When trademark licensors grant a licensee exclusive rights to manufacture and sell licensed products, they often reserve the right to engage in negotiations with one or more potential replacement licensees during a certain period of time before the conclusion of the exclusive license agreement.
In such an event, is a replacement licensee permitted to commence the process of creating new licensed products before the expiration of the exclusive license agreement term? That issue was the subject of a recent dispute between the owner of the Cabbage Patch Kids brand, Original Appalachian Artworks, and its exclusive licensee for Cabbage Patch dolls, Jakks Pacific.
Original Appalachian Artworks entered into two exclusive license agreements with Jakks Pacific, one domestic and one international. Before the license agreements expired on Dec. 31, 2014, Original Appalachian Artworks selected and entered into a deal memorandum with a new licensee, Wicked Cool Toys, and permitted Wicked Cool Toys to begin the process of creating a new line of Cabbage Patch Kids dolls to be manufactured and launched in 2015.
Jakks Pacific claimed breach by Original Appalachian Artworks of the following “key term” in each of the license agreements and stopped paying royalties:
The Doll License granted pursuant to this Section I shall be exclusive for the Licensed Doll Products in the Licensed Territories through the Licensed Distribution Channels. Notwithstanding the foregoing, [Original Appalachian Artworks] reserves for itself the right to engage, during the 365-day period prior to the termination or expiration of this Agreement, in the negotiation, with potential licensees (including competitors of Licensee), of one or more license agreements granting licenses with respect to the Licensed Doll Products covering the Licensed Territories and the Licensed Distribution Channels to become effective upon the expiration or earlier termination of this Agreement.
The parties then commenced arbitration proceedings in accordance with the dispute resolution provisions of the license agreements. In arbitration, Jakks Pacific argued that, under the provision, Original Appalachian Artworks could only negotiate with potential licensees in 2014 and was prohibited from doing anything else to make it possible for a new licensee to launch a new line of Cabbage Patch Kids dolls in 2015. Original Appalachian Artworks responded that the foregoing provision did not prohibit Wicked Cool Toys from design and development activities preliminary to the manufacturing and launch of a new line of Cabbage Patch Kids dolls in 2015.
The arbitrator acknowledged that the provision appears to only permit Original Appalachian Artworks to negotiate a new license in 2014 and not do anything more until the new year. However, considering the commercial reality that, without some preparatory activities in 2014, a successor licensee would not be able to sell any Cabbage Patch Kids dolls in 2015, the arbitrator used governing state laws of contract construction to dig deeper and try to ascertain “the intention of the parties.”
The arbitrator ultimately concluded that the parties intended that Original Appalachian Artworks and Wicked Cool Toys, as successor licensee, “could do what they did in order to transition into the manufacture and launch in 2015 of a new seasonal line of [Cabbage Patch Kids] products, without the de facto creation of a ‘gap’ of about one year.” He reasoned that “it was fair to assume [both] that a successor license could be concluded in 2014, during the pendency of” Jakks Pacific's license agreements, and “that the successor licensee would need to build trade awareness of its accession to the role of licensee and of the products it intended to offer.” As part of his ruling, the arbitrator ordered Jakks Pacific to pay Original Appalachian Artworks $1,117,559 in unpaid royalties.
The parties then filed motions in district court. Jakks Pacific sought to partially vacate the arbitrator’s award and Original Appalachian Artworks sought to confirm the award. When the district court confirmed the award, Jakks Pacific appealed to the Eleventh Circuit Court of Appeals, and the Eleventh Circuit affirmed the judgement of the district court.
According to Bryan Graham, Beanstalk’s SVP of Audit Services, “This is yet another example where license agreements do not reflect commercial realities. To ensure licensed products remain on the shelves when switching licensees, specific terms and conditions need to be agreed to beyond merely defining a sell-off period.”
Consequently, this case is a wake-up call to contracting parties to avoid casually drafting license agreements using “off the shelf” form language. The time, resources and costs devoted to this dispute could have been avoided with some more thoughtful drafting to memorialize the parties’ intent and clarify precisely what the licensor was and was not permitted to do during the 365-day period prior to the expiration of the license agreements. Doing so would help make your exclusive license agreements more conclusive.