Licensors: facing unexpected bumps in the road

Of particular interest on the licensing map is South East Asia—a manufacturing powerhouse for all sorts of electronics, electrical components and electronic devices, such as cell phones, semiconductor chips, hard disk drives and brushless DC fans.

Licensors know well that some licensees are more reliable and trustworthy than others. Companies should learn how to deal with the less reliable kind before they have to solve a problem.

As a result of arm’s length negotiations in personal meetings in Taiwan, a Taiwanese DC fan manufacturer entered into an agreement with a licensor, which covered brushless DC fans for sale anywhere in the world. The licence agreement also covered the Taiwanese fan manufacturer’s subsidiaries, including in the US and in Japan.

A non-exclusive and non-transferable licence, without right of sub-licence, granted the licensee the right to practise the process of making, using and selling licensed products under licensed patents in any country in the world, in exchange for timely royalty payments.

Payments had to be made in US dollars on a quarterly basis, with each quarterly payment due at the same time as the corresponding written report, within 30 days of the end of a quarter. Each written report had to list model numbers for licensed products, the number of units sold of each model, and the net sales of each model.

The licensee was bound to keep records for the purpose of an audit in sufficient detail to enable the royalties payable under the respective agreement to be determined for a period of five years from the dates to which they pertained.

An auditor was supposed to gather information from the licensee to the extent necessary to verify the records and payments provided for in the licence agreement. If the audit results showed an underpayment of royalties by more than 5 percent, the licensee would be responsible for the audit costs and an additional payment of a certain percentage of the underpaid amount, as well as interest on any unpaid balance.

It was agreed to construe the agreement according to the laws of the US. Both parties submitted themselves to the jurisdiction of the US district court for the Northern District of Illinois,

Eastern division, with the proviso that, for any breach of this agreement by the licensee, the licensor could choose to file suit in an appropriate court in the Republic of China (Taiwan). If the licensee defaulted or breached any material provision of the agreement, or failed to pay any of the payments or royalties due, then the licensor reserved the right to cancel the licence.

‘Interviewing’ various employees of the licensee on a semi-yearly/yearly basis in Taiwan made it possible to verify information given orally which contradicted the reported sales numbers substantially. Massive under-reporting seemed to have been the case.

“It was possible to establish, through witness affidavits, that sales numbers had been provided to the plaintiff. This turned out to be sufficient proof for the court to assess damages.”

Despite the audit provision in the licence agreement, during those maintenance visits to the licensee in Taiwan, the goal was to gather verifiable data informally. Obviously, this can work only if the licensee is cooperative. Even though the licensee repeatedly promised to provide data, the information was never given to the licensor.

As a result, an official audit was requested in accordance with the licence agreement. The audit began with two auditors, both fluent in English. Their report was discouraging. Despite the fact that the auditors were allowed to enter the facility of the licensee in Taiwan, the only information provided to them was the known royalty reports and the licence agreement. Countless excuses were made by the licensee.

Even though the auditors had provided a specific list of documents they needed to review before the visit, they were sent back empty-handed.

In a second audit attempt the auditors were, once again, not provided with the information needed, including access to the sales account, sales invoices, purchase orders, sales orders by serial numbers, bank accounts in general, additional documents and computer data. Blocking the auditors constituted a clear breach of the agreement. Therefore, despite many attempts to resolve the issue amicably the only option left had to be pursued: filing a lawsuit.

According to the complaint, the Taiwanese licensee had not properly reported or paid royalties to the licensor, which constituted a material breach of the agreement. The licensor claimed that the licensee refused to allow independent auditors to carry out an audit of the licensee’s records in order to ensure that appropriate royalties had been paid. The licensing company was seeking damages including the royalties due under the licence agreement, interest and legal costs.

With the complaint filed and served to the licensee (defendant), litigation commenced. Represented by a Chicago law firm, the Taiwanese defendant tried to dismiss the suit for lack of jurisdiction, despite the fact that the licensing agreement clearly and unambiguously stated the venue.

To the plaintiff’s surprise, counsel for the defendant withdrew the representation. The Taiwanese defendant then disappeared, and faced an order of default and damages. The defendant was in default for failing to appear, answer or otherwise plead.

The litigation resulted in an order issued by the circuit court, finding that the Taiwanese defendant was properly served under the Hague convention, and that by filing the motion to dismiss, it had submitted itself to the jurisdiction of the court.

Even though that particular motion to dismiss was later stricken, and the defendant in Taiwan and its US subsidiary were ordered to file an answer, both defendants failed to file a response or appear in court and were, therefore, found to be in default. A letter submitted to the court by the Taiwanese defendant failed to meet the standards of a legally sufficient answer or pleading. The defendant was ordered to pay a seven-digit dollar amount. This judgment was not appealed by the defendant.

The question arises of how exactly the plaintiff was able to substantiate damages satisfactorily with the court. Particular sales amounts had been provided to the licensor orally during meetings with the licensee in Taiwan. It was then possible to establish, through witness affidavits, that sales numbers had been provided to the licensor (plaintiff). This turned out to be sufficient proof for the court to assess damages.

With information acquired by a private investigator, it turned out that the Taiwanese brushless DC fan manufacturer had not only closed its US subsidiary but had even shifted its import channel from a US West Coast city to a port in Canada. The verdict had to be enforced in Taiwan, since all US assets seemed to have disappeared. With the help of a local Taiwanese attorney, it was possible successfully to enforce the US court order in Taiwan, against the Taiwanese defendant.

In the end, persistence in gathering information paid off and it was possible to track down the licensee and prove its underreporting. Alongside an experienced US patent attorney, the local Taiwanese attorney and local auditors in Taiwan helped the licensor to establish proof of underpayment with an enforceable verdict providing a substantial financial return. Anyone involved in licensing in South East Asia, especially Taiwan, would be well advised to consider similar steps for enforcing a licensing agreement.