Most Favored Nations Provisions & Damages

What is a "most favored nations" provision in a contract? Why are they important? What happens if they're violated? These are questions that many attorneys may be asking themselves, and for good reason. Most favored nation provisions can have a significant impact on royalty and profit participation calculations, especially in entertainment and intellectual property licensing deals, as well as investment deals and international treaties, to name a few examples. In this blog post, we'll take a closer look at what most favored nation provisions are and how they can lead to audit or other damages claims.

What is a "Most Favored Nations" Provision in a Contract? 

A "most favored nation" provision (also known as an "MFN") is a clause that is included in contracts to ensure that one party receives the same treatment as other parties which may have leverage to negotiate more favorable terms. The "most favored nations"  provision in a contract is based on the principle of equality. It is designed to promote fairness and to prevent one party from taking advantage of parties that may not know the extent of the most favorable terms it can negotiate. MFNs are commonly used in international trade agreements, but can also be found in other types of contracts, such as investment agreements, licenses, and other agreements covering for musical works and sound recordings.

With respect to licensing transactions, the MFN clause protects a licensor from receiving less favorable terms than other licensors. For example, if Licensor A has an MFN clause in its contract with Licensee B, and Licensee B separately gives Licensor C more favorable terms, then Licensor A is entitled to receive the same, more favorable terms as Licensor C. The same principles can be applied to other sorts of transactions including investment agreements and treaties between nations (from where the term "Most Favored Nations" originates).

Why are Most Favored Nations Clauses Important?

By requiring that all parties be treated equally, the most favored nation provision helps to level the playing field and to protect the interests of all involved.

The purpose of most favored nation provisions is to encourage free and fair trade - and encourage parties to feel comfortable signing off on a license or other contract - by ensuring that all trading partners are treated equally and by mitigating the risk that a more favorable deal could have been negotiated. Most favored nations clauses can also be used as a tool to pressure licensors to lower their royalty rates (or pressure countries to lower their trade barriers, such as tariffs, and improve their labor and environmental standards). Most favored nation provisions are an important part of the global trading system and help to promote free and fair trade.

What Happens if The MFN Clause is Violated? 

When a most favored nations clause is contravened, it can have a number of serious consequences. First, it can damage the relationship between the parties involved, creating an atmosphere of suspicion and mistrust, making future agreements more difficult to negotiate. It can even lead to economic retaliation.  As an example concerning treaties between nations, countries who discover a counterparty failed to honor the MFN provision in a treaty may impose punitive tariffs or other trade barriers in response to such breach. As another example, music publishers may refuse to grant reduced rate licenses - or any licenses - to a licensee who is found to have double crossed the licensor by failing to increase royalty rates in accordance with the terms of the MFN clause.

Second, when a "most favored nation" provision is contravened, the party (e.g., a licensor or country) which suffered less favorable terms than agreed is damaged and can bring a law suit, enforce contractual trade sanctions, or take other enforcement measures to claim actual and possibly penalize the licensee or other party that did not honor the MFN agreement. (Actual damages are amounts to make a party "whole" for the injuries it sustained as a result of a contractual violation. In addition, sometimes courts award punitive damages to punish or penalize the party responsible for the violation, and many contracts provide for penalties in the event of a breach).

How to Enforce "Most Favored Nations" Provisions

MFN clauses are typically identified through an audit process (one reason why it is important to carefully negotiate the audit clauses in your agreements), although violations can be disclosed in other ways.  For example, if two parties are in litigation, as part of the discovery process documents produced by a party may disclose the terms of its agreements with other parties, allowing MFN clause compliance to be evaluated. As another example applicable to international trade agreements between nations, a government official or designated third party reviews individual countries' customs data to ensure that it is providing the same benefits to all trading partners with MFN status. 

If an audit finds non-compliance with an MFN provision, or such non-compliance is disclosed in another way, I find in my experience working with legal counsel that the best approach is to first try to settle the claims through diplomacy and/or the audit and breach notice provisions set forth in the agreement. For example, as an auditor, my audit report will disclose my findings and the legal team will demand payment for the damages I identify in the audit report.  Given that may failures to comply with most favored nations clauses are the result of inadequate royalty reporting systems, non-compliance is often unintended, and this gives the parties a chance to fix the problem and maintain a business relationship.

However, if the party that failed to comply with an MFN clause is uncooperative, enforcement can be challenging.  Generally, the damaged party will need to pursue legal action such as arbitration or a trial in court or a tribunal in order to procure a legal order to the violating party to pay damages and, potentially, other consequences (e.g., termination of the underlying contract).

Actions for Attorneys to Take to Help Clients:

If you have a client who has suffered damages as the result of an MFN violation, please call my consulting and forensic accounting firm, Boschan Corp., at (424) 248-8866. We have experts on staff who can help you determine (based on the available information or through auditing or litigation support) whether your client may have a viable damages claim and, if so, what that claim might be worth. Better yet, when you are negotiating your clients' contracts, it can be prudent to get our feedback on some of the language including the audit provision and definitions. Please don't hesitate to contact us to take advantage of our expertise in most favored nations provisions, audits and damages claims. Thank you for reading.

Damages and Other Considerations when Bringing a Copyright Infringement Claim Before the USA's New Copyright Claims Board

Some barriers to entry in bringing or defending a copyright infringement claim in federal court include costs and the requirement for timely registration.

Concerning costs, the legal and expert expenses of federal copyright infringement lawsuits have made it difficult for plaintiffs and defendants who can not afford to spend a minimum of tens or hundreds of thousands of dollars, especially given that experts generally cannot be compensated on a contingent basis. (Further, in diversity actions, the minimum amount in controversy required to invoke the jurisdiction of the federal courts is $75,000.)

The US's CASE Act was designed to provide an avenue for plaintiffs to enforce their copyrights at lower cost and for defendants based in the United States to limit their copyright infringement damages to no more than $30,000 per proceeding by creating a so-called "small claims court" (technically a "Copyright Claims Board") for copyright infringement claims.  While there seem to be some big challenges in effecting the CASE Act's Copyright Claims Board's commencement of hearings, especially its reliance on law school programs and students who may be unwilling to participate, when it is up an running (hopefully later this year), I am optimistic that it may be a good option for potential clients who can't afford to retain legal counsel or experts and defendants who wish to limit their liability.

The second barrier to bringing a copyright infringement claim in federal court is the requirement that the infringed work (if it is a U.S. work) was registered timely with the Library of Congress (i.e., prior to the infringement or within three months after its publication).  If the work was not registered timely (and it is not a foreign work), the plaintiff cannot bring a claim in federal court. However, it can make a claim before the Copyright Claims Board newly established by the CASE Act. 

In any case, keep in mind that, the CASE Act process is voluntary; once a claim is filed, defendants have a sixty day period to opt-out. This method is not available to plaintiffs if the defendant is a federal or state government or a foreign entity, or for claims previously established in pending cases. Therefore, it may not be a proper venue for many cases, even before considering the damages limitations described below.

The maximum damages that the CASE Act's Copyright Claims Board can award are as follows:

• If the plaintiff seeks actual damages, up to US $30,000 per work may be awarded (subject to the limit of US $30,000 per proceeding, meaning that if a plaintiff proved in one case covering multiple works actual damages in excess of US $30,000 for each work claimed, the plaintiff would only be entitled to a maximum of US $30,000).
• If the plaintiff instead seeks statutory damages, awards are limited to US $15,000 per work and US $30,000 per proceeding.
• If the Copyright Claims Board finds that the copyrights claimed were not timely registered, the maximum damages mentioned above are halved to $7,500 per work and $15,000 per claim. 
• Claims under $5,000 are subject to different procedures, which are currently being established.
• The Copyright Claims Board may award reasonable costs and attorneys’ fees for bad faith conduct, which is capped at $5,000 for parties represented by attorneys and $2,500 for pro se claimants.

Also worthy of your consideration when selecting the proper venue to bring a copyright infringement claim is that the Copyright Claims Board can not grant an injunction, but it can approve an agreement between the parties to cease activities as part of its final determination.

This may be the best option for clients who can't afford your (or our) services, or who failed to timely register their copyrights, although, since the system is entirely untested and unproven, I would hesitate to direct one to bring or defend a case before the Copyright Claims Board until we have seen sample outcomes. The website to file a claim with the Copyright Claims Board just launched this month at https://ccb.gov/.

Copyright Infringement Claims Step #1: Identify the Works Infringed

Copyright infringement is a serious offense that can result in significant damages. One common mistake in copyright cases is that a complaint has not properly identified all of the works infringed, or the complaint identifies a plaintiff who has no standing to bring a claim. Further, in order to estimate your or your client's potential liabilities or amount of money a client may be entitled to receive, counsel should first identify the copyrighted works that have been infringed. This can be tricky, but with the help of this post, you should be able to do it. 

Counsel should consider the multiple categories copyrights that may or may not have been infringed. For example, in a music case, a complaint may focus on a singular claim, but reference multiple copyrights (e.g., "song" and "record" - which are separate works), including:

1. The specific underlying musical or literary work (i.e., the composition, song, or words)
2. Sound recordings of the underlying work
3. Audiovisual recordings of the underlying music or literary work and/or sound recordings
4. Album artwork
5. Trademarks and/or rights of publicity (we won't get into this because it is beyond the scope of copyright infringement damages, but at times there are other damages of concern which are in addition to copyright infringement claims).

Given that separate rights are accorded to each of the above examples, the parties will need to investigate authorship and ownership of all of the potential rights infringed before concluding to which works the plaintiff has standing to bring damages and other legal claims. At minimum:

• Procure or create a list of works potentially copied, including dates of creation, publication, renewal/extension, grant termination notification and grant termination, if applicable (to make sure the rights have not fallen into the public domain and in fact the chain of title supports the plaintiff's standing to make a claim)
• Obtain a copy of the infinged work(s) that were potentially copied (besides understanding what category of work(s) were copied, it may be useful later, in investigating whether the nature of an infringement was willful, to note whether the original work bore any copyright notices)
• Examine examples of the potentially infringing copies to identify which works were in fact copied (for example, in a musical case, were both the composition and the recording copied, or was it solely the composition which was re-recorded?)
• Obtain copies of all available agreements covering and notices of intent to use the works potentially copied.  If the agreements were verbal, ask questions to understand the intention of the agreement and what consideration was exchanged and actions were taken to support the claims of such intentions.
• If the agreement mentions that the work is a "work-for-hire," analyze whether the legal criteria were technically met for the work to be deemed a work for hire as defined in 17 U.S.C. § 101 (because it is not a work-for-hire merely because an agreement states so). 
• Search the Internet to identify prior public copyright claims and uses
• Search for and obtain records of copyright registration, copyright grant termination notices.  In the United States, the Copyright Office this year launched the Copyright Public Records System (CPRS) pilot, which will provide enhanced search capabilities as part of its modernization efforts. To participate in the pilot program and gain access to the latest search tools, users must attend a webinar, which can be found here.

While we do frequently assist legal counsel with such investigation, there are legal experts in chain-of-title research, so this may be something best outsourced to a specialist if you are unfamilliar with it.

If you are counsel to one or more plaintiffs, list the correct entities as the plaintiffs in your complaint, including any companies owned by your client(s), which may hold some of the relevant rights. Unfortunately for plaintiffs with loan-out companies, there may be certain drawbacks if the plaintiff is an entity as opposed to an individual.

Typically, either our engagement stops here because we learn that a plaintiff has no standing to make a copyright infringement claim, or the scope of the matter multiplies if we determine that the number of works infringed was greater than the plaintiff originally identified.

I Love My Job

There are many different aspects of royalty accounting and auditing that make it a highly rewarding profession. To start, royalty accountants and auditors get to work with some of the most creative people in the world - musicians, songwriters, and other music industry professionals - and the greatest IP attorneys of all time.

No two days are ever the same in this line of work, but when our team gets messages like the above from clients, it is a golden shining moment for the professionals at our firm, Boschan Corp.

My Accounting Firm's Values

Years ago in "partner training," Jennifer Wilson of Convergence Coaching taught me how a values-based organization can provide meaning, empowerment, belonging and success to the next generation of professionals, as well as firm clients.  See this clip of Wilson here, at the Journal of Accountancy.

Wilson's lessons have led my accounting practice to many successes. I can't recommend Convergence Coaching's services enough to all professional firms including law practices and CPA firms.

But this post is to share with potential new employees that which my current team at Boschan Corp. values, so that you can asses whether you see your values mirrored:

• Accountability - We work as a team to support one another in stretching to reach the highest standards possible and rewarding great results. These high standards garner our firm respect, to the benefit of clients.
  
  
• Appreciation - We regularly praise team members for their impressive accomplishments in reaching or setting standards, and we are always looking for innovative ways to show our profound appreciation for better execution and results. Please share your suggestions in the comments.
  
  
• Communication - Our success depends on courageous communication and we are committed to sharpening our communication skills continuously, from participating in Toastmasters to improving our client reports (a current challenge).
  
  
• Growth - Beyond our firm's sales growth, we make personal development a priority in our daily work schedules and benefits structure. If our people aren't cared for, strong and healthy, our firm won't be either.
  
  
• Profitability - We are implementing a profit sharing program this year. As Boschan Corp. performs better and better, it is due to the excellence of our fine team and they shall share in the rewards!

If you attended a great masters-level accounting program and "being the best" at what you do is important to you, please call Ms. Nguyen at Boschan Corp. at (424) 248-8866 to inquire about joining the team.

Most Favored Nations Damages Claims

During my decades of experience, I have made thousands of audit claims in connection with so-called “MFN” (i.e., Most Favored Nations) clauses.

As examples, many mechanical reproduction licenses for musical works and film profit participation agreements with talent contain MFN clauses, as do many licensing and other agreements.  As part of certain royalty audits, it is my job to quantify damages for non-compliance with this standard agreement provision.

Although counterparties cooperate to various degrees, my approach is generally to request the information – such as agreements with third parties, rate files and accountings - in order to ascertain whether a counterparty has complied with its commitment to pay rates to our firm's client(s) that are equally favorable compared to those agreed or paid to other relevant parties. If my team and I find that a counterparty failed to comply with a most favored nations provision, we utilize actual or estimated rates to quantify reportable royalties from which we deduct royalties reported (or claimed elsewhere in our audit or expert report).

How Long Does a Royalty Audit Take?

Too Long!

Good and true royalty audits take greater than one year to complete and settle. Only once in a great while is an audit opened and closed in less than a year.

Why so long?

• We must wait in the queue at various counterparties - it can take us longer than six months to commence an audit (previously known as "fieldwork")
• It can take us six months to two years to complete an audit because of a multitude of factors beyond our control (warehouse fires, anyone?)
• It can take over six months to receive an initial audit response - again, there is a queue
• Settlement discussions can take another six months or longer - it takes time and money for the parties to reach agreement
• If the parties don't settle, litigation can take years and cost a fortune, so more commonly settlement talks and tolling agreements are extended and the parties take their time to settle

In other words, do not hang your hat on an inflexible timetable for your audit and do hire an attorney who is an expert in tolling agreements to preserve your rights. Please ask if you need a referral to such legal counsel.

In summary, there are tactics to expedite audits, but in general, audits take too long.

Why Your Forensic Accountant May Not Provide Services on a Contingency Basis (i.e., Compensated on a Percentage or Commission of Client Recoveries)

As a forensic accountant, I almost never perform work on a contingency or deferred fee basis for several reasons, including:

1. It introduces some apparent conflicts (e.g., whether we take an aggressive approach for short term gains at the expense of a profitable counterparty-client relationship)... not to mention, who is our client anyway? It is often not one of the parties to a case.
2. It often compromises our ability to provide timely service since we have to prioritize other work to ensure we have the cash to pay our employees for their work
3. Our work will likely be inadmissible in court since contingency accountants or auditors have a financial stake in the outcome of the case 
4. For most of our clients, because they have a great deal of assets at stake, usually it is most cost-effective to engage us on our standard hourly basis
5. On the other hand, it is not profitable for us to accept very small contingency matters
6. There are lenders to clients who need to borrow money to afford legal costs - search "litigation financing" to learn more about this. 

If this fee structure doesn’t work for you, I completely understand. It does not work for everyone.

Looking for my Successor as Treasurer/CFO of Roar As One

Are you interested in a volunteer opportunity to make a difference in people's lives by using your accounting skills? At Roar As One, we have a role with a low time commitment in exchange for great board service and CFO experience serving 501 (c) (3) nonprofit. If you are interested, please contact Huyen Nguyen at Boschan Corp. at 424-248-8866.