The Virtue of a UPC Code for Brand Protection

A brand is a brand is a brand…or so it would seem. Purveyors of fashion understand the allure of a brand in connection with sales.  While knock-offs are ubiquitous and virtually a religion in the United States, apparel which is branded with a recognized label has a greater cachè and commands both prestige and better pricing.  The trademark serves not only to identify the source of the garment but the quality and standards associated with the trademark.  So when a consumer opts to buy a branded product as opposed to a knock off, there is an implied guaranty of certain quality standards associated with such a brand.

Licensing brands and ancillary thereto franchising have become integral to the growth and breadth of a brand’s expansion.  Because of the consumer’s understanding, a licensor who engages in naked licensing can lose its trademark.  A naked license is one in which the licensor does not retain or enforce quality controls.  The reason should be obvious, if a trademark is indeed to represent a value associated with the brand, a diminution due to lack of controls makes the brand at best deceptive.

Failure to maintain quality can lead to claims that the licensor granted a naked license which is a defense against trademark infringement. The antithesis occurs when one imposes quality controls and seeks to enforce the same. Under those circumstances the courts will seek to enhance the remedies available to a trademark holder, such as granting an injunction against the sale of grey market goods, an equitable remedy, which would otherwise be unavailable.

The courts will look to three (3) key factors in determining if a license constitutes a naked license; all of those factors pivot on the issue of quality. First, did the brand owner retain the right to determine quality standards?  Second, even if the brand owner retained the right to exercise control over quality, did he in fact exercise the control, or did he just sit back. Third, was there a reasonable reliance to rely upon the licensee to maintain control?

The first and third quality factors in determining a naked license are obvious. However the exercise of control is what often trips up the licensor.  What steps should a licensor undertake to maintain control?  Zino Davidoff (“Davidoff”) exemplifies the extent to which some manufacturers will go to protect quality and as a concomitant the added value to the brand by doing so.

In Zino Davidoff SA v. CVS Corp., No. 07-2872 (2nd Cir. 2009), Davidoff sued CVS due to its removal of uniform protect code (“UPC”) symbols form Davidoff packaging for its Coty licensed “Cool Water” fragrance packaging.  This UPC code permitted Davidoff to protect against both diversion from the specified channels of distribution and from counterfeiting.  The Davidoff UPC contained information regarding each unit including where and when it was produced, ingredients used and distribution path.

Davidoff restricted Coty’s rights of distribution to maintain the luxury, prestige reputation of “Cool Water”.  CVS was not part of those channels of distribution. So when Davidoff discovered CVS was selling  “Cool Water” packaged goods,  it sent a cease and desist letter.  Eventually CVS agreed to cease selling goods that were known to be counterfeit.  However, since the UPC codes had been removed but the genuiness was not in doubt, CVS argued it should be allowed to sell off its remaining, legitimate inventory.  On its face this appears reasonable since no one disputed the Cool Water goods being sold in CVS were genuine, Coty produced goods.

Davidoff pivoted the dispute to trademark infringement. Relying on Warner-Lambert Co v. Northside Dev. Corp., 86 F.3d 3 (2nd Cir. 1996) which held that a trademark holder was entitled “to an injunction against one who would subvert its quality control measures upon a showing that (i) the asserted quality control procedures are established, legitimate, substantial, and nonpretextual, (ii) it abides by these procedures, and (iii) sales of products that fail to conform to these procedures will diminish the value of the mark”, the Court in Davidoff held the removal of the UPC code which qua  quality control measure to prevent harm to the brand’s good will and reputation, resulted in trademark infringement entitling Davidoff to an injunction against the CVS sale of the goods, again even though those goods were genuine.  Further Davidoff did not have to prove injury just the risk of injury.

By using a UPC as a proactive measure to protect the quality of its brand, Davidoff was able to secure an injunction against CVS for trademark infringement. By moving aggressively to promote, retain and defend the quality of a brand, one is rewarded beyond avoiding the issue of a naked license. The brand holder is rewarded for its vigilance by being granted remedies such as an injunction against the sale of non-counterfeit goods. The court recognized the inherent contradiction to on the one hand require a licensor to protect the quality of its brand or otherwise be deemed a naked licensor and to withhold the remedies which would enable the licensor to protect its brand and control its licensees. The take away is that creative qualitative enforcement of one’s branded products is not only smart business practice but also leverages equitable and legal rights.

Do You Need an Investment Banker?

The life arc of a fashion company is subject to usual and conventional patterns.  Inspiration and creativity is the starting point and focused on the look, image and aspirations of talented individuals, a/k/a designers.  Around the designers a brand is born.  The designers produce signature collections to build brand identity.  Friends and family money is raised to fund fabric acquisition, product distribution and hopefully some salaries.

After that initial stage and the brand has traction an over-the-horizon view will envision the proverbial exit vehicle…tuck in, public offering, reverse merger and so on.

In the middle falls the shadow.  The brand has traction, distribution targets are met, prestigious doors are opened, EBITDA (hopefully) is hitting the bottom line but yet the fashion company is precarious or at an inflection point.  The conundrum is faced by the timing issues of seizing the moment to push the arc of the trajectory and possibly exit first round investors or to grow conservatively, organically, incrementally retaining control and hoping the brand value follows the foreshadowed arc of accomplishment.

At this stage the fashion company will likely be introduced to, or solicited by, investment bankers.  Some welcome this approach as a sign that the hard work of brand development is on the cusp of financial recognition.  But the usual question I receive is so what is it that an investment banker can do for me? Is an investment banker just a glorified broker?

Actually no.  An investment banker has several functions.  It can be the  middleman between the fashion company and the buying public; it raises capital and functions as an underwriter, securing commitments from mutual and pension funds and the like.

The investment banker also advises on mergers and acquisitions, advising the fashion company on such matters as business valuation, negotiation, pricing and structuring of transactions, as well as procedure and implementation.

Personally I have found the process with investment bankers to be a critical component for a fashion company ready to take on new investors, strategic partners or to acquire other targets. There is a necessary reality check as to valuation, to have a perspective on valuation beyond the application of a multiple to EBITDA. Maximization of value cannot be achieved without knowledge of the market as a whole and which targets, be they family offices, private equity firms or strategic.  The good investment bankers are worthy and invaluable strategic partners to extract maximum value.

Of course investment bankers are paid for their services.  While everything is negotiable there are some patterns including minimum retainers and variants on the Lehman Formula including Double Lehman and Double Percentage Lehman. For this the investment banker will take the fashion company from the start of due diligence, to preparation of a teaser, confidentiality agreements, information memorandum, target identification and solicitation, preparation for the target examination and the negation of a letter of intent.

Surprisingly, I have often been asked why do we need investment bankers in an age of public dissemination of information whereby valuation screens and target identification is readily accessible via the Internet. My usual response is that such a process is similar to one using WebMD® to diagnose and treat oneself.

But for reasons beyond economics, clients have been moving to a new model for the mid-stage equity raises.  On the proactive side clients have asked Fox Rothschild to prepare them for the process; clean up otherwise basic or fundamental matters due to budget constraints or mere lack of prioritization are then brought to the fore. An examination of corporate practices, tax optimization, potential tax issues arising from transfer pricing, employee practices and handbooks and even basic corporate records and state qualifications.  Call this the corporate check up and remediation.  Before commencing the process, how will an outsider view the company?  In this process we want to look our best on our first date, and not wait for the multiple rejections before putting on our best garb.

Thereafter we move to the critical commitment stage. We are not ready to jump to the teaser or information memorandum stage. Now we need a vendor due diligence, the “VDD”.  The VDD will be prepared by an external firm of accountants. Multinational companies will use a major firm such as KPMG®. The VDD will be a a micro detailed examination of the company. It will include an overview of the structures, key employees, key policies, tax optimization strategies employed, potential tax liabilities and basically serve as a foundation for monetization optimization.  The VDD is an integral component when not using and investment banker.  It gives a potential target the comfort that should it begin the process of acquisition, the costs of such process will not be wasted because of unknowing  (or gasp, knowing!) soft representations by the fashion company.

Then we draft the teaser which should be, in my opinion, a one-page highlight of the brand, its top line numbers, number of doors and other critical data.  The teaser at this stage does not identify the fashion company.  The key issue now is the validity of the assumption that an appropriate target can be identified to match up the fashion company with a partner, strategic or financial. This is art as well as science.  The degree of confidence may be affected by the personal knowledge and experience of  attorneys, accountants, public relations advisors as well key executives of the company.

If interest is expressed a non disclosure and confidentiality agreement will be drafted and executed by those interested in receiving both the information memorandum as well as the VDD.

If further interest is expressed after preliminary meetings, a process later may issue outlining the fundamentals of an expression of interest and/or a letter of intent.

While I have undertaken the role to shepherd the process without an investment banker, my first advice is to let each professional play its appropriate role. The only time I am enthusiastic about disintermediation the investment banker is if the client is at the stage where we would be dealing with investment bankers at the end of the scale whereby the function is more of a broker. If a quality house is not available then there are good reasons to control the process internally. But in the end each brand, each entrepreneur is different with varying needs at different stages of development and therefore must be evaluated on a case-by-case basis.  Feel free to contact us if you have questions regarding your next equity raise.