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Legal Trap to Avoid: Control Licensee Quality or Risk Losing Your Trademark

  • A winery’s only quality control is the occasional sip and knowing that the licensee’s winemaker has a “world class reputation” (Barcamerica Int’l USA Trust v. Tyfield Importers, (2002));
  • A bridal franchise collects no royalties and exerts no control over how licensees run their shops (Eva’s Bridal Ltd. v. Halanick Enterprises Inc., (2011));
  • An internet network trusts its licensees to police themselves and follow informal guidelines rather than written contractual quality standards (Freecycle Sunnyvalley v. The Freecycle Network, (2010)).

These are just three real-life examples of licensors who lost their trademark because they didn’t exercise adequate quality control over their licensees. Here’s a look at the risk of “naked licensing” and what both licensors and licensees should do to manage it.

Naked Licensing Law, 101

Although you can let the lawyers sweat the details, licensing pros must understand a few things about the law to deal with the threat of naked licensing:

Rule 1. Trademarks can be lost or “abandoned.”

Rule 2. One way a trademark can be abandoned is for the trademark owner to neglect the quality of items sold under the mark.

Rule 3. In the context of licensing, this can happen when the licensor/trademark owner engages in naked licensing, or failure to adequately control licensee quality.

These rules aren’t arbitrary. Remember that the whole point of having trademarks is to protect consumers. Trademarks distinguish brands and establish reliable expectations for brand quality. When a trademark owner doesn’t control the quality of its brands, consumers are deceived.

The good news is that the person challenging a trademark on the grounds of naked licensing must prove the charge, which is not easy. Still, as illustrated by the cases above, it does happen—and more often than you might think. And when a licensed trademark does become unenforceable vis-à-vis a third party, it hurts both the licensor and licensee.

Add Quality Control Provisions to Prevent Naked Licensing

The best way to manage this risk is to ensure the licensing agreement gives the licensor adequate quality control. Stated differently, not having a written quality control provision makes it much easier to prove naked licensing. That’s what happened in the three cases cited above.

What should the contract say? How much control does the licensor need to avoid naked licensing?

Unfortunately, there’s no definitive answer. Trademark legislation doesn’t mention, let alone define the term “naked licensing.” The rule comes from the courts and gets decided case by case. Adding to the difficulties is the fact that the degree of control varies depending on the industry, products being licensed and relationship between parties.

Luckily there is enough case law and expert opinion to lay out some guidelines. At a minimum, the quality control provision should be in writing and:

  • Specify the technical quality standards that the product or service associated with the licensed trademark must meet (Model Clause, Sec. A);
  • Give the licensor the right to engage in regular quality control and review activities, including:
    • Inspection of the licensed goods and services, which may include inspections of the licensee’s site (Model, Sec. B);
    • Review of the licensee’s promotional and advertising materials (Model, Sec. C);
  • Let the licensor veto goods and services and/or use of promotional and advertising materials it deems to be below standard (Model, Sec. D); and
  • Terminate the contract if the licensee fails to comply (Model, Sec. E).

Actual Control Is More Important than the Contract

One final caveat: Although it can help deflect liability, putting a written quality control agreement into your license is just part of the solution:

  • You may still be able to avoid naked licensing if you don’t have a contract; and
  • You may still be found guilty of naked licensing even if you.

At the end of the day, what really matters is not what your contract says or doesn’t say but whether you actually exercise actual quality control over your licensees. Bottom Line: To avoid naked licensing, don’t just insert quality control language into your license agreement; make sure you actually implement it.

Model Contract Language

Although it is in the licensee’s interest to give the licensor control over product quality as a protection against naked licensing, there is also a lot of room for negotiation with regard to the extent and manner of control. depending on the industry, products, relationship between the parties and leverage of the sides. Accordingly, we’ve provided both a pro-licensor and pro-licensee version of a quality control clause that can be adapted for an actual license agreement.  

MODEL QUALITY CONTROL CLAUSE

(Pro-Licensor Version)

  1. Product Quality Standards: All licensed products manufactured and sold by Licensee under this License Agreement shall conform to the standards of quality in materials, design, workmanship, use and advertising set forth in Section [X] above (“Quality Standards”).
  2. Licensor’s Right to Inspect: Licensor shall have the right at any time upon reasonable notice to inspect the products manufactured at Licensee’s facilities, interview Licensee’s employees, review Licensee’s customer service and complaint records and access other locations, personnel and records Licensor deems necessary to verify that such products completely comply with the Quality Standards.
  3. Licensor’s Right to Review Promotional Materials: Licensor shall have the right at any time to request from Licensee copies of promotional and advertising materials and review said materials to verify that they comply with the Quality Standards; Licensee shall provide all requested materials to Licensor’s representative within 3 business days of such request.
  4. Licensor’s Right to Veto: Licensor shall have the right to prohibit Licensee from engaging in the sale of any products or use of any promotional or advertising materials if, in its sole discretion which it will exercise in good faith, it believes that the products or promotional or advertising materials fail to conform with the Quality Standards
  5. Licensor’s Right to Terminate: Failure of Licensee to meet the obligations set forth in this provision shall be deemed a material breach justifying Licensor’s right to terminate the Licensing Agreement.

Here’s a Model Clause that provides the requisite quality control in a way that’s more favorable to the licensee.

MODEL QUALITY CONTROL CLAUSE

(Pro-Licensee Version)

  1. Product Quality Standards: All licensed products manufactured and sold by Licensee under this License Agreement shall conform to the standards of quality in materials, design, workmanship, use and advertising set forth in Section [X] above (“Quality Standards”)
  2. Licensor’s Right to Inspect: Once a year, Licensor shall have the right, upon 8 business days’ prior written notice, to inspect the products manufactured at Licensee’s facilities during normal business hours for the sole purpose of determining whether such products substantially conform to and do not materially vary from the Quality Standards
  3. Licensor’s Right to Review Promotional Materials: Twice a year, Licensor shall have the right to request from Licensee copies of promotional and advertising materials and review said materials to verify that they substantially conform to and do not materially vary from the Quality Standards; Licensee shall provide all requested materials to Licensor’s representative within 5 business days of such request
  4. Licensor’s Right to Veto: Licensor and Licensee shall work diligently and in good faith to remedy any deficiencies identified in accordance with these provisions. In the event that such deficiencies cannot be remedied, Licensor may prohibit Licensee from selling products or using promotional or advertising materials with deficiencies that it determines, exercising an objective and non-discretionary standard, constitute a material breach of the Quality Standards. Licensee shall have the right to sell products that have minor, non-material and merchantable defect
  5. Licensor’s Right to Terminate: Failure of Licensee to meet the obligations set forth in this provision shall be deemed a material breach justifying Licensor’s right to terminate the Licensing Agreement.
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