In a nutshell
The licensing industry is currently worth in excess of £250bn and continues to grow and adapt to changing consumer demands following the Covid-19 pandemic. As well as responding to digital shifts, licensors are becoming more purpose led. In this era of rapid change, it’s vital to monitor the performance and reporting of those you give licences to.
Often audit findings relate to when a contract clause hasn’t been correctly applied, and this results in an error. However, these findings are often easy to discuss and resolve, as they relate to clear deviations from the contract terms. The key issues arise when the clauses in the contract are ambiguous or lack detail, and therefore can result in a difference in perception between the licensee and the licensor.
In this article, we have identified three of the most common issues when it comes to clauses, and how they can be avoided to ensure both the licensor and licensee are getting a fair and clear deal.
Ambiguity over use of intellectual property (IP)
Unauthorised use of your IP can dilute your brand – whether it’s intentional or not. When contracts are not clear over the use of your IP, this can result in dilution of your brand, and potential legal issues.
Areas in which we have noted ambiguity as to how IP can be used are as follows:
A clear listing needs to be created as to which territories your IP can be sold and distributed in. Any countries online retailers distribute to, should be discussed as to whether they can be included. Licensors should also consider a clause in the contract regarding the legal application if you decide you no longer wish to have your IP sold and represented in a certain country, and how quickly this can be implemented.
Use of your brand that has not been granted
This can cover a wide range, and often happens when there is lack of clarity over the detail as to what the clause covers. Some examples are:
- Brand but not logo
- Show with characters – but not all characters included
- Characters – but not limited edition/seasonal/holiday looks included
These aspects should be made clear in your terms, by specifically stating what is included, and therefore anything else not stated is by default excluded.
Sales by a connected company that aren’t covered by the contract
It should be made clear in the licensing agreement who the agreement is between and whether or not the rights to the IP can be shared amongst companies within a group. The risk of not having clear clarification when a contract or amendment covers multiple companies within a group, is that it is easy to lose the transparency when it comes to reporting, as transactions between the companies may not be reported on.
Designs being released to the market before approval
There should be a clear route in the agreement as to how a product should be approved before being released to market. Without this, it can result in products diluting your brand, due to large quantities of unapproved designs being made available to customers. There should also be clarification as to what the steps are if a licensee does breach this clause, in case you either decide to put a pause on their production or decide to cancel the contract altogether.
Over application of discounts and deductions
Your licensees may be unaware of contractual clauses relating to deductions and discounts – and whether there’s a cap.
Without clear visibility of the calculations being inputted into statements, there is a risk that a licensee may not be applying the terms of the discount and deductions caps. To ensure the discounts and deductions have been appropriately applied, a conversation should be had at the start of discussions to understand how they recognise their revenue, and how this is then reported. Otherwise, there is a risk that licensees will be reporting their net sales less any deductions and discounts, rather than based on their gross sales, which can result in understating the revenue reported.
Sales of combined products with varying royalty rates
There may be times when royalty rates on products have been agreed in advance, and later on these items are combined. This often results in a lower price for the customer to buy the items combined, rather than individually, which can then result in an issue when calculating the royalties due when the products have varying royalty rates. Therefore, it should be agreed in advance how the royalties on bundles/sets are calculated based on the weighting of the sets. Ways in which a blended rate could be calculated are as follows:
- Even split - the royalty rate of each item makes up the same proportion of the combined royalty rate – i.e. product X has a royalty rate of 8% and product Y has a royalty rate of 10%, therefore the combined royalty rate is 9%
- Weighted split – the royalty rate of each item is multiplied by the original value of the item divided by the original value of the two items if bought separately – i.e. product X has a royalty rate of 8% and has an original sales value of £10 and product Y has a royalty rate of 10% and has an original sales value of £15. Therefore, the combined royalty rate is 9.2%, being 60% of the 10% royalty rate, plus 40% of the 8% royalty rate
The importance of an audit clause
We often find that audit clauses have not been included in licensing contracts, or if they have, they do not include enough detail. Having an audit clause makes it easy for a licensor to approach a licensee about being audited. We recommend an audit clause includes the following:
- Period from expiry in which they can still audit the contract
- Period of time in which the audit can cover
- If the findings from an audit are over a set percentage (usually 3-5%) of the royalties reported in the audited period, then the licensee will have to pay for the cost of the audit
By having an audit clause, it helps incentivise licensees to ensure they are reporting correctly in order to minimise the risk of being audited.
If you would like to discuss any of the above in more detail, please do not hesitate to get in touch.