Naked Licensing: That’s Your Name, So Don’t Wear It Out

From multinational corporations to franchises to non-profits, there is a lot that goes into building your brand and a positive brand association among consumers. As a company looks to growth strategies, it will consider different ways to develop its brand’s reach, such as expanding its market presence by allowing third parties to use, market, or otherwise promote goods or services using its brand name. The typical situation we often think of (and see) is the well-established franchise model. In this situation, the brand owner will permit a franchisee to use its trademark in connection with the associated goods or services pursuant to a franchise or similar agreement that contains a trademark license as well as other contractual provisions governing, among other things, the nature of the use of the trademark. If it is properly structured and adequate quality control measures are implemented, it is rare that this often-utilized business model would result in the loss of the valuable trademark rights of a brand owner.

However, an unsuspecting trademark owner that allows a third party to use its trademark in connection with the third party’s goods or services to spread brand awareness across broader markets or demographics may inadvertently jeopardize valuable trademark protections under Federal and State trademark laws. Since trademarks are intended to identify the source of a product or service, the trademark’s owner has an affirmative duty to ensure the consistency of its trademarks and the goods and services under which its trademarks are used. When a trademark owner fails to exercise quality control over its marks (or the quality of the trademarked goods or services used by a third party), it risks abandoning all its trademark rights under the theory of “naked licensing.” As a result, engaging in naked licensing can give rise to a defense to trademark infringement, estopping the trademark owner from asserting its trademark rights.[1]

A trademark owner can engage in naked licensing when the owner licenses (or otherwise permits or consents to use) its trademark rights to a third party. Concerns over naked licensing arise when a trademark owner grants a license to another party without retaining some form of quality control over the licensee.[2] A “naked license” signals involuntary trademark abandonment and forfeits protection.[3] The “central question” in a claim of abandonment via naked licensing is whether “the licensees’ operations are policed adequately to guarantee the quality of products sold [or the services promised] under the mark.”[4]

The rationale behind naked licensing is that the public has a right to expect a consistent quality of goods or services associated with a trademark or trade dress.[5] Unpoliced use of a particular trademark, without quality control standards, may result in the trademark ceasing to function as a symbol of quality and a controlled source. Ultimately, many courts have deemed naked licensing to be an act of deception to the consumer because the consumer associates the trademark with a certain quality of goods.[6]

To mitigate the risk of abandonment by naked licensing, a trademark owner should be proactive by entering into a written agreement with a licensee that contains, among other things, a revocable license and imposes quality control standards on its licensees. Owners can—and should—enact strict quality control standards on the goods or services produced or sold by licensees at the outset of the relationship by contractual means. An express contractual right to inspect and supervise the licensee’s operations will be strong evidence against abandonment via naked license.[7] Thus, licensees should be contractually subject to audits and inspections so that the owner can control the use of the trademark and the quality of the associated goods or services. Additionally, a trademark owner should insert a provision into its written agreement retaining all goodwill associated with the mark and providing clear termination rights in favor of the trademark owner.

However, a trademark owner cannot (and should not) rely solely upon a contract to avoid claims of naked licensing.[8] Failing to supervise a licensee or allowing a licensee to depart from the licensor’s quality control standards are important elements courts consider when determining abandonment by naked licensing.[9] This is particularly true when the agreement lacks “an express contract right to inspect and supervise a licensee’s operations.”[10] Indeed, the absence of such provision “is not conclusive evidence of lack of control.”[11] In those cases, courts will require that the licensor “demonstrate actual control through inspection or supervision” to excuse the lack of an express contractual right to control quality.[12]

The efforts required by a trademark owner to police the quality of its mark will depend on the circumstances of a licensing arrangement and the subject goods or services. Courts may elect not to elevate form over substance by requiring the same policing rigor more akin to formal licensing and franchising relationships. In such cases, if the parties have engaged in “a close working relationship and may justifiably rely on each party’s intimacy with standards and procedures to ensure consistent quality and no actual decline in quality standards is demonstrated,” the court may instead depart from the purpose of the law and hold that abandonment did not occur “simply for want of all the inspection and control formalities.”[13]

Overall, the benefit of exercising quality controls over a licensee’s use of a trademark not only aids the trademark owner by ensuring that the quality of goods associated with their trademark remains consistent, but also mitigates the possibility of a trademark owner losing all of its rights under trademark law as a result of abandonment by naked licensing.

To the dissatisfaction of us lawyers, not all legal solutions are straightforward. However, the proactive measures a brand owner can (and should) take to avoid trademark abandonment from naked licensing are relatively easy to achieve with the help of experienced legal counsel.

Three Proactive Steps to Mitigate Naked Licensing

A trademark owner, along with legal counsel, should take three steps to avert a naked licensing determination:

1. Have a written agreement in place that licenses the use of the trademark and retains contractual rights over the quality of the goods or services associated with the trademark.
2. Implement measures for having (and documenting) actual quality control of the trademark use through site visits, audits, inspections, or similar meaningful oversight measures; and
3. Make sure to establish (and enforce) clear guidelines regarding quality to ensure consistency of the quality of use of the trademark.

If a business relationship involving the use of a trademark by a third party is already underway without these critical provisions in place, a trademark owner should immediately take steps to update the operative contractual documents to incorporate these concepts. Lastly, remember that actual policing over the quality of the licensee’s goods associated with the mark will provide evidence to help combat naked licensing claims, regardless of whether there exist quality control provisions in the contract.

Ultimately, businesses invest significant resources into building their brand and implementing various growth strategies. Still, they need to be cautious the next time they permit third parties to use their trademarks since the more third parties use it, the greater the possibility they may wear it out (and result in the inadvertent abandonment of valuable trademark rights).

—————————————————————-

This alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This alert is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, contact us if you need help addressing any of the issues discussed in this alert, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.

Unless expressly provided, this alert does not constitute written tax advice as described in 31 C.F.R. §10, et seq. and is not intended or written by us to be used and/or relied on as written tax advice for any purpose including, without limitation, the marketing of any transaction addressed herein. Any U.S. federal tax advice rendered by DarrowEverett LLP shall be conspicuously labeled as such, shall include a discussion of all relevant facts and circumstances, as well as of any representations, statements, findings, or agreements (including projections, financial forecasts, or appraisals) upon which we rely, applicable to transactions discussed therein in compliance with 31 C.F.R. §10.37, shall relate the applicable law and authorities to the facts, and shall set forth any applicable limits on the use of such advice.

1. See, e.g., Exxon Corp. v. Oxxford Clothes, Inc., 109 F. 3d 1070 (5th Cir. 1997).
2. See Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358, 367 (2d Cir. 1959).
3. Taco Cabana Int’l, Inc. v. Two Pesos, Inc., 932 F. 2d 1113, 1121 (5th Cir. 1991).
4. Patsy’s Italian Rest., Inc. v. Banas, 508 F. Supp. 2d 194, 212 (E.D.N.Y. 2007).
5. See Kentucky Fried Chicken Corp. v. Diversified Packaging Corp., 549 F.2d 368, 387 (5th Cir.1977).
6. See, e.g., Vineyard House v. Constellation Brands US Ops., 515 F. Supp. 3d 1061, 1078-79 (N.D. Cal. Jan. 26, 2021).
7. FreecycleSunnyvale v. Freecycle Network, 626 F. 3d 509, 615 (9th Cir. 2010).
8. Trademark owners should not rely solely on the estoppel defense in response to claims of naked licensing, as a court has “wide latitude” in applying the doctrine. See Emerson Creek Pottery, Inc. v. Emerson Creek Events, Inc., Case No. 6:20-cv-54 (W.D. Va. Feb. 11, 2022). Under the estoppel doctrine, founded in equity, a licensee will be estopped from contesting the validity of a licensor’s title during the course of the licensing arrangement, because a licensee may not” enjoy the use of the licensed mark while at the same time challenging the mark as being invalid.” Id. (citations omitted).
9. Groucho’s Franchise Sys., LLC v. Grouchy’s Deli, Inc., 683 F. App’x 826, 830 (11th Cir. 2017).
10. FreecycleSunnyvale, 626 F.3d at 517-18.
11. Id.
12. Id.
13. Taco Cabana, 932 F.2d at 1121.