Archive for the ‘IP Licensing’ Category

Sep
15

HOLDING COMPANIES AS A STRATEGY FOR IP ASSET PROTECTION – UNDERSTANDING THE PROS AND CONS

Posted by Susan Dierenfeldt-Troy, Esq.

Troy & Schwartz, LLC

Where Legal Meets Entrepreneurship™

Intellectual property assets may comprise as much as 70% of an average company’s value according to the Harvard Business Review.  Not surprisingly, businesses large and small are concerned about: 1) protecting their intellectual property from theft or infringement and potential creditors; and 2) reducing their income taxes as part of an overall IP asset management strategy.  Intellectual property holding companies (IPHCs) became a popular means through which companies sought to protect their IP assets and reduce taxes by establishing a wholly-owned subsidiary whose purpose was only to control and own IP assets such as patents, copyrights, trademarks, trade secrets, and other proprietary information in the 1990s.

The IPHC, established by the parent company, does not itself use the IP it owns (e.g., by manufacturing and distributing a patented product).   Instead, the holding company licenses its IP rights to affiliated operating companies that handle the day-to-day business activities but do not themselves own any of the IP assets.  The holding company as the licensor then receives royalties from its licensee(s).    For example, say ZYX, Inc. owns a U.S. patent for a product it manufactures and sells under a registered trademark.  It has decided to form a Delaware IPHC, CBA, Inc., for holding its patent and registered trademark.  CBA, Inc., now as the IPHC, licenses the patent and registered trademark to ZYC, Inc. in return for a two percent royalty on the patented and trademarked product’s sales.  For states such as Delaware which does not charge income tax on royalties, the tax savings can be substantial. Additionally, ZYX, Inc. can likely take the royalty payment as a tax expense write-off.

States eventually figured out that holding companies were costing them a lot of money and the majority of them have enacted different types of reporting requirements for IPHCs to recover tax monies:  a) mandatory combined reporting (requiring companies to file a single comprehensive tax return for all of their subsidiaries when they calculate their taxes); b) add back statues (requires companies to add back any tax deductions they have taken for royalties paid to their IPHC); and c) the economic nexus approach wherein courts are tasked with finding if an economic nexis (a/k/a/ the Geoffrey rule after a 1993 South Carolina case involving Geoffrey, Inc. as the IHPC for the Toys “R” Us trade name) exists.  As such, IPHCs are not used as much as they were over a decade as a tax “shelter.”  Delaware, however, still continues to be an IPHC tax haven.

What about Florida?  Florida does have a corporate income tax but remains one of a handful of “corporate income” tax states that hasn’t adopted an add-back or combined reporting statute to try and reclaim lost tax revenue attributable to Florida IPHCs.  Furthermore, Florida IPHC law is complicated by the fact that only mining companies, by statute, must count royalties when calculating their income taxes.  For an excellent discussion on the politics surrounding the issue of Florida IPHC taxation see Florida Tax Laws and Intellectual Property by Jason Garcia, Florida Trend Magazine.

Despite the fewer taxation benefits now afforded by most states to IPHCs, IPHCs can still offer IP asset-protection benefits, for example by allowing a company to quarantine its intellectual property from claims brought against the operating companies.  For instance, in the event the affiliated operating company is sued, the separation of IP assets from the affiliate to an IPHC may well protect that property from potential judgments in a lawsuit.

Any business entity, including an IPHC should be structured in a manner that best fits the business model.  All business entities, whether a C-Corp, S-Corp, or Limited Liability Company have their own considerations which should be discussed with in attorney knowledgeable in IP asset protection. Any such IP transfer needs to be in writing and is generally executed as an assignment of rights document.  The assignment of any issued patent and registered trademarks and copyrights should be recorded with the United States Patent and Trademark Office and/or the U.S. Copyright Office.

Anybody considering forming an IPHC should of course understand the taxation requirements of the state where the IPHC entity will be formed.  Additionally, any IPHC owner needs to understand that infringement actions involving the IP owned by an IPHC may result in unintended consequences for the unwary.  For example, whether or not a plaintiff has standing to sue is a threshold question in any lawsuit.  For a patent infringement action, only patent owners or exclusive licensees have standing to sue for infringement.  A typical exclusive licensing agreement may not be “exclusive” for patent infringement purposes. That is, absent a provision within the exclusive licensing agreement that the patent licensee has the right to sue, the exclusive licensee may be found to have no independent right to sue.

Why is this important to an IPHC?  Because the IPHC may be able to obtain an injunction as the patent owner, but will be limited in its ability to seek lost profits as damages.   For example, a patent-holding IPHC normally does not manufacture or sell a product itself.  The IPHC thus suffers no lost profits damages as a result of any infringement of its patent and any recovery will likely be limited to reasonable royalty damages which are generally substantially lower than lost profits.  Rite-Hite Corp. v. Kelly Co., 56 F.3d 1538, 1553 (Fed. Cir. 1995).

As for non-exclusive patent licenses, the IPHC cannot claim lost profits and will be limited to an award of reasonable royalty damages.  However, non-exclusive patent licenses may provide the IPHC with additional opportunities to exploit its IP beyond just one licensee.

In the context of trademark rights, the IPHC holding company must have sufficient quality control over the goods/services provided under the licensed trademarks.  Failure to exercise sufficient quality control may create what is known as “naked licensing”, resulting in potential cancellation of the registered marks.  Click here for a previous blog on the ramifications of naked licensing.

Take Home Points:

  1. Before setting up an IPHC, understand the tax laws of the proposed entity-formation state by consulting with a knowledgeable CPA or tax attorney.
  2. Before setting up an IPHC, determine the best type of business entity by consulting with a knowledgeable IP asset protection attorney.
  3. Ensure that the assignment of IP assets to the IPHC is done via a formal assignment agreement.
  4. Ensure that an exclusive patent licensing agreement includes appropriate provisions giving the exclusive licensee the right to sue for patent infringement. Utilize the services of a knowledgeable IP licensing attorney.
  5. For trademark licensing, ensure that the licensing agreement includes appropriate provisions allowing the IPHC to monitor the quality and goodwill of the licensed marks. As with patent-licensing agreements, utilize the services of a knowledgeable IP licensing attorney.

 

THANK YOU FOR YOUR INTEREST IN THIS BLOG.  AS USUAL THE CONTENT IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT LEGAL ADVICE.

Call us for a complimentary consultation on IPHCs or IP-licensing or any of your IP legal needs at 305-279-4740.

May you and your loved ones stay safe & be well during these challenging times.


© 2020 by Troy & Schwartz, LLC

 

Jun
28

Understanding a Trademark Licensor’s Obligations: Avoiding a “Naked License” Finding

This blog describes an area of trademark law that is often given short shrift.  The licensor of a registered trademark has important obligations during the term of the licensing agreement.  Failure to follow these obligations could result in loss of registered trademark rights.

Background on Trademark Law

A trademark or service mark is a distinctive word, phrase, logo, or graphic symbol that allows consumers to identify the manufacturer, merchant, or service provider responsible for the goods or services.  Basically, a trademark or services mark is a brand.   In contrast to inventions and creative works, both of which have an express basis in the U.S. Constitution, trademarks are not specifically referred to within the Constitution.  Instead, trademark law derives from the Constitution’s commerce clause which provides Congress with the power to regulate interstate commerce

The Lanham Act is the federal statute governing federal trademark registration.  It pertains to marks used in interstate commerce which Congress has the right to regulate under the Constitution.  The United States Trademark and Patent Office (USPTO) is the administrative agency in charge of determining whether an applied-for mark is eligible for federal trademark registration. States, including Florida, also provide for registration of trademarks & service marks. Marks used within only one state are limited to relying on state law protections. Marks which are registered simultaneously in both a state and the USPTO may rely on both federal and state law protections.

Trademark law’s focus is on the protection of the consumer. The objective is to prevent consumer confusion as to the source of the goods and to prevent “palming off” where one producer attempts to pass of its goods as originating from another producer.   That is, the consumer has the right to know that what they are buying is actually from the owner of the mark.  A registered trademark is given to the business/individual to signify to consumers the origin of the product or service bearing the registered mark symbol (the circled R).   Hence the reason why trademark law is encompassed by U.S. commerce law. The other three types of IP are instead focused on protecting the rights of the inventor, creative works creator, and trade secret developer.

Once a registered trademark is granted by the USPTO, the continuation of registration status is dependent upon periodic proof filed with the USPTO that the mark is still in interstate commerce and the payment of a maintenance fee.  Registered TM protection can go on indefinitely as long as the fees are paid and the mark is indeed being used in commerce.

 Trademark Licensing Considerations

As with patents and copyrights, trademarks can be licensed.  Patent and copyright licensors generally stay out of the licensee’s “commercialization” endeavors unless the licensee’s involvement is required to get the invention or work to market.  Trade secret licensing is a really tricky proposition and not something often recommended.   Trademark licensors, on the other hand, have on-going obligations!  Failure to follow these obligations can result in a loss of registered trademark rights if the license is viewed as a naked license by courts or the USPTO.

Example

Mary has developed an organic spice mixture as a seasoning which she has been selling through a website.  She has been featured on HSN and developed a loyal following.  She specifically developed the spice rub for individuals having a histamine intolerance like herself so they too could enjoy tasty food.  She secured a catchy registered trademark under which the spice mixture is sold.  She has been approached by Spiced Right, a national spice manufacturing and distribution company to sell her product on a nationwide scale under her brand name.   They have promised her that her product’s quality will be maintained with large scale manufacturing processes.  The royalty payment is attractive and will allow her to put money away for retirement.  She entered into a detailed exclusive licensing agreement which was devoid of any role on her part.  The agreement also failed to clearly specify component sourcing – specifically organic components from specified suppliers all certified by an independent organic certification authority.

A couple of years later, Spiced Rights started substituting non-organic spices to increase profits.   A substantial number of Mary’s previous customers started complaining on social media that her brand’s quality had declined.  Almost immediately thereafter Spiced Right stopped paying royalties.

Mary sued Spiced Right under 15 U.S.C. §§ 1117, 1125(a) for violation of her rights as a trademark owner (right to receive royalties in this case).  The case was dismissed on the ground that Mary abandoned her mark by engaging in naked licensing – that is, by allowing Spiced Right to use the mark without exercising “reasonable control over the nature and quality of the goods, services, or business on which the mark is used by the licensee.” Restatement Third of Unfair Competition §33 (1995).

Naked licensing issues may also come up during application opposition and registered mark cancellation proceedings before the Trademark Trial & Appeal Board.   See e.g., Barcamerica International USA Trust v. Tyfield Importers, Inc., 289 F.3d 589 (9th Cir. 2002)(finding that the trademark should be cancelled).

What Happened?

  1. Mary relinquished control over the quality of her spice. For trademark licensing purposes, quality does not mean “high end” goods and services. The sort of supervision required for a trademark license (REMEMBER FOCUS ON THE CONSUMER) is the sort that produces consistent quality and expectations in the mind of the consumer.
  2. Mary’s licensing agreement should have specified, g., that she would be policing Spiced Right’s product and the specific quality assurance steps she would take. For example, by regularly buying and sampling the products and receiving reports of the suppliers being used by Spiced Right to formulate her product.  Contingencies for addressing product deficiencies should also have been delineated.
  3. As an aside, generally, the licensor, as the owner of the registered mark, is responsible for filing the necessary documentation for establishing that the mark is in commerce at the Lanham Act’s specified renewal time frames.

 KEY TAKEAWAYS

  1. Trademarks are indicators of consistent and predictable quality assured through the trademark owner’s control over the use of the designation.” Restatement Third of Unfair Competition 33, comment b.
  2. A trademark’s function is to tell shoppers what to expect. Mary’s customers had come to expect a certain taste/quality and it was her reputation that was at stake.   Similarly, a franchise restaurant licensee is expected to provide food/cleanliness/service (the experience) consistent with the franchisor’s requirements as detailed in lengthy franchise agreements.  The licensor’s reputation is at stake in every restaurant outlet so it invests to the extent required to keep the customer satisfied by ensuring a repeatable experience and overseeing the activities of its licensees.
  3. The failure to monitor one’s trademark is seen as an effective relinquishment of a trademark owner’s responsibility under the law.
  4. All IP licensing agreement should be reviewed by an experienced IP attorney who is well-versed in IP licensing nuances. This is especially true for trademark licensing agreements where the licensor/trademark owner has important obligations.  Failure to comply with these obligations may result in loss of valuable registered trademark rights.

 

THANK YOU FOR YOUR INTEREST IN THIS BLOG.   THE CONTENT IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT LEGAL ADVICE.  WE SUGGEST YOU CONSULT WITH AN ATTORNEY IF YOU ARE CONSIDERING AN ACTION WHICH COULD HAVE LEGAL CONSEQUENCES.

©2020

Troy & Schwartz, LLC

Where Legal Meets Entrepreneurship™

(305) 279-4740