For more than three decades, courts have been grappling with whether to hold trademark licensors liable for defective products even where they neither manufactured nor sold defective products. It appears that courts are reaching a consensus concerning the relevant considerations regarding this liability issue.

This article discusses the interplay between the Lanham Act, which permits licensors to retain their trademarks if they do not completely abandon them, and courts’ imposition of liability on trademark licensors who appear to exercise too much control. This article also examines recent cases concerning product liability of trademark licensors. Finally, this article makes recommendations to the wary trademark licensor on how best to avoid the pitfalls courts are now beginning to delineate.

A trademark is legally defined as any “word, name, symbol, or device or any combination thereof … used … to identify and distinguish … goods … from those manufactured or sold by others and to indicate the source of the goods.” 15 U.S.C. § 1127.

Congress enacted the Trademark Act of 1946, 15 U.S.C. § 1051 et seq., commonly referred to as the “Lanham Act” after the congressman who introduced it, to address deceptive uses of protected trademarks and unfair competition and provides remedies for those whose registered marks are infringed.

Under a trademark licensing agreement, the owner of the trademark, known as the licensor, provides permission to another person or entity, known as the licensee, to use its trademark for a specific purpose. The agreement describes the scope of the license, the nature and quality of the goods that the licensee may offer under the trademark, and provides indicia of control that the licensor exercises over the mark.

This retention of control by the licensor is essential in helping to ensure that the licensor will not be deemed to abandon the mark. Unfortunately, the Lanham Act does not provide the amount of control that must be maintained by the licensor to avoid abandonment. The act does specify that a mark is deemed abandoned when its use has been discontinued without intent to resume such use or when course of conduct by the owner causes the mark to lose its significance as a mark, such as by becoming a generic name for the goods with which it is used. Accordingly, a licensor must retain adequate quality control over the goods and services sold under the mark by its licensees otherwise the licensor risks abandonment of its mark.

Trademark infringement defendants sometimes rely on what has been termed the “naked licensing” doctrine, which provides that where a licensor has licensed its mark in such a way that renders the mark meaningless and the mark no longer represents the quality of the product, the mark becomes invalid. Essentially, the doctrine discourages a licensor from granting a license without retaining some degree of control of quality.

In FreecycleSunnyvale v. Freecycle Network , 626 F.3d 509 (9th Cir. 2010), the U.S. Court of Appeals for the Ninth Circuit held that the defendant engaged in naked licensing and therefore abandoned its trademarks. The defendant was a non-profit organization whose purpose was to encourage the public to “freecycle,” that is, to donate an unwanted item to a stranger rather than disposing of it. The plaintiff was a member group of the defendant and used the “freecycle” trademark. The defendant did not maintain a licensing agreement or place nearly any restrictions on the use of the marks, but it did send an e-mail allowing the organization to use the trademarks for non-commercial purposes and a subsequent cease-and-desist letter regarding the use of the marks. The court concluded that the defendant failed to retain express contractual or actual control over the plaintiff’s quality control measures and abandoned the mark.

Similarly, the U.S. Court of Appeals for the Seventh Circuit recently identified “the paradigm of a naked license” as a plaintiff who “had, and exercised, no authority over the appearance and operations of defendants’ business, or even over what inventory to carry or avoid.” Eva’s Bridal Ltd. v. Halanick Enters., 639 F.3d 788, 791 (7th Cir. 2011). In determining whether a mark was abandoned, Chief Judge Easterbrook asked the important question in this case: “How much control is enough?” His answer was: “The licensor’s self-interest largely determines the answer. Courts are apt to ask whether ‘the control retained by the licensor [is] sufficient under the circumstances to insure that the licensee’s goods or services would meet the expectations created by the presence of the trademark.’” This standard resists a bright-line rule, but an examination of some landmark and recent cases provides insight into this nebulous area.

Although trademark licensors must be vigilant to avoid abandoning their marks, retaining significant control over the mark may result in unintended liabilities. Where licensors have exercised too much control over the products that bear their mark, they have been held liable for defects in those products.

Two principle theories of liability that have its sources in the Restatements of Torts have emerged. First, under a “stream of commerce” theory, where the control retained by the licensor may be deemed sufficient for the licensor to have placed the product into the stream of commerce, licensors have been held liable under Restatement (Second) of Torts § 402A.

Second, under the apparent manufacturer doctrine, where the licensor can be deemed to put out the product as its own, the licensor is held to the same liability as the manufacturer under § 400. The analysis does not differ significantly under either theory.

In 1998, the Restatement (Third) of Torts: Products Liability included a derivative of § 400 that explicitly provided that it does not, by its terms, apply to the owner of a trademark who licenses its trademark. Liability does lie, however, when trademark licensors “participate substantially in the design, manufacture, or distribution of the licensee’s products.” This codified the majority of the case law.

Cases after 1998, including recent cases, have been consistent with the § 14 standard and the majority of the case law prior to 1998. Recently, on Aug. 24, 2012, in Acquarulo v. A.O. Smith Corporation, No. CV 095024498S, a Connecticut Superior Court upheld a $2.4 million verdict against a trade association after previously denying its summary judgment motion as to whether it could be liable as a product manufacturer under the Connecticut Products Liability Act. The trade association argued that it neither processed, made, distributed, sold, shipped or re-branded the dry-set mortar product at issue.

The plaintiff argued, however, that the association held a patent on the asbestos-containing product, licensed the manufacture and sale of the product, and retained tight control over the formulation, manufacture, packaging, marketing and research of the product. In agreeing with the plaintiff, the court noted the trade association’s invention of the product; detailed specifications governing all aspects of its product, including the percentage of asbestos to be used; the requirement of in-house testing; the responsibility for packaging and labeling; receipt of licensing fees; and undertaking of issuance of warnings concerning its product.

In Lou v. Otis Elevator Co., 77 Mass. App. Ct. 571, 933 N.E.2d 140 (2010), a Massachusetts court for the first time in a reported case applied the apparent manufacturer doctrine to an entity outside the distribution chain. In Lou, a boy’s hand was caught and injured in an escalator in a department store in China. The boy and his parents brought suit on the basis of breach of the implied warranty of merchantability against the American company that licensed its trademark and technology to the manufacturer of the escalator. Adopting § 14, comment d, and its concept of liability for trademark licensors based on substantial participation, the court affirmed the jury verdict of $3.35 million in damages. The court reasoned that comment d served as a response to a class of cases that had held trademark licensors liable for defective products even without participating in the design, manufacture, or distribution. The court stated that, because the defendant did not argue that it did not substantially participate as provided for in § 14 and there was ample evidence for such a finding, the jury’s determination was not improper.

The Lou court distinguished Burkert v. Petrol Plus of Naugatuck Inc., 216 Conn. 65, 68 (1990), in which the Connecticut Supreme Court declined to apply the apparent manufacturer doctrine to General Motors Corp. where its “role as a Trademark Licensor was unusually limited.” The court noted that General Motors exercised no control over the formulations its licensees used to meet its performance standards, received no royalties or financial benefits from its licensing, provided little supervision of production and distribution, and did not require its licensees to submit samples or test data for performance assurance. Accordingly, the court concluded that General Motors could not, as a matter of law, be an apparent manufacturer.

Likewise, other courts applying or citing favorably § 14 consistently have held that trademark licensors that participate substantially in the design, manufacture or distribution of licensees’ products can be held liable in tort for harm caused by defective products.

These cases demonstrate the risks of abandonment under the Lanham Act and products liability for trademark licensors under the apparent manufacturer doctrine or stream of commerce theory. To avoid liability, trademark licensors must not “participate substantially in the design, manufacture, or distribution of the licensee’s products.”

Licensors should not abstain, however, from any oversight in the use of its mark. Rather, trademark licensors should, pay particular attention to the degree of control it exercises over their mark and be cognizant the indicia of control that could subject them to liability. Specifically, courts examine trademark licensors’ rights to, involvement in, or control over: formula, design, advertisement, packaging, manufacturing, distribution, issuance of specifications, inspection, and management of licensees. Courts have also analyzed the prominence of the trademark, overlapping management of the licensor and licensee, and the licensor’s stockholdings of the licensee. To avoid abandonment under the Lanham Act, trademark licensors should maintain a valid licensing agreement that: specifies at least minimal quality control standards, such as warranties that the products will be free from defects in design and material; provides indemnification for the licensor as to product defects; and requires the licensee to maintain comprehensive insurance coverage for product liability claims.

The licensing agreement may also specifically limit the rights of the licensor, particularly in the areas of design, manufacture, and distribution. Because courts evaluate control on a case-by-case basis, there is no bright-line rule, but limiting any control of those three key areas to general control, if any, would be useful to licensors seeking to limit their liability.•