An existing intellectual property license often overlaps with the licensor's prospective dealings with a successor licensee. This commercial and industry reality often creates complex questions concerning interpretation of ambiguous clauses of the licenses in the event of dispute. For instance, when a license concerns an industry such as consumer products which inescapably requires months, if not years of planning, how do the parties manage to protect their respective rights toward the end of the license's duration? A licensee recently discovered the pitfalls of such a failure to protect its right, as the U.S. Court of Appeals for the Eleventh Circuit held that the ambiguous term of the license meant that the licensee could not prevent the licensor from negotiating and executing a term sheet with a successor licensee, during the final year of the license. See Original Appalachian Artworks v. Jakks Pac., — F'Appx. —-, 2017 WL 5508498 (11th Cir. Nov. 17, 2017).

Facts and Procedural History

Plaintiff Original Appalachian Artworks owns the Cabbage Patch Kids intellectual property (IP), which it licenses to third parties who manufacture and distribute Cabbage Patch Kids dolls and accessories. Plaintiff licensed the IP to JAKKS Pacific (defendant) pursuant to two license agreements that expired on Dec. 31, 2014 (the licenses). Defendant had the exclusive right to use the IP in connection with “the manufacture (including the right to have manufactured), importation, sale, advertising, promotion, shipment and distribution” of Cabbage Patch Kids dolls.

In May 2014, plaintiff chose a new licensee, Wicked Cool Toys, to manufacture and sell Cabbage Patch Kids products starting in 2015 when the licenses expired. Plaintiff and Wicked Cool entered into a deal memorandum on May 30, 2014, which authorized Wicked Cool to immediately commence the creation of a new line of Cabbage Patch Kids for launch in 2015.

Defendant asserted that plaintiff breached the provision of the licenses reserving plaintiff's right to “engage, during the 365-day period prior to the termination or expiration of [the licenses] [i.e. Jan. 1, 2014 to Dec. 31, 2014], in the negotiation, with potential licensees … of one or more license agreements granting licenses with respect to” products covered by the licenses' “to become effective upon the expiration or earlier termination of [the licenses].” (emphasis added). According to defendant, plaintiff could only “negotiate” with Wicked Cool in 2014 and could not sign the deal memorandum nor take any other action to further the goal of launching a new line of Cabbage Patch Kids dolls in 2015.

Plaintiff countered that the licenses did not grant defendant exclusivity concerning the types of activities Wicked Cool engaged in, which plaintiff characterized as “design and development activities preliminary to the manufacturing and launch” of a new line in 2015. Plaintiffs also cited a provision in the licenses granting defendant a non-exclusive right to sell products for 120 days after expiration of the licenses. Consequently, the “nature of the toy industry” would preclude a successor licensee from introducing a new line of Cabbage Patch Kids dolls within 120 days after expiration of the licenses “unless it were permitted to engage in some preliminary or preparatory activities in 2014.”

Arbitration Award in Plaintiff's Favor

Pursuant to the forum selection clause in the licenses, the parties commenced arbitration. Reasoning that plaintiff had breached the licenses, defendant ceased paying royalties for continued use of the IP.

In January 2016, an arbitrator concluded that plaintiff did not breach the licenses (the “award”) on grounds that the “key term” of the license was plaintiff's reservation of rights to engage, in 2014, in the negotiation of a new license with Wicked Cool to take effect in 2015. While acknowledging that the licenses, “[r]ead literally, without examination or context,” permitted plaintiff only to “negotiate a new license in 2014 and not do one thing more to obtain a new licensee until the onset of the new year,” the arbitrator concluded nonetheless that the “undisputed commercial reality” that, without some preliminary activities in 2014, Wicked Cool would not be able to sell any Cabbage Patch Dolls in 2015, rendered the provision ambiguous. The arbitrator rejected defendant's contention that the parties intended such a result when executing the licenses. Instead, the arbitrator held that it was the intention of the parties to allow the execution of a successor license in 2014, given that the successor licensee [Wicked Cool] would need to transition into producing a new line of Cabbage Patch Kids dolls while concomitantly building “trade awareness of its accession to the role of licensee and of the products it intends to offer”—without the “de facto creation of the 'gap' of about one year.”

The arbitrator ordered defendant to pay $1,117,559 in unpaid royalties. Defendant filed a motion in a Georgia district court to partially vacate the award and plaintiff filed a motion to confirm the award. The district court denied defendant's motion, granted plaintiff's motion and confirmed the award.

Legal Analysis and Conclusions

The appeals court reviewed the confirmation of the award under the overarching principle that “[b]ecause arbitration is alternative to litigation, judicial review of arbitration decisions is among the narrowest known to law.” See AIG Baker Sterling Heights v. Am. Multi-Cinema, 508 F.3d 995, 1001 (11th Cir. 2007). Defendant argued that the arbitrator manifestly disregarded the law and overstepped his authority under Georgia law, applied pursuant to the licenses' choice-of-law provision. The court disagreed on both fronts.

First, the court held that the arbitrator did not manifestly disregard the law when he interpreted the Georgia parol evidence rule to allow him to consider extrinsic evidence—the commercial context of the relevant market—when determining that the provision of the licenses concerning plaintiff's negotiation of a successor license in 2014 to be ambiguous. Manifest disregard of law requires “concrete evidence” of the arbitrator's specific intent to purposefully disregard the law, considered absent in the instant case, as even assuming arguendo that the arbitrator misapplied the Georgia parol evidence rule, failure to apply the law is “insufficient to show manifest disregard.”

Second, the court concluded that the arbitrator did not overstep his authority because he did not “determine [a matter] beyond the scope of the case…not properly before him or her,” such a determination by the appeals court which does not entail “decid[ing] the rightness or wrongness” of the interpretation of the licenses. (citations omitted). Rather, the arbitrator drew his decision from the “essence” of the licenses. Since the arbitration centered on the parties' dispute about the construction, meaning and enforceability of certain terms of the licenses, it was the arbitrator's decision to decide the meaning of these provisions—which he concluded permitted plaintiff to negotiate with Wicked Cool in 2014 for a successor license to become effective in 2015.

Defendant fared no better in its attempt to vacate the award under the Federal Arbitration Act (9 U.S.C. §10(a)) on grounds that the arbitrator “exceeded [his] powers.” An arbitration award will avoid vacatur if the arbitrator even arguably interpreted the parties' contract. As previously noted, the court believed the negotiation provision of the licenses was ambiguous on its face and therefore open to interpretation. The arbitrator's interpretation was sufficient to grant plaintiff's motion to confirm, as he “arguably interpreted” the negotiation provision by attempting to give meaning, through the incorporation of extrinsic evidence regarding industry practice, to whether the negotiation provision contemplated preparatory activities by plaintiff and Wicked Cool in 2014 so as to ensure the possibility of successor licensee Wicked Cool launching a new line of Cabbage Patch Dolls in 2015. Accordingly, the court affirmed the judgment of the district court confirming the award.

Conclusion

It is axiomatic that imprecise drafting and an absence of forward thinking often portends litigation involving interpretation and construction of a license. As the JAKKS Pacific case illustrates, only after an arbitrator and/or court deems a license term ambiguous will heightened scrutiny be triggered. In this case, the term “negotiation” was considered ambiguous, given the commercial reality of market for the Cabbage Patch Kids dolls. As a result, context was considered to the defendant's detriment, overriding its challenge under the parol evidence rule. If negotiation is defined more specifically, perhaps plaintiff cannot cite industry protocol and therefore defendant prevails or the dispute is avoided entirely since plaintiff decides not to negotiate with Wicked Cool during the duration of the license.

Richard Raysman is a partner at Holland & Knight and Peter Brown is the principal at Peter Brown & Associates. They are co-authors of “Computer Law: Drafting and Negotiating Forms and Agreements” (Law Journal Press).