United States: If License Is Ambiguous, Licensee Should Keep Paying To Sell Cabbage Patch Kids Dolls

Richard Raysman is a Partner and Elliot Magruder is an Attorney in the New York office

On Nov. 17, 2017, the United States Court of Appeals issued its decision in Original Appalachian Artworks, Inc. v. JAKKS Pac., Inc., --- F'Appx. ----, 2017 WL 5508498 (11th Cir. Nov. 17, 2017). This case concerned the right of a licensor to execute a successor licensee while the relevant license remained in force. The terms of the license were ambiguous, so the decision turned on the commercial realities underlying the right to manufacture and distribute Cabbage Patch Kids dolls. As discussed in detail below, the Eleventh Circuit held that the term "negotiation" as applied to a licensor and successor licensee was ambiguous, meaning that the commercial realities of this type of license – that the licensor needed a portion of the time remaining on the license to negotiate with the successor licensee to ensure commercial continuity – precluded licensor's argument that the licensed had been breached and that therefore the licensor could stop paying license fees.

Background

Plaintiff Original Appalachian Artworks, Inc. (Plaintiff) 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, Inc. (Defendant) pursuant to two license agreements that expired on December 31, 2014 (the Licenses).   

In May 2014, Plaintiff chose a successor licensee, Wicked Cool Toys (Wicked Cool), 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 start creating a new line of Cabbage Patch Kids for launch in 2015. 

Defendant argued that this 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. January 1, 2014 to December 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 argued 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."

Plaintiff Obtains a Favorable Result in Arbitration

Pursuant to the forum selection clause in the Licenses, the parties went to arbitration. Defendant ceased paying royalties for continued use of the IP due to the alleged breach.  

In January 2016, an arbitrator applied Georgia law and concluded that Plaintiff did not breach the Licenses (the Award) because the "key term" of the License permitted Plaintiff to engage, in 2014, in the negotiation of a successor 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," i.e., the Deal Memorandum, 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 negotiation provision ambiguous. The arbitrator rejected Defendant's argument that this was the intended result. Instead, he held that it was the intention of the parties to allow the execution of a successor license in 2014, given that 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 moved in district court to partially vacate the Award and Plaintiff filed a motion to confirm the Award. The district court confirmed the Award.

Eleventh Circuit Upholds the Award Because the Arbitrator Did Not Manifestly Disregard the Law and Did Not Overstep His Authority

The Eleventh Circuit applied a stringent standard of review to the Award "[b]ecause arbitration is alternative to litigation, judicial review of arbitration decisions is among the narrowest known to law." See AIG Baker Sterling Heights, LLC v. Am. Multi—Cinema, Inc., 508 F.3d 995, 1001 (11th Cir. 2007). Defendant argued that, by issuing the Award, the arbitrator manifestly disregarded the law and overstepped his authority. The Eleventh Circuit disagreed on both fronts.

First, the appellate 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 negotiation provision of the Licenses was 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 correctly is "insufficient to show manifest disregard." 

Second, the Eleventh Circuit 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 which does not entail "decid[ing] the rightness or wrongness" of the arbitrator's 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 during the term of the Licenses. 

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 Eleventh Circuit 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. The Eleventh Circuit affirmed the district court's confirmation of 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.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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