Licensing has been one of the most effective ways to maximize the value of a trademark. It's also the easiest way for companies to enter into a new country and achieve dominant market share, thereby establishing international expansion within a short period of time. As a foreign licensee takes the risk for investment and manufacture of goods in its own country, the licensor could gain royalty and increase popularity without incurring significant expenses. However, because trademark regime differs from country to country, foreign companies that obtained a U.S. trademark registration and want to enter into the U.S. market may be surprised to find some issues that are not problems in their home country may nevertheless be problematic under U.S. laws. On the other hand, a foreign licensee may be surprised to know that some U.S. trademark doctrine or case laws, which may not be widely adopted in their home country, could bar its claims in U.S. courts. Accordingly, a U.S. trademark practitioner, when representing a foreign client, must specifically consider issues unique to the U.S. in all stages throughout the trademark licensing process. The following are some key issues that need to be addressed in drafting a U.S. trademark license agreement.
Licensing Common Law Trademarks Are Allowed
In countries where trademark right is established based on registration, the use of the mark is not crucial to its validity. The U.S. is one of the few countries where the trademark right is based on "actual use" rather than registration, and a common law trademark could thus be established absent a federal or state registration, as long as consumers view the brand name as an indicator of the product's source. A common law trademark can still block the U.S. registration of a confusingly similar mark, although the right is limited to the geographic area within the U.S. where the mark is used, and the common law trademark owner bears the burden of establishing its trademark rights.
Therefore, if a foreign company has been using its mark long enough to establish a U.S. common law trademark rights, its mark may be licensed just like any other registered trademark, but the mark may not be protected nationwide. The license will usually be limited to the particular area where the mark is used, since the licensor does not have any rights to license outside that area. In negotiating the licensee royalty or fees, a foreign licensee of a common law trademark should also be aware that common law mark may be less valuable due to this geographical limitation.
The Requirement of Consideration in Forming andModification of A Trademark Licensing Agreement
Under U.S. law, "consideration" is required for a contract to be enforceable. In other words, parties who entered into a contract must bring something in return for the other side's contractual promise. Consideration does not have to be monetary payment, it could be a promise to act or to withhold certain actions. However, the promise must be binding and mutual performance is required. In a trademark licensing context, the consideration for a licensee is the ability to use the mark, and for a licensor may be a royalty payment or simply the increased goodwill and strength resulting from licensee's use of the mark. Consideration is also required to enforce the oral modification of a licensing contract. A trademark licensing agreement allegedly modified by an oral statement without additional consideration in return has been found unenforceable by the federal court. See Wagner Enters. v. John Deere Shared Servs., 397 F. Supp. 2d 1097 (D. Iowa 2005).
In Wagner Enters, the licensee paid a royalty to the trademark owner in exchange for the authorization to manufacture products under the licensed trademark. The contract specified that the license would terminate two years after the commencement date of the license agreement. Id. at 1100. Near the time the license was set to expire, the licensor made an oral statement over lunch, agreeing that the license will be renewed unless the licensee just "totally screwed up" the arrangements in contract. Id. at 1102. Although licensor could receive increased royalties if the license is renewed, it did not receive any new consideration in exchange for its promise for renewal because the original contract already gave the licensor the entitlement to royalties on all licensed products sold by the licensee. Licensee's obligations are still based on the original contract and no new promise is made on its part. Consequently, under U.S. law, the oral promise for renewal of that license agreement is unenforceable and did not bind the licensor.
Unlike the U.S., many civil law countries, such as China or Germany, do not require a "bargain for" consideration to enforce a contract. In these countries, a mere offer and acceptance, even if the license contained only a one-sided promise without anything valuable in return, could constitute an enforceable contract. Accordingly, a foreign company from a civil law country may rely on the licensor's oral modification for renewal, but be surprised to find that the modification is not enforceable in a U.S. court due to the lack of additional consideration.
To avoid consideration problems, a U.S. counsel should always insert clear language that indicates the adequacy of consideration underlying a contract. An example of proper language may be set forth as the following:"[I]n consideration of the mutual covenants and obligations contained in this Agreement, and for good and valuable consideration, the receipt of which is hereby acknowledged, and the parties agree as follows:…"
Quality Control and Naked Licensing
In most civil law countries, the lack of quality control does not affect the validity of a mark, and therefore is not necessarily an issue in licensing negotiations. In the U.S., on the other hand, quality control is a fundamental element in all trademark licensing agreements. Why? Because controlling the quality of the licensed products ensures that the trademark owner is the "source" of those products. Insufficient quality control over the products, also called "naked licensing," will result in the trademark failing to identify the licensor as the source and thereby lead to the abandonment of the licensed mark. Barcamerica Int'l USA Trust v. Tyfield Importer et al., 289 F. 3d 589, at 596 (9th Cir. 2002).
The purpose of quality control provision is to maintain a consistent and predictable quality for all goods and services for which the trademark is used, thus the actual level of quality, be it high or low, is irrelevant. Id. 597-598. For a license to be proper, the mere right to control the quality is not sufficient; there must be "actual" quality control by the licensor. See Alligator Co. v. Robert Bruce Inc., 176 F. Supp. 377 (E. D. Pa. 1959). Absent a formal quality control program or explicit provision for inspection, actual control could still be proven by the fact that parties have a close working relationship which established the basis for licensor's reliance on licensee's integrity. Taco Cabana Int'l Inc. v. Two Pesos Inc., 932 F.2d 1113 (5th Cir. 1991).
The facts of Barcamerica are instructive to show the consequences of "naked licensing". In Barcarmerica, a trademark application for the mark DA VINCI was blocked by an existing registration of DA VINCI for wines. The applicant petitioned to cancel the DA VINCI registration on the ground of abandonment due to naked licensing. The registrant, admitting that its use of that mark was solely through licensee and that no quality control provisions were specified in the licensing agreement, nevertheless argued that it satisfied the quality control requirement based on (1) its reliance on the reputation of the licensee which has a "world famous" winemaker; and (2) its informal and occasional tasting of licensee's wine. Barcamerica, 289 F. 3d at 592. The Ninth Circuit found that the licensor's reliance on the reputation of the winemaker was not justified as the winemaker died during the course of the license. Moreover, the licensor failed to demonstrate when, how often, and under what circumstances he tasted the wine. Accordingly, the Court found the license to be naked, and that the registrant had abandoned his rights. Id. at 597.
Given the difference between U.S. law and civil law system, counsel should pay particular attention when drafting quality control provision for a foreign U.S. trademark owner. A quality control provision must purport to ensure that any products or services offered under the licensed trademark enjoy a quality that's at least equal to, if not better than, any existing products or services offered by the licensor. To make sure licensee's products are of the highest quality and beneficial to licensor's reputation, the license agreement should state the minimum quality standard and, in advance of the production schedule, set forth a timetable for the licensee to submit its product samples for the licensor's review and written approval. It should not only specify the licensor's right to routinely inspect licensee's manufacturing facilities and review customer comments in order to monitor the quality of licensee's products and its compliance, but also describe the procedure for product inspection and the criteria for approval.
The licensing agreement should dictate that the licensed trademark be removed from any products that's below the minimum quality standard. It's also advisable that a licensor keep records of its efforts in maintaining quality control as evidence against the invalidity challenge in the future.
On the other hand, maintaining too much control over the quality of product may expose the trademark owner to the risk of product liability. A nonmanufacturing trademark licensor could be held liable for licensed products sold under its mark if it exercises substantial control in putting the defective product into the stream of commerce. The Ninth Circuit has applied state law which allows the imposition of liability on a trademark licensor who significantly involved in the overall process by which the product reaches consumers, holding that an injured consumer may bring an action against the trademark licensor based on "enterprise theory" because the licensor is the functional equivalent of the manufacturer or seller. Torres v. Goodyear Tire & Rubber Co., 901 F. 2d 750, 751 (9th Cir. 1990).
One way to minimize the risk of product liability is to require the licensee to purchase a product liability insurance covering the trademark owner and to require the licensee to keep this insurance in full effect throughout the licensed period.
Licensee Estoppel Applies In Most Trademark Cases
In the U.S., a licensee may be precluded from challenging the validity of the trademark under the licensee estoppel doctrine. Federal courts have decided that the policy concern in maintaining the stability of a contractual relationship outweighs the need to challenge a trademark. Therefore, when a licensee enters into an agreement to use the trademark of a licensor, it is recognized that the licensee effectively agreed that the mark is valid, and thus is estopped from challenging its validity in the future. A former licensee, however, may challenge the validity of the licensed mark based on facts which arose "after" the license expired. WCVB-TV v. Boston Athletic Association, 926 F. 2d 42 (1st Cir. 1991).
A good example of this doctrine arose in Freeman v. National Association of Realtors, 64 USPQ2d 1700 (TTAB 2002) where the licensee was a member of National Association of Realtors for 20 years, and had been licensed to use the trademark "REALTOR" during that period. She then left the association and the license ended. When the licensor asked her to stop using the REALTOR mark, the licensee petitioned to cancel the REALTOR registration, claiming that it had become a generic term for "real estate agent." Given the fact that the association has spent considerable expenses promoting REALTOR mark to the public, that the licensee had enjoyed the benefits of using that mark for 20 years, and that the issue of genericness is not based on new evidence arising after the license expired, the licensee was estopped from challenging the validity of REALTOR mark. Id.
An exception to trademark licensee estoppel arises in the context of certification mark, as detailed by the Second Circuit in Idaho Potato Commission v. M& M Produce Farm & Sales, 335 F. 3d 130 (2d Cir. 2003). Recognizing the policy conflict between the licensee estoppel doctrine and the need to protect the integrity of certification marks, the Second Circuit held that certification marks protect a different "public interest' from traditional marks, namely, to promote "free and open competition" among the producers and distributors of certified products. Id. at 138. The Court noted that if the validity of a certifier's marks were free from any challenges, a certifier would have no incentive to maintain neutrality in certification process. Also, the licensees of a certification mark "may often be the only individuals with enough economic incentive to challenge [the certification mark owner's] licensing scheme, and thus the only individuals with enough incentive to force [the certification mark owner] to conform to the law." Id. at 139. The Court thereby determined that the equitable interest in preventing validity challenges by licensees is outweighed by the strong public interest in allowing such challenges to ensure that the certification mark can serve its function as to promote the competition.
Most civil law countries do not recognize licensing estoppel doctrine, be it certification mark or not. Therefore, when representing a foreign U.S. trademark owner/licensor, counsel should advise client that licensee estoppel still applies generally, and add language such as "[L]icensee will not, directly or indirectly, contest, challenge, or attack the validity of Licensor's rights in and to the Licensed Mark ..." in the license agreement.
On the other hand, a foreign licensee must be particularly cautious when it comes to a "no-challenge" provision in the license agreement. As analyzed above, a licensee is usually estopped from contesting the validity of the licensed trademarks, unless it's a certification mark. Also, if a mark has been registered and continuously used for five consecutive years from the date of registration, that mark is very strong because it becomes "incontestable" and can only be challenged on the ground of abandonment or genericness, so its value should be higher. Therefore, counsel for a foreign licensee should carefully assess the validity and contestability of the licensed mark before entering into any trademark licensing negotiations.
A successful trademark licensing mechanism requires not only business strategy but also effective legal measures. When licensing U.S. trademarks, foreign companies should always keep in mind that (1) a common law trademark, despite its geographical limitation, can be licensed or used to block the registration of similar marks; (2) consideration is required when forming or modifying a license agreement; (3) failure to exercise adequate quality control over the product may invalidate a mark; and (4) unless it's a certification mark, a licensee is barred from challenging the validity of a licensed mark. Making full use of trademark protection provided by U.S. law is undoubtedly the key for foreign companies to achieve business success in the U.S. market.
This article appeared in Lexis Nexis China Legal Review