Wednesday, November 30, 2011

King of wishful thinking: naked licensing dooms ownership claim

Original Rex, L.L.C. v. Beautiful Brands International, LLC, 792 F. Supp. 2d 1242 (N.D. Okl. 2011)

(This is from earlier in the year, but it just showed up in Westclip now. It’s a good reminder of how complicated facts can get on the ground.) Original Rex sued BB for trademark infringement over BB’s use of the registered mark “Rex’s Chicken.” BB counterclaimed for abandonment, seeking cancellation of the registration.

In 1975, Vernon McFarland acquired the exclusive rights to the Rex process and name for boneless, skinless, bite size chicken for Oklahoma, Missouri, Arkansas and Texas, and in 1981, these rights were expanded to include Kansas, Colorado, Louisiana and New Mexico. He formed MDI in 1976 and opened the first Rex Restaurant in Oklahoma. McFarland incorporated Rex Chicken Company in 1977 in Oklahoma to sell chicken to purported licensees.

Beginning in the mid-1970s, MDI entered into various franchise and license agreements with independent restaurant operators. Some used the “REX” name; others operated under a different name but displayed “REX”; and others did not identify the chicken products using “REX” at all. In 1977, Rex Chicken Co. entered into a franchise agreement with John Ballard/Ballard’s Drive-In, giving it the right to use the name “Rex Chicken” in connection with the sale of “boneless food products.” The agreement required sourcing from Rex Chicken Co. or an approved source and a royalty based on pounds sold. It allowed transfer of the license if the transferee agreed to assume all of the transferor’s obligations and Rex agreed in writing. It also contained quality control provisions. Vernon McFarland visited Ballard’s to deliver chicken about every other week until his death in 1988, and never complained about the restaurant.

Vernon served as president of MDI until he died, at which point his widow Dollie took over. Rex Chicken Co. at some point around 1979 ended its legal existence; there was no written assignment of its rights to MDI, and Ballard never received written notice of any assignment, though the plaintiff contended that everyone understood that an assignment had taken place and that the franchise agreement remained in effect.

After Vernon McFarland died, Dollie and other family members would visit the Drive-In once every two or three years. They only ever complimented the restaurant. Dollie testified that the visits were only partly social because she continued to own an interest in Rex Chicken, LLC, until 2000 and was still very interested in the product.

In 1989, MDI applied to register the Rex’s Chicken mark, alleging first use in 1989. (According to the court, Ballard also began using the Rex’s Chicken mark in connection with the sale of boneless chicken in 1989, limited to use at the Drive-In and surrounding community, though I’m not sure what “began” means here.) The registration issued in 1991, along with another registration for REX THE ORIGINAL.

MDI’s VP of franchise development sent Ballard a letter in March 1992, notifying Ballard that his franchise contract was the last such contract in existence and was set to expire in May. The letter said:
At Dollie's request, we are extending your agreement another year as proposed in the attached Modification Agreement. Dollie recognizes your long relationship with and loyalty to the Rex concept. As she discussed with you, the right to sell the Rex product is yours personally and cannot be sold to anyone else.
Please review and sign two copies of the enclosed Modification Agreement and return both to me in the enclosed envelope. We will then return to you one fully executed copy.
But no executed agreement was produced in the litigation.

The VP testified that MDI’s intent was to terminate Ballard’s franchise agreement and license, as part of the systematic termination of all then-existing licenses, and that any pre-existing users still using the name were defying MDI, though Dollie disagreed with that last statement.

MDI then sold all its assets to Rex Chicken, LLC, and recorded an assignment of the mark. Rex Chicken, LLC, was a wholly owned subsidiary of Magnum Foods, a corporation which was a licensee of Little Caesars Pizza. No written notice of an assignment was produced in the litigation and no written notice was given to Ballard.

Meanwhile, Ballard continuously operated his restaurant and sold Rex chicken since 1977, and since 1989 he used the Rex Chicken mark in advertising. He testified that at some point before the 1993 MDI-Rex sale, Dollie stopped requiring him to pay royalties; that he’d stopped receiving spice packs for Rex Chicken and had been making his own for 3-4 years; and that he’d been obtaining chicken on his own for more than 5-7 years and maybe over 10 years. Since 2002, he hadn’t purchased any products or supplies from Rex Chicken Co. or its successors in interest.

Troy Beats, a former President of Rex Chicken, LLC, testified that he could not define Ballard's relationship as a franchisee or licensee because “they sell a whole different menu that was not what I would consider Rex Chicken. Just the product was what they were selling.” Beats never talked to anyone at Ballard's and Rex Chicken, LLC, didn’t assess Ballard’s operation because they didn’t consider it a franchise. Troy Beats closed all of his Rex Chicken restaurants and ceased paying any royalties by 2002, at which point his relationship with the entity and the mark ceased.

So, we have an entity, Rex Chicken, LLC, that by its own admission ceased to operate the Rex Chicken franchise in November 2000, and claimed to have transferred all rights related to Rex Chicken to Magnum Foods. But there were no documents drafted to evidence that transfer, nor was an assignment of the mark registered. And of course there was no written notice to Ballard about the transfer.

Steven Price, Magnum’s president/CEO, and Teresa Coffman, Magnum’s controller who maintained the Rex Chicken marks with the PTO, also provided evidence. Price testified that he’d never seen the franchise agreement with Ballard, though he’d been to the Drive-In and had met with Ballard once in the late 1990s, or possibly 2000. He hadn’t conducted any oversight or inspection of the Drive-In since 2000, though he testified that he did make a “cordial” visit less than 6-7 years ago to order and eat the product. Coffman likewise testified that, since Magnum's last store closed in 2002, she’d done nothing to keep track of Ballard. His restaurant wasn’t in Magnum’s system and she wasn’t aware of any of his operations.

Ballard, meanwhile, testified that he’d never heard of Magnum and never met Price or Troy Beats. He was unaware of any entity not owned by the McFarland family that ever owned the Rex Chicken mark or franchise system. Moreover, Magnum never had any common ownership or control with Rex Chicken Company, MDI, or the McFarland family.

Despite having ceased to operate the franchise and having transferred its rights to another company in 2000, Rex Chicken, LLC (through Price) declared under oath in 2001 that it was using the Rex’s Chicken mark in commerce in order to renew its registration (though Magnum allowed the Rex “the Original” mark to be cancelled in 2002).

Price testified he closed the last restaurants franchised or operated by Magnum for business reasons. He wanted to cobrand Rex’s with Little Caesars, but nothing came of those discussions. Coffman and Price testified that Magnum intended to and did discontinue use of the mark indefinitely in 2002 because all its restaurants had closed, and because it had developed a replacement mark containing a ribbon logo, which it registered in 2000. The parties disagreed about whether the ribbon mark sufficiently resembled the Rex’s Chicken mark to have continuity of goodwill, but in any event the ribbon mark was cancelled in 2006. Rex Chicken, LLC filed its final tax return in 2002 and has never been revived or reinstated.

In March 2010, though its existence had been terminated by the Oklahoma Secretary of State 7 years past, Rex Chicken, LLC, (through Price) executed a purported assignment of the mark in favor of Dollie McFarland’s children, McAuliff and Johnson. In April 2010, a second assignment purporting to come from Rex Chicken, LLC, and Magnum did the same. (At some point thereafter, McAuliff “prepared an undated typed statement (“Clarification Statement”) purporting to be on behalf of Magnum and Price, stating that Magnum did not intend to abandon the Mark,” which Price then signed.

In April 2010, McAuliff and Johnson formed plaintiff Original Rex, LLC, and transferred the mark to it. (The Rex Chicken, LLC and McAuliff-Johnson transfers were recorded with the PTO.) Other than suing in this lawsuit, Original Rex conducts no other business, though it has a website that states it’s “coming soon” with an image of the cancelled Rex “the Original” mark. (Google didn’t help me find this site, but I did find reviews for a Tulsa Rex’s Chicken with the usual debates over whether it was as good as the “original Rex’s.”) Johnson testified that he’d spoken with one person about potential franchising or business.

Also in April 2010, at the behest of Dollie and her children, Ballard signed an affidavit/assignment “referencing his status as a franchisee and licensee pursuant to the 1977 Franchise Agreement and purporting to grant Dollie McFarland, Terri McAuliff and Joe Johnson all rights he may have in the ‘Rex’ marks, subject to his continuing right to use the marks.”

In 2008, defendant Coney Beach, Inc., began to sell bite size boneless chicken as “Rex’s Chicken.” Plaintiff argued that defendant Beautiful Brands, Inc. and CBI were aware of the mark’s history and goodwill. In October 2008, defendant RFS applied to register Rex’s Chicken, but its application was refused in April 2010 based on likely confusion between that and the REX mark. In June 2010, CBI reopened a restaurant under the name Rex’s Chicken; it’s operated and owned by defendant Big Rex, LLC, pursuant to an agreement with RFS. Plaintiff argued that consumer reaction to the quality has been mixed at best. Meanwhile, to promote its franchising agreements, RFS registered Despite prominently claiming to have been around “Since 1951,” they only started offering boneless bite-size chicken in 2008. The website says: “The BIG attraction since 1951. From the day we opened at an Oklahoma gas station, diners flocked to Rex's Chicken. Word spread until travellers across the USA were mapping a route that brought them to Rex for crispy bite-size chicken, fabulous frybread and honey sides.”

The key here was, obviously, abandonment. Abandonment results from discontinuation with intent not to resume use, which may be inferred from circumstances. Nonuse for 3 years is prima facie evidence of abandonment. The party asserting abandoment has the burden of proof on discontinuation and intent not to resume use, and courts have held that this burden is “strict,” though they’re not all clear on what that means. Moreover, once the presumption of abandonment from 3 years of nonuse attaches, the legal owner has the burden of producing evidence of either actual use or intent to resume use during the relevant period. The presumption can be rebutted by showing valid reasons for nonuse. A vague, subjective intent to resume use at some unspecified future date is insufficient: there must be evidence of intent to resume use within the reasonably foreseeable future.

Moreover, a trademark owner may grant a license and count that as use as long as it maintains quality control. But uncontrolled or naked licensing may cause the mark to lose its source-signifying function.

The court found that Magnum’s shutdown of the Rex franchise business in 2002 meant that the last Rex Chicken restaurant closed, at the latest, in 2003 or 2004. The ribbon mark would have been enough to preserve priority if it had created the same commercial impression, but the cancellation was evidence of abandonment of the ribbon mark starting at least in 2006. Thus, there was a presumption of abandonment even starting the count at the latest possible time, in 2006.

The burden was thus on plaintiff to rebut the presumption. Plaintiff offered (1) the assignments and “clarification statement,” (2) Ballard’s affidavit and assignment, and (3) the contention that the parties’ dispute was a valid reason for nonuse.

The court was unconvinced. The purported assignments didn’t establish either chain of title or the requisite intent to revive the mark. Rex Chicken, LLC, no longer existed as a company when the assignments were executed. It had stopped operating the franchise system nearly 10 years past, transferring it to Magnum. Magnum, in turn, stopped using the mark in 2002 (though it switched to the later-cancelled ribbon mark). The clarification statement was a self-serving affidavit entitled to little weight.

What about the Ballard affidavit? Uses whose nature and quality are controlled by the rights claimant can inure to the benefit of the claimant. But the licensor has to take some reasonable steps towards quality control. Because a finding of naked licensing leads to forfeiture of the mark, there’s again a high burden of proof for such a finding. Courts examine both the written agreements and the conduct of the parties for evidence of control. In some cases, the licensor may justifiably rely on the licensee for quality control, but that requires some sort of special relationship. For example, a close family relationship combined with a long-term working relationship may qualify; so may a situation in which the licensor manufactures at least 90% of the goods sold by the licensee; so may a successful forty-year relationship.

Here, the franchise agreement purported to provide quality control, but the question was whether there was sufficient policing and inspection by the franchisor in fact. The court found the nature of the relationship between Ballard and the franchisors after Vernon McFarland died was “ambiguous at best.” There was no evidence Ballard ever executed the one-year extension of license mailed to him in 1992. None of the registered mark owners ever abided by the terms of the agreement concerning assignment, and they never gave Ballard written notice. Ballard wasn’t required to pay any royalties after the sale to Rex Chicken, LLC, in 1993, and he testified he had never heard of Magnum or Price. Nevertheless, he continued, without any objection from anyone in the series, to sell Rex chicken, even though Price visited Ballard’s and spoke to Ballard some time in 1999 or 2000.

Regardless, the relationship between Ballard and Magnum clearly ended in 2002, when Magnum shut down its franchise system and stopped keeping track of Ballard. Ballard stopped buying food from the franchisor in 2002 at the latest, and nobody conducted any inspections of the place.

Plaintiff argued that the level of control was sufficient because Vernon McFarland exercised control while he was alive and after that Ballard’s had a good enough track record that the owner could rely on him. The court determined that there was no control as of 2002. If Vernon were still alive and his company still owned the mark, the close relationship might suffice to avoid a finding of naked licensing, but we’re many years and several companies past that. “The passage of time, the successive transfer of ownership, the waning exercise of oversight by owners, and ultimately the cessation of the business and use of the Mark altogether weigh in favor of a conclusion that Ballard, by 2002 at the latest, had a naked license.”

Plaintiff also argued that Ballard’s was subject to various state laws requiring licensing and inspection, thus providing adequate supervision by the Oklahoma Department of Health. Though the Restatement (Third) of Unfair Competition provides that the licensor’s obligation of reasonable control can be satisfied by supervision or testing by third parties, the Department of Health wasn’t plaintiff’s agent, and anyway it aims at health and food safety, not the maintenance of particular composition/quality standards.

Finally, plaintiff argued that the current ownership dispute was a valid reason for nonuse. While that’s true for recent nonuse, it doesn’t explain the 2002- (or 2006-)2010 gap. Thus, the mark had been abandoned.

Plaintiff also lacked standing under §1125 for both false advertising and common-law trademark infringement, because it’s never owned or franchised any restaurants, and thus had no commercial or competitive interests at stake. Likewise, its state-law deceptive trade practices failed because it had no actively competing franchises or stores.

One state law claim for common law unfair competition remained (though I’m not clear on its basis; it seems likely to go as well after motion practice), as well as a counterclaim for cancellation of the registered mark (which will presumably be granted, ditto).

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