In this guest analysis, Lusheng Law Firm associate Claire Zhang outlines the most common types of non-compliance with IP licensing agreements, and how best to pursue action when breaches occur.

In today's global marketplace, IP rights are crucial for businesses looking to protect their brands and innovations. Licensing agreements are a common way for these entities to grant permission to others to use their intellectual property in exchange for royalties or other forms of compensation. 

However, when a licensee fails to comply with the terms of the agreement, the licensor can suffer losses as a result of the breach of contract and IP infringement. The overlap between breach of contract and IP infringement can have severe consequences for both parties involved. It can damage brand reputation, erode consumer trust and lead to lost sales and diminished brand equity. Moreover, it can create confusion in the marketplace, making it difficult for consumers to distinguish between genuine and counterfeit products.

The article explores: 

• the common types of non-compliance in relation to IP licensing agreements; 
• the legal consequences of infringement; and 
• how rights holders can effectively manage and pursue action against a local licensee in China.

Common types of non-compliance

Unauthorised use beyond licensed scope 

One common type of non-compliance involving IP infringement is when a licensee uses the licensed intellectual property beyond the scope permitted in the agreement. This use can include:

• exploiting the intellectual property for unapproved products;
• exceeding agreed-on quantities; and 
• continuing to use the intellectual property after the licence term has expired.

According to Article 8 of the Judging Criteria for Trademark Infringement, “without permission of the trademark registrant" includes circumstances where:

• permission has not been obtained; and 
• the goods or services are beyond the category, term or quantity of the permitted goods or services.

For example, if a business licenses out its trademark for use on a specific type of product, but the licensee begins to use the trademark on a different product without the licensor's permission, it constitutes unauthorised use beyond the licensed scope.

Sub-licensing without permission 

Another common issue is sub-licensing without permission. If a licensee grants a sub-licence to a third party without the licensor's consent, it may allow the third party to use the intellectual property in ways that are not authorised by the original licence agreement. This can lead to a loss of control over the use of the intellectual property and can damage the brand's reputation.

Legal consequences and possible actions

When a licensee infringes IP rights, the licensor has both common law contractual remedies and statutory recourses at their disposal. Initially, the licensor can invoke the licensing agreement to terminate the contract or seek financial penalties for the breach. Negotiation is typically a precursor to more severe legal action. In cases where the licensee refuses to cooperate and/or cease and desist the infringement, initiating prompt legal proceedings is often the best option. 

There are four ways to do this:

• Civil litigation for infringement – in the event of infringement, the licensor may file a civil lawsuit against the licensee. The licensor can seek compensatory and, if applicable, punitive damages to cover the financial losses and the impact to its brand reputation.
• Administrative complaints – if the infringement is also considered an administrative violation, the licensor can lodge a complaint with the relevant regulatory authorities. This can lead to administrative penalties (eg, fines and confiscation of the infringing products) and other corrective measures. Seeking remedy for an administrative violation can be more effective than civil litigation at stopping the infringement if the licensee is uncooperative.
• Criminal prosecution – in cases where the infringement is severe and constitutes an offence, the licensor can pursue criminal charges. The pursuit of criminal liability can result in significant penalties (including imprisonment), which reflect the gravity of the infringement.
• Strategic use of legal and contractual tools – the licensor must strategically employ a combination of legal actions to protect their intellectual property effectively. This dual approach not only deters the licensee from further infringement, but also sends a clear message to other potential licensees and infringers.

Different approaches to enforcement 

A business relationship exists between the licensor and the licensee. Even when the licensee is in breach of the agreement, in most instances, the licensor is often reluctant to initiate legal actions immediately. Instead, licensors typically prefer to resolve issues through negotiation. This approach is based on mutual benefit, given the licensor's awareness of its licensing market. For instance, pursuing legal action may deter future potential partners.

However, in extreme cases where the licensee's behaviour is so egregious that it cannot be overlooked, it becomes imperative to initiate enforcement actions through the appropriate legal channels.

To effectively respond to non-compliance involving IP infringement by a local licensee, the licensor must have a comprehensive and explicit licensing agreement, which clearly defines the rights and responsibilities of both parties, including:

• the repercussions of non-compliance (eg, liquidated damages); and 
• the mechanisms for enforcement.

The clarity of contract stipulations is particularly crucial for administrative and criminal actions. In practice, if the contractual provisions are vague, the regulatory authorities may:

• dismiss the case as a civil matter; or 
• conclude that no administrative or criminal offence has been committed, thereby undermining the efficacy of the enforcement measures. 

The following case provides guidance on how to clarify liability in relation to infringement following a licensing agreement.

Case study: clarity in contractual terms  

In the case of Zhe 07 Criminal Final No 1205 (2018), defendant Boshun Co pleaded that it had signed a trademark licensing agreement with Bosideng Co. However, the agreement signed by both parties clearly excluded thermal shirts from the scope of authorisation. The court found that the evidence on record was sufficient to prove that Boshun Co used the registered trademark in question beyond the authorised scope without the permission of the rights holder, and that the amount of illegal gains was substantial, constituting a particularly serious case. As a result, Boshun Co was convicted of the crime of counterfeiting a registered trademark.

It is evident that when specific conditions are clearly stipulated in a contract, the court can disregard a defendant's objections. Drawing from numerous case studies and practical experience in enforcement actions, we believe that a licensor can explicitly define certain breach scenarios as constituting IP infringement, thereby reserving the right to pursue administrative penalties and/or criminal liability.

Further, drawing from our experience in enforcement actions, the authorities often exercise caution when licensing agreements are involved. This stems from the belief that the case may be a civil dispute and, therefore, not within the authority's jurisdiction. When the contractual terms are not explicit, regulatory authorities may be reluctant to intervene, viewing the matter as a civil dispute rather than an actionable infringement, which can significantly hinder the enforcement of IP rights.

Conclusion

Managing the overlap between breach of contract and IP infringement in licensing requires a highly proactive approach. Licensors can effectively protect their IP rights by:

• drafting clear and detailed licensing agreements;
• establishing conditions for enforcement actions; and 
• being prepared to take legal action when necessary.

This article was first published on WTR in August 2024.