Headspace v. Podworks: Good News (With Warnings) for Marijuana Trademark Licensors

In January 2017, Headspace International, LLC, a California-based cannabis company, sued Podworks Corp., a Washington-state-based cannabis company, for trademark infringement. Headspace sells a product called “The Clear” and claimed Podworks “Top Shelf Clear” product infringed on its trademark. Podworks defended itself by claiming that Headspace did not have valid trademark rights in Washington and that the only use of Headspace’s trademark in the state had been by its in-state licensee, X-Tracted. The trial court in Headspace International LLC v. Podworks Corp., dismissed Headspace’s claim, finding that it had not established trademark rights in Washington. Headspace appealed and on October 29, 2018, the Washington Court of Appeals reversed the trial court’s decision and sided with Headspace.

What Does This Mean for Cannabis Businesses? First, the Good News

  • Lawful use of a trademark in Washington only by a licensee and not by the mark’s owner can support the owner’s state trademark rights, even for cannabis products.
  • A trademark licensor can lawfully exert sufficient quality control to maintain valid trademark rights without violating Washington’s Controlled Substances Act (the “CSA”).
  • A trademark licensor is not necessarily a “true party of interest” under the Washington Administrative Code (WAC).

Digging a Little Deeper

The court cited federal precedent in holding that:

. . . indirect use of a protected mark by a licensee inures to the benefit of the owner of the mark when the owner has sufficient control over the quality of the goods or services provided to customers under the licensed mark” and also that such “use” must be “lawful placement of a mark in the ordinary course of trade.”

The court then had to decide if an out-of-state trademark owner can exert “sufficient control” over the quality of its Washington licensee’s marijuana products without making that licensee’s use of the trademark unlawful under the CSA.

What is necessary to have “sufficient control” over quality? Three factors are assessed, any one of which may support a finding of sufficient control:

  • Contract language authorizing control over the licensee by the licensor,
  • Whether the licensor exercised actual control over the licensee, or
  • Whether the product quality over time was sufficient for the licensor to rely on the licensee to ensure quality control.

Under the CSA (as codified at RCW 69.50.331(1)(b)), licenses to legally produce, process or sell marijuana products may only be issued to in-state entities. Further, license holders may not permit any other entity to use the license (RCW 69.50.325), which the court says bars participation “in the production, processing, or sale” of marijuana products. How can an out-of-state trademark licensor exercise quality control without violating these requirements of the CSA?

Podworks claimed that in order to exercise sufficient quality control over its trademark, Headspace had to unlawfully participate in its licensee’s production or processing of the branded products. If true, this would create a “damned if you do, damned if you don’t” dilemma for Headspace — either it had no enforceable trademark rights because it didn’t exert sufficient control over X-Tracted, or it did exert sufficient control but still had no trademark rights because then X-Tracted’s use of the mark was unlawful. Nevertheless, the court held that sufficient quality control could be exerted “through contractual means” or by relying on the licensee’s own quality control measures, neither of which would violate the CSA, as neither would constitute participation in the production, processing or sale of the branded products.

Podworks then argued that the May 17, 2017 addition to the CSA (RCW 69.50.395), which requires marijuana businesses to disclose all licensing agreements to the WSLCB, should be applied retroactively and thus Headspace’s license to X-Tracted was unlawful, as X-Tracted did not disclose it to the WSLCB when it was entered into in 2014. The court held that X-Tracted’s failure to disclose the Headspace license in 2014 did not make it unlawful, but did note that the WSLCB must now require X-Tracted to disclose the license.

Along With the Good News, Consider These Warnings[1]

  • All current licenses must be disclosed to the Washington State Liquor and Cannabis Board (WSLCB), even those entered into before the disclosure obligation was created in 2017.
  • If a trademark licensor is paid a royalty based on a percentage of its licensee’s profits, said licensor will qualify as a “true party of interest” under the WAC and so must:
    • Be named on the licensee’s marijuana business license,
    • Disclose to the WSLCB the source of funds it invests in the licensee’s business, and
    • Have those funds pre-approved by the WSLCB.

This decision makes clear that licensing agreements will continue to be an effective way for Washington cannabis businesses and out-of-state IP owners to work together to their mutual benefit, but also highlights the significant dangers that can arise from poorly drafted or inappropriately implemented licenses. Creative approaches are required to appropriately compensate licensors without turning them into true parties of interest. Lane Powell has structured such deals for both licensors and licensees in Washington and other states.