteed royalty amount (and Licensee shall not manufacture Licensed the license agreement may also provide that the licensee Products during the last six (6) months is fi nancially liable for the shortfall). of any Term that is not being renewed in Accordingly, in order to achieve the minimum excess of the amount Licensee reason- guaranteed royalty level, the licensee will feel pressure to ably anticipates will be sold prior to the generate suffi cient sales volume. Pertaining to the issue of expiration of the applicable Term based pricing and distribution, licensors need to be aware that on the Rolling Forecast. the minimum guaranteed royalty can itself become an Within fi ve (5) business days after ex- incentive for licensees to engage in expanded, unauthor- piration or termination, Licensee shall ized distribution and excessive discounting. provide to Licensor a list of all inven- To combat the risks of expanded, unauthorized dis- tory of Licensed Products, together with tribution, the license agreement should expressly pro- the landed cost and standard wholesale vide that sales in violation of the agreement shall still be price for such inventory. Licensor shall royalty-bearing, but shall not count toward the minimum have the right, but not the obligation, to guaranteed royalty. As such, a licensee’s sales to unau- purchase any or all of such inventory at thorized customers will not help it make progress toward the lower of Licensee’s landed cost or jumping the minimum guaranteed royalty hurdle. ____ percent (__%) off of the standard wholesale price of the inventory. Licen- Here is a sample clause: sor shall provide Licensee with written Licensee shall not offset against any notice of Licensor’s election to purchase Minimum Guaranteed Royalty any any such Licensed Products within fi ve Royalties accruing on sales of Licensed (5) business days after receipt of the list Products to customers other than Autho- of inventory. If Licensor fails to provide rized Customers or any Royalties accru- Licensee with such notice within such ing on sales of Licensed Products which fi ve (5) business day period, Licensee are otherwise in violation of the terms of may sell any or all Licensed Products to this Agreement. Sales of Licensed Prod- any Authorized Customer for a period ucts in violation of this Agreement shall of three (3) months. All sales of Licensed be Royalty-bearing, and Licensor’s accep- Products to any Authorized Customer tance of Royalties on such sales shall not during such three (3) month period shall be deemed to be a waiver of any right or be Royalty-bearing and subject to the remedy of Licensor hereunder relating to terms of this Agreement. such unauthorized sales. NYSBA Inside | Spring/Summer 2016 | Vol. 34 | No. 1 9 Use a Minimum Guaranteed Royalty Structure vice around the licensee. The discount cap effectively That Only Credits a Specifi ed Amount of Deeply escalates the royalty for the deeply discounted sale, and Discounted Sales then that royalty might still excluded from the minimum To combat the risk of excessive discounting, brand guaranteed royalty requirement. This increases the chance licensors should consider requiring that the minimum that there will be a shortfall.