Commonly Encountered Issues in Direct Response Industry Contracts27 Feb, 2011 By: Gregory J. Sater
Below are five of the most important contract-drafting issues that come up regularly during the course of negotiating a DR industry contract and, in particular, one through which a product is going to be licensed to a marketer. There are, of course, many more than five issues, so let’s think of these five as “The Nominees for Best Issues.”
Royalty Base: Everyone focuses on the royalty percentage, but if a royalty is going to be based on revenues, then the definition of what is included in (and what is excluded from) the revenue base is every bit as important. Will up-sells be included? Will the royalty be paid only on the initial transaction or also on one or more types of future sales made to the same customer? It’s important to consider the components of average order value (AOV). Processing and handling, for example, can constitute a significant part of AOV in a “buy-one, get-one free” (BOGO) offer.
Minimums: In other industries, a “minimum” can mean an obligation to pay a certain sum even if sales prove to be insufficient to achieve that sum via the usual royalty structure. In DR, however, a “minimum” usually does not obligate the licensee to pay the stated sum; rather, a failure to achieve sufficient sales to pay the stated “minimum” results only in the licensor’s right to terminate or, sometimes, in the licensee’s loss of exclusivity. This is usually spelled out in the contract, with the licensee having the option to pay the minimum if it wants to preserve its rights. In addition, consider whether there should be a rollover clause allowing the licensee to apply royalties paid in one year, in excess of the annual minimum, to future years when sales might be reduced.
Indemnity: Indemnification is a commitment by one party to the contract to pay money to the other party if, in the future, the other party is sued by someone else for one or more alleged legal violations, e.g., if the Federal Trade Commission (FTC) sues for false or deceptive advertising, or if a competitor sues for patent, copyright, trade dress or trademark infringement. It’s common to put the duty of indemnification on the party that controls the activity that could give rise to the future lawsuit, but is it always clear which party that is? Who is writing the script or other ad copy? Who is developing, or approving, the advertising claims? Who is picking the name of the product, who designed it and who is manufacturing it? Indemnification normally should be stated, expressly, to “survive” the termination of the contract.
Insurance: Because a party in the future may have insufficient funds to satisfy its duty of indemnification, DR contracts usually specify that one or both parties must have product liability and general commercial liability insurance and must name the other as an “additional insured.” Such clauses should require that insurance be maintained for a tail period after termination of the contract and after termination of sales.
Choice of Law; Venue Selection: It’s common for DR contracts to specify what state’s law is going to apply in the event of a dispute between the parties arising out of or relating to the contract. Possibly even more important, however, than a choice-of-law provision is a venue selection provision. Venue refers to the location where any future lawsuit or arbitration would take place between the parties. Being sued 3,000 miles away isn’t as convenient as being sued in your home city and state. Occasionally in DR contracts, one will see a venue selection clause that specifies one of two different venues, depending on which party brings the future lawsuit or arbitration. More commonly, however, either one state is specified or the contract is silent on the issue of venue.
In the rush to get a contract signed and a great product into distribution, don’t forget to cover these and other key issues, as an ounce of prevention is worth a pound of cure.
Gregory J. Sater is a partner in the Advertising, Media and Intellectual Property Group at Los Angeles-based Rutter Hobbs & Davidoff. He can be reached at (310) 286-1700, or via E-mail at firstname.lastname@example.org.