Five Overlooked Clauses in Licensing Contracts

Posted by Jed Ferdinand on March 02, 2013

License agreements come in all shapes and sizes – ranging from the “back of the napkin” variety that are built on little more than a handshake, to fifty-page heavily negotiated documents that spell out the parties’ rights and obligations in excruciating detail.   Whether your preference is keep it simple or for a detailed written agreement, this article will highlight five important and often overlooked clauses that apply to all licensing deals.

Definition of Net Sales:  The parties often spend considerable time negotiating the royalty to be paid by the licensee.  This is an important consideration to be sure. However, the way the parties define “net sales” is equally critical because royalties are typically paid as a percentage of licensee’s net sales.  Left unchecked, the licensee will seek to deduct as many items as possible in an effort to arrive at the lowest possible net sales figure from which a royalty is to be paid.  For this reason, the licensor should take great care to ensure that the licensee’s deductions from gross sales are strictly limited to bona fide returns and closeouts, discounts and allowances actually shown on invoices, subject to a cap in the range of 5 to 10%.  No other deductions for manufacturing, marketing, distribution or sales, or for uncollectible accounts, should be permitted.

FOB Sales:  When retailers elect to take possession of the licensed products at the point of manufacture (i.e. in China) rather than domestically at a U.S. distribution center, this results in a significant cost savings of as much as 30%.  The price paid to the manufacturer will be lower, resulting in less royalty income for the licensor.  To address this, licensors should ask for an extra one or two points above the domestic royalty rate for sales made on an FOB basis.

Product Approvals:  To ensure quality control, licensors should have approval over product and packaging at each stage of the production process.  This includes: (1) design or concept approval; (2) prototype approval; (3) pre-production approval; and (4) post-production approval, which is critical to ensure that shipments of manufactured licensed products conform to the designs and specifications previously approved by Licensor.  At the same time, a licensor should never permit silence (i.e. a failure to respond to an approval request within a certain defined time period) to be deemed approval.

Assignments:  The industry standard is that licenses are not assignable by the licensee without the licensor’s consent.  There are additional considerations that should be addressed as well to ensure greater protection for the licensor.   The definition of an assignment event should include a merger or acquisition, change in control of the licensee or when a factor or other financing entity takes control over the licensed products.  The parties can negotiate in advance an appropriate measure of compensation for the licensor’s consent to an assignment.

Marketing Commitments:  While this will vary depending on the size of license, licensors should seek to obtain specific marketing commitments from licensees.  This can include:  (1) a minimum commitment that the licensee will spend on marketing (typically one or two percent of net sales): (2) an additional contribution by the licensee to a pooled marketing fund that can be spent by the licensor (also typically one or two percent of net sales); (3) attendance at defined trade shows; (4) for fashion licenses, construction of a showroom to display the licensed products to retailers; and (5) preparation of an annual marketing plan.

These five points are only a small fraction of the important terms to be negotiated in licensing contracts.  Additional terms such as territory, product introduction dates and termination will be addressed in future articles.

Jed Ferdinand is the founding member of Ferdinand IP, LLC with offices in New York and Westport, CT, and is a member of the 24 IP Law Group, with offices in Germany, France and the U.K.  Jed’s practice focuses on the protection and exploitation of brands in the United States and internationally.  He can be reached at JFerdinand@24IPLG.com.