Victory flight: How Virgin’s small print cost Alaska Airlines $160m in unpaid fees
Exciting possibilities await when a billion-dollar merger and acquisition (M&A) finally takes off, but legacy clauses related to IP can create some nasty turbulence.
That’s what Alaska Airlines discovered to its cost this month when the High Court of England and Wales ruled that it owed Virgin Airlines $160 million in unpaid fees for the ‘Virgin America’ name even though the branding had been discarded four years earlier.
For Robert Reading, director, government and content strategy at Clarivate, the judgment delivered on February 15, should serve as a cautionary tale ahead of any M&A.
“It underscores the importance of IP for a business in terms of its assets. And far too often, in the world of mergers and acquisitions, IP is treated as a very low priority once other assets are addressed. It's almost treated as an afterthought.”
And this can lead to “some very expensive mistakes”.
Trademark checklist
Errors such as these are also more likely when—as occurred in this particular dispute—the contractual history is lengthy and convoluted.
Back in 2004, Virgin Group decided to form a US-based, low-fare airline but the US Department of Transportation blocked the plan on the basis that Virgin America, a subsidiary of the UK-based Virgin Group, would not be under US ownership or control.
To overcome this obstacle, Virgin proposed a restructuring of the airline limiting its foreign ownership shares to 25% and making it a separate entity.
Virgin unveiled a licensing deal allowing Virgin America the right to use some of the airline’s trademarks with payment terms that included an annual flat fee of about $8 million per year over 25 years.
Fast forward to 2016: Alaska Airlines bought Virgin America for $2.6 billion, broadcasting its intention to wind down its use of the Virgin brand and merge it with Alaska Airlines.
Three years later, Alaska Airlines ceased all payments to Virgin, on the basis that it no longer wanted to use the brand—prompting Virgin to sue for unpaid fees.
The court ultimately found in Virgin’s favour, ruling that updates to the trademark licensing agreement meant that the annual fee was payable regardless of whether or not the trademark was used.
In response to the ruling, an Alaska Airlines spokesperson issued a bullish statement to WIPR, vowing to appeal.
“We disagree with the court’s judgment. Alaska stopped using all Virgin trademarks in 2019. The plaintiff’s lawsuit is without merit and we intend to appeal the decision.”
The power of foresight
So why did Virgin win? A pivotal factor in its success was its recognition that the original 2005 deal posed dangers for its brand in the US, alongside its future revenue streams from the Virgin America trademark.
As Reading explains, the original agreement granted Virgin America an exclusive right to the Virgin brand for a period of 25 years, blocking its use by any third party.
But it came with a downside: If Virgin America stopped using the name and making payments, then the Virgin brand could fall out of use until the contract’s expiration in 2039.
“Virgin would not have been able to generate revenue until the trademark licensing expired, at which point the brand may have suffered in terms of public recognition and value,” says Reading.
As Emma Kennaugh-Gallagher, senior professional support lawyer at Mewburn Ellis, explains, any failure to maximise branding can lead to a later abandonment, or even death, of the mark.
“There is always a danger, when granting a trademark licence, that the licensee might fail to make the best use of the brand as hoped by the licensor.
“While deceased marks may still be revived or restored where the mark still holds goodwill and recognition among consumers—commonly referred to as ‘zombie marks’— the trademark owner will obviously want to avoid the ‘death’ of their marks in the first place,” she adds.
Crucially, in this case, Virgin had the prescience to introduce amendments to the original licensing agreement to safeguard its interest, and neutralise the risk.
This included a 2014 amendment, underscoring Virgin’s right to maintain a minimum royalty payment, unlinked from any use of the Virgin Brand.
A savvy move, says Kennaugh-Gallagher.
“The introduction of these clauses was justified by Virgin on the basis that it was giving up considerable control over the Virgin America entity and taking a significant risk that any acquiring entity would embark on a debrand—leading to the loss of any revenue-based royalties,” she explains.
Buyer beware
Alaska, in turn, argued in court that paying for the non-use of a mark is a surprising construction, which should have been established before it signed the deal and acquired all of Virgin America’s historic contractual obligations.
Did Alaska have a point? After all, the mantra of ‘use or lose it’ has become a sacrosanct one in the trademark world. Why didn’t this golden rule work in its favour?
In the end, the argument couldn’t hold sway in court because, according to Reading, the dispute didn’t revolve around trademark rights, but rather pivoted on whether Alaska had inherited the right to use the mark when it signed the dotted line.
“This is purely about a contract: it's separate from trademark registrations and the process that holds that if you don’t use the mark, then the mark becomes vulnerable. Here the questions were: do you have to use it, or is it just a right to use,” explains Reading.
“The terms were interpreted by the court that it was a right to use it. This means Alaska owed Virgin that minimum payment every year, regardless of whether the airline used the mark or not.”
Additionally, Virgin ensured that this minimum royalty obligation was not revenue-linked and so even if the revenue generated by the licensed activities, ie, the use of the Virgin brand in the course of operating a domestic US airline fell to zero because no licensed activities were carried out—the minimum royalty obligation still stood.
Kennaugh-Gallagher points out, “Virgin knew its brand’s worth and ensured that the minimum royalty obligation ‘bit’ even though the licensee made no use of the licensed marks”.
As Aaron Wood, partner at Brandsmiths, puts it, contractual amendments in this “interesting case” meant that Alaska could not simply “decide to debrand and stop paying fees”.
“In any situation where a brand is being acquired, it is important to make sure not only that you do have the right to use it, but also that you have the right to stop using it,” he cautions.
Brett Kensett, senior manager at intangible assets specialist, EverEdge, agrees that the case highlights the power of clearly articulated contracts and due diligence.
“When buying another company, all agreements need a thorough review. If a licence like this pops up in due diligence, questions need to be asked around whether there is any ambiguity in language regarding fees and trademark use.”
A bargaining tool
And, Kensett argues, the existence of such clauses in some cases isn’t a deal breaker—in fact, the acquiring party can even turn these issues to their advantage and secure a better deal.
“It can be a fantastic bargaining tool for the buyer to bring down the purchase price or have other terms drafted in its favour. Alaska paid $2.6 billion for Virgin America. Maybe, it could have knocked that price down due to commercial risks around the trademark licence.”
As Kennaugh-Gallagher echoes, many of the arguments that Alaska put forward during the legal proceedings would have been better used in the renegotiation of the trademark licence back when it acquired Virgin America.
“A 25-year term licence with no break clause on the licensee’s party—with an annual flat fee unlinked to actual revenue generated by the use of the licensed rights, is precisely the sort of commitment that a pre-acquisition due diligence exercise should have identified.
“Alaska would have been better placed to pay a premium as part of the purchase price in order to terminate the licence agreement and exit the obligations,” she explains.
Its failure to do so meant that Virgin went on to have the upper hand.
“Of course, Virgin Group could have settled, dropped the trademark licence, and then issued a trademark licence to another party in time, but why would it? It’s receiving $8 million a year for a little paperwork, which isn’t too bad a deal,” notes Kensett.
There are, he concludes, some salutary lessons for other companies to be gleaned from this case.
“The biggest takeaway is that due diligence on all contractual agreements will give the buyer a better understanding of an M&A’s risk rating.”
This critical step, he urges, can ultimately help to drive the purchase negotiations in their favour or, if the terms are still deemed too risky, ”to make an informed decision to walk away”.
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