Have You Gotten What You Bargained For? Royalty Underpayments on Brand Licensing

Have You Gotten What You Bargained For? Royalty Underpayments on Brand Licensing

Getting what you bargained for does not mean alienating your relationship with a licensee.

April 30, 2019

CrossFit, Inc. is the world’s leader in fitness training with 15,000 licensed CrossFit affiliates/gyms across the world.[1] Reebok International Ltd. (“Reebok”), a subsidiary of Adidas, entered into a License and Sponsorship Agreement (the “Agreement”) with CrossFit on September 25, 2010. The Agreement grants Reebok the rights to be the exclusive outfitter of CrossFit and the CrossFit Games for products such as clothing, footwear, and headgear, as well as the nonexclusive rights for leather goods and Open Category Products such as apparel, merchandise, and accessories in connection with the promotion of individual CrossFit gyms.[2] In exchange for the rights, Reebok agrees to pay CrossFit a quarterly royalty based on net sales for all licensed products in addition to marketing and sponsorship payments.[3] (Figure 1)

Figure 1. CrossFit License and Sponsorship Agreement Products and Royalty Rates

CrossFit License and Sponsorship Agreement 

The Disputes

In late 2015 and again in mid-2017, CrossFit triggered the audit clause within the Agreement and found indications of noncompliance in certain royalty calculations as well as other deficiencies.[4]  On June 14, 2018, after unsuccessful mediation, CrossFit filed a lawsuit against Reebok claiming that Reebok “has robbed CrossFit of the benefit of its bargain to the tune of at least $4.8 million in royalties” and “breached its contractual obligations to CrossFit … by failing to meet its substantial marketing commitments, and by funneling potential customers of CrossFit-branded products to Reebok’s online store in order to avoid higher royalties owed for sales on CrossFit’s online store.”[5] One of the key issues to the lawsuit involved the definition of net sales, which contributed to a significant portion of the claimed $4.8 million in underpaid royalties. According to the Agreement, net sales is defined as follows:

“’Net Sales’ shall mean the invoiced selling price of the Licensed Products solely less (i) actual and documented customer returns and taxes, and (ii) chargebacks solely related to the Licensed Products taken in the normal course of business and which are separately stated on an invoice or credit memo.”

According to its lawsuit, CrossFit believed that net sales, in accordance with the above definition, “is the price that a third party pays to Reebok, whether that third party is an end customer, wholesaler, or distributor.”[6] Reebok, however, had a different view of the contract regarding the net sales as noted in its September 2016 email responding to CrossFit’s inquiry regarding the accuracy of Reebok’s most recent royalty statement:[7]

“…we confirm that it is accurate based upon our view of the contract. The confusion lies in the fact that we have agreed with your team that the net sales definition of the contract says that we will pay 50% of net sales value for ecommerce sales.”

In December 2016, Reebok further proposed to amend the Agreement, including an extension of the term to 2025, eliminating Reebok’s marketing commitments and revising the royalty rate and net sales definition:[8]

  • Royalty rate will be at 11% of net sales of all licensed product – footwear, apparel, accessories
  • Net Sales means “Net Sales Wholesale” plus “Net Sales Own Retail and Online”
  • “Net Sales Wholesale” means the gross revenues from all sales of Licensed Products invoiced to third-party customers, less returns, discounts, and allowances.
  • “Net Sales own Retail and Online” means 50% of the gross revenues received from all sales of Licensed Products to consumers via own-retail (whether in a physical store or online), less discounts, rebates, taxes, and returns.

CrossFit denied the claim in Reebok’s September 2016 email. Furthermore, as of June 14, 2018, when the lawsuit was filed, the parties had not entered into an amended agreement as suggested by Reebok. Nonetheless, CrossFit and its auditors found that the alleged royalty underpayments were largely a direct result of Reebok’s interpretation of the net sales definition, which went as follows:[9]

  • Calculated royalties during 2013 to 2016 based on 50% of net sales generated from its e-commerce sales channel
  • Calculated royalties since the fourth quarter of 2017 based on 50% of net sales generated from e-commerce sales and retail channels, such as Reebok stores

The different calculation of royalties on net sales by Reebok effectively trimmed the royalties associated with the e-commerce and retail channel sales by one-half compared with CrossFit’s expectation. Through active post-license monitoring, including the two third-party royalty audits, CrossFit was able to identify the issues and potential scope of noncompliance, and proactively seek resolution with Reebok. Although the lawsuit was filed, the parties were able to quickly settle and resolve all issues two-and-a-half months later in August 2018.

The Outcome

Contrary to the conventional thinking, the triggering of the audit compliance clause, the identification of issues regarding calculation methodologies, and even the filing of a lawsuit by CrossFit did not jeopardize its long-term partnering relationship with Reebok. As CrossFit CEO Jeff Cain explained in a joint press release, “[e]very partnership confronts challenges from time to time. Great partnerships learn from them, overcome them, and become stronger in the resolution of them.”[10] Cain’s statement was echoed by Reebok President Matt O’Toole, “Our brands are stronger together in the resolution of this dispute, which means great things on the horizon for the CrossFit community.”[11]

The Lesson

According to License Global, licensed merchandise sales reported by the top 150 licensors reached as high as $272.2 billion in recent years.[12] While brand and trademark licensing provides tremendous monetization opportunities for their owners, careful post-license monitoring is critical to ensure that the licensee and the licensor are on the same page regarding all the relevant terms and conditions of the Agreement and helps to cultivate a win-win-win relationship. As noted by Cain, the outcome of CrossFit and Reebok’s shared resolution is not only a stronger partnership but also “a victory for CrossFit trainers, affiliates, and athletes,” particularly with continuing Reebok’s sponsorship of the CrossFit Games.[13]

  1. Press Release, “CrossFit And Reebok Settle Licensing Dispute,” August 28, 2018.
  2. Complaint filed on June 14, 2018, Exhibit A; Press Release, “CrossFit And Reebok Settle Licensing Dispute,” August 28, 2018.
  3. Complaint filed on June 14, 2018, p. 9 and Exhibit A.
  4. Id., p. 11-15.
  5. Id., p. 1.
  6. Complaint filed on June 14, 2018, p. 8.
  7. Exhibit B to Complaint filed on June 14, 2018.
  8. Complaint filed on June 14, 2018, p. 12-13 and Exhibit C.
  9. Id., p. 11-14.
  10. Press Release, “CrossFit And Reebok Settle Licensing Dispute,” August 28, 2018.
  11. Ibid.
  12. “To 150 Global Licensors,” License Global, April 2017, Volume 20, Number 2 and April 2018, Volume 21, Number 2.
  13. Press Release, “CrossFit And Reebok Settle Licensing Dispute,” August 28, 2018; See also Exhibit C to Complaint filed on June 14, 2018 (proposing over $36 million in CrossFit Games sponsorship through 2025).