By downloading this agreement, you agree not to distribute the agreement as a blank legal form or to create a download link directly to the agreement.
Explanation for Merchandise Agreement
Below is an explanation for each clause in the Merchandise License. For more information on licensing, read our Licensing Overview.
Introductory Paragraph. The introductory paragraph should identify the people or companies entering into the agreement, known as the “parties.” The introductory paragraph may also include the parties’ business structure (corporation, sole proprietorship and so on) and business address. Insert that information, if desired, following the name of each party—for example, “Artco Manufacturing, a California corporation located at 434 W. Oakdale Avenue, Los Angeles, California.” Instead of Licensee and Licensor, the agreement can be drafted to use the names of the parties throughout the agreement or terms such as “Artist” for the licensor and “Manufacturer” for the licensee. But once you’ve chosen to use certain terminology such as this, make sure to use it consistently throughout the agreement. In some license agreements, the introductory information is referred to as the “Whereas” provisions. For example, the agreement might read: “Whereas DTK Decorating Company (the licensee) desires to acquire rights.” The use of the term “whereas” has no particular legal significance.
The Work. Your crafts work (the design or crafts work) is referred to as the “Work.” Any appropriate term can be substituted instead of “work”—for example, “the Design” or “the Jewelry”—as long as this terminology is used consistently within the agreement. If more than one work is being licensed from the licensor, each work can be identified separately, such as Work #1, Work #2 and so on. You don’t need to go into great detail yet—it’s customary to do this in the first attachment to the agreement, “Exhibit A.” There, you’ll describe each work, or, if possible, reference a separate photocopy of the artwork or text that will also be attached to the agreement.
The Licensed Product. A licensed product is any merchandise that incorporates the work. If the definition of the product is too narrow, the licensee may be precluded from certain markets. For example, if the licensed product is described as “T-shirts,” other shirts like tank tops could not be sold. Similarly, the term “ceramic cups” precludes the sale of plastic cups. If, however, you want to keep the range of potential merchandise narrow, be sure to define your licensed product very specifically. For instance, instead of “upper body apparel,” define your licensed product only as “T-shirts.” The definitions should be inserted in Exhibit A.
The Grant of Rights. The grant of rights (also known as the “grant”) officially permits use of the work, describes the legal rights being licensed and establishes whether the rights are exclusive or nonexclusive. In a merchandise license agreement, the grant must include the following rights:
- The right to reproduce. This refers to the right to make copies of the work or merchandise. This is similar to the grant of rights for a regular license agreement that gives the right to make copies on various media such as print or film. This right is essential for the merchandise agreement. Without it, the licensee won’t even get to square one. The right to reproduce is not unlimited. The agreement specifically limits it to the use of the material on “Licensed Products.” In other words, the artwork can only be used on specific products as defined in the attached exhibit.
- The right to distribute copies. This refers to the right to sell or give away the work. Reproduction and distribution are closely related and every merchandise license agreement requires both rights. Other rights, however, are optional.
- The right to adapt or create derivatives. This refers to the right to modify the work—for example, to alter a design so that only a portion is used. The result of the modification is referred to as a derivative work. If the licensee plans to create a derivative work, the grant of rights must reflect that permission has been granted to modify the original work. The language in the model agreement allows you to own any modifications or contributions the licensee makes to the work. If this language is not included, the result may be that you and the licensee may become co-authors of any jointly created derivative work—a result you may not desire (for more on co-authorship, see Chapter 8).
- The right to display publicly. This refers to the right to publicly exhibit or display a licensed product. Even without acquiring this right in the agreement, the licensee can, under copyright law, display the artwork (as it is included on the merchandise) in connection with advertisements.
Exclusive vs. Nonexclusive Rights. Every merchandise license agreement is either exclusive or nonexclusive. Exclusive means that only the licensee will have the rights granted in the agreement. —no one else can be given those same rights for as long as the agreement lasts. Nonexclusive means that the owner of the crafts can give the same rights to someone else—for example, two different companies could license your pottery designs.
An exclusive license is usually more expensive than a nonexclusive license, but not always. For example, the fee for an exclusive license to use an image on auto seat covers may be the same as a nonexclusive license simply because the seat cover market is limited and there are few manufacturers. However, an exclusive license for T-shirts or calendars may be two or three times the cost of a nonexclusive license.
Sublicenses. A sublicense allows the licensee to turn around and license its rights to another company. For example, a licensee may want to grant rights to other companies in the United States or in foreign countries, where the licensee is not prepared to play an active role itself. The only problem with sublicensing is that a new company—one with which you had no chance to meet and negotiate—suddenly has the right to make your design. In addition, you may be apprehensive about having your work sublicensed, especially if it’s going somewhere where it would be expensive for you to enforce your legal rights. (You can limit foreign sublicensing by restricting the territory covered by the agreement to a particular country.) The safest route is to give the licensee a very limited right to sublicense rights abroad—one conditioned on you giving your consent to the deal. That way, you can review each sublicense agreement to determine its relative advantages and disadvantages. If you are experienced at selling in foreign markets and can handle foreign licensing yourself, you will probably want to prohibit foreign sublicensing and retain those rights. The model agreement provides three choices regarding sublicensing. You can either:
- not permit sublicensing
- permit sublicensing only with your written consent, or
- permit sublicensing with your written consent, while stating that your consent cannot be unreasonably withheld. This is the preferred option for most licensees, because it means that you can only withhold consent for a valid business reason.
Reservation of Rights. Ordinary contract law says that if you do not grant a specific right, you have retained (also known as “reserved”) that right. Although it makes no legal difference whether you state this fact in your agreement, most licensors prefer to include this statement.
Territory. You can geographically limit where the licensee can exercise rights, by defining a “territory” in your agreement. If the territory is to be the entire world, insert the word “worldwide” into this section. If the territory is to be a specific region or country, insert that information. As a general rule, restrict the territory to regions where the licensee has previously sold goods with success. If in doubt, simply limit the agreement to North America (the United States and Canada).
Term. By including a Term provision in your agreement, you can limit how long the merchandise license lasts. As a general rule, the licensee wants permission for as long as possible in order to properly develop and exploit the work. You, as the licensor, are likely to prefer a shorter period. That way, if you’re not happy with the licensor’s performance or you want out for some other reason, you’ll have less time to wait before the agreement comes to a natural ending point—for example, one year instead of two or three years. The date that an agreement commences is usually referred to as the effective date. If the agreement has a fixed date of termination, say in ten years, you would start counting the ten years at the effective date. Our model agreement prohibits a term that is longer than U.S. copyright or design patent protection would last. This makes sense because once these legal rights expire, the licensee should not have to pay to use the licensed work while the rest of the world can use it for free. Even if no time limit is expressed, U.S. copyright law allows you, under some circumstances, to terminate the merchandise license after 35 years. This is true even if the agreement contains a statement that the license is “forever” or “in perpetuity.”
Payments. Under your license agreement, you will be paid a continuing payment (“royalty”) based upon a percentage of the income from the licensed product. In other words, if the merchandise sells well, you’ll receive more money. In some cases, a licensee must make payments in advance of royalties (known as “advances”) or must pay fixed or “guaranteed minimum annual royalty” payments (see below) regardless of sales. In other words, money and time may be spent even if the licensed product is not successful. Below are definitions of some royalty terms you might need to use. Gross sales refers to the total amount billed to customers. Net sales are usually defined as the licensee’s gross sales minus certain deductions. In other words, the licensee calculates the total amount billed to customers and deducts certain items before paying the royalty. It is generally acceptable to deduct from gross sales any amounts paid for taxes, credits, returns and discounts made at the time of sale. It is also common to deduct shipping (the cost of getting the products to the buyer).
An advance against royalties is an up-front payment to you, usually made at the time the license agreement is signed. An advance is almost always credited or “recouped” against future royalties, unless the agreement provides otherwise. It’s as if the licensee is saying, “I expect you will earn at least $1,000 in royalties, so I am going to advance you that sum at the time I sign the agreement.” When you start earning royalties, the licensee keeps the first $1,000 to repay the advance. If the licensor doesn’t earn the $1,000 in royalties, the licensee takes a loss. You don’t have to return the advance unless you breach the agreement.
A percentage of net sales (the licensed product royalty) is the most common form of licensing payment. Net sales royalty payments are computed by multiplying the royalty rate against net sales. For example, a royalty rate of 5% multiplied by net sales of $1,000 equals a net sales royalty of $50. Estimates of merchandise royalties are provided in Section A1, above.
Back to agreement
A per unit royalty is tied to the number of units sold or manufactured, not to the total money earned by sales. For example, under a per unit royalty you might receive $.50 for each licensed product sold or manufactured. The licensee cannot choose both per unit and net sales royalties. If the licensee intends to license your work for a free distribution, for example, giving out hundreds of the products at a promotion, check the “manufactured” box. If the licensee will be offering your work for sale (not for free), check the “sold” box. Generally, net sales royalties are preferred over per unit royalties because revenue may come from sources such as sublicensing, in which case the total net sales will be easier to track.
A guaranteed minimum annual royalty payment (GMAR) is when the licensee promises that you’ll receive a specific payment every year, regardless of how well the merchandise sells during each year. The licensee pays the GMAR at the beginning of the year. At the end of that year, if the earned royalties exceed the GMAR, you’re paid the difference. If the GMAR exceeds the earned royalties, the licensee takes a loss. To avoid taking the loss, a licensee may insist that the agreement contain a clause stating that this difference will be carried forward and deducted against the next year’s royalties. Also don’t be surprised if the licensee wants to limit the initial term of the agreement. Otherwise, the licensee risks being locked into paying GMARs when the merchandise is not selling at all.
On rare occasions, a licensee may pay you a one-time license fee at the time of signing the agreement. This fee differs from an advance, because it is not deducted from royalties. The licensee may arrange to make the payment when the licensed product is first distributed. That way, if the licensed product is not produced, the licensee does not have to pay. If the license agreement permits sublicensing, keep the provision for sublicensing revenue in the agreement. (See the section of the Agreement entitled “Sublicensing.”)
Audits. In case you suspect that the licensee has failed to properly pay you royalties owed, you’ll want the right to perform an audit to detect and quantify the shortfall. The Audit provision describes when you (or your representative) can access licensee records. If the audit uncovers an error of a certain magnitude—usually a sum between $500 and $2,000—the licensee will have to not only compensate you for the shortfall, but pay for the audit as well. Insert an amount in the blank space. If the audited sum is lower than this amount, you are the one who will have to pay for the audit.
Warranties and Indemnity. Warranties are contractual promises that you and the licensee will make. If you break one of these promises, you will—under the indemnity provision—have to pay for any costs that result. In this way, warranties and indemnity work together. Indemnities are discussed in more detail below. A merchandise license can also be written without including warranties or indemnity provisions. They are recommended, but not essential for the agreement.
- Warranties. In some agreements, warranties are labeled as “covenants” or “representations.” Regardless of the title, they are essentially the same things—promises made between the parties. For example, you might promise that you own the rights in the crafts product and that the crafts work doesn’t infringe third-party rights. (Third parties are people who are not part of the agreement.) In case you feel uncomfortable making this kind of assurance, the model agreement provides a more palatable warranty, stating that you have “no knowledge as to any third-party claims.” In other words, you recognize the remote possibility that the crafts work may infringe someone’s copyright, but you—after performing a reasonable investigation—don’t have any knowledge that it does. You should ask that the licensee provide a warranty that sales and marketing of the licensed product will conform to applicable laws. A sample provision is included in the model merchandise agreement. If an agreement includes a warranty but not an indemnity provision, the parties can still sue for “breach of warranty.” However, you would have to go to court for a decision on whether the breaching party must pay the costs or attorney fees associated with the breach.
- Indemnity. Indemnity is recommended, but is not essential for the agreement. A licensor who provides indemnity is agreeing to pay for the licensee’s damages in certain situations. For example, if you indemnify the licensee against infringement, you will have to pay damages (and legal fees) if the licensee is sued by a company claiming that your work is a copy of its work. In this way, indemnity acts like a powerful shield. The licensee can deflect a lawsuit and make you pay for the damages and legal fees. Indemnity provisions are also sometimes referred to as “hold harmless” provisions, because the language for an indemnity provision often states that the “Licensor shall hold the Licensee harmless from any losses, and so on”. If possible, you should avoid indemnity, as it means taking on a legal obligation to pay someone else’s legal costs. If a licensee is insistent, however, you may have to agree to this provision. But hold firm on insisting that the amount not be larger than any amounts you have received under the agreement. In some cases, you may insist on establishing an indemnity fund. With such a fund, if indemnity is triggered, the licensee stops paying you royalties and places these payments into the fund. This deprives you of ongoing royalty payments but prevents you from having to pay out any additional money for indemnity. You may also request that the licensee provide you with indemnification as well. Indemnification would protect you from any third-party claims arising from illegal licensee business practices or from any additions or modifications that the licensee makes to your design.
Back to agreement
Intellectual Property Rights. If you have not filed a copyright registration or a design patent covering your work and do not plan to, the licensee may register for protection under this provision. For information about copyright registration, consult the Copyright Office website at www.copyright.gov. It is common for the licensee to deduct the reasonable costs of registration from future royalties.
The licensee’s failure to include the credit could provide a basis for termination. The Credit section also provides the licensee with the right to use the licensor’s name and trademark in advertising for the merchandised product. If you are an established crafts artist, the licensee will have a strong motivation to use your name (and maybe your image) in advertising and promotional materials.
Infringement by Third Parties. Imitation may be a form of flattery, but it’s also a form of infringement. Unethical competitors often create imitations of successful licensed products. If you do not have the money to fight an infringer, this provision allows the licensee to sue or settle with infringers. It provides for funding of a lawsuit and for determining how to divide any money that is recovered from the infringer. The provision in our model agreement establishes a 50/50 division of any award money after payment of attorney fees.
Exploitation. When it comes to licensing your work, exploitation is a good thing. You want to be sure that the licensee won’t simply sit on your work, which would prevent you from earning the royalties you’re anticipating. If your agreement is an exclusive one, inaction by the licensee would be doubly frustrating, since you would be unable to license the product to anyone else. The exploitation provision addresses these concerns by setting a date by which the licensee must release the licensed product. Sometimes the release date is set to coincide with a specific trade show or a seasonal catalog. If the licensee fails to meet this date, you can claim that there has been a “material breach,” which is a basis for termination of the license agreement.
Back to agreement
Approval of Samples and Quality Control. This provision gives you the right to look at and approve samples and prototypes of the artwork before it goes into full production. The provision gives the licensee an incentive to reproduce your work properly—and it prevents nasty surprises. If you have the clout and bargaining power, you may expand this provision to give you a right to inspect the manufacturing facilities and to reject any subcontracting manufacturing if their standards are insufficient.
Licensor Copies and Right to Purchase. You will probably want some free copies of the licensed product, for yourself and your close friends and relatives. This provision allows you and the licensee to specify how many you’ll receive. The number you agree upon will probably depend on the value of the product and the size of the market—obviously, the licensee doesn’t want you to undercut his profits by playing Santa Claus. If you think your generosity will exceed the number of free copies, you can negotiate for the right to purchase more product at the wholesale cost.
Confidentiality. Though it may seem obvious that your discussions are confidential, you’d be surprised at how easy it is for you—or the other party—to forget this and disclose confidential information provided by one party. When you’re deep in a conversation with your friend, hairdresser or mechanic, it may seem so natural to say, “This company I’m dealing with is planning to expand into the fabric business.” You’ve now revealed potentially important facts about the condition of the other party’s business. Confidential information includes any information that gives a business an advantage and is maintained in confidence. The Confidentiality clause below reminds each party to preserve the other’s confidential information—and allows each to sue for breach of contract if the other slips up.
Insurance. Those patterned mugs may look innocent now, sitting on the shelf. But you should never underestimate the capacity of consumers to use products in a way that injures them—and then blame someone else for it. If a consumer is injured using the licensed product and claims it’s defective, you and the licensee can be sued under a legal theory called “product liability.” For these reasons, you want to make sure that the licensee, as the one who’ll be selling the merchandise, acquires product liability insurance. The first benefit of such insurance is that the insurance company—not you or the licensee—will have to defend the claim. That’s a significant benefit, because legal fees can add up quickly, even in a case that you ultimately win. In addition, by requiring that the licensee name you in the policy, you will be shielded from paying damages in the event that a customer wins a product injury claim. The minimum amount of coverage -inserted for the policy should be $1,000,000. Product liability insurance doesn’t usually cover trademark, patent or copyright lawsuits. The licensee needs a separate business policy for protection against infringement claims.
Termination. Even without a termination provision, either party can terminate a merchandise license agreement if the other party commits a “material breach.” A material breach means a substantial abuse of the agreement—for example, if the licensee uses the crafts work for purposes not described in the agreement. Most licensors will insist upon a written termination provision and will seek some or all of the rights listed in our model agreement, including the right to terminate as to a specific portion of the territory if it is not exploited.
Effect of Termination. If the licensee breaches the agreement for any of the reasons provided under “Licensor’s Right to Terminate”—for example, the licensee stops paying you royalties—the licensee should not be permitted to continue profiting from your art by selling off inventory. If the agreement has expired or ended amicably, however, it’s reasonable to permit the licensee to sell off the remaining inventory during a fixed time period, say six months. Naturally, the licensee must also pay royalties and provide an accounting for these products.
Dispute Resolution. To avoid the high costs associated with formal court trials, many contracts now commit the parties to trying alternative methods of resolving their disputes first. Your two main choices are arbitration and mediation. With arbitration, the parties pay one or more arbitrators—experts at resolving disputes—to evaluate the dispute and make a determination. Even if neither party is entirely happy with the arbitrator’s decision, they have to live with it—that’s why it’s often called “binding arbitration.” With mediation, a neutral evaluator helps the parties settle their dispute themselves. That is, the mediator offers advice so that the parties can reach a solution together, but doesn’t interject his or her own solution. Mediation and arbitration are referred to as alternative dispute resolution or ADR. The model agreement includes two alternative dispute resolution provisions. The second is only for arbitration. The first provides for mediation first, then for arbitration if mediation fails.
No Special Damages. If either party breaches the agreement, state laws provide that the nonbreaching party can recover the amount of the loss directly resulting from the breach. For example, if the licensee fails to accurately pay royalties, you can sue to recover the unpaid amount, along with attorney fees if the agreement provides for such fees. However, under some state laws, claims may be made for additional damages—for example, special or punitive damages that are awarded to punish the breaching party. These are sometimes double or triple the amount of damage that the nonbreaching party actually suffered. If you and the other party agree that you don’t want to expose each other to this level of risk, you can insert a No Special Damages provision into your agreement. This provision prevents either party from claiming any damages other than those actually suffered directly from the breach.
Miscellaneous Provisions. Many agreements contain provisions entitled “Miscellaneous” or “General.” These provisions actually have little in common with one another except for the fact that they don’t fit anywhere else in the agreement. They’re contract orphans and for that reason are usually dumped at the end of the agreement. Lawyers often refer to these provisions as “boilerplate.” Don’t be misled by the fact that boilerplate is buried at the back of the agreement. You’ll be turning straight to that page if you’re in the middle of a dispute with the licensee and need to know the procedures for resolving the dispute and how a court will enforce the agreement. Even though the Miscellaneous and General provisions are important, they are not mandatory. In other words, if you and the licensee agree to leave them out, you can do so without affecting the validity of the remaining agreement. Here’s a summary of common boilerplate provisions.
Assignability. Although you might think of your agreement as being between you and the licensee alone, that’s not always the way business works. It is possible that the licensee may, at some point, wish to transfer the rights under your agreement to another company. Normal contract law allows her to do this by “assigning” her rights to a third party—unless you insert a provision to stop or control this. For example, let’s imagine that the licensee has two agreements with you: one to license your earring design and the other to license your bracelet design. The licensee later decides it only wants to concentrate on earrings. It wants to assign its rights in the bracelet design to a company that specializes in bracelet merchandising. You may—or may not—be happy with the change. For example, if the new company has a bad reputation when it comes to paying royalties, you’re likely to regard this as a disaster. For this reason, our model agreement provides three choices regarding assignability.
- The first option requires that your written consent be given for an assignment. Under this option, you can review the deal and decide, for any reason, that you don’t like the assignment and won’t have it.
- The second choice also requires your written consent, but you must not refuse it without having a valid business reason. A valid business reason usually means an actual and substantial business risk—for example, the new company has a negative financial rating.
- The third provision permits a transfer without your consent, so long as the new party is a company purchasing the licensee’s business. Some licensees insist on this provision because they want the freedom to sell the whole company (and its license agreements).
Signatures. Each party must sign the agreement. If individuals are signing on behalf of a company, then the people who sign must have the authority to do so. Use the rules expressed in Chapter 11 to determine how the agreement should be signed.
Exhibit A. Agreements often have attachments known as “exhibits,” which are stapled to the agreement. In license agreements, the exhibit summarizes some of the essential business elements. For example, in the model agreement, Exhibit A includes a description of the work, the licensed product and, if applicable, the sales minimum required to renew the agreement. One important advantage of using an exhibit is that if you are dealing with multiple licensees or if you are licensing more than one item to one licensee, you may be able to keep the body of the agreement the same and only change the exhibit.
Right of First Refusal. Some merchandise agreements include a provision known as a right of first refusal. Its purpose is to give the licensee the first shot at licensing any new works from you. For example, if you previously licensed a series of crockpot designs, the licensee will want the first opportunity to license your new designs. If another company makes a better offer than the licensee, this provision gives the licensee a period of time to match the offer.