Best practice provisions and considerations for sports merchandising agreements

Merchandising, in its simplest form, is the practice of using the branding or imagery of one ‘product’ in connection with the sale of another (often unconnected) product or service.

In a sporting context, opportunities to exploit the commercial potential of a sporting brand are rife, with merchandising opportunities almost endless – for example, a key ring bearing the branding of a major football tournament, or a cap featuring the name and image of an athlete.

Sometimes, the original rights holder (in the above example, the organiser of the football tournament) may apply its branding to its own products. However, more often than not, a rights holder will license the rights to third parties who may already produce these products, and wish to apply the rights holder’s branding to its products. It is in this latter scenario where a merchandising agreement (a form of intellectual property licence) will be used.

These agreements will contain a licence from the owner (or controller) of a particular brand to the licensee, giving the licensee permission to develop, manufacture and sell products using the relevant branding. The licence will usually also extend to allowing the licensee to use the relevant branding on packaging and promotional materials.

Licensees wish to use the third party branding so as to increase the desirability of their product, therefore increasing sales revenues. The licensor not only benefits financially through the arrangement (as described below), but may also see a benefit from increased visibility of the brand through the increased reach and variety of products.

It is worth noting at the outset that a rights holder or rights controller (the licensor) is often in a very strong bargaining position: the licensor is often the exclusive controller of a limited commodity (the brand) and therefore has sole control of how and where that brand is used. On the flip side, potential licensees for merchandising opportunities are rather more numerous, and a licensor will often be able to cherry pick the licensees it works with in particular geographies and product categories, and is likely to largely dictate the terms of a deal. That said, there is nearly always scope for negotiation, and for these agreements to work successfully and achieve the aims of both the rights holder and licensee, a number of key matters need to be given upfront and ongoing consideration.

Grant of rights

The first consideration for both the licensor and the licensee should be what rights are being granted and received, and for what purpose. The fundamental points that a brand owner will need to consider are:

• what rights does the licensor actually own, for example, in the context of a football club, is the club entitled to license the right to use the images of its players, and on what basis?
• once the scope of owned/controlled rights has been established, the licensor needs to decide which of those rights it is prepared to licence – e.g. trade marks, trade names, images and/or slogans? A brand owner may consider that some of its branding is not appropriate to exploit in connection with merchandising opportunities;
• what type of products it wishes this branding to appear on, and what impact this may have on its own and others’ competing products in the market. Licensees will usually be appointed on a product by product basis, so the licensor will want to ensure that it has the strongest licensee in each product category, with genuine production expertise and settled sales channels;
• in what geographical area the branded products should be sold – e.g. worldwide, Australia or Europe (and the impact of competition law should certainly be considered). Again, licensees will often be appointed to sell their products in a particular country/region in order to best exploit local contacts and distribution networks;
• how long the agreement should last;
• how it wishes to be compensated for the licensing of its rights;
• whether the licence will be exclusive or non-exclusive - the licensee will fight for an exclusive licence to ensure that it will be the sole producer of branded products in the marketplace, but this will come at a price; the brand owner is unlikely to commit to an exclusive licence without a guarantee of an acceptable level of revenue; and
• whether the licensor is under any contractual restrictions from exploiting a merchandising opportunity - for example, a sportswear sponsor of a rugby club is likely to prevent the rugby club from granting a third party the right to use its branding in connection with sporting apparel.

How much?

Often the first point of commercial agreement will be how much the brand owner will receive from the licensee for the grant of the relevant licence. This is usually a royalty rate to be applied to the revenues of a licensee from the sale of products incorporating the branding, but it may also be structured as a flat fee for the right to use the branding for a certain period of time. A royalty rate can vary significantly between the brand being licensed, the product category and the territory, but as a rule of thumb can be expected to be between 10 and 15%.

The royalty model is often the preferred route as it minimises risk to both parties: a licensee knows that it only pays a royalty based on the products that it actually sells, and the brand owner shares the risk and reward of those sales. As a brand owner will often have a choice of licensees for certain territories/product categories, it may be able to further minimise its commercial risk and incentivise its selected licensees by asking licensees to guarantee a minimum level of return. This may be framed as a minimum, often upfront, payment to the brand owner, with royalties accruing against that minimum guaranteed amount and only becoming payable once those royalties surpass the minimum amount.

The occurrence of a major sporting tournament, or significant victory for a team or individual, can dramatically increase the demand and value of a brand. If a long term deal is being signed with a licensee, a licensor may wish to include provisions requiring additional ‘bonus’ payments to the licensor, based on the success of the sporting brand. For example, in the context of a long-term agreement giving a licensee the right to use a European football federation’s branding, a minimum level of income may be guaranteed in each year, with that minimum amount rising in years when the national team of the federation will be competing in the World Cup Finals and the European Championships. The agreement may then contain provisions providing for the payment of a bonus if the national team reaches the final stages of, or wins, those tournaments. Likewise, a licensee may argue that the minimum guaranteed amounts in tournament years should be reduced if the federation’s team fails to qualify for the competition proper.

In addition, the agreement should include clear provisions stating when reports of sales should be provided to the brand owner, and when payment of royalties should then be made by the licensee. If the financial return for the brand owner is linked to product sales then the brand owner will also want the right to audit the licensee to verify the level of reported sales.

A licensor may also be advised not to price good licensees out of the market by insisting on extremely aggressive financial terms – a licensee will add its royalty payment to its manufacturing costs and profit margin when setting a selling price for a product. If that price makes the product commercially unviable, no one wins – retailers will not set aside shelf space for the licensed product, consumers cannot obtain the official product, licensees will go out of business, and the licensor’s royalty revenues will fall. Not only that, but where official merchandise is not available, counterfeiters will happily fill the void, putting lower quality, often unsafe products on the market, that do not follow brand guidelines and do not offer any financial benefit to the licensor.

Protecting the brand owners’ brand

Complimentary to a specific and clear grant of rights should be protections for the brand owner to prevent the actions of the licensee from damaging the brand. Where any products are produced otherwise than directly by the brand owner, a degree of control over how the brand is used is given up. However, the impact of a poor or defective product in the market will still impact the reputation, and therefore commercial value, of the brand. This risk can be mitigated by including relevant controls in the merchandising agreement.

Quality control

Quality control provisions should be included to ensure that the products produced by the licensee meet with the brand owner’s standards as to design, safety, materials and construction. The agreement may therefore include procedures for brand owner approval of each product and promotional material. Time limits for approval will often be given, and the licensee may seek a provision that the brand owner must act reasonably in giving this approval so that the licensee does not lose time and money designing products that are unreasonably rejected. A brand owner may, however, feel that it must have absolute discretion in this area to protect its brand.

In addition, the agreement may reference brand guidelines setting out how the licensor’s branding is to be applied to products – this ensures that branding is used in a consistent manner by all licensees.

In terms of product safety, the licensee should agree to comply with all applicable legislation (specifically, consumer safety and product-specific legislation, such as food labelling and testing requirements) and other industry best practices. As products will often be manufactured in regions where labour is cheaper and standards of health and safety may be lower, the brand owner may also impose requirements relating to the manufacturing process - for example, it is relatively common to see clauses relating to the employment of underage workers and factory safety/inspections.

Brand protection provisions

Alongside quality control measures there are more general provisions that are likely to be included to protect the brand. Thought should also be given as to who is to be responsible for legal action in the event that the licensee’s right to use the licensed branding is challenged, and also who will be charged with tackling competing counterfeit goods in the market.

Promotional products

In the sporting world, companies pay vast amounts of money to become official sponsors and partners of sports clubs and personalities – sponsorship allows the sponsoring party to use the sponsored party’s image and branding in conjunction with its own, effectively increasing the exposure and value of the sponsor’s brand through association with the sponsored party. Therefore, a brand owner is likely to want to include a provision in its merchandising agreements preventing the licensee from applying any third party branding (including its own) on the licensed products to avoid any confusion as to the licensee’s status as a licensee, rather than a sponsor.

Intellectual Property

The most important protection for a licensee will be a warranty (sometimes backed up by an indemnity) that the intellectual property in the branding is owned or controlled by the licensor, and is valid and enforceable. The licensee will also want to know that the licensee’s use of the branding will not infringe any third party’s rights. A brand owner may be unwilling to give this comfort to the licensee as it may seek to argue that it simply cannot know whether there are competing third party rights in some far-flung territories. If the warranty is to be given, it may therefore be qualified by either the awareness of the brand owner, or only given in relation to specific key territories.

To protect its intellectual property, a brand owner is likely to contractually prohibit the licensee from applying to register any trademarks which have been licensed to it, and to acknowledge that its use of the brand is solely as a licensee. The licensee should agree to inform the brand owner if it becomes aware of a third party using the brand owner’s branding without authorisation, or of any claim by a third party that the brand owner’s branding breaches that third party’s rights.

Termination

What events can cause the agreement to be terminated?

Both parties should give serious thought to what breaches of the agreement could result in either of them wishing to end the agreement. For the brand owner, the protection of its branding will be a key priority; an unsafe product linked to the brand owner is bad news – and any breach of any safety or compliance provisions is likely to give rise to right to terminate. The brand owner will also want the right to terminate if the licensee fails to pay or accurately report royalties. Finally, a termination right for the brand owner may be included if the licensee does not meet certain sales targets; this is an alternative incentivisation method to the inclusion of a minimum guarantee and ensures the continued commercial benefit of the agreement.

The licensee may have made, or intend to make, significant investment in a product and its promotion; the licensee is therefore likely to resist giving a brand owner too many options to terminate. A licensee is less likely to want to terminate the agreement, although a challenge to the ownership of, or the licensee’s right to use, the licensed branding would likely have a significant impact on a licensee’s ability to sell products (and therefore to meet its minimum commitments); a right of termination in these circumstances may therefore prove useful.

What are the effects of expiration/termination?

As much as what occurs during the agreement is important, what happens upon expiration (or earlier termination) of the agreement should also be given a great deal of consideration.

The brand owner should ensure that on termination all rights granted to the licensee under the agreement cease, and the licensee can no longer manufacture and sell products or produce any promotional materials. A well-drafted agreement will usually prevent the licensee from manufacturing products towards the end of its licence, and include provisions requiring it to report on stock levels in the run up to termination; in this way, a brand owner knows that stock is being managed down. The licensee should also stop holding itself out as being associated with, or associating its products with, the brand owner.

No matter how well-intentioned the licensee is in disposing of all stock prior to the end of its contract period, there will often be some stock left at the end of the licensee’s rights period. The parties must also agree what happens to those products, and there are several options:

1. 1. a sell off period may be granted to the licensee, allowing the licensee a further period in which to sell excess stock (in which case the brand owner will want to ensure that obligations to report and pay royalties on any such sales remain);
   2. the licensee may agree to destroy the remaining products (and in any event, this would apply at the end of a sell-off period); and/ or
   3. the licensee may be required to sell the products back to the brand owner at cost (again this option could also be prescribed after a sell-off period expires).

Often, the brand owner will give itself significant discretion over what option is taken.

Conclusion

This article provides an overview of the best practice commercial and legal provisions for sports merchandising agreements. As mentioned above, the legal position reached is likely to reflect the bargaining position of the parties; in the context of merchandising, it is often the brand owner who can drive the terms of the deal, both financially and legally. Therefore, more often than not, licensees will be required to accept relatively onerous terms in order to obtain the required rights, but there is often scope to negotiate and obtain some key contractual protections.

• Contract Law Intellectual Property Merchandising United Kingdom (UK)