Legally Speaking

The Impact of the Pandemic on ‘Effective Royalty Rates

By: Gregory J. Battersby

BOOK AVAILABLE!

THE BUSINESS OF LICENSING The Essential Guide for Intellectual Properties

Licensing has has exploded into a $250+ billion worldwide industry at retail and generates more than $7 billion in royalty income for those property owners who are savvy enough to license their properties for a wide variety of consumer products. About 8 years ago, lawyer Gregory J Battersby and licensing veteran Danny Simon introduced the first Basics of Licensing book. They published a revised version a couple of years later and followed it with a Licensee edition and then finally an International edition. Recognizing that there was a degree of commonality between these editions, Battersby and Simon concluded that it was time for the definitive work on licensing, hence, The Business of Licensing which combines the best of all three prior editions and takes the subject to the next level. This book takes the reader through the nuts and bolts of how to conduct a licensing program and handle many of the problems that it might face There is a substantial amount of reference material. They have included an expanded history of merchandising, and an extensive collection of the forms that any licensing professional may need which they intend to provide to purchasers with electronic access to the forms via Dropbox.

The Complete Business of Licensing is available at a cost of $39.95 ($34.95 for LI members). https://www.totallicensingworld.com/ site/business_of_licensing

Gregory J. Battersby Battersby Law Group, LLC 25 Poplar Plains Rd. Westport, CT 06880 (203) 454-9646 gjbattersby@gbiplaw.com www.gbiplaw.com

Since the beginning of the pandemic in 2020, manufacturers have struggled, facing government lockdowns, supply chain problems, rising component and labor costs, and spotty demand at retail. This is particularly true for manufacturers of licensed products who also face the challenge of meeting their contractual requirements under license agreements entered into pre-pandemic.

As many licensed products are manufactured in China, the internal problems in that country have had a significant impact on a licensee’s ability to market and sell products in a manner and amount initially contemplated. Specifically:

• Lockdowns throughout different cities and provinces in China have limited factory production and impacted shipping; • The closing of roads and highways surrounding factories have created delivery problems both to and out of the factories; • Predicting production schedules has been challenging; and • Stay home orders have resulted in many factories’ slowing down or closing.

In addition, the Russia/Ukraine war has significantly impacted the shipping industry, which relies heavily on Russian and Ukrainian seafarers, who make up about 15% of the shipping industry personnel.

These delays and rising costs have resulted in many licensees “underperforming” in their sales of licensed products and their ability to meet the Minimum Guaranteed Royalty (“MGR”) obligation of their license agreements.

While virtually all license agreements are royaltybased, most licensors will also require that the licensee meet a MGR obligation if the licensee’s earned royalties do not meet this MGR. Unfortunately, the problems created by the pandemic have had a significant impact on the ability of many licensees to meet this MGR obligation. The impact of this can be seen when calculating a licensee’s “Effective Royalty Rate,” which is calculated by dividing the licensee’s actual sales by the MGR. Where the licensee’s sales are significantly lower than initially projected, the “Effective Royalty Rate” can be a multiple of the contractual royalty rate. This has a double whammy on the licensee, who experienced higher costs and expenses and lower profits on its sales of the licensed products and then must pay an Effective Royalty Rate of five or even ten times the negotiated rate. For example, some licensees had previously negotiated a 12% royalty rate, but the Effective Royalty Rate was 50% or higher when factoring in the MGR. Manufacturers cannot remain in business with such a burden.

Licensees have been carefully reviewing their agreements to see whether they can find some relief from such obligations. While most contracts include a force majeure provision that protects the licensee from acts of God, terrorism, governmental action, and even pandemics, the vast majority of such provisions contemplate a limited period of non-performance, e.g., 3 or 4 months, followed by a return to normal. Few, if any, consider a 2+ year impact. During the Great Recession, the courts ruled that an economic downturn was not a force majeure event.

Thus, many licensing “partners” now face the problem of trying to find a reasonable business solution to a problem that was the fault of neither party, relying on the “implied covenant of good faith and fair dealing” that is inherent in all license agreements.

While licensors and licensees have both been reluctant to discuss how they are handling the problem publicly, the most common solution is to extend the term of the license agreement to allow the licensee to “earn out” the MGR, reduce or even eliminate the MGR, or agree to early termination of the agreement. Those are difficult situations but are ones that good licensing partners need to resolve.