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/.