“OWNED AND CONTROLLED” LICENSES: REVISED 2016

Ivan Hoffman, B.A., J.D.

     [NOTE: I originally wrote this article in 1999, long before there was wi-fi, streaming and even before the Internet “took off” and long before “mobile” was around in the pervasive way it is as of this update.   It was thus “prescient” even if I do say so myself.  Where I have inserted new materials, those are indicated in [  ].]

     In the coming years, as we turn on our televisions, it will become increasingly more difficult to tell whether we are actually seeing television or instead are watching the Internet or, more likely, a combination of both.  As broad band and digital television combines with DSL and cable modem technology, multicasting of all sorts will be a reality. [“DSL”…how quaint!  As indicated, this was written long before there was wi-fi and mobile and streaming and all the technologies we have as of this writing] This convergence of technologies already has many implications in terms of intellectual property and contract law and it is the visionary party that, knowing what is in truth already here, negotiates agreements with this quantum shift in mind.           

     The integration of which I write is when one company purchases another company, in whole or in part, and the second company is in the business of exploiting some or all of the rights owned by the first company.  As an example: a publishing company purchases an interest in a merchandising company or a book distribution company.  Another example: a recording company owns an Internet related business.  Still other examples are motion picture or television companies owning broadcast and cable stations.  [And of course now this list would include distributors producing content and content companies owning distributors, as just further examples]  It goes on but the leit motif in all these situations is that one party owns or controls the other, most often through stock ownership or otherwise, and as a result of that ownership and control, can be in a position to determine the course of what might otherwise be an independent and unrelated business deal, a “license,” as described in this article. 

     Royalty participants of all sorts—authors, recording artists, song writers, [film makers, actors, directors] and the like—must surely be aware of this vertical and horizontal integration that has been taking place in the publishing, recording, television and now Internet businesses.  While this has been going on for some time now, it seems to have reached a frenzied pitch in the past few years. [Actually, in 1999 it was just in its infancy compared to now] It can have a direct and material impact on the royalties these participants receive. 

     A royalty participant for the purpose of this article is someone who has a contractual right to receive a percentage of income received by some other party that controls the right to administer and exploit certain forms of intellectual property.  For example: an author has the right to receive a percentage of the income received by a publisher from the sale and/or license of the publishing rights to a book, magazine article or the like.  A recording artist or a song writer have the right to receive a royalty from the exploitation of recordings and songs by a record company.  There may be other forms of such royalty participants including actors,  directors, co-venturers, licensors of other intellectual property rights such as trademarks, individuals licensing their rights of commercial exploitation and so on. 

     Thus the issue is joined:  when the party controlling the rights but having a corresponding contractual obligation to pay a percentage of income received from the exploitation of those rights to another party exploits those rights within an “owned and controlled” relationship, what is there to protect the interests of the royalty participant?

How The Issue is Presented

     The common thread presented by these relationships is that they offer the party with whom the royalty participant has contracted an opportunity to license rights to another company that is owned or controlled [or is otherwise related to], in whole or in part, by the contracting party or visa versa.  However the relationship is structured, the issue is that the two parties are able to contract with one another in a manner that can be quite lucrative to those parties but quite unfair to the royalty participant.  They can make what is known as a “sweetheart deal” which refers to making a deal between them on terms that are less than what would have been negotiated had the parties not be so related.  Where there is no owned or controlled relationship between the two parties, what the law refers to as an “arms length transaction,” then the licensor (the party with whom the royalty participant has a contract) will, at least in theory, strive to make the best deal possible in the transaction, both in terms of money and other terms, and that best deal will benefit both the licensor and the royalty participant.  

     On the other hand, when there is an owned or controlled relationship, it is not necessarily to the benefit of the licensor to seek out the best deal because in the end, the internal bookkeeping methods that exist between the licensor and the company owned and controlled by it (or vice versa) is set up to show the largest profit possible.  Thus, it is not in the best interest of these related parties to have one party, in this instance the licensee, pay a large advance or high license royalty to the licensor since that would cut into the profit of the licensee.  Instead, the related parties may opt simply for a less than top-of-the-line deal and handle it by some sort of internal bookkeeping entry.  The result of course is that the royalty participant does not receive his, hers or its share of what might otherwise be a large deal were it to have been made between unrelated parties, an arms length deal.

An Example

     Let’s use the book publishing business as an example throughout this article for the sake of simplicity although as I have indicated, the royalty participant-licensor relationship may be a variety of different structures.  And again for simplicity, let’s say that the royalty participant is to receive 50% of licensed income from the exploitation of certain rights, say for example, merchandising royalties.  If you are some other form of royalty participant, you would have to modify these examples accordingly.

     Generally speaking, the underlying agreement creating the royalty participation will provide that the publisher will pay the author or other participant some percentage of income received by the other party from the sale, license or other exploitation of a stated set of rights, say foreign reprint or translation rights, or merchandising rights or such. 

     Thus the first issue is how this participation is phrased.  It can be in the form of a certain percentage of the gross or net income of the publisher.  The difference can be quite significant.  Gross means 100% of the money while net means that from the total money received a given and hopefully stated number of categories are deducted.  This difference is significant in all forms of transaction but becomes especially important in these owned and controlled situations.  If the agreement calls for a net participation, how is that “net” defined and does it allow for deductions that are not actually paid for by the licensor?  In other words, supposed that between the licensor and its owned subsidiary they create a bookkeeping charge for “administrative expenses,” is this an appropriate deduction as between the licensor and the royalty participant?  There are many other such issues that arise in the definition of “net” but I am trying to keep this simple.

     Even in the gross deal, what if the parties make one of those “sweetheart deals” I mentioned above?  For example, what if the licensor licenses merchandising rights to the owned company for a lower royalty or advance or maybe no advance at all than might have been received had the licensor not had an interest in the merchandising company? 

The Contract and The Law

     The most pertinent answer of course is what does the contract between the royalty participant and the licensor say about owned and controlled dealings?  Is there even a provision covering the issue?  If there is no such provision (for I am still constantly amazed at how many parties on all sides seem to try and do their own legal work and use form, cut and paste agreements that are woefully inadequate to cover this and other issues), is there any obligation imposed on the licensor to treat the royalty participant “fairly?”  Does the law impose on the licensor some obligation of “good faith and fair dealing?”

     And whether or not the agreement covers the point or there is some obligation imposed by law, how is the standard for what is “good faith and fair dealing” to be defined?  What is an “arms length transaction” when there is no arms length?  

     The answers to the above questions are the subject of a case by case analysis and the courts look to a number of factors in making such determinations.  Thus the terms of the agreement are important since parties should never leave large, gaping issues to the decision making of a court or jury.  In the negotiated agreement, the parties should cover this situation by appropriate provisions defining what is an “owned and controlled” situation and how the royalty participant’s share is to be calculated in such an instance.

     Keep in mind that contracts are private laws.  Generally speaking, absent some public policy or other reason not to enforce an agreement, courts will most often follow the desires of the parties.  Therefore, it is incumbent on those parties to face and resolve this issue in clear terms within the four corners of the agreement.  Read the article on my site entitled “Private Laws” under the link “Articles About Being An Entrepreneur.”

Conclusion

     As indicated above, the answers to these and of course many other issues involved within the main issue are complex and depend upon a whole variety of factual determinations and there is no single answer to all situations.  What is important for the purposes of this article is that the parties become aware of the already existing realities of the convergence world and address themselves to them in their negotiations.

      And of course it is a reality that many parties never believe that anything that they are working on can become a success and thus warrant the expense of a professionally negotiated and drafted agreement.  And in those instances, it has been my extensive experience that the worst thing that can befall those parties is that the project becomes a success!  If it is a failure, no one is [probably] going to care [though sometimes money isn’t the deciding point].  But if the project is a success [or even if it is not], you cannot count the number of claimants that are going to come forward, each having their team of lawyers, each making claims against the deal because the presented by this article were not even addressed.

     Have vision.  Believe in your project.  Believe in yourself.  Assume success and be prepared.

Copyright © 1999, 2016 Ivan Hoffman.  All Rights Reserved.

 

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This article is not legal advice and is not intended as legal advice.  This article is intended to provide only general, non-specific legal information.  This article is not intended to cover all the issues related to the topic discussed.  The specific facts that apply to your matter may make the outcome different than would be anticipated by you.  This article is based on United States law.  You should consult with an attorney familiar with the issues and the laws of your country.  This article does not create any attorney client relationship and is not a solicitation. 

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No portion of this article may be copied, retransmitted, reposted, duplicated or otherwise used without the express written approval of the author.

 


 

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