The Sports Law & Policy Centre | The Anatomy of a Sports Licensing and Merchandising Agreement
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The Anatomy of a Sports Licensing and Merchandising Agreement

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By Roshan Gopalakrishna

Background

Sport has undergone such a revolutionary change over the past decade that today it constitutes a fascinating industry with the potential to generate substantial revenue for those involved in it. Much of this revenue is generated through the organisation of sports events, sale of broadcast rights and marketing of products related to the participating sportsmen, governing bodies and event organisers.

Commercial merchandising and licensing related to major sports events, teams, and superstar professional athletes is a facet of sports business that continues to witness rapid and varied development. Licensing and merchandising arrangements could relate to licensing of logos of prestigious international sports events such as the Olympics to licensing of sports computer games, such as FIFA Football ’11. The right to brand merchandise with popularly known symbols, logos and emblems, is much sought after by different kinds of manufacturers. Sporting bodies such as FIFA and the IOA are themselves keen on giving licenses for merchandise to prominent manufacturers, as revenue generated from such licensed products is now close to overtaking revenue generated through sale of broadcast rights.

The licensing and merchandising business depends not merely upon a well negotiated commercial arrangement, but more importantly upon a well structured and well drafted licensing and merchandising agreement. In order to maximise financial returns from sports licensing agreements, there are certain basic points that need to be incorporated into the agreement. This article seeks to chart out these basic points, which are integral to achieving an effective licensing and merchandising arrangement.

Parties – The agreement should clearly identify all parties to the agreement along with their individual/corporate status, any other identifying information and their registered or mailing addresses, at the beginning of the agreement. This is of particular significance in multi-party agreements that include an intermediary such as an agent or merchandising/marketing representative. Clear identification of the parties would form the basis for structuring the relative obligations and responsibilities of the parties amongst themselves.

Definitions and Interpretation–The agreement should set out a list of definitions in order to establish or clarify the meaning of important terms contained in and extensively used throughout the agreement. As the terms defined appear throughout the remainder of the agreement, they are usually capitalised. This should prompt the reader to cross-check the meaning of the word in the definitions section each time it is used in the agreement as the entire meaning thereof, with limitations and exceptions, is imported into the provision in which it is used.

Grant of Rights– The most important provision in any licensing and merchandising agreement is the ‘grant of rights’ clause. This clause provides clarity regarding the nature and scope of rights being granted by the licensor to the licensee. The clause will specify whether the license granted is an exclusive or a non-exclusive one, and will also specify the products and territories that can be commercially exploited. An exclusive license is one where only a single licensee has the right to sell the licensed products in a specified territory.

License Term – The license term indicates the time period for which the license is valid. A short license period is initially suitable for a licensor to gauge the success of the agreement before committing towards a longer term agreement. In case of a successful arrangement, a shorter term enables the licensor to work out and seek a higher rate of royalty prior to initiating negotiations towards renewing the agreement. Also, it could be mutually beneficial for the licensor and licensee to agree on a short initial term with automatic renewal if certain royalty targets or met, or conversely, agree on a longer term, which would be terminated if the royalty targets are not met.

The Licensed Property –The agreement should state clearly the property or properties to be licensed and may be used for merchandise, and if possible, actual copies of the property should be attached to the agreement. It is necessary for a licensee to establish that the property to be licensed can be safeguarded under trademark, copyright and other applicable intellectual property rights laws. If a trademark is granted as a licensed property, it would be in the interests of the licensee to register the mark for use on the various types of merchandise it intends to produce under the license agreement. However, the licensor also needs to ensure that the clause clearly states that the licensed property constitutes the property solely of the licensor.

The Licensed Products – Every licensing and merchandising agreement should specify the precise features of the merchandise that is to be licensed. If we consider the case of a professional football team granting a license to a sports goods manufacturer to manufacture official kits for the team, it is usually the right of the team to stipulate the design, patterns, materials and colours it requires for the kit and the obligation of the manufacturer to produce samples of these for approval. The licensor may be inclined to restrict the licensee’s rights to only certain kinds of merchandise and it may also feel the need to reserve to itself the right to make any changes in that merchandise. The licensee, on the other hand, may seek a right of first refusal in case the licensor desires to license the property for other kinds of products.

Defining the territory – The agreement must clearly define the territory in which the licensee may use the licensed property. This includes mentioning the geographic areas in which the licensee may sell the licensed merchandise. In defining such areas the licensor should seek to restrict the license to territories in which the licensee has a reasonable presence, has a significant fan base and would therefore be assured of generating sales of merchandise. It would also be ideal for the licensor to specify the medium and channels through which the merchandise will be distributed. The licensor may for instance want particular merchandise to only be sold at upscale department stores, other merchandise to be sold in common general stores and some merchandise to be sold online only.

Quality Control – A major requisite for a sound licensing and merchandising agreement is a clause which stipulates the right of the licensor to examine the quality of the licensed merchandise and the related advertising materials before they are released to the public. Quality control plays a vital part in ensuring the maximisation of returns from the sale of officially licensed merchandise, and any dip in quality would cast a negative light on the image of the licensor’s brand and the licensor itself. To secure quality control, the licensor may need to give itself the right to examine random samples of the licensee’s merchandise to ensure compliance with standards for manufacture and advertising that have been communicated by the licensor. When a trademark is the licensed property, a failure to include strong quality control measures may lead to a situation where the licensor loses its rights in the mark. Therefore quality control measures are a vital necessity for a licensing and merchandising agreement to reflect positively on the licensor and increase goodwill.

Guarantee of Sales Efforts – From the licensor’s perspective, it is imperative that the licensee provides an assurance to make bona fide efforts to ensure manufacture and sale of the licensed merchandise and maximise returns for the licensor. Measures to ensure compliance with such a guarantee include provisions which stipulate that the licensee maintains a certain minimum annual royalty, and if such amount is not reached, the licensee will pay the difference to the licensor. Another measure is the inclusion of a minimum sales requirement for every year of the licensed term with associated penalties or termination remedies in the case of failure to achieve these targets. Advertising and marketing play an important role in the creation of profits and, in this context, it is advisable for the licensor to prescribe certain norms that it expects of the licensee when it comes to the marketing and advertising of the licensed merchandise.

Royalties – In the case of a licensing and merchandising agreement, royalties refer to the payment that is made by the licensee to the licensor on the sale of the sanctioned merchandise. Royalties may either be in addition to an up-front license fee or may be the sole compensation to the licensor.

Two points to be considered while transacting compensation for a licensing and merchandising arrangement are the royalty percentage and the base against which that percentage will be applied. Generally royalties are based on net sales of licensed products, but different agreements may provide for different definitions of what would constitute ‘net sales’. The royalty percentage is dependent upon various factors such as the type of licensed property, the types of licensed products to be manufactured, the demand for such licensed products, and the brand image of the licensor.

The calculation of royalty is usually settled through the multiplication of the royalty percentage, also known as the royalty rate, by the net sales of licensed products. It is the wholesale price of the licensed products that determines the eventual net sales. However there will be certain items that are deducted from the wholesale price before arriving at the net sales, and these include credits for returns, quantity discounts, freight charges and so on. The licensor would seek to limit such deductions wherever possible and set a certain cap on the total amount that may be deducted. This provides the royalty base.

Timing of Payments – The parties to the licensing and merchandising agreement must confer on the timing of the payments. Generally, royalties are accounted for and paid on a quarterly basis for all sales that have occurred in that quarter. Statements are expected within a period of thirty days from the end of each quarter.

Auditing – It is necessary for the licensor to stipulate a right for itself to audit the licensee’s books to verify the actual sales and royalties that are due. It would be prudent for the licensee to establish a period within which its books and records may be audited by the licensor and it may also want to restrict the number of times the same records may be audited. An advance notice requirement may also be necessary for conducting an audit. An allocation of costs and consequences of the audit determining significant mis-reporting will usually be specified.

Notices and Credits – All licensing and merchandising agreements should necessarily impose an obligation upon the licensee to include proper copyright and trademark notices on the merchandise or on the labels and tags attached to the merchandise. The licensor may seek credit that it is the owner of the licensed property, and such property should indicate the same. This is often important in order to ensure that the trademark or copyright owner remains in compliance with the ‘marking’ requirements under applicable intellectual property laws.

Indemnity and Insurance – Trademarks are often perceived as an indication of the goods being owned by the organisation which bears that trademark, and any defect in the quality of such goods will therefore cause damage to the organisation’s reputation. To avoid being held responsible for any defective products made by the licensee, it is advisable to have a clause which provides that the licensee indemnifies the licensor against claims made by third parties which arise from defective products manufactured by the licensee. The licensor should ensure that the licensee has a general liability insurance policy and such policy should name the licensor as an additional insured party. On the other hand, the licensee may deem it fit to seek indemnity from the licensor against claims made by third parties, questioning the licensee’s right to use the specified marks.

Termination of the Agreement – If a situation has arisen wherein there is a need for termination of the license even before the expiry of the prescribed term, then the agreement must stipulate a provision to enable the licensor to do so. If, for instance, the licensee fails to perform what is expected of it from the agreement, or it carries on activities outside the scope of the agreement, the licensor may wish to terminate the license. Broadly speaking, there are three different events under which the agreement may be terminated, and they are as follows:

(a) Events that are grounds for termination without any time being given for the licensee to cure the problem.

(b) Events that may lead to termination if the licensee does not cure the issue within a reasonable period after a notice has been issued.

of the Events which are restricted to a specific part of a license, and may lead to termination of that part of the license, if a cure is not affected within a reasonable period after a notice has been issued.

Sales after Termination – It is quite likely that even after the expiry of the license term or termination of the licensing and merchandising agreement, there will be stocks of the licensed merchandise with the licensee, and it may want to sell off the same. It would be in the interest of both parties to agree on a sell-off period within which such stocks should be sold at ordinary market prices so as to provide the licensee with a fair opportunity to exhaust existing stock and to ensure that the licensor continues to receive royalty. However, it should be clarified that the licensee cannot manufacture any licensed products during the sell-off period. After the expiry of such period the licensee should ensure the destruction of any remaining stocks of merchandise, and it is necessary for this to be stipulated in the license agreement. The licensor may also desire provisions stating that it is necessary for the licensee, on the termination of the agreement, to give a sworn statement regarding the stocks of merchandise in its inventory.

Morals Clause – When dealing with licensing and merchandise agreements in the sports world, it is of utmost importance that the integrity and prestige of the sports team, organisation, athlete or event which has granted the license, takes pride of place and is guaranteed under the agreement. Licensees must be made to agree that in exercising their rights under the license agreement, they would not do anything that would bring the sport, team or event into disrepute.

Conclusion

Merchandise licensing is, without doubt, a hugely profitable venture if the right deal and right agreement have been worked out between the parties involved. A prospective licensor can look forward to the advantages of additional income, publicity, and widespread recognition with a good licensing deal. The advantages for the licensee stem from the goodwill associated with the licensor’s properties, and a good licensing agreement will pave a path towards lucrative markets. The future in the business of sport seems to point towards an age where licensing merchandise will be a key to both popularising sport as well as generating massive streams of revenue for the industry. All this can be achieved only through the formation of a lucid written agreement, which is endorsed by the parties wholeheartedly, and the agreement itself must be capable of being a guiding light towards a profitable partnership.

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