Conversations in IP Law

Oliver Herzfeld of Beanstalk Talks about Brand Value and Outsourcing

Janet A. Marvel

©2016. Published in Landslide, Vol. 9, No. 2, November/December 2016, by the American Bar Association. Reproduced with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association or the copyright holder.

Oliver Herzfeld is senior vice president and chief legal officer of Beanstalk, an Omnicom-owned agency and global brand extension consultancy. Beanstalk represents leading brands, celebrities, and media properties, manufacturers, and retailers, assisting them in identifying, exploiting, and managing licenses for the purpose of brand extension. Oliver oversees all aspects of Beanstalk’s legal department, including managing a team of lawyers responsible for drafting and negotiating all the license agreements on behalf of Beanstalk’s clients, updating legal templates to reflect the latest intellectual property laws and industry trends, managing the representation agreement process with new clients, and overseeing Beanstalk’s contract administration department.

Oliver holds a BA cum laude, Phi Beta Kappa, from New York University and a JD with honors from Columbia University School of Law.

 

Please explain some of the benefits of licensing. Why do your clients want to do it?

Licensing is an endeavor within the realm of advertising and marketing. It’s really a unique area because when you’re engaged in most types of marketing, such as advertising, you’re usually paying money out of your own pocket to promote your brand. Whereas licensing is a revenue generating endeavor within marketing.

 

You have used a mnemonic: “promotion, protection, profit” to explain the benefits of licensing. Would you explain that for us?

The “promotion” benefit of licensing leverages the level of commitment that brands engender from customers. Say you are an automotive manufacturer like Ford, and you’re granting licensees the right to manufacture and sell licensed apparel products. When a devoted fan of Mustang goes to the retail marketplace, he’s taking money out of his own pocket to buy your branded product and then to wear it. That’s really quite unique. He’s not sitting and watching a commercial on TV that he might skip over or not. He’s committing his own money affirmatively to buy your product. And then he’s going to wear it and display it for the world to see. So that’s all the promotion benefit.

 

What about “protection”?

The “protection” benefit is the trademark protection you receive by using a trademark in a new market. If you are Procter & Gamble or Stanley Black & Decker, and you’re licensing out your trademark to new categories, by virtue of your licensing you are by extension using the trademark in commerce in those categories. You get trademark protection as a result of that.

 

And “profit”?

Obviously the “profit” benefit is your licensing revenue. You usually receive an advance when you enter into license agreements. There are minimum guaranteed royalties. Also, there are running royalties based on sales.

 

Any other benefits?

Licensing extends brand awareness, reach, and affinity to new consumers. It strengthens a brand’s relationship with its customers, reinforces brand values, and creates additional contact with existing customers. It allows brands to enter into new territories, categories, retail channels, and markets without increasing capital expenditures or ongoing expenses. So if Stanley is interested in potentially producing ladders, and doesn’t currently produce ladders, it could initially license ladders to a third party without any capital expenditure in creating a factory or warehouse or any risk in sales. In fact, it would receive guaranteed royalties from sales. And then if it sees that ladders are successful—and by the way, Stanley ladders are very successful—it could decide when the license expires that it wants to produce ladders itself.

 

What do licensees receive?

What the licensees are predominantly looking for are ways to increase their sales. If a manufacturer in Asia is making power tools, just as an example, and it’s able to put Stanley’s name on them, that could help it make sales to new retailers, get better distribution, and increase its sales. So, those are the key benefits for licensees. Licensees seek to benefit from the trademark’s selling power to build competitive advantage, bring new excitement to product lines, increase sales, enter new channels of distribution, achieve new consumer and retailer benchmarks, and stave off competition.

 

In some of my own experience, I’ve had lawyers in corporations say: “Look, the profit that we want is going to be a relatively small portion of the overall business of the company.” So, in those cases they’re looking primarily for customer relations. Do you see different interests among different clients in terms of the types of things they want to license and their overall rationale for licensing? Is there any way to generalize that sort of thing?

Every client is specific but I’ll try to make some broad generalizations. When you’re dealing with famous personalities, celebrities, and the like, not always, but perhaps, the profit might be a very important component of the licensing program. There are only 365 days in a year. If a famous personality is a movie star, they want to devote themselves to doing X number of films a year, that will require X number of days to be on set and X number of days for promoting the film. If they want to do licensing, they have limited time to devote to it. They want to see a certain amount of return on their investment in exchange for that because they could use the same time perhaps to do other projects or to do promotions or advertising. So the profit might be very, very important to them.

When you’re a large organization like Procter & Gamble, or an automotive manufacturer, the revenues you generate from licensing can sometimes be extremely meaningful and other times be a very small percentage of the overall revenues of the organization. In the latter case, the most important thing may be the customer relationship and perhaps fulfilling needs or aspirations of younger purchasers who might become future customers. So there are many other motivations for very large organizations where overall revenues might be completely eclipsing the amounts they can receive from licensing.

There are other motivations as well. An important part of our relationship with the U.S. Army is enhancing their ability to recruit new enlistees as well as their relationships with veterans.

 

I imagine that part of that relationship is that there are veterans who want to advertise their connection with the Army, as you mentioned, and of course with those people there’s a certain amount of respect for their service and a desire to pay it forward.

Right. It’s honoring what they’ve contributed and wanting to continue to stay connected. And it’s also helping recruit future soldiers. In the U.S. Army program, there are many, many people who are veterans, who start creating some products in their garage in the best of faith, not aware that they are required to procure a license in order to use the U.S. Army’s name and insignias. And the quality might be just fine. We’re very frequently working with the U.S. Army to grant those veterans a license, and to invite them into the fold.

 

Can you outline the common legal issues you see in your practice, and how you handle them?

The number one legal issue is quality control. When you’re the owner of a brand and you’re licensing out the right to use the brand to a third party, you are assuming a considerable amount of risk that the licensee could do something that could hurt your brand. You really don’t get a second chance at your brand. You have all kinds of recourse in the agreement, but that really is not going to put the genie back into the bottle. Whereas the licensee could be licensing 10 different brands, and if things don’t succeed with one brand, they could just focus on other brands. They can live to fight another day. So, really it’s so important to a licensor to get the quality control right.

Besides that, there’s a whole obligation under trademark law regarding approvals. You have to make sure that you have that all buttoned up. A licensor’s name stands for products and services of a certain quality. If the licensor allows people to use its name without asserting a right of approval to maintain that level of quality, that’s a so-called naked license—a license without approval rights. The consequences are that the licensor could be considered to have abandoned its trademark. It could lose all of its trademark rights.

The licensor wants to have provisions for approval in all the different stages of product development: the concept stage, the prototype, and the final stage. You want to have certain provisions that say that if the licensor doesn’t approve within a certain period of time, then the product is deemed disapproved, just to protect the licensor. Of course, the licensee would like to have that in reverse. They’d say if you don’t respond within 10 days, it’s deemed approved.

There are other bells and whistles. You could suspend the approval process if the licensee is in breach of other provisions in the agreement. You could clarify that the licensee doesn’t have any rights for damages if the licensor fails to approve the licensed product for any reason or no reason at all.

Quality control is a very important issue. But it’s not the only issue. There are also thorny issues of IP ownership. Licensors want to assert rights to own anything that’s created and branded with their trademark. And many times the licensees agree to that. But sometimes, the licensees will push back. For example, if a licensee is cobranding its name or technology with a licensor’s, it’s not going to want to give up ownership of its own brands. A licensee that gives up its brands or technology is locked out of its own house. But at the same time, the licensor is not going to want a licensee to benefit from the use of its brand name after the license is over. The licensee would then continue to sell the same products that the consuming public has come to associate with the licensor’s trademark, but without the licensor’s name, and ride on that benefit. There are several ways to split the baby in terms of IP ownership.

Another issue is licensor liability. If the licensed product has a defect that leads to product liability damages, is the licensor liable for that? There are a number of different legal theories of which licensors must be mindful. What’s the level of control? On one hand, a licensor must maintain approval rights and quality control over the products. But if it exerts a lot of control, the licensor could be exposed to liability for licensed product defects. There was a case recently where Viacom licensed SpongeBob SquarePants for a toy guitar, and the toy guitar was in the shape of Gibson’s Flying V guitar shape. Gibson sued both the toy manufacturer and Viacom. So the question is, to what extent is the licensor liable for infringement caused by the licensee?

And what happens if the licensee misbehaves? If the licensee sells products that are not approved; if the licensee sells products that are approved, but they sell them outside the territory where they’re granted rights, or outside the permitted channels of distribution where they’re granted rights, or somehow otherwise breaches the agreement? Certainly, the licensor can sue for breach, but there are other provisions that you want to include in your agreement—whether the licensor receives liquidated damages, for example.

And then there’s the whole issue of inducement and reliance. What do the licensees expect when they’re entering into the agreement? It may not say so explicitly in the license agreement, but a licensee may come back later on and say, “You know, I thought that by entering into this license agreement with you (owner of big famous name), that you would assist me with getting retail placement, or you might provide marketing assistance, or you would enforce your trademark in a particular region. There are infringers out there in my category. Why am I paying for this license to use your name in this category when there are infringers out there that are not paying for it, and you’re not enforcing your name against them?” It’s ideal to address those issues directly in the license agreement.

In addition, if a licensee is paying for the rights to use a trademark, it is going to want to know for sure that the licensor owns the trademark. It would want to know that the licensor has registered the trademark in the jurisdiction the license covers. But the licensor might be reluctant to invest in the cost of registering its mark in the territory for a category until it knows that it has a real live deal. That’s a chicken-and-egg problem. As a licensing agency, we stand in the middle; we get caught in that crossfire. Sometimes we have to nudge our clients to register in order to be able to broker deals. Many times, the licensor will insist that the licensee show that it actually has the capability of distributing the products in the territory where it’s seeking rights. In a multiterritory license, a savvy licensor might negotiate separate minimum guarantees by territory so that if the licensee does really great in one territory but does not make a single sale in another, the licensor will still receive the separate minimum guaranteed royalties for the territory without sales.

And then you get into issues of indemnity. The licensor wants the licensee to indemnify it for a number of different things: if their products are defective, if their products infringe, if there’s a violation of law. There are other conditions that would require indemnification.

One last important legal issue is royalty compliance audits. The entire licensing industry is based on the honor system. It’s very similar to the tax system in the United States. As taxpayers we all self-report our income. And then the IRS has the option to audit us, but it’s all based on us self-reporting. And the licensing industry is based on the same kind of model where licensees report their sales and if the licensors accept the reports and don’t take any action, then it remains at that. The key way a licensor can verify whether its licensees are actually reporting correctly is to audit them. The further option would be to sue them if the licensor knows for sure that they are breaching, but in the absence of going all the way to the nuclear option of suing, the intermediary step is to periodically audit licensees. That raises issues about the audit lookback period. How far back can you audit at any one time? The licensor would like to go back to the beginning of creation, and the licensee would like to limit the audit period to a narrower time frame. The licensor wouldn’t want it to be a short period like one year because the licensor is realistically not going to audit the licensee every year. But what if the agreed audit period is longer than the applicable statute of limitations for a breach of contract? The licensor could audit for the entire period but, if the parties reach an impasse regarding settling the audit, the licensor presumably could not sue for underreported sales and other claims that took place before the applicable statute of limitations for a breach of contract.

There is also a question about who pays for the audit. And that involves an entire dance routine. The licensee says, “Okay, you can come into my shop and audit me, but I’m not going to pay for it. If you want to audit me, you do it on your own dime.” Audits can be expensive. And the licensor will say, “Okay, I’ll pay for the audit, but what if it turns out that you were underpaying me? If you were underpaying me, then you should pay for the audit.” And then the licensee will say, “Okay, but what if I was only underpaying you by $1? Do I have to pay for the entire audit, just because I underpaid you by $1?” And so the parties arrive in the middle where they come up with a threshold where they say, “Look, if you were underpaying me by some percentage, typically between 3 percent and 5 percent, then you have to pay for the audit.” But if it’s underneath whatever the agreed threshold is, then the licensor pays for the audit.

 

Do you have a lot of situations where the licensor says, “I have the power, take it or leave it”?

Certainly. And ultimately, license agreements are largely one-sided agreements because it’s not a partnership. It’s not like 50/50 equal power coming into the relationship, and it’s all keyed off the point I made before, that the licensor has only one name, and that gives the licensor a lot of power. But, you know, licensors want to choose licensees that are best in class. Many times the licensees will have excellent quality products, or they may have some unique technology, or they may have a relationship with a retailer or a set of retailers that the licensor wants to take advantage of. And so the licensee has some power too.

 

Regarding “direct-to-retail” brand extension, can you explain what that means?

Absolutely. Typically, licensing is done between a trademark owner and a manufacturer. That’s the most common method of licensing. But sometimes, the licensor will grant rights to a retailer instead. And the retailer will have the option to either produce the products itself or to go out and engage in its own sublicensing to manufacturers. The resulting products will usually be sold exclusively at that retailer. That’s “direct to retail.” So, for example, Beanstalk represents Salma Hayek for a cosmetics, skincare, and haircare product line that has several hundred SKUs. It is quite unique and has won a number of awards. We could have managed that by going to one manufacturer after another to make one product at a time and then have them sold wherever each manufacturer has retail placement, but instead we did one deal with CVS. That’s a great example of a direct-to-retail program.

 

What’s the benefit to having just the one exclusive retailer?

The licensor doesn’t have to deal with multiple manufacturers. There is a commitment to the placement and promotion at that retailer, and there’s a cachet to exclusivity. You’ll see a lot of apparel brands with exclusives at a single retailer. So, for example, I think Starter and Ocean Pacific are exclusively at Walmart, Sears has Joe Boxer and Bongo, and Kohl’s has Candie’s. So it’s good for the brand, and it’s good for the retailer. The latest trend has been mass retailers getting exclusives from higher-end luxury brands that sell in limited collections. You see people go crazy and stand in long lines in order to buy those products. That generates a lot of good publicity.

 

Right. The Target model.

Yes. For example, in April 2015, Target announced a collaboration with Lilly Pulitzer. Within hours, the exclusive collection was entirely sold out, in stores and online.

 

Can you discuss what the biggest impact on licensing law or practice has been in the last five years?

I think that in the last five years the biggest impact has been the evolution of celebrity licensing and how celebrities have become increasingly involved and very strategic about the use of their names and their brands. The best example of that would be Dr. Dre and his creation of Beats. In the past, celebrities might have allowed people to use their names in order to make—I don’t want to sound too flip—a quick buck. They would get a promotional fee for it. They would do a commercial, or allow their faces to appear on a box of Wheaties. Whereas Dr. Dre created Beats in 2008, and in 2014, he sold it to Apple for reportedly $3 billion, making him the richest man in hip hop. That’s a great example of how celebrities have become much more involved.

But, that’s not the only example:

  • Anheuser-Busch engaged Justin Timberlake to be its creative director for Bud Light Platinum;
  • Diet Coke engaged Taylor Swift as its ambassador for several Diet Coke initiatives;
  • Will.i.am became Intel’s director of creative innovation; and
  • Lady Gaga was engaged by Polaroid as its creative director.

So you see a lot of situations where celebrities are much more involved than they were in the past.

In addition, food companies have really emerged with close-to-core licensing in the last few years. Historically, a food company might engage in licensing to make some T-shirts or hats, or some accessories to their product, but not allow people to actually license to make food itself. Now, that’s different. We represent, just for an example, TGI Friday’s, and broker deals for licensed sauces, salads, and sides, and that’s new and unique. And we represented Arby’s. You can go to the store and buy their famous curly fries in the frozen section.

A third is in the apparel field. Athleisure has really grown to be very big. Technology licensing has also grown. The two of them together have grown in licensing with smart wear apparel products.

Janet A. Marvel

Janet A. Marvel is a partner with Pattishall, McAuliffe, Newbury, Hilliard & Geraldson LLP.