Technology & Commercial IP

Merchandise Licensing: Contractual Arrangements

This is the second part of a two-part article introducing best practices in this sector. The first part focused on securing relevant IP. This part focuses on merchandise licensing arrangements.

There are often mistakes made and opportunities missed when a foreign merchandise licensing company (merchandiser) adapts its global template contracts for use with licensees and sublicensees in China (licensees). Local conditions warrant a different approach in many respects, as discussed in detail below.

Grey goods restrictions

With few and narrow exceptions, China largely allows the flow of parallel imports/grey goods into the country on the assumption that the IP owner has been paid on the first sale of the goods outside of China (exhaustion doctrine). To stem the flow, a merchandiser should place restrictions on its licensees, making it a breach of contract for a licensee to deal in grey goods. Though in most cases such sales would not constitute infringement, the merchandiser would at least have contractual remedies against the licensee. This is true not only in relation to PRC licensees, but also non-PRC licensees, who will likely be aggressively approached by PRC importers that may be eager to source and import genuine products to set themselves up as unofficial “distributors” in China.

IP protection

A well-drafted cross-border merchandise licensing contract should prohibit the licensee from (1) incorporating the merchandiser’s marks as part of the licensee’s enterprise name or domain names, (2) filing unauthorized trademark applications for marks identical or similar to those of the merchandiser, and (3) actively assisting or passively permitting a known third party (such as the licensee’s affiliates, and relatives and friends of the licensee’s management team) from doing either of these two actions. Such restrictions should also be imposed on a licensee’s sub-licensee(s) (if sub-licensees are to be permitted).

Another helpful restriction to include is a prohibition on licensees handling enforcement work directly. It is better to have them not disclose to third parties information about new infringements that come to their attention, and also to require that they notify the merchandiser within 24 hours. In no case should the merchandiser be obligated to act on such information.

Indemnification; liquidated damages

If the licensee’s local merchandise distributors violate IP or other contractual provisions, the licensee should indemnify the merchandiser for relevant losses.

It is also advisable to have a liquidated damages clause that applies in case of breach, fixing an amount agreed by the parties in lieu of having to work out (and fight over) the figure to which actual losses amount. That amount should be a reasonable (and supportable) estimate of likely damages. If the amount is viewed as a penalty, the liquidated damages provision could be deemed unenforceable.

Termination/expiration

Although most merchandisers draft their contracts with a clear distinction between termination (for cause or otherwise) and expiration at the end of the contract term, some merchandisers do not make the distinction between contract expiration/termination and license grant expiration/termination. The two need not be coterminous; in fact, it can be quite beneficial for a merchandiser to have certain circumstances trigger a termination of certain aspects of the license grant, but keep the remainder in effect until contract expiration (essentially, a partial termination). During that period where the license grant is narrower than initially granted, any of the licensee’s actions to continue on entirely as before the partial termination took effect would constitute IP infringement (for the then-unlicensed aspects) and open the door for the merchandiser to have stronger and more effective remedies against an errant licensee than would otherwise be provided by mere contractual remedies.

Admittedly, the understanding that the license grant and contract term are separate but run simultaneously, and the powerful consequences that might flow therefrom, is still somewhat new in China, and the implications thereof should be carefully explained to the licensee in advance of contract execution.

Also, be sure to include a wind-down period of six months or so, where the contract will not be renewed, making clear that post-expiration or post-termination sales are prohibited, and consider having a buy-back provision (at merchandiser’s option) where commercial circumstances suggest this (and have the new licensee be responsible for buying old product, where feasible). Lastly, the license grant should be clear, when taken together with the termination provisions, that licensee should have no ability to continue producing and selling post-termination, even where the licensee claims that early termination by the merchandiser was improper.

Dispute resolution

Most foreign parties doing deals with PRC parties would rather avoid adopting PRC law to govern the contract, and court venue in the PRC, but such thinking is becoming increasingly outdated.

Resolving disputes in a foreign court (especially with exclusive jurisdiction) is not advisable unless the licensee has assets in that jurisdiction, and the old wisdom of using offshore arbitration to resolve disputes came about when China’s modern court system was in its infancy. Although there is still room for improvement, things have changed a lot in the past 30 years, with the courts becoming more professional and judgments more in line with international norms. Arbitration isn’t always quick or inexpensive, and civil remedies available in China include preliminary and interim relief such as asset preservation and evidence preservation measures.

No matter the dispute resolution method adopted, it is always critically important that there be a carve-out such that the merchandiser can take action to protect its IP whenever and wherever necessary or advisable, including by resort to injunctions issued by PRC courts and/or administrative enforcement actions.

Escrow

Finally, to ensure that licensees play by the rules, consider having a bank guarantee or deposit that ensures there are real consequences for a failure at any time to pay royalties (particularly at the end of the relationship).

Troy Rice and Joe Simone