Settlement Agreements Involving Trademark Licenses: Important Terms to Be Included

In a recent decision involving a trademark settlement agreement, the U.S. Court of Appeals for the Fifth Circuit in Liberto v. D.F. Stauffer Biscuit Co., Inc., found that a final judgment in a trademark infringement action did not preclude a further action involving claims of trademark infringement, breach of contract, and the defense of incontestability. 441 F.3d 318 (5th Cir. 2006). The case highlights the significance of including certain important terms in a settlement agreement involving a trademark license.

Frank G. Liberto has manufactured and distributed snack foods using packaging containing yellow and red stripes since 1950. He registered his trademark with the U.S. Patent and Trademark Office in 1986. In 1987, D. F. Stauffer Biscuit Co., Inc. ('Stauffer') began using red and yellow stripes on the packaging for its animal crackers and applied for a trademark registration in 1988, which issued in 1989.

Liberto filed an initial action against Stauffer in 1996. After 3 years a settlement agreement was executed, by which Liberto agreed to dismiss the action and grant an exclusive license to Stauffer to the trademarked design. Stauffer agreed to enforce the mark against other food manufacturers and pay Liberto royalties for its use of the design. The agreement contemplated that the parties would continue to negotiate specific terms of the license. The parties made a joint motion for final judgment, and the court entered the settlement agreement as final judgment in the case.

After judgment, the parties continued to negotiate the terms of the license. Disagreement over royalty payments resulted in arbitration proceedings. Liberto filed a second federal court action in 2002 alleging federal trademark infringement, common law trademark infringement, unfair competition, dilution, and bad faith negotiation. In March 2004, the district court ruled on the parties' cross-motions for summary judgment, granting partial judgment for Liberto on his claim of federal trademark infringement, trademark infringement under Texas state law, trademark dilution, unfair competition, and breach of contract. The district court enjoined Stauffer from using the trademarked design, and Stauffer appealed.

The U.S. Court of Appeals for the Fifth Circuit vacated and remanded the district court's grant of injunctive relief. The Fifth Circuit found that the settlement agreement was an unenforceable 'agreement to agree' because it lacked important terms necessary in a settlement agreement, particularly one involving a trademark license. Id. at 323-25. The Fifth Circuit also concluded that the district court improperly applied the doctrines of res judicata and judicial and licensee estoppel, because the final judgment in the previous litigation did not constitute a final judgment 'on the merits.' Id. at 325-26.

Important Terms to Include in a Settlement Agreement Involving a Trademark License

The Liberto case highlights important elements of a settlement agreement involving a trademark license. The settlement agreement in Liberto left open for future negotiation certain critical provisions, such as the duration of the license, the grounds for its renewal or termination, and the time of performance. Id. at 324-25. The agreement also failed to specify how the licensed mark could be used, and other elements of quality control. Id. Finally, the agreement failed to include a claim preclusion clause. Id. at 326-27. Each of these elements is important, if not essential, to a settlement agreement involving the licensing of a trademark.

Necessary Terms

Settlement agreements are treated as contracts and require the same definiteness as other contracts. See Corbin on Contracts '4.1 (3d ed. 2005) ('Vagueness of expression, indefiniteness and uncertainty as to any of the essential terms of an agreement, have often been held to prevent the creation of an enforceable contract.') Trademark license agreements, in general, are governed by the general rules of contracts. See McCarthy on Trademarks and Unfair Competition '18:43 (4th ed. 2006). In the Liberto case, the court found that certain terms were essential to a trademark license agreement under Texas law. Liberto, 441 F.3d at 323. The parties' failure to include the terms listed above caused the Fifth Circuit to conclude that the settlement agreement was a mere 'agreement to agree' and not a contract. Id. at 325.

Most importantly, the Liberto agreement failed to contain a clause specifying the methods of controlling quality. Id. at 324-25. The licensor of a registered trademark has an affirmative obligation to prevent misleading uses of the licensed mark by its licensees. See Dawn Donut Co. v. Hart's Food Stores, Inc., 267 F.2d 358, 366 (2d Cir. 1959). Licensing a mark without adequate control over the quality of trademarked goods and services may cause the mark to lose its good will and can result in abandonment or cancellation of the trademark registration. See Barcamerica Int'l USA Trust v. Tyfield Imps., Inc., 289 F.3d 589 (9th Cir. 2002) (agreeing with the lower court that Barcamerica engaged in naked licensing of its mark which appropriately resulted in the forfeiture of its rights in the mark and cancellation of its registration of the mark). A term relating to quality control is a very important, if not essential, element of a trademark license.

What constitutes sufficient quality control? Courts have found that it is irrelevant whether the quality of the goods is objectively 'good' or 'bad,' rather what matters is that the quality of goods and services sold under the mark is consistent and predictable. See Barcamerica Int'l USA Trust, 289 F.3d at 598 (citing McCarthy on Trademarks and Unfair Competition '18:55 at 18-94). The amount of quality control necessary varies depending upon the type of goods and the licensing arrangements. See McCarthy on Trademarks and Unfair Competition '18:55 (4th ed. 2006).

The reported decisions relating to quality control are inconsistent and difficult to reconcile. Id. However, many of the cases hold that the critical question is determining whether there is actual control, not merely the right to control. See, e.g., General Motors Corp. v. Gibson Chemical & Oil Corp., 786 F.2d 105 (2d Cir. 1986); see also Dawn Donut Co., 267 F.2d at 368 (2d Cir. 1959) (finding that the absence of an express contract right to inspect and supervise a licensee's operations did not necessarily mean that the licensor failed to comply with the Lanham Act, provided that the licensor did in fact exercise control). Further, there must be a balance between too little control, which may result in invalidation of the license and abandonment of the mark, and too much control, which may violate the Federal antitrust laws. McCarthy on Trademarks and Unfair Competition '18:62 (4th ed. 2006).

When Does a Settlement Agreement Constitute a Final Judgment on the Merits?

In Liberto, the Fifth Circuit held that the lower court incorrectly applied the doctrines of res judicata and judicial and licensee estoppel. Liberto, 441 F.3d 318. The Liberto court found that the judgment in the previous litigation did not qualify as a judgment 'on the merits' because the court never adjudicated the merits of Liberto's trademark infringement claim. Id. at 326. Furthermore, the settlement agreement embodied in the final judgment did not contain a clause relating to claim preclusion, nor did it 'tacitly adjudicate the merits of trademark infringement.' Id. at 326-27. The Fifth Circuit held that Stauffer was not judicially estopped from raising any defense to trademark infringement, because in the previous case Stauffer did not 'urge or convince the court to accept any position in conflict with its defense to trademark infringement.' Id. at 328.

When determining the effect to be given to a judgment or decree entered by the parties' consent, 'consideration is to be given to their intention with respect to the finality to be accorded the decree as reflected by the record and the words of their agreement.' Id. at note 24 (citing Kaspar Wire Works, Inc. v. Leco Engineering & Machine, Inc., 575 F.2d 530, 540 (5th Cir. 1978)). Settlement agreements, in general, should include a clause precluding further litigation of the subject matter litigated in the first case. Furthermore, while a clause estopping a trademark licensee from challenging the validity of the licensor's mark may be upheld, some courts have struck non-challenge clauses finding that the public interest outweighs the agreement of the parties. See Idaho Potato Comm'n v. M & M Produce Farm & Sales, 335 F.3d 130 (2d Cir. 2003), cert. denied, 124 S. Ct. 2066 (2004). In Liberto, the court did not consider licensee estoppel, because it determined that the license was invalid.

Conclusion

Liberto highlights several of the important terms and clauses to include in a settlement agreement involving a trademark license. Most importantly, license agreements should contain language relating to quality control, and a licensor must understand that failure to police his licensees can result in forfeiture and/or cancellation of his trademark rights. Finally, in the context of settlement agreements, a carefully drafted preclusion clause can prevent future litigation between the parties.

Howard J. Shire is a partner at Kenyon & Kenyon LLP and is editor-in-chief of this newsletter. He can be reached at 212-908-6205 or [email protected]. Amy Feinsilver Bersh is an associate at Kenyon & Kenyon LLP. She can be reached at 212-908-6341 or [email protected].

In a recent decision involving a trademark settlement agreement, the U.S. Court of Appeals for the Fifth Circuit in Liberto v. D.F. Stauffer Biscuit Co., Inc., found that a final judgment in a trademark infringement action did not preclude a further action involving claims of trademark infringement, breach of contract, and the defense of incontestability. 441 F.3d 318 (5th Cir. 2006). The case highlights the significance of including certain important terms in a settlement agreement involving a trademark license.

Frank G. Liberto has manufactured and distributed snack foods using packaging containing yellow and red stripes since 1950. He registered his trademark with the U.S. Patent and Trademark Office in 1986. In 1987, D. F. Stauffer Biscuit Co., Inc. ('Stauffer') began using red and yellow stripes on the packaging for its animal crackers and applied for a trademark registration in 1988, which issued in 1989.

Liberto filed an initial action against Stauffer in 1996. After 3 years a settlement agreement was executed, by which Liberto agreed to dismiss the action and grant an exclusive license to Stauffer to the trademarked design. Stauffer agreed to enforce the mark against other food manufacturers and pay Liberto royalties for its use of the design. The agreement contemplated that the parties would continue to negotiate specific terms of the license. The parties made a joint motion for final judgment, and the court entered the settlement agreement as final judgment in the case.

After judgment, the parties continued to negotiate the terms of the license. Disagreement over royalty payments resulted in arbitration proceedings. Liberto filed a second federal court action in 2002 alleging federal trademark infringement, common law trademark infringement, unfair competition, dilution, and bad faith negotiation. In March 2004, the district court ruled on the parties' cross-motions for summary judgment, granting partial judgment for Liberto on his claim of federal trademark infringement, trademark infringement under Texas state law, trademark dilution, unfair competition, and breach of contract. The district court enjoined Stauffer from using the trademarked design, and Stauffer appealed.

The U.S. Court of Appeals for the Fifth Circuit vacated and remanded the district court's grant of injunctive relief. The Fifth Circuit found that the settlement agreement was an unenforceable 'agreement to agree' because it lacked important terms necessary in a settlement agreement, particularly one involving a trademark license. Id. at 323-25. The Fifth Circuit also concluded that the district court improperly applied the doctrines of res judicata and judicial and licensee estoppel, because the final judgment in the previous litigation did not constitute a final judgment 'on the merits.' Id. at 325-26.

Important Terms to Include in a Settlement Agreement Involving a Trademark License

The Liberto case highlights important elements of a settlement agreement involving a trademark license. The settlement agreement in Liberto left open for future negotiation certain critical provisions, such as the duration of the license, the grounds for its renewal or termination, and the time of performance. Id. at 324-25. The agreement also failed to specify how the licensed mark could be used, and other elements of quality control. Id. Finally, the agreement failed to include a claim preclusion clause. Id. at 326-27. Each of these elements is important, if not essential, to a settlement agreement involving the licensing of a trademark.

Necessary Terms

Settlement agreements are treated as contracts and require the same definiteness as other contracts. See Corbin on Contracts '4.1 (3d ed. 2005) ('Vagueness of expression, indefiniteness and uncertainty as to any of the essential terms of an agreement, have often been held to prevent the creation of an enforceable contract.') Trademark license agreements, in general, are governed by the general rules of contracts. See McCarthy on Trademarks and Unfair Competition '18:43 (4th ed. 2006). In the Liberto case, the court found that certain terms were essential to a trademark license agreement under Texas law. Liberto, 441 F.3d at 323. The parties' failure to include the terms listed above caused the Fifth Circuit to conclude that the settlement agreement was a mere 'agreement to agree' and not a contract. Id. at 325.

Most importantly, the Liberto agreement failed to contain a clause specifying the methods of controlling quality. Id. at 324-25. The licensor of a registered trademark has an affirmative obligation to prevent misleading uses of the licensed mark by its licensees. See Dawn Donut Co. v. Hart's Food Stores, Inc., 267 F.2d 358, 366 (2d Cir. 1959). Licensing a mark without adequate control over the quality of trademarked goods and services may cause the mark to lose its good will and can result in abandonment or cancellation of the trademark registration. See Barcamerica Int'l USA Trust v. Tyfield Imps., Inc., 289 F.3d 589 (9th Cir. 2002) (agreeing with the lower court that Barcamerica engaged in naked licensing of its mark which appropriately resulted in the forfeiture of its rights in the mark and cancellation of its registration of the mark). A term relating to quality control is a very important, if not essential, element of a trademark license.

What constitutes sufficient quality control? Courts have found that it is irrelevant whether the quality of the goods is objectively 'good' or 'bad,' rather what matters is that the quality of goods and services sold under the mark is consistent and predictable. See Barcamerica Int'l USA Trust, 289 F.3d at 598 (citing McCarthy on Trademarks and Unfair Competition '18:55 at 18-94). The amount of quality control necessary varies depending upon the type of goods and the licensing arrangements. See McCarthy on Trademarks and Unfair Competition '18:55 (4th ed. 2006).

The reported decisions relating to quality control are inconsistent and difficult to reconcile. Id. However, many of the cases hold that the critical question is determining whether there is actual control, not merely the right to control. See, e.g., General Motors Corp. v. Gibson Chemical & Oil Corp., 786 F.2d 105 (2d Cir. 1986); see also Dawn Donut Co., 267 F.2d at 368 (2d Cir. 1959) (finding that the absence of an express contract right to inspect and supervise a licensee's operations did not necessarily mean that the licensor failed to comply with the Lanham Act, provided that the licensor did in fact exercise control). Further, there must be a balance between too little control, which may result in invalidation of the license and abandonment of the mark, and too much control, which may violate the Federal antitrust laws. McCarthy on Trademarks and Unfair Competition '18:62 (4th ed. 2006).

When Does a Settlement Agreement Constitute a Final Judgment on the Merits?

In Liberto, the Fifth Circuit held that the lower court incorrectly applied the doctrines of res judicata and judicial and licensee estoppel. Liberto, 441 F.3d 318. The Liberto court found that the judgment in the previous litigation did not qualify as a judgment 'on the merits' because the court never adjudicated the merits of Liberto's trademark infringement claim. Id. at 326. Furthermore, the settlement agreement embodied in the final judgment did not contain a clause relating to claim preclusion, nor did it 'tacitly adjudicate the merits of trademark infringement.' Id. at 326-27. The Fifth Circuit held that Stauffer was not judicially estopped from raising any defense to trademark infringement, because in the previous case Stauffer did not 'urge or convince the court to accept any position in conflict with its defense to trademark infringement.' Id. at 328.

When determining the effect to be given to a judgment or decree entered by the parties' consent, 'consideration is to be given to their intention with respect to the finality to be accorded the decree as reflected by the record and the words of their agreement.' Id. at note 24 (citing Kaspar Wire Works, Inc. v. Leco Engineering & Machine, Inc., 575 F.2d 530, 540 (5th Cir. 1978)). Settlement agreements, in general, should include a clause precluding further litigation of the subject matter litigated in the first case. Furthermore, while a clause estopping a trademark licensee from challenging the validity of the licensor's mark may be upheld, some courts have struck non-challenge clauses finding that the public interest outweighs the agreement of the parties. See Idaho Potato Comm'n v. M & M Produce Farm & Sales, 335 F.3d 130 (2d Cir. 2003), cert. denied, 124 S. Ct. 2066 (2004). In Liberto, the court did not consider licensee estoppel, because it determined that the license was invalid.

Conclusion

Liberto highlights several of the important terms and clauses to include in a settlement agreement involving a trademark license. Most importantly, license agreements should contain language relating to quality control, and a licensor must understand that failure to police his licensees can result in forfeiture and/or cancellation of his trademark rights. Finally, in the context of settlement agreements, a carefully drafted preclusion clause can prevent future litigation between the parties.

Howard J. Shire is a partner at Kenyon & Kenyon LLP and is editor-in-chief of this newsletter. He can be reached at 212-908-6205 or [email protected]. Amy Feinsilver Bersh is an associate at Kenyon & Kenyon LLP. She can be reached at 212-908-6341 or [email protected].