The busy holiday shopping season has concluded; we hope that it was good to all our friends and colleagues.  As in past years, among the best-loved gifts were those that bore famous-brand labels—names that consumers associate with quality, status, a particular lifestyle message, or any combination of tangible and intangible attributes that enhance the market value of goods and services. 

 

For a lender or prospective lender, brand names are also special.  They help define the market and prospects for a company’s offerings, and can embody substantial and valuable goodwill.  Where an owned and famous trademark is among a company’s assets, it is often an important item of non-borrowing-base (“boot”) collateral that helps support the lender’s underwriting thesis.  In a liquidation, famous marks can contribute significantly to the ultimate recovery.  We have all seen the examples of national retailers such as Toys“R”Us and Sharper Image, that now survive principally in limited, e-commerce form, because of the value of their brands that were sold in liquidation.  Alternatively, any number of struggling businesses and associated credit facilities have been propped up and turned around by adding a secured senior or subordinated term loan facility largely supported by the value of their intellectual property.  This is all potentially helpful in the case of a company that owns its trademarks, tradenames, and other intellectual property.  However, we must assess critically the special structuring and strategic considerations associated with lending to a business that uses, but does not own, famous marks.

The business that manufactures and/or sells its products utilizing rights to marks it does not own, is generally a licensee.  It has the benefit of licensed rights for specified purposes, applications, geography, duration, channels of distribution, etc.  Where the licensed rights are material to the conduct of the business, the license itself is a material contract of the business—on the same order from a lender’s perspective as an indenture, or an exclusive requirement, output, or fulfillment services contract.  Accordingly, examining and addressing the license(s) will be fundamental to the underwriting and structuring phases of a proposed financing transaction. 

The focus of the review and analysis, of course, is the underlying terms of the license—but with a particular emphasis on the availability or unavailability to the lender or its agents of the licensed rights in connection with an exercise of the rights and remedies of a secured creditor.  Suppose, for example, the license permits the manufacture and sale of branded goods of a particular type by the licensee in a specified geographic area (e.g., U.S. and Canada) for a term of three years.  The review and analysis should include determinations at three levels, as follows:

i. Licensed Rights and the Business Model

The rights included under the license must line up correctly with the business of the prospective borrower as conducted and intended to be conducted during the term of the proposed credit facility.  If the projections envision sales in both the U.S. and Canada, but the license does not include Canada, that would be a problem.  Similarly, if the covered goods include all wearing apparel, but do not include other items the prospective borrower intends to make and sell, such as eyewear, small leather goods,and perfume, then there is a mismatch between the rights that are available and the needed rights.  So the first level of inquiry is simply confirming that the requisite rights will be available in order to enable the company to conduct business as anticipated.

ii. Risks to the Licensed Rights

Even when the scope of the license is effectively sufficient to enable the company to conduct its business as intended, its rights to do so are not unconditional.  In addition to the inevitable payment of royalties, the owner of valuable rights generally retains the ability to police the use of their famous name—both to ensure the preservation and value of its good name and because a failure to do so could put the effectiveness of its rights in legal peril.  In this connection, the continued availability of the rights under the license may be subject not only to the payment of required royalties, but maintenance of elaborate quality-control standards designed to ensure that the licensee uses the trademarks in a manner that preserves and protects the value of the marks.  Thus, the second level of inquiry is a due diligence assessment of the licensee’s current use of the licensed rights, and a determination of the risk that the licensed rights could be impaired or lost.

iii. Assignment and Sublicense

Finally, and most importantly, the lender must ascertain whether the license permits assignment and/or sublicense of the rights under the license and, if so, under what circumstances and subject to what conditions.  Specifically, the lender wants to be confident that it has access to an irrevocable, royalty-free right to use the relevant intellectual property to dispose of collateral bearing the marks without modification and in a manner consistent with its exit strategy.  If and when necessary, the lLender must be able to implement its collateral disposition strategy as determined in the initial underwriting.  This can mean a range of things and the approach to the issue may flow directly from the underlying license terms. 

In many instances, the underlying license to the borrower may explicitly address the means by which inventory will be handled after a termination of the license—whether resulting from a default of the borrower to the licensor, or otherwise.  The licensor, concerned for its reputation in the marketplace, may include in its license a requirement (or option in its favor) to buy back the inventory in the possession of the licensee.  As one might expect, however, the buyback price often reflects a re-stocking fee and is further reduced to cover the costs of shipment and other expenses.  If the buyback includes a20% “discount” and the advance rate against this inventory was 90%, then instead of having a cushion, a lender would be undersecured if it were to rely on this arrangement for its exit strategy--but again, in the initial underwriting stage, this is valuable data.

In other cases, a license may contain a pre-negotiated sell-off right allowing for post-termination disposition of inventory on specific terms.  The keys to reviewing such a right are two-fold:  first, how does it line up with the exit plan of the lender, and second, is it exercisable by the lender or its agent—or only the borrower?  As to the first consideration, if the appraisal and related underwriting contemplated a 120-day liquidation, but the sell-off right is only 60 days, there is an obvious disconnect and impairment of net realizable value.  Similarly, suppose the lender’s plan for potentially liquidating inventory contemplates selling through existing channels for 30 days and then through discounters or other vendors thereafter.  However, if sale through any channels other than the existing channels is strictly prohibited, this approach would be unavailing.  Regarding the second consideration, a non-assignable sell-off right will necessitate liquidation sales by the borrower through its existing channels.  This approach often helps maximize value, and may be acceptable in the case of a borrower that is owned by a sponsor with which a lender has a long-standing and diversified lending relationship.  In those cases, the lender may reasonably decide to rely upon the cooperation of management, even post-default.  But in the case of a large family business, the risk that the company simply “throws the lender the keys” represents an unacceptable risk if the lender will be left with collateral that it simply is prohibited from selling.

We recall a particular Chapter 11 bankruptcy case later converted to Chapter 7 bankruptcy case in which a distributor and retailer of cosmetics and perfumes was the exclusive seller of a famous perfume that bore the licensed name and image of a prominent actress.  The license was explicit.  Under no circumstances could the perfume be sold other than in the borrower’s stores.  When a warehouse filled with this brand of perfume remained unsold following completion of the liquidation and store closures, the inventory never saw the light of day.  Fortunately, the lender knew what portion of the collateral this product represented—and in the structuring and documentation stages, adjusted eligibility criteria, reserves, and advance rates to account for the risks.  But in the absence of strategic planning, and without the benefit of assignable rights, the outcome for the lender might not have smelled as sweet as the product!

iv.  A Special License in Favor of the Lender

The post-default rights of the borrower may be non-assignable or inadequate, or it may be improvident in the circumstances to anticipate relying upon the borrower to facilitate collateral disposition.  In such cases, the lender and its counsel may conclude that in order to provide availability under the borrowing base for branded inventory, the lender must receive a royalty-free, irrevocable license to use the marks in question on acceptable terms for the exercise of its rights and remedies as a secured creditor.  What that license might look like, and how the process of negotiating it with the owner of the rights may play out, is fraught with permutations to consider.

a. What Lender Rights are Realistic?

Not all trademarks are created equal.  The most famous brand names have multi-billion dollar valuations[1] and embody compelling and irreplaceable market power.  As noted above, owners of such brands (or even smaller, but exclusive, names) usually would prefer that they have an initial right to take back their goods in a foreclosure situation, rather than risk their “misuse” and attendant impairment of their value.  These rights can take the form of a “put” right in favor of the lender (who can compel repurchase) or an option right in favor of the registered trademark owner (who can elect to repurchase).  In either case, the key considerations are the “triggers” for the right, how much will be paid for the branded inventory, how quickly the right must or can be exercised, and whether all or only some of the inventory is subject to the arrangement.  Including a provision such as this in a form of license—almost like including a buy-out right in an intercreditor agreement—can help overcome other potential concerns by granting the trademark owner the power to control the situation on a mutually acceptable basis.

b.  How a Lender Might Liquidate

The first and best option in favor of the lender is an irrevocable, royalty-free license for a fixed term, that allows disposition of the inventory (and possibly also the completion of work-in process, if applicable), by the lender or its agents.  In addition to the liquidation window (perhaps 90 or 120 days), the lender and trademark owner must negotiate the geographic scope and channels of distribution for the sale of the inventory.  If a trademark owner has traditionally allowed its branded products to be sold only through “authorized dealers” and/or other exclusive sellers, it would be unrealistic for the lender to expect to be allowed to sell off the inventory through “bargain basement” style channels of distribution.  However, a licensor may allow some flexibility.  For example, after declining to exercise a purchase option, a licensor might well allow (following an initial sell-off period through historic channels only) on-line inventory sales, consolidation with other like goods, and/or sale through next level, slightly lower-tier outlets (for a limited additional liquidation term).

c. Assumed Obligations

When a lender bargains for the right to use licensed marks, he will inevitably assume in exchange certain responsibilities to the trademark owner.  The delicate balance is to ensure that the needed rights will be available, without taking on obligations that are too costly or impractical for a lending institution or its agents to fulfill.   While a lender might acknowledge that the signage and advertising materials associated with sales of the goods must be of a certain character (and that the associated costs can be reasonably managed), offering and honoring prospective product warranty support is probably outside the realm.  Lender and its counsel, working together, must ensure that they know the requirements of the licensor by negotiating with them directly and in advance.  This will afford the lender a level of certainty concerning timing, methodology, costs, logistics, timeframe, and scope of rights, all for the compelling goals of underwriting a successful financing that hopefully will not need an exit strategy—but will have a sound one in place. 

About the authors: 

John DePledge is head of Asset-Based Lending at Leumi Business Credit, a division of Bank Leumi USA. He is also president of the Secured Finance Network.

Lon Singer is a Senior Partner in the New York office of the Financial Services Group of Riemer & Braunstein LLP.

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