How Much is Enough? What Effort Does Licensee Owe To Licensor?

September 2003
The Licensing Book

"Larry, I must be missing your point.  How do you expect to prevail in this case?  Your Client licensed its trademark, received a substantial advance payment and also was paid a negotiated minimum annual royalty.  All of the payments were made on time and in the right amounts.  Yet your Client now wants to sue the Licensee for non-performance and you have agreed to consider the case.  What do you hope to accomplish?"

Putting aside his menu, Larry Lexus the Licensing Lawyer gazed across the table of the street café where we had met for lunch and over my shoulder toward the splashing sounds of a large fountain across the square.  The fountain periodically launched columns of water from the surface of a pond that bordered the small park at the city-center, and the columns fell back in a staccato cascade.  The day was warm, though overcast, and the patrons were protected against the possibility of rain by multi-colored umbrellas covering each table.  Our waiter appeared, and I drank from my water glass as Larry placed our order. 

The Benefit and Burden of Exclusivity

When the waiter had left, Larry returned his attention to our conversation. "My friend, your observations omit a central element of the analysis of this matter: Having granted exclusive rights for important product categories, a brand Licensor must rely upon the diligence of the Licensee for whatever revenue is to be gained in those categories."

"But Larry, the Licensor agreed to accept the advance and minimum guarantee payments as a measure of the value it placed on those product categories.  How can the Licensee not have lived up to its obligations if it made the negotiated payments?  How could it be expected to do more than it agreed to do?"

"My friend, we are becoming a bit circular in our discussion.  In fact, your position is supported by a significant line of court decisions.  However, there is a second line of cases holding that the Licensee to an exclusive grant of rights owes the Licensor more than merely paying the advance and minimum guarantee.  In such circumstances, the Licensee in good faith must exercise best efforts to exploit the rights granted to it. 

"As you are aware, more than 80 years ago, one of the leading jurists in the history of our legal system, the honorable Benjamin Cardozo, established that exclusive Licensees bear an implied obligation to exercise best efforts on behalf of the property they are authorized to represent.  In the case Wood v. Lady Duff-Gordon, 222 N.Y.88 (1917), the plaintiff who was a leading fashion designer of the day, granted an exclusive trademark license to one Otis Wood who was authorized to represent her interests in authorizing clothing manufacturers to market products under her brand identification.  No minimum level of marketing effort was specified in the agreement, but Justice Cardozo established the fundamental principle that an exclusive license carries with it the obligation of diligence."

"I'm familiar with that case, Larry, but I also recall that there was no advance or minimum royalty guaranteed to Lady Duff-Gordon.  Had there been no implied obligation to generate sales, the Licensor might well have received nothing in exchange for giving up the use of her brand in the categories of its most significant value.  In fact, one might argue that without the implied obligation of best efforts, the license agreement was not even an enforceable contract, because the Licensee would not be obliged to do anything.  The courts often refuse to enforce such agreements on the basis that they are 'illusory.'  That certainly is not the situation you are facing."

Conflicting Views

Larry replied patiently, "Allow me to elaborate on the two lines of cases, my friend.  Supporting your position is the 1990 decision of the Sixth Circuit Court of Appeals in the case Permanence Corp v. Kennametal, Inc., 908 F. 2d 98.  In that case, the Court addressed a license agreement in which the Plaintiff-Licensor received both a non-recoupable fee and an advance against royalties, each of which was in six figures.  In exchange, it granted an exclusive license to certain process patents.  Seven years into the term of the agreement, Permanence Corp. filed suit asking the Court to impose an obligation similar to that created by Justice Cardozo.  However, the Court decided that the Licensor had received all it bargained for in accepting the two lump sum payments.  The agreement was not 'illusory' because of those payments, and the amounts paid were determined to be '…in lieu of obtaining an express agreement to use best efforts…'.  That is, the Court found that the Licensor had evaluated the rights it was granting and decided how much they were worth.  That value had been paid.  No additional implied obligation was necessary.

"A more recent decision consistent with Permanence is reported in Emerson Radio Corp v. Orion Sales, Inc., 253 F.3d 159 in which the Third Circuit Court of Appeals decided that an agreement under which a $4,000,000 minimum annual royalty for use of the EMERSON trademark for electronics was entirely sufficient to reward the Licensor.  The Court refused to decide that an additional obligation of diligent marketing efforts should be imposed."

At this point, the waiter served our meals and the conversation turned to more personal matters.  Larry and his wife had recently returned from a beach vacation accompanied by their young granddaughters, and he regaled me with his inevitably sentimental stories of seashells, ice cream and dolphin sightings.

To the Contrary…

Returning to his earlier subject, Larry continued, "The cases we have discussed to this point are impressive, but I believe the better view is that which resists the temptation to create hard and fast rules, and which takes into account the circumstances of the individual case.  The economics of 'opportunity cost' must be viewed from each side of the relationship.  The Licensor incurs an opportunity cost when its commits its property to the Licensee.  By granting exclusivity, it forgoes income streams that it might otherwise enjoy, and reasonably expects to be rewarded in excess of an artificially and speculatively determined "guaranteed" sum.  Indeed, the guarantee should not be understood to comprise the entire reward expected by the Licensor for the grants of rights.  Were that to be so, then presumably there would be no need for royalty calculation at all…rather the guarantee could be characterized as a 'fee' exchanged for its rights granted.  I would suggest that the guaranteed sum might be viewed as a minimum "worst-case" payment if the appropriate marketing efforts prove futile.

"As for the Licensee, the opportunity cost can have a very different implication.  Every business has limited resources, which it seeks to husband in the most profitable fashion for the good of its business.  Having committed to an exclusive license, however, I would posit that a Licensee forfeits to a certain degree its discretion in making these choices.  Application of this theory is exemplified by litigation involving the venerable Walt Disney Company.  In the case at bar, Disney occupied the unfamiliar role of Licensee for the marketing of a cartoon character named "Marsupilami," for which it paid $500,000 advance and a guaranteed annual royalty of $2,000,000.  Obviously, when Disney acquired the rights in August 1990, the Company had high hopes for the property.  However, events led to a re-evaluation of the Company's plans for allocating its resources.

The World According to Walt

"Specifically, successes of other animated Disney properties, including Aladdin and The Little Mermaid, as well as the phenomenally successful Lion King generated strong new revenue streams, but at the same time put a heavy burden on Disney's internal talent pool and other resources.  Decisions had to be made in allocating those resources, and the Marsupilami property was left out of the mix.  In other words, Disney determined that dedication of its resources to its other currently successful properties would lead to a greater corporate profit than attempts to establish yet another property.

"At its earliest opportunity, Disney terminated its contract with its Licensor, Marsu, after having paid $5,000,000 in guarantees.  Notwithstanding these large payments, Marsu sued Disney for breach of its unstated duty to exercise best efforts in promoting the Marsupilami property.  At trial, a telling memorandum from a member of Disney's top management was introduced which stated:
'Our hot properties are consuming all of our attention…we can't divert attention from these major hits to do Marsupilami…we have more than enough to do to stay busy for years into the future.  Internationally, we have neither the time nor the resources to do Marsu right - we'd be leaving millions of lost opportunity on film merchandise potentially on the table.'

"The Court concluded that the application by Disney of the philosophy articulated in this memo had resulted in unfair treatment to the owners of the Marsupilami property, and awarded the Licensor more than $8 million in lost profits.  The Court of Appeals affirmed the decision.  Because of the exclusive nature of the grant, the Courts concluded that Disney had forfeited some of the discretion which it normally could exercise in allocating its resources.  It owed its Licensor a greater effort than it delivered…in fact, it owed its best efforts."

What We Really Meant Was…

Larry was respectfully silent as I absorbed this new information.  Then he continued, "As you can see, there are arguments to be made for each side.  I believe that the facts of the case involving my Client favor a decision in line with that of the Disney case.  (I won't bore you with the minutiae of the situation.  They will be detailed in due course.)  In any event, as you can see, such situations are fact-driven and do not yield simple determinations."

As I reached for the check, Larry concluded, "The intent of the parties must be taken into consideration.  My Client believes that its property would have yielded a much greater return if the Licensee had exercised appropriate promotional efforts.  Moreover, the Licensee has been unable to point to any evidence of a lack of support or cooperation in its efforts by my Client.  We believe that the Licensee simply decided that its own objectives would be better served by placing greater emphasis on its other exploits.  We also believe that the exclusive rights that it had been granted took away its discretion to make such decisions without due consideration for the impact those decisions would have on its Licensor."

I could see both sides to the argument, and Larry was certainly resolute in his belief.  Only time would tell whether he would succeed.