London information technology & internet law firm Crefovi is delighted to bring you this new technology & data privacy blog, to provide you with forward-thinking and insightful information on hot business and legal issues in the digital & high technology sectors.
This new technology & data privacy blog provides regular news and updates, and features summaries of recent news reports, on legal issues facing the global information technology, media and internet community, in particular in the United Kingdom and France. This new technology & data privacy blog also provides timely updates and commentary on legal issues in the hardware, software and e-commerce sectors. It is curated by the IT lawyers of our law firm, who specialise in advising our information technology & internet clients in London, Paris and internationally on all their legal issues.
Crefovi practices in information technology, hardware & software since 2003, in Paris, London and internationally. Crefovi advises a wide range of clients, from start-ups in the tech world requiring legal advice on contractual, tax and intellectual property issues, to large corporations – renowned in the information technology and ‟Consumer discretionary” sectors – which require advice to negotiate and finalise their licencing or distribution deals, or to enforce their intellectual property rights. Crefovi’s ‟Internet & digital media” team participates in high-profile transactions. It assists leading established and emerging companies in mergers and acquisitions; litigation, including intellectual property litigation; financing transactions; securities offerings; structuring cross-border international operations; technology and intellectual property transactions; joint ventures and in matters involving online speech, privacy rights, advertising, e-commerce and consumer protection, and regulatory issues. Crefovi writes and curates this new technology & data privacy blog to guide its clients through the complexities of information technology, and internet & digital media, law.
The founding and managing partner of Crefovi, Annabelle Gauberti, regularly attends, and is a speaker on panels organised during, important events from the calendar of the world of information technology and internet, such as the tradeshows CES, Slush, SXSW, Viva Technology, Wired and Web Summit.
Moreover, Crefovi has industry teams, built by experienced lawyers with a wide range of practice and geographic backgrounds. These industry teams apply their extensive industry expertise to best serve clients’ business needs. Some of these industry teams are the ‟Information technology, hardware & software”, as well as the ‟Internet & digital media” departments, which curate this new technology & data privacy blog below, for you.
Annabelle Gauberti, founding and managing partner of London information technology & internet law firm Crefovi, is also the president of the International association of lawyers for creative industries (ialci). This association is instrumental in providing very high quality seminars, webinars & brainstorming sessions on legal & business issues to which the creative industries are confronted.
Perhaps surprisingly in a Conservative government, the IR35 rules have been tightened, in order to ensure that the taxman gets its fair share of revenues, when creators and their clients enter into entertainment, film, media and professional sports contractual arrangements. What is at stake for the creative industries in the UK? How to make the most of loan-out companies and loan-out agreements, while ensuring compliance with the revised IR35 rules?
1. What are loan-out companies?
In the entertainment industry, accountants often advise their clients, who work as key talent and crew in the film, TV, sports and media sectors, to set up a personal service company (‟PSC”) with Companies House, the United Kingdom (‟UK”) registrar of limited companies.
Such personal service companies are also called ‟loan-out” corporations because this is the jargon term they are referred by, which comes from the USA. Indeed, the US, as a global leader in the entertainment industry, was the first country where creators used this form of US business entities to loan-out their services, via the corporate body, to their end-clients.
The creator is usually the sole shareholder and director of the loan-out company.
The loan-out entity is engaged by external third parties (i.e. the end-clients) to fulfil entertainment, media or professional sports services, which are going to be performed and executed solely by the creator. Consequently, it is the talent’s loan-out company that is referred to, and liable, in contracts to perform the services required.
Since the creator’s services are typically performed on individual contract bases, in exchange of large, irregular sums of income throughout the year, the loan-out business model is especially prominent in the entertainment, media and professional sports industries.
Article 17 of the OECD Model Income Tax treaty of 1930 appears to be the foundation by which loan-out corporation structures may be used, as it provides that athletes, celebrities, artists who operate across several countries, and who therefore earn income under several national taxation systems, may only be taxed in their home jurisdiction’s source of income (even without an established corporate body).
By the 1970s-1980s, loan-out companies, or PSCs as they are more commonly referred to by the UK taxman, HMRC, and UK lawmakers, were widely used by entertainers, top talent and crew, as well as professional sportspeople, in the UK.
2. How to use PSCs and loan-out agreements?
Loan-out companies are used as a means to reduce the personal liability of the talent, as well as protect their personal assets.
Indeed, since the SPC is the sole party to any services agreement entered into with the end-customer, then, such end-client cannot go after the personal assets and liability of the creator, in case things go south during the execution phase of such services. The end-client – who is the counterparty to that loan-out agreement – will only be able to sue the SPC and trigger the limited liability of such loan-out company.
Moreover, in the UK, private companies limited by shares (which represent over 95 per cent of all companies in existence in that country), limit the liability of their shareholders to creditors of the company, to the capital originally invested, i.e. the nominal value of the shares and any premium paid in return for the issue of the shares by the company. Therefore, a shareholder’s personal assets are protected in the event of the company’s insolvency or increased liability to a third party.
Also, in the UK, the corporate veil is thick and not often, or easily, pierced: UK company directors incur no personal liability because all their acts are undertaken as agents of the SCP. While there are certain circumstances where personal liability may be imposed by the UK courts, particularly in respect of wrongful or fraudulent trading, it is rare that the corporate veil is pierced, and that the owners are held accountable, on their own assets, to pay off the limited company’s debts.
In a loan-out agreement, the party which is the loan-out company is typically responsible for dealing with the tax and/or any applicable national insurance contributions (‟NICs”) on any payments made under this agreement, by the counterparty.
This loan-out structure is therefore beneficial to, and flexible for, the end-client, who is unencumbered by HMRC’s rules on income tax and employer NICs payable on employees’ salaries, as well as protective employment law regulations applying to employees and self-employed people/freelancers relating, in particular, to a right to holiday, the national minimum wage, workplace pension and the maximum amount of 48 work hours per week.
There are also some tax advantages to this loan-out arrangement for the creator: first, the range of expenses which the PSC may set against its taxable profits will be much wider than that allowed to an employee to set against their taxable income. Second, there will be a cash-flow benefit in avoiding income tax being deducted at source each month. Third, the individual, as shareholder, may be in a position to be paid dividends by their loan-out company, which is a more tax-efficient alternative to only being paid earnings as the PSC’s employee, since this dividend form of income is not subject to NICs.
Therefore, loan-out agreements often lead to win-win situations, for the talent and their end-clients, provided that such services agreements are drafted correctly. In particular, the producing entity needs to ensure that all intellectual property created by the talent is assigned to the production.
Such loan-out agreements are typically called ‟producer agreement” or certificate of engagement (‟COE”). Indeed, a COE transfers to a studio or production company all rights in the results and proceeds of the services of an independent contractor (talent like an actor, producer, model, director or professional sportsperson) on an entertainment production, such as a television movie, theatrical motion picture film, TV or online series, social media content, or commercial. The COE includes work made for hire and assignment provisions. The parties negotiate and execute the COE promptly after agreeing to all deal terms before entering into a long-form agreement, such as a producer agreement, at a later stage.
As there can be some risks with the loan-out approach, in case the COE and/or long-form agreement are drafted incorrectly, it is best practice to seek expert legal advice when drafting, and reviewing as well as negotiating, a loan-out agreement.
3. What is the future of loan-out companies and agreements within the new IR35 landscape?
While I highlighted that loan-out agreements may be a win-win arrangement for the creator and their end-clients, there is one entity which has a lot to lose out of them: the taxman.
By the late 1990s, there were concerns that PSCs were being widely used, in the UK, to disguise the fact that, in many situations, individuals were working effectively as their client’s employee, while garnering the loan-out structure’s tax benefits.
To counter this type of tax avoidance in the March 1999 Budget, the Labour government announced it would introduce provisions to allow the tax authorities to look through a contractual relationship, where services were provided through an intermediary such as a PSC, but the underlying relationship between the worker and the client had the characteristics of employment. In those circumstances, the Labour proposals went, the engagement would be treated as employment for tax purposes.
Provision to this effect was included in the Finance act 2000, with effect from the 2000/01 tax year. The legislation is commonly called ‟IR35”, after the number of the Budget press notice which first announced this measure.
For the last 20 years, IR35 remained controversial, but were retained, even by the Conservative governments which succeeded the Labour one.
However, concerns escalated when it was discovered that the use of PSCs was common by senior staff in the public sector and by contractors working for the state-owned broadcaster BBC.
Since 2014, the various Tory governments went about cleaning the slate, by reforming the way the IR35 rules worked in the public sector. Following these reforms to the application of IR35 in the public sector, the government introduced legislation to make similar changes for the private sector to take effect from April 2021.
How do these changes affect creators in the entertainment, media and professional sports industries, since April 2021?
From 6 April 2021, IR35 rules applying to PSCs shift the responsibility from the PSC to the organisation receiving the talent’s services.
Before 6 April 2021, it was the loan-out company that was responsible for assessing and making payment of income tax and/or NICs for the services being provided by the creator/talent.
The government’s reforms for private sector companies are intended to improve compliance with the IR35 rules by moving the responsibility for tax assessment and payment from the contractor to the end-client. What this means, in the film, media and sports context, is that a producer engaging the services of a talent is now responsible for assessing whether that individual should be legally treated as an employee if they were being engaged directly by the producer, rather than through the loan-out company, and, if so, for accurately deducing income tax and NICs from the individual’s pay.
However, this change only affects large and medium size businesses, meaning that producers which fall into the category of a ‟small business” are not affected by the new IR35 provisions. However, it is not yet known how a ‟small business” will be defined by HMRC, and what criteria will be applied by HMRC to any assessment as to business size.
For example, our law firm Crefovi recently advised a client, whose producer services were retained by a production company working on behalf of the BBC, the commissioning broadcaster of an upcoming TV series, via his loan-out company. When I asked this client how much the budget of these TV series was, since such information was not disclosed in the draft producer agreement he had asked us to review and analyse on his behalf, he replied ‟GBP10 million”. I would argue that this budget size definitely places the BBC- commissioned production company into the category of ‟medium to large business”. Yet, the production company’s solicitor had drafted the loan-out agreement in such a way that the onus of paying any income tax and NICs liabilities, on the producer’s payments, layed solely with our client’s loan-out company, not with the production company.
Even if HMRC has confirmed, in its guidance on the new IR35 rules, that ‟customers will not have to pay penalties for inaccuracies in the first 12 months relating to the off-payroll working rules, regardless of when the inaccuracies are identified, unless there’s evidence of deliberate non-compliance”, and that HRMC ‟will not use information acquired as a result of the changes to the off-payroll working rules to open a new compliance enquiry into returns for tax years before 2021 to 2022, unless there is reason to suspect fraud or criminal behaviour”, it seems that UK production companies and their accountants and lawyers still turn a blind eye on their new responsibilities, post April 2021. This will trigger quite a few compliance enquiries with HMRC and, no doubt, tax litigation in the coming years.
Watch that space and, if you are a responsible creator, or production company owner, do reach out to us, at Crefovi, so that we may advise you on how to still rip the benefits of loan-out companies and structures, while minimising heightened legal and tax risks caused by this more stringent IR35 framework.
In the globalisation age, fashion and luxury brands aspire to doing business everywhere, servicing their retail clients on each continent.
Yet, trade and geographical barriers are still in place, and even increased during the inward-looking Trump era, in the US, and Brexit transition, in the UK, making smooth and seamless fashion and luxury purchase transactions a challenge.
So, what is the best approach, in the post-COVID, post-Trump, and post-Brexit world, to sell your fashion and luxury wares around the world, while making high margins?
1. Selling fashion products between the US and Europe, via your own e-commerce sites, at a profit: ‟how to” guide
In an age stricken by lockdowns and compulsory sanitary passes induced by COVID, online sales are a life saver. They took off during the pandemic and retail customers have now gotten used to shopping online.
It is therefore time to make your ecommerce site, as well as social media accounts, as attractive, and user-friendly, as possible. This way, you may capitalise on this online shopping spree, provided that you offer free worldwide shipping and returns, 24/7 customer service and a faultless and enjoyable electronic buying experience.
a. Consumer protection on distance-selling transactions
One thing to bear in mind, though. While there is no singular or specific law governing e-commerce by retailers or any other seller of goods or services via the internet, in the US, it is a distribution channel which is tightly regulated in the European Union (‟EU”) and the UK.
In particular, national laws transposing the EU directive 2011/83 on consumer rights, which aims at achieving a real business-to-consumer internal market, striking the right balance between a high level of consumer protection and the competitiveness of businesses, apply in the 27 EU member-states and in the UK, as ‟retained EU law” (i.e. a new type of UK law filling the gap where EU law used to be, pursuant to the EU withdrawal act 2018).
Thanks to these EU and UK national laws, the withdrawal period during which a consumer may withdraw from the sale, has been extended from 7 to 14 days. They introduced the use of a standard form, that can be used by consumers to exercise their withdrawal rights. Such form must be made available to consumers online or sent to them before the contract is entered into. If a consumer exercises this withdrawal right, the business must refund the consumer for all amounts paid, including delivery costs, within a period of 14 calendar days.
If your US fashion or luxury brand wants to sell, online, to European consumers, it must comply with those above-mentioned EU and UK national laws protecting consumers.
So, your best bet is to adopt a best practice approach, offering the same level of consumer protection rights to all your clients, all over the world, which will be in compliance with the high standards imposed by the EU and UK national laws transposing the EU directive 2011/83 on consumer rights.
b. General data protection regulation and privacy
Also, Europeans are quite touchy with regards to their personal data and how businesses manage it.
The General data protection regulation (‟GDPR”), adopted in April 2016, reflects these concerns and how they are addressed in the EU and the UK.
In addition, companies offering products and services to EU and UK consumers must appoint a data protection officer, ensuring that they:
- comply with such data protection legal framework,
- have a systemic and quick process in place, should they suffer from a data breach or some hacking issues of their e-commerce website, and
- have a designated point of contact, who will liaise with the EU or UK data protection authority, such as the ‟Commission informatiques et Libertés” (‟CNIL”) in France, or the Information Commissioner’s Office (‟ICO”) in the UK.
Again, perhaps the best approach, for any fashion and luxury business with global ambitions, is to set up a data protection policy worldwide, which will apply to all its customers globally, and which will meet the high standards imposed by the GDPR.
While it may be a steep learning curving, to bring your ecommerce website and business up to these standards, your fashion brand will only gain in reputation, coming across as a deeply respectful company, in tune with consumers’ needs and concerns with respect to data protection and privacy.
c. Value added tax
Online sales are taxed in the same way than sales in brick-and-mortar retail stores, in the EU and the UK: they are all subjected to a 20 percent value added tax (‟VAT”) rate. It is the standard VAT rate in France and the UK and is applicable on all fashion and luxury products.
Indeed, since July 2021, all e-commerce purchases, even those made by retailers based outside the EU or the UK, are subjected to VAT. While there used to be an exemption of VAT, for goods imported in the EU, and sold for less than 22 Euros, they are no longer exonerated of VAT.
So, what does this mean, practically, for a US fashion business that sells its wares via e-commerce in Europe? It must register with the Import one-stop shop (‟IOSS”), to comply with its VAT e-commerce obligations on distance sales of imported goods. And it must charge VAT on all fashion goods imported to the EU.
d. Import duties
If the VAT and import duties (or trade tariffs) are not planned for, and paid promptly, when the imported fashion products enter the EU or UK, this will cause customs delays, slow your delivery time and negatively impact your customer’s experience.
It is therefore essential to clarify from the outset, with your EU or UK customer, who is in charge of bearing those costs, and how. These additional costs, and the responsibility for paying these, must be clearly communicated on your e-commerce website and/or social channels, as well as at the checkout.
Generally, the customs clearance process is more or less the same in all EU countries. As far as shipping documents go, a commercial invoice and air waybill are required for all international shipments.
Personal shipments of low-value, unregulated goods can usually clear customs without any additional documentation.
However, fashion brands in non-EU countries will need an Economic operators registration and identification number (‟EORI number”), if they will be making customs declarations for shipments to EU countries. Shippers based outside the EU can request the EORI number from the customs authority in the EU country where they first lodge a customs declaration.
Customs duties will be charged for shipments valued over 150 Euros.
As a US fashion or luxury brand keen to do business in the EU and the UK, you need to adapt your e-commerce website, by adding some information and checkout options relating to VAT and custom duties, and by adding appropriate terms and conditions’ webpages, compliant with the GDPR and EU laws on consumer protection during distance-selling transactions. This will be a winning recipe for your European conquest.
2. Selling fashion products from the US to Europe, via third-party e-commerce sites: the holy grail
When you sell your fashion wares via third party ecommerce websites, as a US business, you somehow delegate the above-mentioned EU and UK compliance issues to someone else.
Indeed, it will be down to the mytheresa, net-a-porter, theoutnet and matchesfashion of this world to have all their ducks in a row, in order to comply with EU regulations.
However, you still have to focus on two main points, when selling your products via third party ecommerce sites.
Firstly, a working capital consideration: are you ready to accept consignment, or do you only do wholesale? In other words, will you get paid only if and when your product is sold by the e-commerce platform, or will you get paid for the product, by this third-party retailer, whether or not it sells on the online retail store?
Secondly, are your products compliant with EU regulations relating to product safety rules and standards? This is especially true if you are selling high risk products such as jewellery (in direct contact with the skin) or children’s apparel and jewellery. For example, the EU REACH regulation limits the concentration of lead in jewellery and other articles, while US jewellery companies have no such limitations on their internal market. It is therefore essential for your US fashion and luxury brand to double-check, before exporting to the EU or the UK, that your products comply with these EU and UK product safety rules and standards, especially now that class action lawsuits are allowed in Europe.
3. Selling US fashion products via European brick & mortar retailers and stockists: the traditional route
During the European seasonal fashion trade shows, such as Pitti and White, in Italy, and Tranoi, Man/Woman and Premiere Classe in Paris, France, your US brand may meet some European stockists interested in selling your wares in their EU or UK brick-and-mortar retail stores.
This is a great opportunity to showcase your US brand to European consumers and should be embraced with ‟cautious celebration”. Indeed, while the two above-mentioned considerations of consignment vs wholesale, and of compliance with EU product safety rules and standards, should be taken into account, a proper discussion about the retail channels of the EU or UK brick & mortar stores also needs to take place.
Does the EU or UK stockist intend to sell solely in their physical store, or also online, on their e-commerce boutique? Under article 101 of the treaty on the Functioning of the European Union (‟TFEU”), luxury and fashion brands cannot ban their distributors from selling their products online, through ecommerce, as this would be a competition law breach, deemed to be an ‟anticompetitive restriction”. However, luxury and fashion brands may impose some criteria and conditions to their stockists, to be able to sell their products online, in order to preserve the luxury aura and prestige of their products sold online, via the terms of their distribution agreements.
Indeed, these above-mentioned discussions and conditions could be the premises of setting up a selective distribution network for your US brand in Europe. Selective distribution is the most-used distribution technique for perfumes, cosmetics, leather accessories and ready-to-wear in Europe. It escapes the qualification of anti-competitive agreement, under article 101(3) of the TFEU, via a vertical agreement block exemption.
If you decide to appoint an agent, or a distributor, for the EU and UK territories, so that they find more stockists for your products in their geographical territories, your fashion brand must have a clear distribution plan in place, which needs to be set out in their agency agreement or distribution agreement. This way, your agent or distributor will be able to implement this distribution strategy, according to your guidelines and its contractual undertakings, in the designated EU or UK territory.
4. What’s in the works, with a global tax for digital platforms? How is that going to affect fashion and luxury brands worldwide?
Earlier this year, after the election of Joe Biden, we have heard a lot about an agreement on the corporate taxation of multinationals, paving the way to create new rules for the imposition of levies on the world’s multinational enterprises (‟MNEs”).
This is because European governments, and businesses, are fed up with US MNEs, such as Amazon, Google, Facebook, Starbucks and Apple, not paying corporate tax on their soil, but solely in the US and/or in European tax havens such as Ireland (which corporate tax rate is among the lowest in Europe at 12.5 percent).
Also, transfer pricing (that is, what affiliated companies charge each other for finished goods, services, financing or use of intellectual property) has been a source of tax planning opportunity, and the largest single source of tax controversy for MNEs, in a wide variety of industries, including retail and consumer products companies.
The French government went as far as setting up its own unilateral digital services tax, at a 3 percent rate, which applies to social networks, search engines, intermediaries such as online selling platforms, digital services, online retailers, since December 2020.
In July 2021, 130 countries and jurisdictions, representing more than 90 percent of global GDP, had joined a new plan to reform international taxation rules and ensure that MNEs pay a fair share of tax, wherever they operate, according to the OECD. If these reforms take place, taxing rights on more than USD100 billion of profit are expected to be reallocated to market jurisdictions each year, while the global minimum corporate tax will be at a rate of at least 15 percent and will generate around USD150 billion in additional global tax revenues annually.
While these global tax reforms may not affect the P&L of most fashion and luxury brands directly, it will definitely impact the tax burden of their digital distributors, marketplaces and channels, around the world.
These tax reforms will level the playing field, ensuring that wealth is redistributed more fairly, while globalisation and fashion distribution continue their ineluctable growth and expansion.
As explained in our two previous articles relating to Brexit, ‟How to protect your creative business after Brexit?” and ‟Brexit legal implications: the road less travelled”, the European Union (‟EU”) regulations and conventions on the jurisdiction and the recognition and enforcement of judgments in civil and commercial matters, ceased to apply in the United Kingdom (‟UK”) once it no longer was a EU member-state. Therefore, since 1 January 2021 (the ‟Transition date”), no clear legal system is in place, to enforce civil and commercial judgments after Brexit, in a EU member-state, or in the UK. Creative businesses now have to rely on domestic recognition regimes in the UK and each EU member-state, if in existence. This introduces additional procedural steps before a foreign judgment is recognised, which makes the enforcement of EU civil and commercial judgments in the UK, and of UK civil and commercial judgments in the EU, more time-consuming, complex and expensive.
1. How things worked before Brexit, with respect to the enforcement of civil and commercial judgments between the EU and the UK
a. The EU legal framework
Before the Transition date on which the UK ceased to be a EU member-state, there were, and there still are between the 27 remaining EU member-states, four main regimes that are applicable to civil and commercial judgments obtained from EU member-states, depending on when, and where, the relevant proceedings were started.
Each regime applies to civil and commercial matters, and therefore excludes matters relating to revenue, customs and administrative law. There are also separate EU regimes applicable to matrimonial relationships, wills, successions, bankruptcy and social security.
The most recent enforcement regime applicable to civil and commercial judgments is EU regulation n. 1215/2012 of the European parliament and of the council dated 12 December 2012 on the jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the ‟Recast Brussels regulation”). It applies to EU member-states’ judgments handed down in proceedings started on or after 10 January 2015.
The original Council regulation n. 44/2001 dated 22 December 2000 on the jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the ‟Original Brussels regulation”), although no longer in force upon the implementation of the Recast Brussels regulation on 9 January 2015, still applies to EU member-states’ judgments handed down in proceedings started before 10 January 2015.
Moreover, the Brussels convention dated 27 September 1968 on the jurisdiction and the enforcement of judgments in civil and commercial matters (the ‟Brussels convention”), also continues to apply in relation to civil and commercial judgments between the 15 pre-2004 EU member-states and certain territories of EU member-states which are located outside the EU, such as Aruba, Caribbean Netherlands, Curacao, the French overseas territories and Mayotte. Before the Transition date, the Brussels convention also applied to judgments handed down in Gibraltar, a British overseas territory.
Finally, the Lugano convention dated 16 September 1988 on the jurisdiction and the enforcement of judgments in civil and commercial matters (the ‟Lugano convention”), which was replaced on 21 December 2007 by the Lugano convention dated 30 October 2007 on the jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (the ‟2007 Lugano convention”), govern the recognition and enforcement of civil and commercial judgments between the EU and certain member-states of the European Free Trade Association (‟EFTA”), namely Iceland, Switzerland, Norway and Denmark but not Liechtenstein, which never signed the Lugano convention.
The 2007 Lugano convention was intended to replace both the Lugano convention and the Brussels convention. As such it was open to signature to both EFTA members-states and to EU member-states on behalf of their extra-EU territories. While the former purpose was achieved in 2010 with the ratification of the 2007 Lugano convention by all EFTA member-states (except Liechtenstein, as explained above), no EU member-state has yet acceded to the 2007 Lugano convention on behalf of its extra-EU territories.
The UK has applied to join the 2007 Lugano convention after the Transition date, as we will explain in more details in section 2 below.
b. Enforceability of remedies ordered by a EU court
Before Brexit, the Recast Brussels regulation, the Original Brussels regulation, the Brussels convention, the Lugano convention and the 2007 Lugano convention (together, the ‟EU instruments”) provided, and still provide with respect to the 27 remaining EU member-states, for the enforcement of any judgment in a civil or commercial matter given by a court of tribunal of a EU member-state, whatever it is called by the original court. For example, article 2(a) of the Recast Brussels regulation provides for the enforcement of any ‟decree, order, decision or writ of execution, as well as a decision on the determination of costs or expenses by an officer of the court”.
The Original Brussels regulation also extends to interim, provisional or protective relief (including injunctions), when ordered by a court which has jurisdiction by virtue of this regulation.
c. Competent courts
Before the Transition date, proceedings seeking recognition and enforcement of EU foreign judgments in the UK should be brought before the high court in England and Wales, the court of session in Scotland and the high court of Northern Ireland.
Article 32 of the Brussels convention provides that the proceedings seeking recognition and enforcement of EU foreign judgments in France should be brought before the president of the ‟tribunal judiciaire”. Therefore, before the Transition date, a UK judgment had to be brought before such president, in order to be recognised and enforced in France.
d. Separation of recognition and enforcement
Before the Transition date, and for judgments that fell within the EU instruments other than the Recast Brussels regulation, the process for obtaining recognition of a EU judgment was set out in detail in Part 74 of the UK civil procedure rules (‟CPR”). The process involved applying to a high court master with the support of written evidence. The application should include, among other things, a verified or certified copy of the EU judgment and a certified translation (if necessary). The judgment debtor then had an opportunity to oppose appeal registration on certain limited grounds. Assuming the judgment debtor did not successfully oppose appeal registration, the judgment creditor could then take steps to enforce the judgment.
Before the Transition date, and for judgments that fell within the Recast Brussels regulation, the position was different. Under article 36 of the Recast Brussels regulation, judgments from EU member-states are automatically recognised as if they were a judgment of a court in the state in which the judgment is being enforced; no special procedure is required for the judgment to be recognised. Therefore, prior to Brexit, all EU judgments that fell within the Recast Brussels regulation were automatically recognised as if they were UK judgments, by the high court in England and Wales, the court of session in Scotland and the high court of Northern Ireland. Similarly, all UK judgments that fell within the Recast Brussels regulation were automatically recognised as if they were French judgments, by the presidents of the French ‟tribunal judiciaires”.
Under the EU instruments, any judgment handed down by a court or tribunal from a EU member-state can be recognised. There is no requirement that the judgment must be final and conclusive, and both monetary and non-monetary judgments are eligible to be recognised. Therefore, neither the UK courts, nor the French courts, are entitled to investigate the jurisdiction of the originating EU court. Such foreign judgments shall be recognised without any special procedures, subject to the grounds for non-recognition set out in article 45 of the Recast Brussels regulation, article 34 of the Original Brussels regulation and article 34 of the Lugano convention, as discussed in paragraph e. (Defences) below.
For the EU judgment to be enforced in the UK, prior to the Transition date, and pursuant to article 42 of the Recast Brussels regulation and Part 74.4A of the CPR, the applicant had to provide the documents set out in above-mentioned article 42 to the UK court, i.e.
- a copy of the judgment which satisfies the conditions necessary to establish its authenticity;
- the certificate issued pursuant to article 53 of the Recast Brussels regulation, certifying that the above-mentioned judgment is enforceable and containing an extract of the judgment as well as, where appropriate, relevant information on the recoverable costs of the proceedings and the calculation of interest, and
- if required by the court, a translation of the certificate and judgment.
It was incumbent on the party resisting enforcement to apply for refusal of recognition of the EU judgment, pursuant to article 45 of the Recast Brussels regulation.
Similarly, for UK judgments to be enforced in France, prior to the Transition date, the applicant had to provide the documents set out in above-mentioned article 42 to the French court, which would trigger the automatic enforcement of the UK judgment, in compliance with the principle of direct enforcement.
While a UK defendant may have raised merits-based defences to liability or to the scope of the award entered in the EU jurisdiction, the EU instruments contain express prohibitions on the review of the merits of a judgment from another EU member-state. Consequently, while a judgment debtor may have objected to the registration of a judgment under the EU instruments (or, in the case of the Recast Brussels regulation, which does not require such registration, appeal the recognition or enforcement of the foreign judgment), he or she could have done so only on strictly limited grounds.
In the case of the Recast Brussels regulation, there are set out in above-mentioned article 45 and include:
- if recognition of the judgment would be manifestly contrary to public policy;
- if the judgment debtor was not served with proceedings in time to enable the preparation of a proper defence, or
- if conflicting judgments exist in the UK or other EU member-states.
Equivalent defences are set out in articles 34 to 35 of the Original Brussels regulation and the 2007 Lugano convention, respectively. The court may not have refused a declaration of enforceability on any other grounds.
Another ground for challenging the recognition and enforcement of EU judgments is the breach of article 6 of the European Convention on Human Rights (‟ECHR”), which is the right to a fair trial. However, since a fundamental objective underlying the EU regime is to facilitate the free movement of judgments by providing a simple and rapid procedure, and since it was established in Maronier v Larmer  QB 620 that this objective would be frustrated if EU courts of an enforcing EU member-state could be required to carry out a detailed review of whether the procedures that resulted in the judgment had complied with article 6 of the ECHR, there is a strong presumption that the EU court procedures of other signatories of the ECHR are compliant with article 6. Nonetheless, the presumption can be rebutted, in which case it would be contrary to public policy to enforce the judgment.
To conclude, pre-Brexit, the EU regime (and, predominantly, the Recast Brussels regulation) was an integral part of the system of recognition and enforcement of judgments in the UK. However, after the Transition date, the UK left the EU regime as found in the Recast Brussels regulation, the Original Brussels regulation and the Brussels convention, since these instruments are only available to EU member-states.
So what happens now?
2. How things work after Brexit, with respect to the enforcement of civil and commercial judgments between the EU and the UK
In an attempt to prepare the inevitable, the EU commission published on 27 August 2020 a revised notice setting out its views on how various conflicts of laws issues will be determined post-Brexit, including jurisdiction and the enforcement of judgments (the ‟EU notice”), while the UK ministry of justice published on 30 September 2020 ‟Cross-border civil and commercial legal cases: guidance for legal professionals from 1 January 2021” (the ‟MoJ guidance”).
a. The UK accessing the 2007 Lugano convention
As mentioned above, the UK applied to join the 2007 Lugano convention on 8 April 2020, as this is the UK’s preferred regime for governing questions of jurisdiction and enforcement of judgments with the 27 remaining EU member-states, after the Transition date.
However, accessing the 2007 Lugano convention is a four-step process and the UK has not executed those four stages in full yet.
While step one was accomplished on 8 April 2020 when the UK applied to join, step two requires the EU (along with the other contracting parties, ie the EFTA member-states Iceland, Switzerland, Norway and Denmark) to approve the UK’s application to join, followed in step three by the UK depositing the instrument of accession. Step four is a three-month period, during which the EU (or any other contracting state) may object, in which case the 2007 Lugano convention will not enter into force between the UK and that party. Only after that three-month period has expired, does the 2007 Lugano convention enter into force in the UK.
Therefore, in order for the 2007 Lugano convention to have entered into force by the Transition date, the UK had to have received the EU’s approval and deposited its instrument of accession by 1 October 2020. Neither have occured.
Since the EU’s negotiating position, throughout Brexit, has always been ‟nothing is agreed until everything is agreed”, and in light of the recent collision course between the EU and the UK relating to trade in Northern Ireland, it is unlikely that the UK’s request to join the 2007 Lugano convention will be approved by the EU any time soon.
b. The UK accessing the Hague convention
Without the 2007 Lugano convention, the default position after the Transition date is that jurisdiction and enforcement of judgments for new cases issued in the UK will be determined by the domestic law of each UK jurisdiction (i.e. the common law of England and Wales, the common law of Scotland and the common law of Northern Ireland), supplemented by the Hague convention dated 30 June 2005 on choice of court agreements (‟The Hague convention”).
I. At common law rules
The common law relating to recognition and enforcement of judgments applies where the jurisdiction from which the judgment relates does not have an applicable treaty in place with the UK, or in the absence of any applicable UK statute. Prominent examples include judgments of the courts of the United States, China, Russia and Brazil. And now of the EU and its 27 remaining EU member-states.
At common law, a foreign judgment is not directly enforceable in the UK, but instead will be treated as if it creates a contract debt between the parties. The foreign judgment must be final and conclusive, as well as for a specific monetary sum, and on the merits of the action. The creditor will then need to bring an action in the relevant UK jurisdiction for a simple debt, to obtain judicial recognition in accordance with Part 7 CPR, and an English judgment.
Once the judgment creditor has obtained an English judgment in respect of the foreign judgment, that English judgment will be enforceable in the same way as any other judgment of a court in England.
However, courts in the UK will not give judgment on such a debt, where the original court lacked jurisdiction according to the relevant UK conflict of law rules, if it was obtained by fraud, or is contrary to public policy or the requirements of natural justice.
With such blurry and vague contours to the UK common law rules, no wonder that many lawyers and legal academics, on both sides of the Channel, decry the ‟mess” and ‟legal void” left by Brexit, as far as the enforcement and recognition of civil and commercial judgments in the UK are concerned.
II. The Hague convention
As mentioned above, from the Transition date onwards, the jurisdiction and enforcement of judgments for new cases issued in England and Wales will be determined by its common law, supplemented by the Hague convention.
The Hague convention gives effect to exclusive choice of court clauses, and provides for judgments given by courts that are designated by such clauses to be recognised and enforced in other contracting states. The contracting states include the EU, Singapore, Mexico and Montenegro. The USA, China and Ukraine have signed the Hague convention but not ratified or acceded to it, and it therefore does not currently apply in those countries.
Prior to the Transition date, the UK was a contracting party to the Hague convention because it continued to benefit from the EU’s status as a contracting party. The EU acceded on 1 October 2015. By re-depositing the instrument of accession on 28 September 2020, the UK acceded in its own right to the Hague convention on 1 January 2021, thereby ensuring that the Hague convention would continue to apply seamlessly from 1 January 2021.
As far as types of enforceable orders are concerned, under the Hague convention, the convention applies to final decisions on the merits, but not interim, provisional or protective relief (article 7). Under article 8(3) of the Hague convention, if a foreign judgment is enforceable in the country of origin, it may be enforced in England. However, article 8(3) of the Hague convention allows an English court to postpone or refuse recognition if the foreign judgment is subject to appeal in the country of origin.
However, there are two major contentious issues with regards to the material and temporal scope of the Hague convention, and the EU’s and UK’s positions differ on those issues. They are likely to provoke litigation in the near future.
The first area of contention relates to the material scope of the Hague convention: more specifically, what is an ‟exclusive choice of court agreement”?
Article 1 of the Hague convention provides that the convention only applies to exclusive choice of courts agreements, so the issue of whether a choice of court agreement is ‟exclusive” or not is critical as to whether such convention applies.
Exclusive choice of court agreements are defined in article 3(a) of the Hague convention as those that designate ‟for the purpose of deciding disputes which have arisen or may arise in connection with a particular legal relationship, the courts of one Contracting state or one or more specific courts of one Contracting state, to the exclusion of the jurisdiction of any other courts”.
Non-exclusive choice of court agreements are defined in article 22(1) of the The Hague convention as choice of court agreements which designate ‟a court or courts of one or more Contracting states”.
Although this is a fairly clear distinction for ‟simple” choice of court agreements, ‟asymmetric” or ‟unilateral” agreements are not so easily categorised. These types of jurisdiction agreements are a common feature of English law-governed finance documents, such as the Loan Market Association standard forms. They generally give one contracting party (the lender) the choice of a range of courts in which to sue, while limiting the other party (the borrower) to the courts of a single state (usually, the lender’s home state).
There are divergent views as to whether asymmetric choice of court agreements are exclusive or non-exclusive for the purposes of the Hague convention. While two English high court judges have expressed the view that choice of court agreements should be regarded as exclusive, within the scope of the Hague convention, the explanatory report accompanying the Hague convention, case law in EU member-states and academic commentary all suggest the opposite.
This issue will probably be resolved in court, if and when the time comes to decide whether asymmetric or unilateral agreements are deemed to be exclusive choice of court agreements, susceptible to fall within the remit of the Hague convention.
The second area of contention relates to the temporal scope of the Hague convention: more specifically, when did the Hague convention ‟enter into force” in the UK?
Pursuant to article 16 of the Hague convention, such convention only applies to exclusive choice of court agreements concluded ‟after its entry into force, for the State of the chosen court”.
There is a difference of opinion as to the application of the Hague convention to exclusive jurisdiction clauses in favour of UK courts entered into between 1 October 2015 and 1 January 2021, when the UK was a party to the Hague convention by virtue of its EU membership.
Indeed, while the EU notice states that the Hague convention will only apply between the EU and UK to exclusive choice of court agreements ‟concluded after the convention enters into force in the UK as a party in its own right to the convention” – i.e. from the Transition date; the MoJ guidance sets out that the Hague convention ‟will continue to apply to the UK (without interruption) from its original entry into force date of 1 October 2015”, which is when the EU became a signatory to the convention, at which time the convention also entered into force in the UK by virtue of the UK being a EU member-state.
To conclude, the new regime of enforcement and recognition of EU judgments in the UK, and vice versa, is uncertain and fraught with possible litigation with respect to the scope of application of the Hague convention, at best.
Therefore, and since these legal issues relating to how to enforce civil and commercial judgments after Brexit are here to stay for the medium term, it is high time for the creative industries to ensure that any dispute arising out of their new contractual agreements are resolved through arbitration.
Indeed, as explained in our article ‟Alternative dispute resolution in the creative industries”, arbitral awards are recognised and enforced by the Convention on the recognition and enforcement of foreign arbitral awards 1958 (the ‟New York convention”). Such convention is unaffected by Brexit and London, the UK capital, is one of the most popular and trusted arbitral seats in the world.
Until the dust settles, with respect to the recognition and enforcement of EU judgments in the UK, and vice versa, it is wise to resolve any civil or commercial dispute by way of arbitration, to obtain swift, time-effective and cost-effective resolution of matters, while preserving the cross-border relationships, established with your trade partners, between the UK and the European continent.
What happens when you let some old farts from the UK judiciary, fueled by a doomed Brexit, single-handedly decide the technological future, advances and boon to which UK users should have access to? Well, stupid business choices justified by perfectly elegant and intellectually stimulating legal decisions handed down by old timers on a rampage to make ‟Britain great again”. I am sorry that TuneIn had to pay such a hefty price, on the UK market but, oh boy, it did.
As a daily jogger, I am an early adopter, and fervent user, of radio apps, such as Radio Garden and TuneIn, in order to listen to, in particular, Los Angeles’ radio stations such as KCRW Eclectic 24 and KPFK, while I am practising my daily and morning sport exercises. While at home, I listen to French radio stations such as FIP or Nova, or to LA channels, via Tunein which is accessible on my Sonos home sound systems, software (installed on my two iphones) and speakers.
However, over the last year or so, I could not help but notice that European radio stations, such as FIP or France Inter, were no longer accessible from either TuneIn station or Sonos Radio station, while I am in the United Kingdom (‟UK”).
Intrigued, I decided to delve deeper into this case and gulped (there is no other word) the 47 pages of the Warner Music UK Ltd and Sony Music Entertainment UK Ltd versus TuneIn Inc decision handed down by the High court of justice of England & Wales on 1 November 2019, as well as the 56 pages of the TuneIn Inc versus Warner Music UK Limited and Sony Music Entertainment UK Limited judgment handed down by the Court of appeal on 26 March 2021.
Whilst I admire the intellectual virtuosity of the first degree judge, Justice Birss, displayed in the above-mentioned first degree decision, as well as the ‟strong hand in a velvet glove” approach favoured by the appeal judge, Justice Arnold, in the appellate judgment, I can only conclude that this exercise in intellectual masturbation by the judiciary has led, yet again, to another castration of a technological product full of creativity, advancement, connectivity to the world and fantastic ubiquity.
Am I therefore pissed off?
Yes. Here is why.
Are you actually saying that TuneIn should ditch internet radio stations which are unlicensed in the UK?
The ‟modus operandi” of TuneIn is to operate an online platform, website and apps, which provide a service enabling users to access radio stations around the world. The service is called TuneIn Radio.
It is now available on over 200 platform connected devices, including smart phones, tablets, televisions, car audio systems, smart speakers such as Sonos, and wearable technologies.
TuneIn Radio has links to over 100,000 radio stations, broadcast by third parties from many different geographic locations around the world. It is monetised through advertising and subscriptions, although the subscription is free for many users of hardware products such as Sonos and Bose sound systems.
TuneIn Radio is awesome because, like Radio Garden, it allows users to save some radio channels as favourites, offers some curation services as well as some search functions, which a new user may use when he or she does not know what radio stations he or she may like. In addition, TuneIn Radio provides perks such as personalisation of content, collation of station information presented on individual station pages, and artist information set out on dedicated artist pages.
Even better, until a few years ago, TuneIn Radio offered a recording device, through its Pro app, which also included a curated repertoire of a large number of music internet radio stations.
As a user, you are therefore blissfully entertained, and your every musical needs catered for, when using the full gamut of TuneIn Radio’s perks and services.
Well, such users’ bliss was short-lived, however, since the High court decision, confirmed by the 2021 appellate judgment, found that by including internet radio stations which are either unlicensed, such as Capital FM Bangladesh and Urban 96.5 Nigeria, or not compliant with the local neighbouring rights regime, such as Kazakhstan station Gakku FM and Montenegro’s City Radio, TuneIn Radio was infringing under section 20 of the 1988 Copyright, designs and patents act (the ‟Act”) which provides:
‟20. Infringement by communication to the public
(1) The communication to the public of the work is an act restricted by the copyright in—
(a) a literary, dramatic, musical or artistic work,
(b) a sound recording or film, or
(c) a broadcast.
(2) References in this Part to communication to the public are to communication to the public by electronic transmission, and in relation to a work include—
(a) the broadcasting of the work;
(b) the making available to the public of the work by electronic transmission in such a way that members of the public may access it from a place and at a time individually chosen by them.”
So not only those unlicensed and non-compliant internet radio stations are in breach of the right to communicate to the public, but TuneIn Radio is too, since it provides links to those streams.
Had TuneIn Radio not obtained a warranty from those internet radio stations that they operated lawfully in their home state? God forbid, TuneIn Radio could not rely on such warranty, of course, and the onus was on TuneIn Radio to double-check that such internet radio stations were either licensed or compliant with their local neighbouring rights regime.
So what is the direct consequence of such stance, taken by the UK High court and Court of appeal? Well, all those internet radio stations become unavailable to the public, in the UK but also probably in other European countries such as the 27 member-states of the European Union (‟EU”), via the TuneIn Radio platforms, websites and apps.
Indeed, all the reasoning made by Justice Birss, in the first degree case, as well as Justice Arnold, in the appellate case, revolved around article 3 of the EU Information Society Directive (the ‟Directive”), which was transposed into the above-mentioned section 20 of the Act, and the abondant, eye-wateringly complex and excruciatingly intricate related case-law of the Court of Justice of the European Union (‟CJEU”) on the right of communication to the public.
So, yeah, you bet, this TuneIn case is valid both for the UK (which has now exited the EU via its unwitty Brexit), and the 27 remaining member-states of the EU.
Therefore, users and customers lose because they cannot listen to all worldwide internet radio streams via TuneIn anymore, as a direct consequence of the UK decisions.
And it does not stop there! Perish the thought.
What about those music radio stations which are licensed for a local territory other than the UK, such as VRT Studio Brussel in Belgium, Mix Megapol in Sweden and MavRadio in the USA?
For these radio stations outside the USA, the countries operate various kinds of remuneration rights regimes and these stations are paying remuneration under these local schemes. The USA operates a statutory licence scheme conditional on paying royalties and the sample radio MavRadio pays those royalties. However, in all of these cases, the relevant body has not granted geographical rights for the UK.
Ahhh, the UK first degree judgement, confirmed in appeal says, that’s not my problem, my dear sir: TuneIn’s act of communication in relation to those sample radio streams which pay royalties to a body that does not grant geographical rights for the UK, is unlawful, unless licensed by the UK rights holder. Since it is currently not, TuneIn’s actions amount to infringement under above-mentioned section 20 of the Act.
Therefore, TuneIn has to now remove all this pool of internet radio stations from its platforms, apps and websites too, until it has figured out how to strike a deal with the UK rights holders.
Probably, TuneIn’s best call is to reach out to the UK neighbouring rights collecting society, PPL, and start the licensing negotiations from there, immediately. Also, TuneIn better cooperate directly with labels Warner and Sony, to strike those licences, now that the UK first degree decision has been confirmed in appeal and since these two claimants ‟account for more than half the market for digital sales of recorded music in the UK and about 43 percent globally” (sic).
While I can understand that the UK courts would slam TuneIn for not proactively getting a UK neighbouring rights’ licence for its own premium radio stations, made available exclusively to TuneIn’s subscribers, I found it profoundly castrating to make TuneIn’s liable for primary infringement of the right of communication to the public for merely providing streams to unlicensed and non-compliant third party internet radio stations and to third party internet radio stations which do not pay royalties in the UK.
What about the right of UK and EU users to have access to as much culture, musical experience and knowhow, as possible, even in a geopolitical context where most countries in the world do not care about, and probably don’t even know what are, neighbouring rights?
This is directly discriminating UK and, probably, all EU listeners and users, because TuneIn will now have to geoblock all its links to non-compliant and unruly streams, which probably constitute at least 50 percent of the 100,000 internet radio stations available on its apps, platforms and websites.
So Justice Birss and Justice Arnold can now breathe a sigh of relief, at the thought of having saved European neighbouring rights in the face or barbarian non-British cultural invasion, but I am sure that most UK users of TuneIn only have a ‟fuck you” to respond in return, for their ill-advised, technologically-stiffling and Brexitist stance on the matter.
Now, by using TuneIn Radio, a UK user will only have access to music radio stations which are licensed in the UK by PPL, such as BBC Radio 2, Heart London, Classic FM and Jazz FM. Thank you very much, but we can already access those radio channels on our terrestrial radio sets or on their respective online platforms, from the UK, so what is the added value of TuneIn Radio in the UK now, pray tell?
So I can’t use the recording service on TuneIn anymore?
Of course, Justice Birss, and then Justice Arnold, went for the jugular with respect to the recording option by users of TuneIn’s Pro app.
Indeed, in terms of a user’s use of the recording function, the claimants contended that the Pro app was not just a recording device. It also included a curated repertoire of a large number of music internet radio stations. The purchaser of the Pro app would, reasonably, understand that TuneIne had sold them the Pro app (with its built in recording function) in order to allow them to record audio content offered by the TuneIn Radio service. There was also a point on the degree of control exercised by TuneIn. Only internet radio stations provided by TuneIn could be recorded and TuneIn could disable the record function at a station-by-station level.
While this TuneIn recording function was a very original, and unique, offered feature, in the competitive world of radio aggregators, the High court decision, confirmed in appeal, swiftly killed it, by finding that ‟TuneIn had authorised the infringements carried out by its users by recording using the Pro app” and therefore ‟TuneIn’s service via the Pro app when the recording function was enabled infringed the claimants’ copyrights under Section 20 of the Act”.
Even if Justice Arnold allowed the appeal, in his appellant judgment, against the conclusion drawn by the first degree judge, that TuneIn was liable for infringement by communication to the public in relation to the ‟category 1” stations (i.e. the internet radio stations which already are licensed in the UK via PPL) by virtue of providing the Pro app to UK users with the record function enabled, the outcome is the same: off with its head, with respect to the great recording function offered by TuneIn’s Pro app.
As Susan Butler wisely wrote, in her Music Confidential’s last three issues, ‟in my view, however, that does not mean that (intellectual property) must be disruptive to digital innovation across national borders”. ‟(…) the bad kind of disruption – the costly and destructive kind – seems to occur most often when anyone tries to drag old business models or entities built around old business models into new multi-national digital marketplace. (…) Everyone must become more pliable to truly reshape the market to support true innovation”.
Well, Susan, with the old farts who handed down the 2019 and then 2021 decisions (check them out on the audio-video recorded hearings here!), count on it.
Another example of UK splendid and backward looking isolation, my friends: where is my visa to move to Los Angeles asap, please?
Crefovi’s founding and managing partner, Annabelle Gauberti, attended, by way of her MacBookPro, the EFM online 2021 session from 1 to 5 March 2021. What are Crefovi’s key takeaways from the first European film festival and market of the year? Was this online session a success, managing to link buyers and sellers, as well as their respective service providers, together?
Distributors’ need for European content to meet the statutory ratios set out in the Audiovisual Media Services Directive (‟AVMSD”)
This directive had to be transposed by September 2020 into national legislation in the 27 EU member-states. Yet, since only Denmark, Hungary, the Netherlands and Sweden notified transposition measures to the EU, the EU Commission sent formal notices to all the other 23 EU member-states, requesting them to provide further information, in November 2020.
Be that as it may, the AVMSD is already impacting the buying strategy of distributors and other streaming companies (called ‟streamers” during the EFM online 2021 session).
Indeed, the AVMSD governs EU-wide coordination of national legislation on all audiovisual media, both traditional TV broadcasts and on-demand services.
Since one of the goals of this EU coordination, via the AVMSD, is to preserve cultural diversity, each EU member-state is currently figuring out how best to transpose into national law the new obligation, for video on-demand services (which include streamers), to ensure at least a 30 percent share of European content in their catalogues, and to give prominence to such European content. The provisions of the AVMSD also allow, under certain conditions, EU member-states to impose on media service providers that are established in other member-states, obligations to contribute financially to the production of European works. The new obligations do not apply to media service providers with a low turnover or a low audience, in order not to undermine market development and inhibit the entry of new market players.
So, of course, the likes of Netflix, Amazon Prime, Disney+ are opening their large purses freely, in order to catch the best European titles, and therefore meet the 30 percent share of European works, which is a ‟sine qua non” condition for them to keep on, or start (in the case of Disney+, Hulu, HBO Max), offering their video on-demand services to EU consumers.
This was a blessing for European film producers, directors and sales agents present at the EFM online 2021 session. Indeed, a lot of key deals were signed at the European Film Market, this year, for European titles such as French work ‟Petite Maman” from Céline Sciamma, Radu Jude’s Golden Bear winner ‟Bad Luck Banging Or Loony Porn” (from Romania), and many more.
COVID 19’s negative impact on the production stage of film projects and how the UK and French film industry stakeholders rebounded
There is another reason why current new film content has not met the high demand (for European titles and other international works) in the supply chain. Well, you guessed it, the COVID 19 pandemic is the cause, of course.
Due to health and safety issues, the logistics of going into the film production stage have, for a while, seemed unsurmountable. Almost all film productions shut down, during the first European lockdown in February to June 2020. Then, everybody took a hold of themselves and went back to work, putting in place extremely stringent health and safety precautionary measures, pre, during and post production, such as:
- administering PCR COVID test to all above-the-line and below-the-line production staff upon entry in the UK and France, and then on each day of production;
- mandatory wear of personal protective equipment for all staff other than actors currently filming;
- keeping the mandatory 2 meters’ apart distanciation rule, between all team members.
Major talents and film producers would have none of the nonsense that COVID deniers would throw their way, with Tom Cruise going on record for his outburst towards UK film crew members who were flouting social distancing guidelines, on the Leavesden set of the 7th instalment of his ‟Mission: impossible” franchise, in December 2020.
The panel for EFM online 2021 session, from the British film commission, provides vivid description of how UK film producers and their staff had to adapt, at very short notice, when the pandemic hit in 2020, and how they are regularly reviewing and improving their health and logistics protocols, in order to ensure that they are compliant with the latest health news and information about the virus.
Also, the cost of insurance went through the roof, for most film productions around the world, making it impossible for many a project to move onto production stage. This disproportionately impacted independent filmmakers, to the point that governments stepped in, such as the UK government issuing a ‟Film & TV production restart scheme” for UK film and TV productions struggling to get insurance for Covid-related costs.
Of course, at the end of the film supply chain, a major change occurred, thanks to the pandemic: the tyranny, imposed by major film studios and European governments, consisting in forbidding ‟day-and-date” release (i.e. a simultaneous release of a film on multiple platforms – most commonly theatrical and on-demand videos services), dissolved. Cinemas have been closed for a while, now, since March 2020, on-and-off, due to the pandemic-induced lockdown. Therefore, there is a change of paradigm, for film producers and directors, from asking themselves ‟Should we go for a day-and-date release?”, to ‟On which video on-demand service and/or streamer, my film will shine most?”.
Indeed, die-hard fans of the theatrical window have started to yield, such as film major Universal pictures which released big films on streamers from March 2020 onwards.
Other major studios have preferred to hold back releasing many big titles indefinitely, such as Wes Anderson’s ‟The French dispatch”, much to the chagrin of end-consumers and fans.
EFM online 2021: filling the gap for more top-quality content with VFX hacks such as virtual production
One of the major takeaways from the EFM online 2021 is that, due to this huge demand for content, film professionals need to produce more, faster, at an affordable cost, and in very high production value.
This is where virtual production is coming, to deliver this faster, smoother and enhanced quality.
From the moment where the initial upfront cost and investment of acquiring top virtual production tools and material have been incurred, it is a no-brainer: virtual production specialists laude the cost and time savings, as well as agility, induced by this new technology, predicting that every filmmaker will irresistibly move to virtual production in the near future.
So what is virtual production? Virtual production is the use and incorporation of visual effects (‟VFX”) and technology throughout the production life cycle. While this process is not entirely new, the film industry is now paying much attention to virtual production, because it enhances production planning, increases shooting efficiency and reduces the number of expensive reshoots. Through visualisation, motion capture, hybrid camera, and LED live-action, the virtual production techniques that belong to the toolset of modern content creation are perfectly adapted to a COVID 19-era of film production.
Potentially, virtual production would allow actors, and crew members, to shoot and work from multiple locations, in a safe environment where they have set up their respective COVID-19 health and safety protocols and bubble.
The challenge now is for film professionals to jump on the bandwagon and swiftly obtain appropriate training on virtual production and other VFX tools and technologies, so that they can hit the ground running and offer their new much-needed skills to French and UK film productions.
To conclude, while I would have liked all presentations and virtual events to be accessible to all participants, during the EFM online 2021 (festival organisers cannot pretend that the room has a limited number of seats, anymore, right?), I deeply enjoyed the virtual attendance of this film market and festival, getting a lot out of it, from catching up on the latest trends to catching up with our film clients and prospects via Cinando and the online EFM platform. We will be back!
In the creative industries, many intellectual property rights, such as copyright, trademarks, registered designs and patents, are subjected to licenses, in order for right owners and creators to monetize such rights. However, things do not always go smoothly during and after the term of the licensing agreement, between the licensor and the licensee. Therefore, what are the remedies that the licensor may put in place, in order to ensure that his or her intellectual property rights are fairly monetised? How to remedy a breach of license which term is overran?
1. What is a license agreement?
A license is the contract which authorises the use of a certain intellectual property right (‟IPRs”), be it copyright, a trademark, a design or a patent, for commercial purposes, by a licensee, in exchange for the payment of royalties to the licensor, i.e. the right owner. These royalties are usually computed as a percentage of the turnover generated by the sale of products manufactured, or services provided, by the licensee under this license agreement.
A license is different from an assignment agreement, in that the former has a limited term, whereby the authorisation to use the IPRs granted to the licensee by the licensor will expire, after a period of time explicitly set out in the license agreement. On the contrary, an assignment is a perpetual and irreversible transfer of ownership of some designated IPRs, from the assignor to the assignee, in exchange for the payment of a consideration (usually, a one-off sum of money).
To resume, a license is temporary and reversible upon expiry of a term, while an assignment is irrevocable and irreversible if made for consideration.
2. How are licenses used in the creative industries?
Licenses are often used in the creative industries, in order for creatives to monetise the IPRs that they created.
For example, in the music industry, many copyright licenses are entered into, in order for music distributors to distribute the masters of sound recordings to new territories, which are difficult to reach for the music label which owns such masters because this label is located in a totally different geographical area. Therefore, the licensor, the music label, relies on the expertise of the local licensee, the national distributor, to put in place the best local strategy to broadcast the masters of its sound recordings, via radio plays, local streaming websites, TV broadcasting, and then to generate revenues through these various income streams and local neighbouring rights collecting societies.
Another example of a copyright license, in the fashion and luxury sectors, is when a brand commissions an artist or designer to make some drawings and designs, which the brand will then display on its website(s), as well as in its various stores. These drawings and designs being protected by copyright, the brand, as licensee, will enter into a license agreement with the artist, as licensor, to obtain the right to use these drawings and designs in set locations and premises of this brand.
Licenses are also extremely widely used in the context of trademarks, especially with respect to distribution of luxury and fashion products on new geographical territories by local distributors (who need to have the right to use the trademark to advertise, market and open retail locations), and also with respect to deals where the licensee manufactures products in which it has a lot of expertise (such as perfumes, cosmetics, children’s garments), which the licensee then sells under the trademark of a famous fashion or luxury brand, i.e. the licensor.
In the technology sector, patent and/or copyright licenses are the norm. Indeed, softwares and sources codes are protected by copyright, so many tech companies make a living licensing their copyright into such inventions, to their retail or business customers, in exchange for some royalties and/or licensing fees. As far as technological products are concerned, those can be protected by patents, provided that they are novel, that an inventive step was present in creating such products, and that the invention is capable of industrial application. Therefore, most technological hardware products, such as mobile phones, computers, tablets, are protected by patents. And whenever there is a dichotomy between the creator of these products, and the manufacturers and distributors of such products, then some patent license agreements are entered into.
Technology licenses are, indeed, so critical, that fair, reasonable and non-discriminatory terms (‟FRAND”) have been set up in order to level the playing field: FRAND terms denote a voluntary licensing commitment that standards organisations often request from the owner of an IPR (usually a patent) which is, or may become, essential to practice a technical standard. One of the most common policies, is for the standard- setting organisation to require from a patent holder that it voluntarily agrees to include its patented technology in the standard, by licensing that technology on FRAND terms. Failing or refusing to license IPRs on FRAND terms could even be deemed to infringe antitrust rules, in particular those of the European Union (‟EU”). For example, the EU commission sent a statement of objections to Motorola Mobility, for breach of EU antitrust rules, over its attempt to enforce a patent infringement injunction against Apple in Germany. The patents in question relate to GPRS, a part of the GSM standard, which is used to make mobile phone calls. Motorola accepted that these patents were standard essential patents and had, therefore, agreed that they would be licensed to Apple on FRAND terms. However, in 2011, Motorola tried to take out, and enforce, a patent infringement injunction against Apple in Germany, based on those patents, even although Apple had said that it was willing to pay royalties, to use the patented technology. Samsung was also the recipient of a statement of objections from the EU commission, after it sought patent infringement injunctions to ‟prevent Apple from infringing patents”, despite Apple apparently being willing to pay a license fee and negotiate a license on FRAND terms.
3. How to remedy a breach of license which term is overran: what to do if the license has expired but your licensee keeps on using your IPRs?
Due to poor management and in-house record-keeping, as well as human resources disorganisation and high turnover rate of staff, the licensee may breach the licensing agreement by keeping on using the licensed IPR, although the license agreement has reached its term.
For example, in the above-mentioned case of the copyright license on some masters of sound recordings, the French local distributors and licensees of such masters overran the term of the license and kept on collecting royalties and revenues on those masters, in particular from French neighbouring rights collecting societies, well after the date of termination of this license. How, on earth, could have this happened? Well, as I experienced first hand at the music trade show Midem, many music distributors, labels and catalogues’ owners, such as music publishers, often mingle together in order to buy and sell to each other music catalogues, be it of copyrighted musical compositions and lyrics, or of copyrighted masters of sound recordings. Therefore, the terms of the first license agreement, between the licensor and the initial first licensee, become more and more blurry and forgotten, with basic provisions, such as the duration of the initial license, being conveniently lost into oblivion by the generation of successive licensees. Yes, I guarantee you, it happens very often.
Another example, relating to the above-mentioned case of a copyright license granted by an artist, on his drawings and designs commissioned by a luxury brand, which used these drawings on its website(s) and stores, in order to promote its luxury products … even after the termination date of the license!
So what can a licensor do, when he or she notices that the licensee has, or is, breaching the terms of the license agreement by overrunning its duration? How to remedy a breach of license which term is overran?
First and foremost, the licensor must gather as much pieces of evidence as possible of such breach of the term of the license agreement, by the licensee. For example, the music label, licensor, may reach out to French neighbouring rights collecting societies and ask for the royalties statements for the French distributor, ex-licensee, up-to-date, in order to have some indisputable evidence that this ex-licensee kept on collecting the neighbouring rights royalties on the sound recordings which were the subject of the license, even after the termination date of this license. The French artist, whose designs and drawings kept on being used by the luxury brand after the term of his license with this brand expired, instructed our law firm to liaise with a French bailiff, in order to have this bailiff execute a detailed report of copyright infringement on internet, by taking snapshots of the webpages of this brand’s website displaying his drawings and designs.
These pieces of evidence are indispensable, in order to prove the IPR infringement (since the license expired), to show it to the ex-licensee, if necessary, and to use it in any future lawsuit for IPR infringement lodged with a local court, if and when the ex-licensee refuses to settle further to receiving the ex-licensor’s letter before court action.
You will have guessed by now that, indeed, once the ex-licensor has gathered as much conclusive evidence as possible that his or her IPR is being infringed by the ex-licensee because the latter keeps on using such IPR outside the contractual framework of the now-expired license agreement, the second stage is to instruct counsel, in the country where such IPR infringement is taking place, and have such counsel send a robust, cordial yet frank letter before court action to the ex-licensor, asking:
- for the immediate cessation of any IPR infringement act, by stopping using the IPR at once;
- for the evidence of, and information about, turnover and sales, relating to the sale of products and/or services, generated thanks to the use of the IPR beyond the term of the expired license, and
- for the restitution of all those revenues generated by the sale of those products and/or services, generated thanks to the use of the IPR beyond the term of the expired license, as well as accrued late payment interests at the statutory interest rate,
within a short deadline (usually, no longer than 14 days).
Here, the ex-licensee has an option: either it decides to cave in and avoid a tarnished reputation by immediately complying with the terms of the ex-licensor’s letter before court action, or it may decide to act as a blowhard and ignore the requests set out in this letter. The first approach is favoured by anglo-saxon companies, while the second option is usual among French, and all other Mediterranean, ex-licensees.
If the dispute may be resolved out-of-court, a settlement agreement will be drafted, negotiated and finalised, by the lawyers advising the ex-licensor and the ex-licensee, which will provide for the restitution of a very clearly defined sum of money, representing the sales generated by the ex-licensee during the period in which it overran the use of the litigious IPR.
If the dispute cannot be resolved out-of-court, then the ex-licensor will have no other option left than to lodge a lawsuit for IPR infringement against the ex-licensee, which – provided the former has strong evidence of such breach of licensing agreement – it will won.
Once the slate is clean again, i.e. after the ex-licensee has paid damages or restituted sums to the ex-licensor with respect to its use of the IPR after the termination date of the first license agreement, then ex-licensor and the ex-licensee may decide to resume doing business together. Here, I strongly advise that the parties draft a transparent, clear and straightforward new license agreement, which clearly sets out the termination date of this new future license, and foreseeable consequences in case the future licensee keeps on using the IPR beyond the end of such termination date. Using the services of either in-house lawyer or external counsel is very much advisable, in this instance, in order to avoid a repeat of the messy and damaging business situation which occured in the first place, between the licensor and the licensee.
Do you need to put in place an escrow agreement with respect to the software and/or source code that you license?Crefovi : 22/06/2020 4:01 pm : Antitrust & competition, Articles, Copyright litigation, Emerging companies, Gaming, Information technology - hardware, software & services, Insolvency & workouts, Intellectual property & IP litigation, Internet & digital media, Litigation & dispute resolution, Outsourcing, Product liability, Technology transactions
In this digital and technological corporate world, having a plan B in case your software or computer program license goes wrong is a must. Can a customer successfully leverage its position, by entering into an escrow agreement with the licensor? How does the source code escrow work, anyway? When can the source escrow be released to the licensee?
1. What is software escrow and source code escrow?
1.1. What is source code?
Source code is the version of software as it is originally written (i.e. typed into a computer) by a human in plain text (i.e. human readable alphanumeric characters), according to the Linux Information Project.
The notion of source code may also be taken more broadly, to include machine code and notations in graphical languages, neither of which are textual in nature.
For example, during a presentation to peers or potential clients, the software creator may ascertain from the outset that, ‟for the purpose of clarity, ‟source code” is taken to mean any fully executable description of a software system. It is therefore construed to include machine code, very high level languages and executable graphical representations of systems”.
Often, there are several steps of program translation or minification (i.e. the process of removing all unnecessary characters from the source code of interpreted programming languages or markup languages, without changing its functionality) between the original source code typed by a human and an executable program.
Source code is primarily used as input to the process that produces an executable computer programme (i.e. it is compiled or interpreted). Hence, computer programmers often find it useful to review existing source code to learn about programming techniques. So much so, that sharing of source code between developers is frequently cited as a contributing factor to the maturation of their programming skills.
Moreover, porting software to other computer platforms is usually prohibitively difficult – if not impossible – without source code.
1.2. Legal status of software, computer programs and source code
In the United Kingdom, section 3 (Literary, dramatic and musical works) of the Copyright, Designs and Patents Act 1988 (‟CDPA 1988”) provides that among works which are protected by copyright, are ‟computer programs”, ‟preparatory design material for a computer program” and ‟databases” (i.e. collections of independent works, data or other materials which are arranged in a systematic or methodical way and are individually accessible by electronic or other means).
Section 3A of the CDPA 1988 provides that the standard for copyright protection is higher, for databases, than for other ‟literary works”, since they must be original (i.e. by reason of the selection or arrangement of the contents of the database, the database constitutes the author’s own intellectual creation). Since the CDPA 1988 has no equivalent provision for computer programs, it is common knowledge that the provisions of section 3A of the CDPA 1988, relating to originality, apply to both databases and computer programs.
Moreover, the European Directive on the legal protection of databases (Directive 96/9/EC) and the Computer Directive (Directive 91/250/EEC) confirm these higher standards of originality for computer programs and databases, in the sense that they are the author’s own intellectual creation. This is a higher standard of originality than ‟skill, labour and judgment”.
Article L112-2 of the French intellectual property code (‟IPC”) provides that softwares, including preliminary conception work, are deemed to be ‘works from the mind’ protected by copyright. That copyright protection includes source code.
Both in France and the UK, the duration of copyright for software and computer programs is 70 years after the death of the author or, if the author is a legal entity, from the date on which the software was made public.
Copyright is acquired automatically in France and the UK, upon creation of the software or computer program, without any need for registration of such intellectual property right.
Both under English and French law, computer programs are regarded as not protectable via other registered intellectual property rights, such as patents. Indeed, section 1(2) (c) of the Patents Act 1977 (‟PA 1977”) lists computer programs among the things that are not regarded as being inventions “as such”. Article L611-10 of the IPC does the same in France.
1.3. Software escrow / source code escrow
Since authors of software and computer programs – which include source code – own the copyright to their work, they can licence these works. Indeed, the author has the right to grant customers and users of his software some of his exclusive rights in form of software licensing.
While some softwares are ‟open source”, i.e. free to use, distribute, modify and study, most softwares are ‟proprietary”, i.e. privately owned, restricted and, sometimes, kept secret.
For proprietary software, the only way for a user to have lawful access to it is by obtaining a license to use from its author.
When some very large sums of money are exchanged, between the licensor (i.e. the author of the software and source code) and its licensees (i.e. the users of such software and source code), a precautionary measure may be required by the latter: software escrow.
It is the deposit of software source code with a third-party escrow agent, such as Iron Mountain or SES. The source code is securely administered by a trusted, neutral third party to protect the developer’s intellectual property, while at the same time keeping a copy safe for the licensees in case anything happens, such as the licensor no longer being able to support the software or going into bankruptcy. If that situation materialises, the licensees request a release of the source code from the escrow account and are able to keep their businesses up and running. This escrow solution effectively gives the licensee control of the source code and options to move forward.
2. How do you put source code escrow in place?
Many organisations have a standing policy to require software developers to escrow source code of products the organisations are licensing.
Therefore, alongside the licensing agreement to use the computer program, in-house or external lawyers of the licensees also negotiate the terms of an escrow agreement pursuant to which the source code of that computer program will be put in escrow with a trusted third party.
3. Is it worth requesting source code escrow alongside a software license?
Only a small percentage of escrows are ever released: Iron Mountain, the dominant escrow agent in the USA, has thousands of escrow accounts and more than 45,000 customers worldwide that have stored their software and source code with them. Over the 10-year period from 1990 to 1999, Iron Mountain released 96 escrow accounts, less than 10 per year.
Just as well, because escrow agreements are entered into as a kind of insurance policy, only to be used in case something goes very wrong at the licensor’s company, which triggers one of the release events (insolvency, case of force majeure, death of the computer developer, etc.).
However, one valid cons is that most escrowed source code is defective: often, upon release, source code fails to provide adequate protection because it is outdated, defective or fails to meet the licensee’s needs. According to Iron Mountain again, 97.4 percent of all analysed escrow material deposits have been found incomplete and 74 percent have required additional input from developers to be compiled. This is a valid point and licensees of the software, who insist on getting an escrow agreement as well, must insert some clauses in the escrow agreement whereby the escrowed source code is tested on a very regular basis by both the licensee and the licensor, in order to ensure that such escrowed source code will be usable as soon as one ‟release event”, set out in the escrow agreement, materialises. The licensor should have an obligation of result to maintain the escrowed source code up-to-date and fully operational, throughout the duration of the escrow agreement.
Another point of caution is that licensees may lack the expertise to use the released source code. Even if the licensor has been diligent and the released source code is properly updated, well-documented and fully operational, most licensees lack the technical resources or capability to utilise the source code upon release. The licensees may work around this problem by either hiring an engineer who has the technical knowledge to make the most of that released source code (bearing in mind that most software licensing agreements bar licensees from poaching licensor’s employees during the term of the license) or instructing a third-party software company. The best and most economical approach is to be as autonomous as possible, as a licensee, by developing in-house expertise on the workings of the software, and its source code, even before one of the release events materialises.
Another identified problem is that software licensors may prevent the timely release of the escrowed source code by imposing some unilateral conditions to the release, such as the vendor having to provide its written prior approval before the source code is released by the escrow agent, upon the materialisation of a release event. Additionally, many escrow agreements require parties to participate in lengthy alternative dispute resolution proceedings, such as arbitration or mediation, in the event of a dispute relating to the release of the source code. A commonly disputed issue is whether a release event actually occurred, even when the software licensor has gone into bankruptcy! The long delay and expensive legal battle needed to obtain the source code release, may become very heavy burdens for a licensee, compounded by the difficulty to keep the licensee’s computer program and software working – as the licensor, and its technical support, have faded away. In order to avoid such delays and complications in the release of the escrowed source code, the terms of the escrow agreement must initially be reviewed, and negotiated, by an IT lawyer experienced in this area, so that all clauses are watertight and can be executed immediately and in a smooth manner, upon the occurrence of a release event.
Another cost consideration is that the expenses related to the opening and maintenance of an escrow agreement are high, and typically borne by the licensee. In addition to the fees paid to the escrow agent, the customer will often incur significant legal expenses related to the drafting and negotiation of the escrow agreement, as explained above. Software licensors being really resistant to providing their proprietary source code to anyone, escrow agreements are often subjects of long negotiations, before they are signed. However, while doing a costs/benefits analysis of getting the source code escrow, the licensee must assess how much it would cost, in case a release event occurred (bankruptcy of the licensor, case of force majeure, etc) but no prior software escrow had been put in place. If the licensee has made a considerable investment in the software, the cost to protect this asset via an escrow agreement may be trivial.
Some companies say that, since they now rely on Software-as-a-Service solutions (‟SaaS”) for some of their IT needs and functionalities, there is no need for software escrow because the SaaS relies on a cloud-based system. However, SaaS implies that you need to think about both the software and your company’s data, which is indeed stored on the cloud – which adds a level of complexity. Since most SaaS provider’s business continuity/disaster recovery plans do not extend to a company’s application and data, some new insurance products have entered the market, combining both the source code escrow and disaster recovery and risk management solution. For example, Iron Mountain markets its SaaSProtect Solutions for business continuity.
To conclude, licensees need to conduct a costs/benefits analysis of having an escrow agreement in place, alongside the licensing agreement of their major software applications, in respect of each computer program which is perceived as absolutely paramount to the economic survival, and business continuity, of the licensees. Once they have balanced out the pros and cons of putting in place escrow agreements, they need to draft a list of their essential ‟wants” to be set out in each escrow agreement (for example, a detailed list of the release events which would trigger the release of source code to the licensee, the quarterly obligation borne by the licensor to maintain the source code in up-to-date form and working order, the secondment of a highly qualified computer programmer employee of the licensor to the offices of the licensee, on a full-time or part-time basis, in order to train in-house IT staff about the intricacies of the software and its source code) and then pass on such list to their instructed lawyer – who should be an IT expert lawyer, seasoned in reviewing and negotiating escrow agreements – for his or her review and constructive criticism and feedback. Once the licensees have agreed an ‟escrow insurance plan” strategy internally, and then with their counsel, they need to contact the licensor, its management and legal team, and circulate to them a term sheet of the future escrow agreement, in order to kick off the negotiation of the escrow agreement.
An escrow agreement is, and should remain, an insurance policy for the licensee, as long as it – in coordination with its legal counsel – has paved the way to a successful and well thought-out escrow rescue plan. This way, the user of the software will avoid all the pitfalls of poorly understood and drafted escrow agreements and source codes, for the present and future.
Since its inception in 2003, the law of luxury goods and fashion law have evolved, matured, and become institutionalised as a standalone area of specialisation in the legal profession. Here is Crefovi’s 2020 status update for fashion law in France, detailing each legal practice area relevant to such creative industry.
1. Market spotlight & state of the market
1 | What is the current state of the luxury fashion market in your jurisdiction?
France is the number one player worldwide in the luxury fashion sector, as it is home to three major luxury goods conglomerates, namely:
• LVMH Moet Hennessy-Louis Vuitton SE (full year (‟FY”) 2017 luxury goods sales US$27.995 billion and the number one luxury goods company by sales FY2017, with a selection of luxury brands, such as: Louis Vuitton, Christian Dior, Fendi, Bulgari, Loro Piana, Emilio Pucci, Acqua di Parma, Loewe, Marc Jacobs, TAG Heuer, Benefit Cosmetics);
• Kering SA (FY2017 luxury goods sales US$12.168 billion and the number four luxury goods company by sales FY2017, with a selection of luxury brands, such as: Gucci, Bottega Veneta, Saint Laurent, Balenciaga, Brioni, Pomellato, Girard-Perregaux, Ulysse Nardin); and
• L’Oreal Luxe (FY2017 luxury goods sales estimate US$9.549 billion and the number seven luxury goods company by sales FY2017, with a selection of luxury brands, such as: Lancome, Kiehl’s, Urban Decay, Biotherm, IT cosmetics).
2. Manufacture and distribution
2.1. Manufacture and supply chain
2 | What legal framework governs the development, manufacture and supply chain for fashion goods? What are the usual contractual arrangements for these relationships?
The French law on duty of vigilance of parent and outsourcing companies, dated 27 March 2017 (article L 225-102-4 inserted in the French commercial code), is the French response to the UK Modern Slavery Act and the California Transparency in Supply Chains Act.
This is a due diligence measure that requires large French companies to create and implement a ‟vigilance plan” aimed at identifying and preventing potential human rights violations – including those associated with subsidiaries and supply chain members.
The law applies to any company headquartered in France that has (i) 5,000 or more employees, including employees of any French subsidiaries; or (ii) 10,000 or more employees, including French and foreign subsidiaries.
The law requires that the vigilance plan address activities by the company’s subcontractors and suppliers (‟supply chain entities”), where the company maintains an ongoing business relationship with these supply chain entities, and such activities involve its business relationship. The vigilance plan, as well as the minutes related to its implementation, must be made available to the public.
As of February 2019, the enforceability of this new French law was mitigated, at best. Certain corporations had still not published a vigilance plan regardless of their legal obligation to do so (eg, Lactalis, Credit Agricole, Zara or H&M). Those that had published vigilance plans merely included them in their chapter on social and environmental responsibility within their company’s annual report. Such vigilance plans were vague and had gaps, the actions and measures were not detailed enough and only very partially addressed the risks mentioned in the risk mapping. There is, therefore, room for improvement.
The usual contractual arrangements for the relationships relating to the development, manufacture and supply chain for fashion goods in France are standard French law-governed manufacturing agreements or supplier agreements.
Such contractual arrangements are subject to the French civil code on contract law, and the general regime and proof of obligations, which was reformed in October 2016, thanks to Order No. 2016-131 of 10 February 2016. The order codified principles that had emerged from the case law of French courts, but also created a number of new rules applicable to pre-contractual, and contractual, relationships, such as:
• new article 1104 of the French civil code, which provides that contracts must be negotiated, concluded and performed in good faith, and failure to comply with such obligation can not only trigger the payment of damages, but also result in the nullification of the contract;
• new article 1112-1 provides that if a party to the contractual obligations is aware of information, the significance of which would be determinative for the consent of the other party, it must inform such other party thereof if such other party is legitimately unaware of such information, or relies on the first party;
• new article 1119 provides that general conditions invoked by a party have no effect against the other party, unless they have been made known to such other party and accepted by it. In the event of a ‘battle of the forms’, between two series of general conditions (eg, general sales conditions and general purchase conditions), those conditions that conflict are without effect;
• new article 1124, which provides that a contract concluded in violation of a unilateral promise, with a third party that knew of the existence thereof, is null and void; and
• new article 1143 provides that violence exists when a party abusing the state of dependency in which its co-contracting party finds itself, obtains from such co-contracting party an undertaking which such co-contracting party would not have otherwise agreed to in the absence of such constraint, and benefits thereby from a manifestly excessive advantage.
2.2. Distribution and agency agreements
3 | What legal framework governs distribution and agency agreements for fashion goods?
In addition to the reform of the French civil code on contract law and the general regime and proof of obligations explained in question 2 above, distribution and agency agreements for fashion goods need to comply with the following legal framework:
• European regulation (‟EU”) No. 330/2010 dated 20 April 2010 on the application of article 101(3) of the Treaty on the Functioning of the European Union (‟TFEU”), which places limits on restrictions that a supplier could place on a distributor or agent (the ‟Regulation”);
• article L134-1 of the French commercial code, which sets out what the agency relationship consists of;
• article L134-12 of of the French commercial code, which sets out that a commercial agent is entitled to a termination payment at the end of the agency agreement;
• books III and IV, and article L442-6 of the French commercial code, which set out that a relationship between two commercial partners needs to be governed by fairness and which prohibit any strong imbalance between the parties; and
• the law No. 78-17 dated 6 January 1978 relating to IT, databases and freedom (the ‟French Data Protection Act”) and its implementation decree No. 2005-1309.
French luxury houses often use selective distribution to sell their products. It is, indeed, the most-used distribution technique for perfumes, cosmetics, leather accessories or even ready-to-wear.
The Regulation provides for an exemption system to the general prohibition of vertical agreements set out in article 101(1) of the TFEU. The lawfulness of selective distribution agreements is always assessed via the fundamental rules applying to competition law, in particular article 101 of the TFEU.
Selective distribution systems may qualify for block exemption treatment under the vertical agreements block exemption set out in article 101(3) of the TFEU.
4 | What are the most commonly used distribution and agency structures for fashion goods, and what contractual terms and provisions usually apply?
Under French law, it is essential to avoid any confusion between a distribution agreement and an agency agreement.
French law sets out that a distributor is an independent natural person or legal entity, who buys goods and products from the manufacturer or supplier and resells them to third parties, upon the agreed trading conditions, and at a profit margin set by such distributor.
A distributor may be appointed for a particular territory, either on an exclusive, or non-exclusive, basis.
Under French law, there is no statutory compensation for the loss of clientele and business due to the distributor upon expiry or termination of a distribution agreement. However, French case law has recently recognised that some compensation may be due when some major investments had been made by the distributor, on behalf of the manufacturer or supplier, in the designated territory.
Moreover, there is no statutory notice period to terminate a distribution agreement under French law. However, most distribution agreements set out a three-to-six-month termination notice period. French law sets out a detailed legal framework relating to the role of commercial agent, which is of a ‘public policy’ nature (ie, one cannot opt out from such statutory legal provisions). In particular, commercial agents must be registered as such, on a special list held by the registrar of the competent French commercial court.
Under French law, not only is it very difficult to terminate a commercial agent (except for proven serious misconduct), but also there is a statutory considerable compensation for the loss of clientele and business that is due to the terminated agent by the manufacturer or supplier.
Selective distribution is the most commonly used distribution structure for luxury goods in France, as explained in question 3.
Such selective distribution systems of luxury products can escape the qualification of anticompetitive agreements, pursuant to article 101(3) of the TFEU (individual and block exemption). However, in 2011, the European Court of Justice (‟ECJ”) held that the selective distribution agreement that has as its object the restriction of passive sales to online end-users outside of the dealer’s area excluded the application of the block exemption in its decision in Pierre Fabre Dermo-Cosmétique SAS v Président de l’Autorité de la concurrence and Ministre de l’Économie, de l’Industrie et de l’Emploi. The ECJ ruled that it was down to the French courts to determine whether an individual exemption may benefit such selective distribution agreement imposed by French company Pierre Fabre Dermo-Cosmétique SAS to its distributors. To conclude, it is clear that the ECJ set out that the prohibition of internet sales, in a distribution agreement, constitutes an anticompetitive restriction.
2.3. Import and export
5 | Do any special import and export rules and restrictions apply to fashion goods?
A French company, upon incorporation, will be provided with the following numbers by the French authorities:
• an intra-community VAT number, provided to all companies incorporated in a EU member state;
• a SIRET number, which is a unique French business identification number; and
• an EORI number, which is assigned to importers and exporters by the French tax authorities, and is used in the process of customs entry declaration and customs clearance for both import and export shipments, travelling to and from the EU and countries outside the EU.
Fashion and luxury products manufactured outside of the EU, and brought into the EU, will be deemed to be imports, by French customs authorities.
In case such fashion and luxury products are transferred from France, or another member state of the EU, to a third party country in the rest of the world (outside of the EU), then these products will be deemed to be exports by French customs authorities.
For imports of fashion and luxury products, (ie, when they enter the EU), the French importer will have to pay some customs duties or other taxes when it imports these products from a third-party country to France or another member state of the EU.
Such customs duties are the same in each of the 27 member states of the EU because they are set by EU institutions. The importer can compute such customs duties by accessing the RITA encyclopedia, which sets out the integrated referential to an automated tarif, for each luxury and fashion product.
Through rather complex manipulations on the RITA encyclopedia, the importer can find out the relevant customs duties, additional taxes and any other fees (such as anti-dumping rights) payable for each type of fashion product and other imported merchandise.
For example, if you are importing a man’s shirt in France or any other EU member state from China, there will be a 12 percent customs duty to pay (the ‟Customs duty”).
Such Customs duty will be payable on the price paid to the Chinese manufacturer for the man’s shirt in China plus all transportation costs from China to France (or another EU member state).
Therefore, if the man’s shirt has a manufacturing price (set out on the invoice of the Chinese manufacturer) of €100, and if there are €50 of transportation costs, the customs value basis will be €150 and the customs duty amount will be €18 (€150 multiplied by 12 per cent).
The computation of Customs duties, additional taxes and other charges being such a complicated and specialised area, and the filling out of customs declarations being done only on the Delta software that is accessible only to legal entities that have received an authorisation to use such software, most EU companies that sell fashion and luxury goods use the services of registered customs representatives, also called customs brokers or customs agents.
For exports of fashion and luxury products (ie, when they leave the EU to go to a third party in the rest of the world), a French company will not have to pay any Customs duties or other taxes. However, it is also important to check whether such third-party country will charge the French exporter some Customs duties, additional taxes and other charges, upon the luxury and fashion products entering its territory.
In addition, it is important for the importers to double check whether the EU, and consequently France, may be giving preferential treatment to fashion and luxury products imported from certain developing countries, which names are set out on the list entitled ‟Système Généralisé de Préférence” (‟SPG”). SPG is a programme of trade preferences for goods coming from developing countries, such as Bangladesh, Vietnam, etc. It may be financially more advantageous to manufacture luxury and fashion products in the countries that are included on the SPG list, to ensure that lower tariffs and Customs duties will apply when importing these products to the EU.
Finally, and especially if the goods are in the luxury bracket, it may be possible to put a ‟Made in France” label on them, provided that such products were assembled in France.
2.4. Corporate social responsibility and sustainability
6 | What are the requirements and disclosure obligations in relation to corporate social responsibility and sustainability for fashion and luxury brands in your jurisdiction? What due diligence in this regard is advised or required?
As explained in question 2 above, the French law on duty of vigilance for parent and outsourcing companies, dated 27 March 2017 (article L 225-102-4 inserted in the French commercial code) is the legal framework that applies to disclosure obligations in relation to corporate social responsibility and sustainability for fashion and luxury brands in France.
The vigilance plan made compulsory by such French law must set out a detailed risk mapping stating the risks for third parties (ie, employees, the general population) and the environment. French companies subject to this law must then publish their risk mapping, explicitly and clearly stating the serious risks and severe impacts on health and safety of individuals and on the environment. In particular, the vigilance plan should provide detailed lists of risks for each type of activity, product and service.
It is these substantial risks (ie, negative impacts on third parties and the environment deriving from general activities) on which vigilance must be exercised and which the plan must cover. Moreover, the vigilance plan must include the evaluated severity criteria regarding the level, size and reversible or irreversible nature of the impacts, or the probability of the risk. This prioritisation should allow the French company to structure how it implements its measures to resolve the impacts or risks of impact.
The vigilance plan, as well as the minutes related to its implementation, must be made available to the public.
The French law on duty of vigilance of parent and outsourcing companies sets out some stringent enforcement mechanisms. Any person with a demonstrable interest may demand that a company comply with the due diligence requirements (i.e. creating and implementing a vigilance plan) and, if the French company fails to comply, a court may fine the offending company up to €10 million, depending on the severity of the breach and other circumstances. Additionally, if the activities of a French company – or the activities of its supply chain entities – cause harm that could have been avoided by implementing its vigilance plan, the size of the fine can be trebled (up to €30 million), depending on the severity and circumstances of the breach and the damage caused, and the company can be ordered to pay damages to the victims.
7 | What occupational health and safety laws should fashion companies be aware of across their supply chains?
As set out above in our answers to the questions set out in sub-paragraphs 2.2. and 2.4. above, the French law on duty of vigilance of parent and outsourcing companies, dated 27 March 2017 (article L 225-102-4 inserted in the French commercial code) is the legal framework that applies to disclosure obligations in relation to occupational health and safety across their supply chains, for fashion and luxury brands in France.
In addition, the main legislation on occupational health and safety in France is set out in Part IV of the French labour code, entitled ‟Health and Safety at Work”. Health and safety at work legislation is supplemented by other parts of this labour code (ie, work time legislation, daily rest period, respect of fundamental freedoms, bullying, sexual harassment, discrimination, execution in good faith of the employment agreement, work council competencies, employee delegates’ abilities).
Collective bargaining is also a source of health and safety legislation (via inter-branch agreements, branch agreements, company-level agreements) in France. These collective agreements regulate employer versus employee relationships, in particular as far as occupation health and safety are concerned.
3. Online retail
8 | What legal framework governs the launch of an online fashion marketplace or store?
The Hamon law dated 17 March 2014 (‟Hamon law”) transposes the provisions of the Directive 2011/83/EU on consumer rights, which aims at achieving a real business-to-consumer internal market, striking the right balance between a high level of consumer protection and the competitiveness of businesses. This law strengthened pre-contractual information requirements, in relation to:
• the general duty to give information that applies to any sales of goods or services agreement entered into on a business-to- consumer basis (for on-premises sales, distance sales and off-premises sales); and
• information specific to distance contracts about the existence of a withdrawal right.
Thanks to this law, the withdrawal period has been extended from 7 to 14 days. It introduced the use of a standard form that can be used by consumers to exercise their withdrawal rights. Such form must be made available to consumers online or sent to them before the contract is entered into. If a consumer exercises this right, the business must refund the consumer for all amounts paid, including delivery costs, within a period of 14 calendar days.
With respect to the cookies policy, e-commerce stores must comply with the cookies and other tracking devices guidelines published by the CNIL in July 2019.
3.2. Sourcing and distribution
9 | How does e-commerce implicate retailers’ sourcing and distribution arrangements (or other contractual arrangements) in your jurisdiction?
As explained in our answer to question 4, luxury and fashion brands (manufacturers, suppliers) cannot ban their distributors from selling their products online, through e-commerce, since this would be a competition law breach under article 101 of the TFEU, entitled an anticompetitive restriction.
However, luxury and fashion brands may impose some criteria and conditions for their distributors to be able to sell their products online, in order to preserve the luxury aura and prestige of their products sold online, via the terms of their distribution agreements.
3.3. Terms and conditions
10 | What special considerations would you take into account when drafting online terms and conditions for customers when launching an e-commerce website in your jurisdiction?
As explained in our answer to question 8, these terms and conditions for customers of an e-commerce website must comply with the GDPR, the French Data Protection Act and the cookies and other tracking devices guidelines from the CNIL.
Therefore, those terms must comply with the following principles:
• privacy by design, which means that fashion and luxury businesses must take a proactive and preventive approach in relation to the protection of privacy and personal data;
• accountability, which means that data controllers, such as an e-commerce website, as well as its data processors, must take appropriate legal, organisational and technical measures allowing them to comply with the GDPR. They must be able to demonstrate the execution of such measures to the CNIL;
• privacy impact assessment, which means that an e-commerce business must execute an analysis relating to the protection of personal data, on its data assets, to track and map risks inherent to each data process and treatment put in place, according to their plausibility and seriousness;
• a data protection officer must be appointed, to ensure the compliance of treatment of personal data by fashion businesses whose data treatments present a strong risk of breach of privacy;
• profiling, which is an automated processing of personal data allowing the construction of complex information about a particular person, such as his or her preferences, productivity at work and whereabouts. This type of data processing may constitute a risk to civil liberties; therefore, online businesses doing profiling must limit their risks and guarantee the rights of individuals subjected to such profiling, in particular by allowing them to request human intervention or contest the automated decision; and
• right to be forgotten, which allows an individual to avoid that information about his or her past that interferes with their current, actual life. In the digital world, that right encompasses the right to erasure, as well as the right to dereferencing.
11 | Are online sales taxed differently than sales in retail stores in your jurisdiction?
No, online sales are not taxed differently than sales executed in brick-and- mortar stores. They are all subjected to a 20 percent VAT rate, which is the standard VAT rate in France, and which is applicable on all fashion and luxury products.
4. Intellectual property
4.1. Design protection
12 | Which IP rights are applicable to fashion designs? What rules and procedures apply to obtaining protection?
French fashion designs are usually protected via the registration of a design right in France, with the Institut National de la Propriété Industrielle (‟INPI”). Articles L 512-1 et seq and R 511-1 et seq of the French intellectual property code govern the design application and registration process.
Of course, this French design protection applies in addition to any registered or unregistered community design right that may exist.
To qualify for protection through the French design right, the design must be novel and have individual character. Functional forms, as well as designs in breach of public policy or morality, are excluded from protection.
French fashion designs are protected by copyright, as long as they meet the originality criteria. Indeed, article L 112-2 14 of the French intellectual property code provides that ‟the creations of the seasonal industries of garments and dresses” fall within the remit of copyright, as ‟works of the mind”.
Copyright being an unregistrable intellectual property right in France, the existence of copyright on fashion products is often proven via the filing of an ‟enveloppe SOLEAU” with INPI, or by keeping all prototypes, drawings and research documents on file, to be able to prove the date on which such copyright arose.
Indeed, under the traditional principle of unity of art, a creation can be protected by copyright and design law. Recent case law distinguishes between these IP rights, by stating that the originality required for copyright protection differs from the individual character required for design protection, and that both rights do not necessarily overlap.
In the same way, the scope of copyright protection is determined by the reproduction of the creation’s main features; while in design law the same overall visual impression on the informed user is required.
As far as the ownership of commissioned works is concerned, the default regime in France is that both an independent creator (i.e. a fashion freelancer, contractor, creative director) and an employee of any French fashion house is automatically deemed to be the lawful owner of all intellectual property rights on a fashion and luxury item that he or she has created during the course of his or her service or employment. Therefore, it is essential in all French law-governed service providers agreements entered into with third-party consultants, and in all French law-governed employment agreements entered into with employees, to set out that an automatic and irrevocable assignment of all intellectual property rights in any fashion creation will always occur, upon creation.
13 | What difficulties arise in obtaining IP protection for fashion goods?
France enjoys the most extensive and longstanding intellectual property rights in connection with fashion designs. As explained in our answer to question 12, copyright protection is extended to any original work of the mind.
Even spare parts are protectable under French design law, which means that a design protecting only a spare part (eg, a bag clip) is valid without taking into consideration the product as a whole (ie, the bag).
Therefore, IP protection for fashion goods is very achievable in France, and it is important for applicants to systematically register their designs (not rely simply on copyright law) to be on the safe side.
4.2. Brand protection
14 | How are luxury and fashion brands legally protected in your jurisdiction?
Luxury and fashion brands are usually protected by a French trade mark registration filed with INPI.
French trade marks are governed mainly by law 1991-7, which implements the EU first council directive related to trade marks (89/104/EEC) and is codified in the French intellectual property code. This code was amended several times, in particular by Law 2007-1544, which implements the EU IP rights enforcement directive (2004/48/EC).
Ownership of a trade mark is acquired through registration, except for well-known trademarks within the meaning of article 6 bis of the Paris convention for the protection of industrial property dated 20 March 1883. Such unregistered well-known trademarks may be protected under French law if an unauthorised use of the trade mark by a third party is likely to cause damage to the trade mark owner or such use constitutes an unjustified exploitation of the trade mark.
To be registered as a trademark, a sign must be:
• represented in a way that allows any person to determine precisely and clearly the subject-matter of the trade mark protection granted to its owner;
• not deceptive;
• lawful; and
French trademarks, registered with INPI, may coincide with EU trademarks (filed with the European Union Intellectual Property Office (‟EUIPO”)) and international trademarks (filed with the Word Intellectual Property Office (‟WIPO”), through the Madrid protocol).
Under French law, unauthorised use of a trade mark on the internet also constitutes trade mark infringement. The rights holder may sue those that unlawfully use its trade mark on the ground of trade mark infringement or unfair competition.
Moreover, luxury and fashion brands are also protected by domain names, which may be purchased from domain name registrars for a limited period of time on a regular basis.
French domain names finishing in .fr can only be purchased for one year, once a year, pursuant to the regulations of the French registry for .fr top level domains, Afnic.
It is the responsibility of the person purchasing, or using, the domain name in .fr to ensure that he or she does not breach any third party rights by doing so.
A dispute resolution procedure called Syreli is available for disputes relating to .fr domains, along with judiciary actions. This procedure is managed by Afnic and decisions are issued within two months from receipt of the complaint.
With online ransom, a proliferation of websites being used for counterfeit sales, fraud, phishing and other forms of online trade mark abuse, most French luxury and fashion companies take the management and enforcement of domain name portfolios very seriously.
With the advent of new generic top-level domains (generic top-level domains or ‟gTLDs”), it is now an essential strategy for all French luxury and fashion houses to buy and hold onto all available gTLDs relating to fashion and luxury (eg, .luxury, .fashion, .luxe).
15 | What rules, restrictions and best practices apply to IP licensing in the fashion industry?
French IP rights may be assigned, licensed or pledged. The French intellectual property code refers to licences over trade marks, patents, designs and models, as well as databases. With respect to copyright, this code only refers to the assignment of the patrimonial rights of the author (ie, representation right and reproduction right) in its article L122-7. In practice, copyright licences often occur, especially over software.
When it involves French design rights, the corresponding deed, contract or judgment must be recorded in the French Design register, to be enforceable against third parties. The documents must be in French (or a translation must be provided). Tax will be incurred only up to the 10th design, in a recordal request filed with INPI. For community designs, recordal must be made with EUIPO. For the French designation of an international design, recordal must be requested through WIPO for all or part of the designation.
When it involves French trade marks, the corresponding deed, contract or judgment should be recorded in the INPI French trade mark register, especially for evidentiary and opposability purposes, for the licensee to be able to act in infringement litigation and for such deed, contract or judgment to be enforceable against third parties. Again, the copy or abstract of the deed, or agreement, setting out the change in ownership or use of the trade marks should be in French (or a French translation be provided).
Of course, copyright of fashion products does not have to be recorded in any French register, as there is no registration requirement for French copyright. However, best practice is for the parties to the deed, agreement or judgment to keep, on record, for the duration of the copyright (70 years after the death of the creator of the copyright) such documents, so that the copyright assignment, pledge or licence may be enforceable against third parties.
Fashion brands such as Tommy Hilfiger, Benetton and Ermenegildo Zegna use franchising to access new markets, increase their online presence and develop flagship stores. Franchise agreements generally include a trade mark, trade name or service mark licence, as well as the transfer of knowhow by the franchisor, to the franchisee. On this note, knowhow licences exist in France, although knowhow does not constitute a proprietary right benefiting from specific protection under the French intellectual property code.
A licensor must make some pre-contractual disclosure to prospective licensees, pursuant to article L330-3 of the French commercial code, when he or she makes available to another person a trade name or a trademark, and requires from such other person an exclusivity undertaking with respect to such activity. The precontractual information must be disclosed in a document provided at least 20 days prior to the signature of the licence agreement. Such document must contain truthful information allowing the licensee to commit to the contractual relationship in full knowledge of the facts.
A licensing relationship governed by French law must comply with the general contract law principles, including the negotiation, conclusion and performance of contracts in good faith (article 1104 of the French civil code). This statutory legal provision implies an obligation on each party of loyalty, cooperation and consistency. In case of breach of this good faith principle, the licence may be terminated and damages potentially awarded.
16 | What options do rights holders have when enforcing their IP rights? Are there options for protecting IP rights through enforcement at the borders of your jurisdiction?
Lawsuits involving the infringement or validity of a French design, or the French designation of an international design, may be lodged with one of the 10 competent courts of first instance (Bordeaux, Lille, Lyon, Marseille, Nanterre, Nancy, Paris, Rennes, Strasbourg and Fort-de-France).
Lawsuits involving the infringement, in France, of a registered or unregistered community design may be lodged only with the Paris court of first instance. An invalidity action against a community design may only be brought before EUIPO. However, invalidity may be claimed as a defence in an infringement action brought before the Paris tribunal.
The scope of protection for the design is determined exclusively by the various filed views, on the design registration, irrespective of actual use. Therefore, applicants should pay great care to those views, when filing a design application, so as to anticipate the interpretation made by the judiciary tribunal.
Infringement is identified when a third-party design produces, on the informed observer, the same overall visual impression as the claimant’s design.
The infringement lawsuit may be lodged by the design owner, or the duly recorded exclusive licensee.
The claimant will be indemnified for lost profits, with the court taking into account: (i) the scope of the infringement; (ii) the proportion of actual business lost by the claimant; and (iii) the claimant’s profit margin for the retail of each unit.
Damages may also be awarded for the dilution or depreciation of a design.
As far as trademarks are concerned, lawsuits may be lodged before the 10 above-mentioned competent courts at first instance if they are French trademarks or the French designation of an international trademark. Lawsuits relating to the infringement of EU trade marks may only be lodged with the Paris judiciary tribunal.
Such infringement proceedings may be lodged by either the trademark owner or the exclusive licensee, provided that the licence was recorded in the trademark register.
To determine trademark infringement, the judiciary tribunal will assess: (i) the similarity of the conflicting trademarks, on the basis of visual, phonetic and intellectual criteria; and (ii) the similarity of the goods or services, bearing such trademarks, concerned. Such trademark infringement may be evidenced by any means.
To secure evidence of the infringement, and to obtain any information related to it, rights holders may ask, and obtain, from the competent judiciary tribunal, an order to carry out a seizure on the premises where the products that infringe the copyright, trademarks, designs, etc. are located. Such order authorises a bailiff to size the suspected infringing products, or to visit the alleged infringer’s premises to collect evidence of the infringement by taking pictures of the suspected infringing products, or by taking samples. The IP rights holder must lodge a lawsuit against the alleged infringer with the competent judiciary tribunal within 20 working days, or 31 calendar days, whichever is the longer, from the date of the seizure. Otherwise, the seizure may be declared null and void on the request of the alleged infringer, who may also ask for some damages.
In addition, IP rights holders may also request an ex parte injunction, to prevent an imminent infringement, which is about to happen, or any further infringement, to the competent judiciary tribunal.
Infringement action, for all IP rights, must be brought within three years of the infringement. There is one exception, for copyright, which statute of limitations is five years from the date on which the copyright owner was made aware, or should have been aware, of such copyright infringement.
There is also an option to protect design rights, copyright, trade marks, patents, etc at French borders, which we often recommend to our fashion and luxury clients. They need to file their IP rights with the Directorate-General of Customs and Indirect Taxes, via a French and EU intervention request, and obtain some certifications from those French customs authorities, that such IP rights are now officially registered on the French and EU customs databases. Therefore, all counterfeit products infringing such IP rights registered on these French and EU customs databases, which enter the EU territory via French borders, will be seized by customs at French borders for 10 days. Potentially, provided that certain conditions are met, French customs may permanently destroy all counterfeit products thus seized, after 10 days.
5. Data privacy and security
17 | What data privacy and security laws are most relevant to fashion and luxury companies?
As explained in questions 8 and 10, fashion and luxury companies must comply with the GDPR, the French Data Protection Act and the cookies and other tracking devices guidelines from the CNIL.
5.2. Compliance challenges
18 | What challenges do data privacy and security laws present to luxury and fashion companies and their business models?
The strict compliance with the GDPR, as well as the amended version of the French Data Protection Act, do present some challenges to luxury and fashion companies and to their business models.
Indeed, on a factual level, most small and medium-sized enterprises (‟SMEs”) incorporated in France are still not in compliance with the GDPR, the French Data Protection Act and the cookies and other tracking devices guidelines from the CNIL. Most of the time this is because such SMEs do not want to allocate time, money and resources to bringing their business in compliance, while they are fully aware that a serious breach may trigger a fine worth up to 4 per cent of their annual worldwide turnover, or €20 million, whichever is greater.
Fashion and luxury companies now have to take ownership of, and full responsibility for, the rigorous management and full protection of their data assets. They can no longer rely on a ‘I was not aware this may happen’ defence strategy, which was very often used by fashion companies before the GDPR entered into force when their internal databases or IT systems got hacked or leaked to the public domain (eg, Hudson’s Bay Co, which owns Saks Fifth Avenue, Macy’s, Bloomingdales, Adidas, Fashion Nexus, Poshmark). The way to rise up to such challenge, though, is to see the GDPR as an opportunity to take stock of what data your company has, and how you can take most advantage of it. The key tenet of GDPR is that it will give any fashion company the ability to find data in its organisation that is highly sensitive and high value, and ensure that it is protected adequately from risks and data breaches.
With the GDPR, almost all fashion and luxury businesses worldwide that sell to EU customers (and therefore French customers), either online or in brick and mortar locations, now have a Data Protection Authority (‟DPA”). Businesses will determine their respective DPA with respect to the place of establishment of their management functions as far as supervision of data processing is concerned, which will allow them to identify the main establishment, including when a sole company manages the operations of a whole group. However, the GDPR sets up a one-stop DPA: in case of absence of a specific national legislation, a DPA located in the EU member state in which such organisation has its main or unique establishment will be in charge of controlling its compliance with the GDPR. This unique one-stop DPA will allow companies to substantially save time and money by simplifying processes.
To favour the European data market and the digital economy, and therefore create a more favourable economic environment, the GDPR reinforces the protection of personal data and civil liberties. This unified regulation will allow businesses to substantially reduce the costs of processing data currently incurred in the 27 member states: organisations will no longer have to comply with multiple national regulations for the collection, harvesting, transfer and storing of data that they use.
The scope of the GDPR extends to companies that are headquartered outside the EU, but intend to market goods and services into the EU market, as long as they put in place processes and treatments of personal data relating to EU citizens. Following these EU residents on the internet to create some profiles is also covered by the scope of the GDPR. Therefore, EU companies, subject to strict and expensive rules, will not be penalised by international competition on the EU single market. In addition, they may buy some data from non-EU companies, which is compliant with GDPR provisions, therefore making the data market wider.
The right to portability of data allows EU citizens subjected to data treatment and processing to gather this data in an exploitable format, or to transfer such data to another data controller, if this is technically possible. Compliance with the right to portability is definitely a challenge for fashion and luxury businesses.
5.3. Innovative technologies
19 | What data privacy and security concerns must luxury and fashion retailers consider when deploying innovative technologies in association with the marketing of goods and services to consumers?
Innovative technologies, such as AI and facial recognition, involve automated decision making, including profiling. The GDPR has provisions on:
• automated individual decision making (making a decision solely by automated means without any human involvement); and
• profiling (automated processing of personal data to evaluate certain things about an individual), which can be part of an automated decision-making process.
These provisions, set out in article 22 of the GDPR, should be taken into account by fashion and luxury businesses when deploying innovative technologies. In particular, they must demonstrate that they have a lawful basis to carry out profiling or automated decision making, and document this in their data protection policy. Their Data Protection Impact Assessment should address the risks, before they start using any new automated decision making or profiling. They should tell their customers about the profiling and automated decision making they carry out, what information they use to create the profiles, and where they get this information from. Preferably, they should use anonymised data in their profiling activities.
5.4. Content personalisation and targeted advertising
20 | What legal and regulatory challenges must luxury and fashion companies address to support personalisation of online content and targeted advertising based on data-driven inferences regarding consumer behaviour?
There is a tension, and irrevocable difference, between the GDPR’s push towards more anonymisation of data, and the personalisation of online content and targeted advertising based on data-driven inferences regarding consumer behaviour. This is because the latter needs data that is not anonymous, but, instead, traceable to each individual user.
Indeed, a fashion and luxury business cannot truly personalise an experience in any channel – a website, a mobile app, through email campaigns, in advertising or events in a store – unless it knows something about that customer, and the luxury business cannot get to know someone digitally unless it collects data about him or her. The GDPR and the increasing concerns around privacy complicate this process.
However, GDPR does not prohibit fashion businesses from collecting any data on customers and prospects. However, they must do so in compliance with the core GDPR principles set out in question 10.
6. Advertising and marketing
6.1. Law and regulation
21 | What laws, regulations and industry codes are applicable to advertising and marketing communications by luxury and fashion companies?
Advertising and marketing communications are regulated by the following French laws:
• law dated 10 January 1991 (‟Evin law”) that prohibits advertising alcohol on French TV channels and in cinemas, and limits such advertising on radio and on the internet;
• law dated 4 August 1994 (‟Toubon law”) that provides that the French language must be used in all advertising in France; and
• decree dated 27 March 1992 that provides for specific rules relating to advertising on TV.
Various legal codes set out some specific rules governing advertising and marketing communications in France, such as: the French consumer code, which prohibits deceptive and misleading advertising, and regulates comparative advertising; or article 9 of the French civil code, which protects individuals’ images and privacy.
Moreover, there are some industry codes of practice, drafted by the French advertising self-regulation agency (‟ARPP”), which represents advertisers, agencies and the media. These codes of practice set out the expected ethical standards and ensure proper implementation of these standards, through advice and pre-clearance, including providing mandatory advice before the broadcast of all TV advertising.
The French consumer and competition governmental authority (‟DGCCRF”) has investigative powers in relation to all matters relating to the protection of consumers, including advertising and marketing practices.
DGCCRF agents are entitled to enter the professional premises of the advertiser, advertising agency or communication agency during business hours to request an immediate review of documents, take copies of these documents, and ask questions.
The ARPP works with an independent jury that handles complaints against advertisements that violate ARPP standards. Its decisions are published on its website.
If there is a data breach within a marketing campaign, the CNIL, the French DPA, may fine the culprit data controller (such as an advertiser or an agency) up to €20 million, or 4 percent of their worldwide annual turnover, whichever is the highest.
6.2. Online marketing and social media
22 | What particular rules and regulations govern online marketing activities and how are such rules enforced?
Online marketing activities are regulated in the same manner as activities conducted in the ‟real world”, pursuant to the French digital economy law dated 21 June 2004. However, more specific to the online world, the digital economy law provides that pop-ups, advert banners, and any other types of online adverts must be clearly identified as such and therefore distinguished from non-commercial information.
Article L121-4-11 of the French consumer code provides that an advertiser who pays for content in the media to promote its products or services must clearly set out that such content is an advertisement, through images or sounds clearly identifiable by consumers. Otherwise, this is a misleading advert or an act of unfair competition.
The ARPP issued a standard relating to digital adverts, communications carried out by influencers, native advertising, etc emphasising the fact that all such online marketing communications and advertising should be clearly distinguishable as such by consumers.
7. Product regulation and consumer protection
7.1. Product safety rules and standards
23 | What product safety rules and standards apply to luxury and fashion goods?
French law dated 19 May 1998, which is now set out in articles 1245 et seq of the French civil code, transposes EU directive 85/374/EEC on the liability for defective products in France.
Alongside this strict civil liability for defective products exists some criminal liability for defective products on the grounds of deceit, involuntary bodily harm, involuntary manslaughter or endangering the lives of others.
Articles 1245 et seq. of the French civil code apply when a product is considered unsafe. Therefore, a fashion business would be liable for damage caused by a defect in its products, regardless of whether or not the parties concluded a contract. Consequently, these statutory rules apply to any end-user in possession of a fashion product, whether or not such end-user had entered into an agreement with the fashion company.
Articles 1245 et seq. of the French civil code provide for a strict liability, where the claimant does not need to prove that the ‘producer’ made a mistake, committed an act of negligence or breached a contract. The claimant only has to prove the defect of the product, the damage suffered and the causal link between such defect and such damage.
A defective product is defined in article 1245-3 of the French civil code, as a product that does not provide the safety that any person is entitled to expect from it, taking into account, in particular, the presentation of such product, the use that can reasonably be expected of it and the date on which it was put on the market.
Such strict civil liability rules apply to the ‟producer”, a term that may refer to the manufacturer, the distributor, as well as the importer in the EU, of defective products.
As soon as a risk of a defective product is recognised, the ‟producer” should comply with its duty of care and take all necessary actions to limit harmful consequences, such as a formal public warning, a product recall or the mere withdrawal of such product from the market.
7.2. Product liability
24 | What regime governs product liability for luxury and fashion goods? Has there been any notable recent product liability litigation or enforcement action in the sector?
The regime governing product liability for luxury and fashion goods is described in our answer to question 22.
The Hamon law introduced class action for French consumers. Consequently, an accredited consumer association may take legal action to obtain compensation for individual economic damages suffered by consumers placed in an identical or similar situation, that result from the purchase of goods or services.
There has been no notable recent product liability litigation in the fashion and luxury sectors. However, a health class action matter is currently pending before the Paris judiciary tribunal. A pharmaceutical company was sued by 4,000 French individuals because it sold an anti-epileptic drug without providing adequate information relating to the use of such drug during pregnancy. As a result, some French babies were born with health defects because such drug has detrimental effects on foetal development. The judiciary tribunal should hand down its decision about the laboratory’s liability soon.
8. M&A and competition issues
8.1. M&A and joint ventures
25 | Are there any special considerations for M&A or joint venture transactions that companies should bear in mind when preparing, negotiating or entering into a deal in the luxury fashion industry?
As set out in question 2, the general contract law provisions included in the French civil code, which underwent a major reform in 2016, must be complied with. Therefore, for private M&As, the seller would seek to promote competition between different bidders through a competitive sale process, which conduct must comply with the statutory duty of good faith.
In France, it is compulsory for the transfer of assets and liabilities from the seller to the buyer to cover all employment contracts, commercial leases and insurance policies pertaining to the business. Except from those, all other assets and liabilities relating to the transferred business may be excluded from the transfer transaction by agreement. Furthermore, the transfer of contracts requires the approval from all relevant counterparties, thus making the prior identification of such contracts in the course of the due diligence an important matter for any prospective buyer.
In private M&As, there is no restriction to the transfer of shares in a fashion company, a fashion business or assets in France. However, French merger control regulations (in addition to merger control regulations of other EU member states) may require a transaction to be filed with the French competition authority (‟FCA”) if: (i) the gross worldwide total turnover of all the fashion companies involved in the concentration exceeds €150 million; and (ii) the gross total turnover generated individually in France by each of at least two of the fashion companies involved in the concentration exceeds €50 million.
There are no local ownership requirements in France. However, French authorities may object to foreign investments in some specific sectors that are essential to guarantee France’s interests in relation to public policy, public security and national defence. As of today’s date, fashion and luxury are not part of these sectors that are protected for national security purposes.
In addition to prior agreements, such as non-disclosure agreements or promises, final agreements will set out the terms relating to the transaction; in particular, a description of the transferred assets, the price, the warranties granted by the seller, the conditions precedent, any non-competition or non-solicitation clauses. Asset purchase agreements must set out compulsory provisions, such as the name of the previous owner, some details about the annual turnover, otherwise the buyer may claim that the sale is invalid. Most of these agreements, and most sales of French targets and assets, are governed by French law; in particular, the legal transfer of ownership of the target’s shares or assets.
More specific to the fashion and luxury industries, any sale of a fashion business would entail transferring the ownership of all intellectual property rights tied into that fashion target. As such, the trade marks, which have sometimes been filed on the name of the founding fashion designer of the acquired fashion business (eg, Christian Dior, Chantal Thomass, John Galliano, Ines de la Fressange) would be owned by the buyer, after the sale. Thus, the founding fashion designer would no longer be able to use his or her name to sell fashion and luxury products, without infringing on the trade mark rights of the buyer.
26 | What competition law provisions are particularly relevant for the luxury and fashion industry?
Articles L 420-1 and L 420-2 of the French commercial code are the equivalent to articles 101-1 and 102 TFEU and provide for anticompetitive agreements and abuses of a dominant position, respectively.
Specific provisions of the French commercial code are also applicable, such as article L 410-1 et seq. on pricing, article L 430-1 et seq. on merger control, L 420-2-1 on exclusive rights in French overseas communities, L 420-5 on abusively low prices and L 442-1 et seq. on restrictive practices.
For example, a decision handed down by the Paris court of appeal on 26 January 2012 confirmed the existence of price fixing agreements, and anti competitive behaviour, between 13 perfume and cosmetics producers (including Chanel, Guerlain, Parfums Christian Dior and Yves Saint Laurent Beaute) and their three French distributors (Sephora, Nocibe France and Marionnaud). The court also upheld the judgment from the FCA, dated 14 March 2006, sentencing each of these luxury goods companies and distributors to fines valued at €40 million overall.
Court action for breach of competition law may be lodged with a French court of the FCA by any person having a legal interest. Class actions have been available since the entering into force of the Hamon law, but only when the action is filed by a limited number of authorised consumer associations.
There has been a rise in antitrust damage claims lodged in France, and French courts are now responsive to such claims. A section of the Paris commercial court has been set up to review summons lodged in English, with English-language exhibits, and can rule on competition cases with proceedings fully conducted in the English language.
As set out in question 4, while selective distribution is tolerated as an exemption, pursuant to article 101(3) TFEU, total restriction of online sales by a manufacturer, to its selective distributors, is a breach under article 101(1) TFEU (Pierre Fabre Dermo-Cosmétique SAS v Président de l’Autorité de la concurrence and Ministre de l’Économie, de l’Industrie et de l’Emploi, ECJ, 2011).
The ECJ has refined its case law (which, of course, applies to France) in its 2017 ruling in Coty Germany GmbH v Parfümerie Akzente GmbH. The ECJ ruled that a contractual clause, set out in the selective distribution agreement entered into between Coty and its selective distributors, and which prohibits members of such selective distribution network from selling Coty cosmetics on online marketplaces, such as Amazon, complies with article 101(1) TFEU. This is because, according to the ECJ, the clause is proportionate in its pursuit of preserving the image of Coty cosmetics and perfumes, and because it does not prohibit distributors from selling Coty products on their own online e-commerce sites, provided that some quality criteria are met.
This new ECJ case law is useful guidance for national courts on how to assess, in pragmatic terms, the prohibition of selling luxury products in marketplaces. Indeed, the Paris court of appeal handed down a judgment in relation to the validity of a similar clause set out in the contracts for Coty France on 28 February 2018, and used the ECJ analysis to confirm the validity of such prohibition, in relation to a marketplace that sold Coty perfumes during private sales.
9. Employment and labour
9.1. Managing employment relationships
27 | What employment law provisions should fashion companies be particularly aware of when managing relationships with employees? What are the usual contractual arrangements for these relationships?
Employer–employee relationships are governed by the following complex set of laws and regulations that leave little room for individual negotiation:
• the French labour code set out a comprehensive legal framework for both individual and collective relationships between employers and employees;
• collective bargaining agreements have been negotiated between employers’ associations and labour unions covering the industry as a whole, or between employers and labour unions covering a company. In the former case, the collective agreement usually applies to the industry sector as a whole, even to companies within that sector that are not part of the employers’ associations (for the fashion and luxury sectors, the ‟clothing industry collective agreement”, the ‘textile industry collective agreement (OETAM)’, or the ‟collective agreement for the footwear industries” may apply, for example); and
• individual employment agreements, which relate only to the aspects of the employer–employee relationship not already covered by the labour code or relevant collective bargaining agreement.
Because more than 90 per cent of French employees are protected by collective bargaining agreements, the rules set out in the French labour code are supplemented by more generous rules in areas such as paid leave, maternity leave, medical cover and even working time.
Under the ‟Aubry law” dated 19 January 2000, a standard 35-hour working week became the rule. Employees working beyond 35 hours are entitled to overtime. A company-wide collective bargaining agreement may provide for a maximum working time of 12 hours, and a maximum weekly working time of 46 hours over 12 consecutive weeks. Extra time is either paid via overtime, or compensating by taking extra days off (called ‟RTT”).
Any dismissal of a French employee must be notified in writing, and based on a ‘real and serious’ cause. A specific procedure must be followed, including inviting the employee to a pre-dismissal meeting, holding such meeting with the employee, and notifying the dismissal by registered letter with an acknowledgement of receipt. Dismissal for economic reasons and dismissals of employee representatives are subject to additional formalities and requirements, such as the implementation of selection criteria to identify the employees to be dismissed, the involvement of, and approval from, the French labour authorities and compulsory consultation with employee representatives. Upon termination, French employees are entitled to a number of indemnities (severance payment, notice period, paid holidays, etc) and, should the dismissal be deemed to be unfair, the ‟Macron scale”, set out in article L 1235-3 of the French labour code, provides that, in case of a court claim for unfair dismissal, French labour courts must allocate damages to former employees ranging between a minimum and a capped amount, based on the length of service with the former employer. Because many regional labour courts were resisting the application of the ‟Macron scale” to their court cases, the French supreme court ruled in July 2019 that such ‟Macron scale” is enforceable and must apply.
Of course, French freelancers and consultants who work for fashion and luxury houses are not protected by the above-mentioned French labour rules applying to employer–employee relationships. However, French labour courts are prompt at requalifying an alleged freelancing relationship into an employment relationship, provided that a subordination link (characterised by work done under the authority of an employer, which has the power to give orders, directives, guidelines, and to control the performance of such work, and may sanction any breach of such performance) exists, between the alleged freelancer and the fashion company. Most creative directors of French fashion houses are consultants, not employees, and therefore have the right to execute other fashion projects or contracts, for other fashion houses (for example, Karl Lagerfeld was the creative director of both Chanel and Fendi).
Article L 124-1 et seq of the French education code provide that a ‟gratification” (not a salary) may be paid to an intern, in France, if the duration of his or her internship is more than two consecutive months. Below that time frame, a French company has no obligation to pay a gratification to an intern. The hourly rate of such gratification is equal to a minimum of €3.90 per internship hour; however, in certain sectors of the industry where collective bargaining agreements apply, the amount may be higher than €3.90.
9.2. Trade unions
28 | Are there any special legal or regulatory considerations for fashion companies when dealing with trade unions or works councils?
As mentioned in question 24, an employer may have to consult employee representatives if it wants to dismiss, for economic reasons, some of its employees. Also, trade unions, either covering a company or a group of companies, or covering an industry as a whole, negotiate, and will renegotiate and amend, any collective bargaining agreements in place in France.
Unsurprisingly, employee representatives play a very important role, in French employer–employee relationships. Depending on the size of a company, some employee delegates or a works council, as well as a health and safety committee, may have to be appointed and set up. Such employee representatives not only have an important say on significant business issues such as large-scale dismissals, but must be consulted prior to a variety of changes in the business, such as acquisitions, or disposals, of business lines or of the company itself. In French companies with work councils, employee representatives are entitled to attend meetings of the board of directors, but are not allowed to take part in any votes at such meetings. As a result, most strategic decisions are made outside of board of directors’ meetings.
Dismissals of employee representatives are subject to additional formalities and requirements, such as the approval given by French labour authorities.
While the top creative management of French fashion houses may be terminated at will, because most creative directors are freelancers, the core labour force of most French fashion and luxury houses (eg, blue-collar workers on the shop floor (seamstresses etc), lower to middle management, etc) is almost immovable because of the above-mentioned strict French labour laws relating to hiring and firing. One advantage of such ‟job security” is that French students and the young labour force do not hesitate to train for, and take on, highly specialised and technical manual jobs, which are necessary to creative and exceptionally high-quality luxury products (eg, embroiderers working for Chanel-owned Lesage, bag makers working for Hermes, feather workers employed by Chanel-owned Lemarie and all the seamstresses working for Chanel and all the haute couture houses in Paris).
29 | Are there any special immigration law considerations for fashion companies seeking to move staff across borders or hire and retain talent?
Yes, the multi-year ‟passeport talent” residence permit was created to attract foreign employees and self-employed persons with a particular skillset (eg, qualified or highly qualified employee, self-employed professional, performer or author of a literary or artistic work) in France.
Such residence permit provides the right to stay for a maximum of four years in France, starting from the date of arrival in France. A multi-year residence permit may also be granted to the spouse and children of the ‟talented individual”.
10. Update and trends
30 | What are the current trends and future prospects for the luxury fashion industry in your jurisdiction? Have there been any notable recent market, legal and or regulatory developments in the sector? What changes in law, regulation, or enforcement should luxury and fashion companies be preparing for?
The future prospects of the luxury and fashion sectors in France are extremely high, because the Macron reforms are slowly but surely transforming the French economy into a liberalised and free-trade powerhouse, bringing flexibility and innovation at the forefront of the political reform agenda. However, the downside to these sweeping changes is the resistance, violence and riots that have taken place, and still regularly happen, in France, and in Paris in particular, emanating from a French people unsettled about, and scared of, a more free and competitive economic market.
Fashion and luxury businesses are the first to bear the brunt of these violent acts of resistance, as their retail points on the Champs Elysees and other luxurious locations in Paris and in the provinces have been heavily disrupted (and sometimes ransacked) by rioters, some ‟yellow vests” and ‟anti-pension reforms” social unrest movements.
However, in the medium to long term, fashion and luxury businesses will be among the first to benefit from those sweeping reforms, thanks to a highly productive, and more flexible, French workforce, better contractual and trade conditions to conduct business in France and abroad, and a highly efficient legal framework and court system that are among the most protective of IP rights owners, in the world.
Reproduced with permission from Law Business Research Ltd. This article was first published in Lexology Getting the Deal Through – Luxury & Fashion 2020 (Published: April 2020).
Why the valuation of intangible assets matters: the unstoppable rise of intangibles’ reporting in the 21st century’s corporate environmentCrefovi : 15/04/2020 8:00 am : Antitrust & competition, Art law, Articles, Banking & finance, Capital markets, Consumer goods & retail, Copyright litigation, Emerging companies, Entertainment & media, Fashion law, Gaming, Hospitality, Hostile takeovers, Information technology - hardware, software & services, Insolvency & workouts, Intellectual property & IP litigation, Internet & digital media, Law of luxury goods, Life sciences, Litigation & dispute resolution, Mergers & acquisitions, Music law, Outsourcing, Private equity & private equity finance, Restructuring, Tax, Technology transactions, Trademark litigation, Unsolicited bids
It is high time France and the UK up their game in terms of accounting for, reporting and leveraging the intangible assets owned by their national businesses and companies, while Asia and the US currently lead the race, here. European lenders need to do their bit, too, to empower creative and innovative SMEs, and provide them with adequate financing to sustain their growth and ambitions, by way of intangible assets backed-lending.
Back in May 2004, I published an in-depth study on the financing of luxury brands, and how the business model developed by large luxury conglomerates was coming out on top. 16 years down the line, I can testify that everything I said in that 2004 study was in the money: the LVMH, Kering, Richemont and L’Oreal of this word dominate the luxury and fashion sectors today, with their multibrands’ business model which allows them to both make vast economies of scale and diversify their economic as well as financial risks.
However, in the midst of the COVID 19 pandemic which constrains us all to work from home through virtual tools such as videoconferencing, emails, chats and sms, I came to realise that I omitted a very important topic from that 2004 study, which is however acutely relevant in the context of developing, and growing, creative businesses in the 21st century. It is that intangible assets are becoming the most important and valuable assets of creative companies (including, of course, luxury and fashion houses).
Indeed, traditionally, tangible and fixed assets, such as land, plants, stock, inventory and receivables were used to assess the intrinsic value of a company, and, in particular, were used as security in loan transactions. Today, most successful businesses out there, in particular in the technology sector (Airbnb, Uber, Facebook) but not only, derive the largest portion of their worth from their intangible assets, such as intellectual property rights (trademarks, patents, designs, copyright), brands, knowhow, reputation, customer loyalty, a trained workforce, contracts, licensing rights, franchises.
Our economy has changed in fundamental ways, as business is now mainly ‟knowledge based”, rather than industrial, and ‟intangibles” are the new drivers of economic activity, the Financial Reporting Council (‟FRC”) set out in its paper ‟Business reporting of intangibles: realistic proposals”, back in February 2019.
However, while such intangibles are becoming the driving force of our businesses and economies worldwide, they are consistently ignored by chartered accountants, bankers and financiers alike. As a result, most companies – in particular, Small and Medium Enterprises (‟SMEs”)- cannot secure any financing with money men because their intangibles are still deemed to … well, in a nutshell … lack physical substance! This limits the scope of growth of many creative businesses; to their detriment of course, but also to the detriment of the UK and French economies in which SMEs account for an astounding 99 percent of private sector business, 59 percent of private sector employment and 48 percent of private sector turnover.
How could this oversight happen and materialise, in the last 20 years? Where did it all go wrong? Why do we need to very swiftly address this lack of visionary thinking, in terms of pragmatically adapting double-entry book keeping and accounting rules to the realities of companies operating in the 21st century?
How could such adjustments in, and updates to, our old ways of thinking about the worth of our businesses, be best implemented, in order to balance the need for realistic valuations of companies operating in the “knowledge economy” and the concern expressed by some stakeholders that intangible assets might peter out at the first reputation blow dealt to any business?
1. What is the valuation and reporting of intangible assets?
1.1. Recognition and measurement of intangible assets within accounting and reporting
In the European Union (‟EU”), there are two levels of accounting regulation:
- the international level, which corresponds to the International Accounting Standards (‟IAS”), and International Financial Reporting Standards (‟IFRS”) issued by the International Accounting Standards Board (‟IASB”), which apply compulsorily to the consolidated financial statements of listed companies and voluntarily to other accounts and entities according to the choices of each country legislator, and
- a national level, where the local regulations are driven by the EU accounting directives, which have been issued from 1978 onwards, and which apply to the remaining accounts and companies in each EU member-state.
The first international standard on recognition and measurement of intangible assets was International Accounting Standard 38 (‟IAS 38”), which was first issued in 1998. Even though it has been amended several times since, there has not been any significant change in its conservative approach to recognition and measurement of intangible assets.
An asset is a resource that is controlled by a company as a result of past events (for example a purchase or self-creation) and from which future economic benefits (such as inflows of cash or other assets) are expected to flow to this company. An intangible asset is defined by IAS 38 as an identifiable non-monetary asset without physical substance.
There is a specific reference to intellectual property rights (‟IPRs”), in the definition of ‟intangible assets” set out in paragraph 9 of IAS 38, as follows: ‟entities frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licenses, intellectual property, market knowledge and trademarks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights”.
However, it is later clarified in IAS 38, that in order to recognise an intangible asset on the face of balance sheet, it must be identifiable and controlled, as well as generate future economic benefits flowing to the company that owns it.
The recognition criterion of ‟identifiability” is described in paragraph 12 of IAS 38 as follows.
‟An asset is identifiable if it either:
a. is separable, i.e. capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, identifiable asset or liability, regardless of whether the entity intends to do so; or
b. arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations”.
‟Control” is an essential feature in accounting and is described in paragraph 13 of IAS 38.
‟An entity controls an asset if the entity has the power to obtain the future economic benefits flowing from the underlying resource and to restrict the access of others to those benefits. The capacity of an entity to control the future economic benefits from an intangible asset would normally stem from legal rights that are enforceable in a court of law. In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for control because an entity may be able to control the future economic benefits in some other way”.
In order to have an intangible asset recognised as an asset on company balance sheet, such intangible has to satisfy also some specific accounting recognition criteria, which are set out in paragraph 21 of IAS 38.
‟An intangible asset shall be recognised if, and only if:
a. it is probable that the expected future economic benefits that are attributable to the asset will flow to the entity; and
b. the cost of the asset can be measured reliably”.
The recognition criteria illustrated above are deemed to be always satisfied when an intangible asset is acquired by a company from an external party at a price. Therefore, there are no particular problems to record an acquired intangible asset on the balance sheet of the acquiring company, at the consideration paid (i.e. historical cost).
1.2. Goodwill v. other intangible assets
Here, before we develop any further, we must draw a distinction between goodwill and other intangible assets, for clarification purposes.
Goodwill is an intangible asset that is associated with the purchase of one company by another. Specifically, goodwill is the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process (= purchase price of the acquired company – (net fair market value of identifiable assets – net fair value of identifiable liabilities)).
The value of a company’s brand name, solid customer base, good customer relations, good employee relations, as well as proprietary technology, represent some examples of goodwill, in this context.
The value of goodwill arises in an acquisition, i.e. when an acquirer purchases a target company. Goodwill is then recorded as an intangible asset on the acquiring company’s balance sheet under the long-term assets’ account.
Under Generally Accepted Accounting Principles (‟GAAP”) and IFRS, these companies which acquired targets in the past and therefore recorded those targets’ goodwill on their balance sheet, are then required to evaluate the value of goodwill on their financial statements at least once a year, and record any impairments.
Impairment of an asset occurs when its market value drops below historical cost, due to adverse events such as declining cash flows, a reputation backlash, increased competitive environment, etc. Companies assess whether an impairment is needed by performing an impairment test on the intangible asset. If the company’s acquired net assets fall below the book value, or if the company overstated the amount of goodwill, then it must impair or do a write-down on the value of the asset on the balance sheet, after it has assessed that the goodwill is impaired. The impairment expense is calculated as the difference between the current market value and the purchase price of the intangible asset. The impairment results in a decrease in the goodwill account on the balance sheet.
This expense is also recognised as a loss on the income statement, which directly reduces net income for the year. In turn, earnings per share (‟EPS”) and the company’s stock price are also negatively affected.
The Financial Accounting Standards Board (‟FASB”), which sets standards for GAAP rules, and the IASB, which sets standards for IFRS rules, are considering a change to how goodwill impairment is calculated. Because of the subjectivity of goodwill impairment, and the cost of testing impairment, FASB and IASB are considering reverting to an older method called ‟goodwill amortisation” in which the value of goodwill is slowly reduced annually over a number of years.
As set out above, goodwill is not the same as other intangible assets because it is a premium paid over fair value during a transaction, and cannot be bought or sold independently. Meanwhile, other intangible assets can be bought and sold independently.
Also, goodwill has an indefinite life, while other intangibles have a definite useful life (i.e. an accounting estimate of the number of years an asset is likely to remain in service for the purpose of cost-effective revenue generation).
1.3. Amortisation, impairment and subsequent measure of intangible assets other than goodwill
That distinction between goodwill and other intangible assets being clearly drawn, let’s get back to the issues revolving around recording intangible assets (other than goodwill) on the balance sheet of a company.
As set out above, if some intangible assets are acquired as a consequence of a business purchase or combination, the acquiring company recognises all these intangible assets, provided that they meet the definition of an intangible asset. This results in the recognition of intangibles – including brand names, IPRs, customer relationships – that would not have been recognised by the acquired company that developed them in the first place. Indeed, paragraph 34 of IAS 38 provides that ‟in accordance with this Standard and IFRS 3 (as revised in 2008), an acquirer recognises at the acquisition date, separately from goodwill, an intangible asset of the acquiree, irrespective of whether the asset had been recognised by the acquiree before the business combination. This means that the acquirer recognises as an asset separately from goodwill an in-process research and development project of the acquiree, if the project meets the definition of an intangible asset. An acquiree’s in-process research and development project meets the definition of an intangible asset when it:
a. meets the definition of an asset, and
b. is identifiable, i.e. separable or arises from contractual or other legal rights.”
Therefore, in a business acquisition or combination, the intangible assets that are ‟identifiable” (either separable or arising from legal rights) can be recognised and capitalised in the balance sheet of the acquiring company.
After initial recognition, the accounting value in the balance sheet of intangible assets with definite useful lives (e.g. IPRs, licenses) has to be amortised over the intangible asset’s expected useful life, and is subject to impairment tests when needed. As explained above, intangible assets with indefinite useful lives (such as goodwill or brands) will not be amortised, but only subject at least annually to an impairment test to verify whether the impairment indicators (‟triggers”) are met.
Alternatively, after initial recognition (at cost or at fair value in the case of business acquisitions or mergers), intangible assets with definite useful lives may be revalued at fair value less amortisation, provided there is an active market for the asset to be referred to, as can be inferred from paragraph 75 of IAS 38:
‟After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be measured by reference to an active market. Revaluations shall be made with such regularity that at the end of the reporting period the carrying amount of the asset does not differ materially from its fair value.”
However, this standard indicates that the revaluation model can only be used in rare situations, where there is an active market for these intangible assets.
1.4. The elephant in the room: a lack of recognition and measurement of internally generated intangible assets
All the above about the treatment of intangible assets other than goodwill cannot be said for internally generated intangible assets. Indeed, IAS 38 sets out important differences in the treatment of those internally generated intangibles, which is currently – and rightfully – the subject of much debate among regulators and other stakeholders.
Internally generated intangible assets are prevented from being recognised, from an accounting standpoint, as they are being developed (while a business would normally account for internally generated tangible assets). Therefore, a significant proportion of internally generated intangible assets is not recognised in the balance sheet of a company. As a consequence, stakeholders such as investors, regulators, shareholders, financiers, are not receiving some very relevant information about this enterprise, and its accurate worth.
Why such a standoffish attitude towards internally generated intangible assets? In practice, when the expenditure to develop intangible asset is incurred, it is often very unclear whether that expenditure is going to generate future economic benefits. It is this uncertainty that prevents many intangible assets from being recognised as they are being developed. This perceived lack of reliability of the linkage between expenditures and future benefits pushes towards the treatment of such expenditures as ‟period cost”. It is not until much later, when the uncertainty is resolved (e.g. granting of a patent), that an intangible asset may be capable of recognition. As current accounting requirements primarily focus on transactions, an event such as the resolution of uncertainty surrounding an internally developed IPR is generally not captured in company financial statements.
Let’s take the example of research and development costs (‟R&D”), which is one process of internally creating certain types of intangible assets, to illustrate the accounting treatment of intangible assets created in this way.
Among accounting standard setters, such as IASB with its IAS 38, the most frequent practice is to require the immediate expensing of all R&D. However, France, Italy and Australia are examples of countries where national accounting rule makers allow the capitalisation of R&D, subject to conditions being satisfied.
Therefore, in some circumstances, internally generated intangible assets can be recognised when the relevant set of recognition criteria is met, in particular the existence of a clear linkage of the expenditure to future benefits accruing to the company. This is called condition-based capitalisation. In these cases, the cost that a company has incurred in that financial year, can be capitalised as an asset; the previous costs having already been expensed in earlier income statements. For example, when a patent is finally granted by the relevant intellectual property office, only the expenses incurred during that financial year can be capitalised and disclosed on the face of balance sheet among intangible fixed assets.
To conclude, under the current IFRS and GAAP regimes, internally generated intangible assets, such as IPRs, can only be recognised on balance sheet in very rare instances.
2.Why value and report intangible assets?
As developed in depth by the European Commission (‟EC”) in its 2013 final report from the expert group on intellectual property valuation, the UK intellectual property office (‟UKIPO”) in its 2013 ‟Banking on IP?” report and the FRC in its 2019 discussion paper ‟Business reporting of intangibles: realistic proposals”, the time for radical change to the accounting of intangible assets has come upon us.
2.1. Improving the accurateness and reliability of financial communication
Existing accounting standards should be advanced, updated and modernised to take greater account of intangible assets and consequently improve the relevance, objectivity and reliability of financial statements.
Not only that, but informing stakeholders (i.e. management, employees, shareholders, regulators, financiers, investors) appropriately and reliably is paramount today, in a corporate world where companies are expected to accurately, regularly and expertly manage and broadcast their financial communication to medias and regulators.
As highlighted by Janice Denoncourt in her blog post ‟intellectual property, finance and corporate governance”, no stakeholder wants an iteration of the Theranos’ fiasco, during which inventor and managing director Elizabeth Holmes was indicted for fraud in excess of USD700 million, by the United States Securities and Exchange Commission (‟SEC”), for having repeatedly, yet inaccurately, said that Theranos’ patented blood testing technology was both revolutionary and at the last stages of its development. Elizabeth Holmes made those assertions on the basis of the more than 270 patents that her and her team filed with the United States patent and trademark office (‟USPTO”), while making some material omissions and misleading disclosures to the SEC, via Theranos’ financial statements, on the lame justification that ‟Theranos needed to protect its intellectual property” (sic).
Indeed, the stakes of financial communication are so high, in particular for the branding and reputation of any ‟knowledge economy” company, that, back in 2002, LVMH did not hesitate to sue Morgan Stanley, the investment bank advising its nemesis, Kering (at the time, named ‟PPR”), in order to obtain Euros100 million of damages resulting from Morgan Stanley’s alleged breach of conflicts of interests between its investment banking arm (which advised PPR’s top-selling brand, Gucci) and Morgan Stanley’s financial research division. According to LVMH, Clare Kent, Morgan Stanley’s luxury sector-focused analyst, systematically drafted and then published negative and biased research against LVMH share and financial results, in order to favor Gucci, the top-selling brand of the PPR luxury conglomerate and Morgan Stanley’s top client. While this lawsuit – the first of its kind in relation to alleged biased conduct in a bank’s financial analysis – looked far-fetched when it was lodged in 2002, LVMH actually won, both in first instance and on appeal.
Having more streamlined and accurate accounting, reporting and valuation of intangible assets – which are, today, the main and most valuable assets of any 21st century corporation – is therefore paramount for efficient and reliable financial communication.
2.2. Improving and diversifying access to finance
Not only that, but recognising the worth and inherent value of intangible assets, on balance sheet, would greatly improve the chances of any company – in particular, SMEs – to successfully apply for financing.
Debt finance is notoriously famous for shying away from using intangible assets as main collateral against lending because it is too risky.
For example, taking appropriate security controls over a company’s registered IPRs in a lending scenario would involve taking a fixed charge, and recording it properly on the Companies Registry at Companies House (in the UK) and on the appropriate IPRs’ registers. However, this hardly ever happens. Typically, at best, lenders are reliant on a floating charge over IPRs, which will crystallise in case of an event of default being triggered – by which time, important IPRs may have disappeared into thin air, or been disposed of; hence limiting the lender’s recovery prospects.
Alternatively, it is now possible for a lender to take an assignment of an IPR by way of security (generally with a licence back to the assignor to permit his or her continued use of the IPR) by an assignment in writing signed by the assignor. However, this is rarely done in practice. The reason is to avoid ‟maintenance”, i.e. to prevent the multiplicity of actions. Indeed, because intangibles are incapable of being possessed, and rights over them are therefore ultimately enforced by action, it has been considered that the ability to assign such rights would increase the number of actions.
Whilst there are improvements needed to the practicalities and easiness of registering a security interest over intangible assets, the basic step that is missing is a clear inventory of IPRs and other intangible assets, on balance sheet and/or on yearly financial statements, without which lenders can never be certain that these assets are in fact to hand.
Cases of intangible asset- backed lending (‟IABL”) have occurred, whereby a bank provided a loan to a pension fund against tangible assets, and the pension fund then provided a sale and leaseback arrangement against intangible assets. Therefore, IABL from pension funds (on a sale and leaseback arrangement), rather than banks, provides a route for SMEs to obtain loans.
There have also been instances where specialist lenders have entered into sale and licence-back agreements, or sale and leaseback agreements, secured against intangible assets, including trademarks and software copyright.
Some other types of funders than lenders, however, are already making the ‟intangible assets” link, such as equity investors (business angels, venture capital companies and private equity funds). They know that IPRs and other intangibles represent part of the ‟skin in the game” for SMEs owners and managers, who have often expended significant time and money in their creation, development and protection. Therefore, when equity investors assess the quality and attractiveness of investment opportunities, they invariably include consideration of the underlying intangible assets, and IPRs in particular. They want to understand the extent to which intangible assets owned by one of the companies they are potentially interested investing in, represent a barrier to entry, create freedom to operate and meet a real market need.
Accordingly, many private equity funds, in particular, have delved into investing in luxury companies, attracted by their high gross margins and net profit rates, as I explained in my 2013 article ‟Financing luxury companies: the quest of the Holy Grail (not!)”. Today, some of the most active venture capital firms investing in the European creative industries are Accel, Advent Venture Partners, Index Ventures, Experienced Capital, to name a few.
2.3. Adopting a systematic, consistent and streamlined approach to the valuation of intangible assets, which levels the playing field
If intangible assets are to be recognised in financial statements, in order to adopt a systematic and streamlined approach to their valuation, then fair value is the most obvious alternative to cost, as explained in paragraph 1.3. above.
How could we use fair value more widely, in order to capitalise intangible assets in financial statements?
IFRS 13 ‟Fair Value Measurements” identifies three widely-used valuation techniques: the market approach, the cost approach and the income approach.
The market approach ‟uses prices and other relevant information generated by market transactions involving identical or comparable” assets. However, this approach is difficult in practice, since when transactions in intangibles occur, the prices are rarely made public. Publicly traded data usually represents a market capitalisation of the enterprise, not singular intangible assets. Market data from market participants is often used in income based models such as determining reasonable royalty rates and discount rates. Direct market evidence is usually available in the valuation of internet domain names, carbon emission rights and national licences (for radio stations, for example). Other relevant market data include sale/licence transactional data, price multiples and royalty rates.
The cost approach ‟reflects the amount that would be required currently to replace the service capacity of an asset”. Deriving fair value under this approach therefore requires estimating the costs of developing an equivalent intangible asset. In practice, it is often difficult to estimate in advance the costs of developing an intangible. In most cases, replacement cost new is the most direct and meaningful cost based means of estimating the value of an intangible asset. Once replacement cost new is estimated, various forms of obsolescence must be considered, such as functional, technological and economic. Cost based models are best used for valuing an assembled workforce, engineering drawings or designs and internally developed software where no direct cash flow is generated.
The income approach essentially converts future cash flows (or income and expenses) to a single, discounted present value, usually as a result of increased turnover of cost savings. Income based models are best used when the intangible asset is income producing or when it allows an asset to generate cash flow. The calculation may be similar to that of value in use. However, to arrive at fair value, the future income must be estimated from the perspective of market participants rather than that of the entity. Therefore, applying the income approach requires an insight into how market participants would assess the benefits (cash flows) that will be obtained uniquely from an intangible asset (where such cash flows are different from the cash flows related to the whole company). Income based methods are usually employed to value customer related intangibles, trade names, patents, technology, copyrights, and covenants not to compete.
An example of IPRs’ valuation by way of fair value, using the cost and income approaches in particular, is given in the excellent presentation by Austin Jacobs, made during ialci’s latest law of luxury goods and fashion seminar on intellectual property rights in the fashion and luxury sectors.
In order to make these three above-mentioned valuation techniques more effective, with regards to intangible assets, and because many intangibles will not be recognised in financial statements as they fail to meet the definition of an asset or the recognition criteria, a reconsideration to the ‟Conceptual Framework to Financial Reporting” needs being implemented by the IASB.
These amendments to the Conceptual Framework would permit more intangibles to be recognised within financial statements, in a systematic, consistent, uniform and streamlined manner, therefore levelling the playing field among companies from the knowledge economy.
Let’s not forget that one of the reasons WeWork co founder, Adam Neumann, was violently criticised, during WeWork’s failed IPO attempt, and then finally ousted, in 2019, was the fact that he was paid nearly USD6 million for granting the right to use his registered word trademark ‟We”, to his own company WeWork. In its IPO filing prospectus, which provided the first in-depth look at WeWork’s financial results, WeWork characterised the nearly USD6 million payment as ‟fair market value”. Many analysts, among which Scott Galloway, begged to differ, outraged by the lack of rigour and realism in the valuation of the WeWork brand, and the clearly opportunistic attitude adopted by Adam Neumann to get even richer, faster.
2.4. Creating a liquid, established and free secondary market of intangible assets
IAS 38 currently permits intangible assets to be recognised at fair value, as discussed above in paragraphs 1.3. and 2.3., measured by reference to an active market.
While acknowledging that such markets may exist for assets such as ‟freely transferable taxi licences, fishing licences or production quotas”, IAS 38 states that ‟it is uncommon for an active market to exist for an intangible asset”. It is even set out, in paragraph 78 of IAS 38 that ‟an active market cannot exist for brands, newspaper mastheads, music and film publishing rights, patents or trademarks, because each such asset is unique”.
Markets for resale of intangible assets and IPRs do exist, but are presently less formalised and offer less certainty on realisable values. There is no firmly established secondary transaction market for intangible assets (even though some assets are being sold out of insolvency) where value can be realised. In addition, in the case of forced liquidation, intangible assets’ value can be eroded, as highlighted in paragraph 2.2. above.
Therefore, markets for intangible assets are currently imperfect, in particular because there is an absence of mature marketplaces in which intangible assets may be sold in the event of default, insolvency or liquidation. There is not yet the same tradition of disposal, or the same volume of transaction data, as that which has historically existed with tangible fixed assets.
Be that as it may, the rise of liquid secondary markets of intangible assets is unstoppable. In the last 15 years, the USA have been at the forefront of IPRs auctions, mainly with patent auctions managed by specialist auctioneers such as ICAP Ocean Tomo and Racebrook. For example, in 2006, ICAP Ocean Tomo sold 78 patent lots at auction for USD8.5 million, while 6,000 patents were sold at auction by Canadian company Nortel Networks for USD4.5 billion in 2011.
However, auctions are not limited to patents, as demonstrated by the New York auction, successfully organised by ICAP Ocean Tomo in 2006, on lots composed of patents, trademarks, copyrights, musical rights and domain names, where the sellers were IBM, Motorola, Siemens AG, Kimberly Clark, etc. In 2010, Racebrook auctioned 150 American famous brands from the retail and consumer goods’ sectors.
In Europe, in 2012, Vogica successfully sold its trademarks and domain names at auction to competitor Parisot Group, upon its liquidation.
In addition, global licensing activity leaves not doubt that intangible assets, in particular IPRs, are, in fact, very valuable, highly tradable and a very portable asset class.
It is high time to remove all market’s imperfections, make trading more transparent and offer options to the demand side, to get properly tested.
3. Next steps to improve the valuation and reporting of intangible assets
3.1. Adjust IAS 38 and the Conceptual Framework to Financial Reporting to the realities of intangible assets’ reporting
Mainstream lenders, as well as other stakeholders, need cost-effective, standardised approaches in order to capture and process information on intangibles and IPRs (which is not currently being presented by SMEs).
This can be achieved by reforming IAS 38 and the ‟Conceptual Framework to Financial Reporting”, at the earliest convenience, in order to make most intangible assets capitalised on financial statements at realistic and consistent valuations.
In particular, the reintroduction of amortisation of goodwill may be a pragmatic way to reduce the impact of different accounting treatment for acquired and internally generated intangibles.
In addition, narrative reporting (i.e. reports with titles such as ‟Management Commentary” or ‟Strategic Report”, which generally form part of the annual report, and other financial communication documents such as ‟Preliminary Earnings Announcements” that a company provides primarily for the information of investors) must set out detailed information on unrecognised intangibles, as well as amplify what is reported within the financial statements.
3.2. Use standardised and consistent metrics within financial statements and other financial communication documents
The usefulness and credibility of narrative information would be greatly enhanced by the inclusion of metrics (i.e. numerical measures that are relevant to an assessment of the company’s intangibles) standardised by industry. The following are examples of objective and verifiable metrics that may be disclosed through narrative reporting:
- a company that identifies customer loyalty as critical to the success of its business model might disclose measures of customer satisfaction, such as the percentage of customers that make repeat purchases;
- if the ability to innovate is a key competitive advantage, the proportion of sales from new products may be a relevant metric;
- where the skill of employees is a key driver of value, employee turnover may be disclosed, together with information about their training.
3.3. Make companies’ boards accountable for intangibles’ reporting
Within a company, at least one appropriately qualified person should be appointed and publicly reported as having oversight and responsibility for intangibles’ auditing, valuation, due diligence and reporting (for example a director, specialist advisory board or an external professional adviser).
This would enhance the importance of corporate governance and board oversight, in addition to reporting, with respect to intangible assets.
In particular, some impairment tests could be introduced, to ensure that businesses are well informed and motivated to adopt appropriate intangibles’ management practices, which should be overseen by the above-mentioned appointed board member.
3.4. Create a body that trains about, and regulates, the field of intangible assets’ valuation and reporting
The creation of a professional organisation for the intangible assets’ valuation profession would increase transparency of intangibles’ valuations and trust towards valuation professionals (i.e. lawyers, IP attorneys, accountants, economists, etc).
This valuation professional organisation would set some key objectives that will protect the public interest in all matters that pertain to the profession, establish professional standards (especially standards of professional conduct) and represent professional valuers.
This organisation would, in addition, offer training and education on intangibles’ valuations. Therefore, the creation of informative material and the development of intangible assets’ training programmes would be a priority, and would guarantee the high quality valuation of IPRs and other intangibles as a way of boosting confidence for the field.
Company board members who are going to be appointed as having accountability and responsibility for intangibles’ valuation within the business, as mentioned above in paragraph 3.3., could greatly benefit from regular training sessions offered by this future valuation professional organisation, in particular for continuing professional development purposes.
3.5. Create a powerful register of expert intangible assets’ valuers
In order to build trust, the creation of a register of expert intangibles’ valuers, whose ability must first be certified by passing relevant knowledge tests, is key.
Inclusion on this list would involve having to pass certain aptitudes tests and, to remain on it, valuers would have to maintain a standard of quality in the valuations carried out, whereby the body that manages this registry would be authorised to expel members whose reports are not up to standard. This is essential in order to maintain confidence in the quality and skill of the valuers included on the register.
The entity that manages this body of valuers would have the power to review the valuations conducted by the valuers certified by this institution as a ‟second instance”. The body would need to have the power to re-examine the assessments made by these valuers (inspection programme), and even eliminate them if it is considered that the assessment is overtly incorrect (fair disciplinary mechanism).
3.6. Establish an intangible assets’ marketplace and data-source
The development most likely to transform IPRs and intangibles as an asset class is the emergence of more transparent and accessible marketplaces where they can be traded.
In particular, as IPRs and intangible assets become clearly identified and are more freely licensed, bought and sold (together with or separate to the business), the systems available to register and track financial interests will need to be improved. This will require the cooperation of official registries and the establishment of administrative protocols.
Indeed, the credibility of intangibles’ valuations would be greatly enhanced by improving valuation information, especially by collecting information and data on actual and real intangibles’ transactions in a suitable form, so that it can be used, for example, to support IPRs asset-based lending decisions. If this information is made available, lenders and expert valuers will be able to base their estimates on more widely accepted and verified assumptions, and consequently, their valuation results – and valuation reports – would gain greater acceptance and reliability from the market at large.
The wide accessibility of complete, quality information which is based on real negotiations and transactions, via this open data-source, would help to boost confidence in the validity and accuracy of valuations, which will have a very positive effect on transactions involving IPRs and other intangibles.
3.7. Introduce a risk sharing loan guarantee scheme for banks to facilitate intangibles’ secured lending
A dedicated loan guarantee scheme needs being introduced, to facilitate intangible assets’ secured lending to innovative and creative SMEs.
Asia is currently setting the pace in intangibles-backed lending. In 2014, the intellectual property office of Singapore (‟IPOS”) launched a USD100 million ‟IP financing scheme” designed to support local SMEs to use their granted IPRs as collateral for bank loans. A panel of IPOS-appointed valuers assess the applicant’s IPR portfolio using standard guidelines to provide lenders with a basis on which to determine the amount of funds to be advanced. The development of a national valuation model is a noteworthy aspect of the scheme and could lead to an accepted valuation methodology in the future.
The Chinese intellectual property office (‟CIPO”) has developed some patent-backed debt finance initiatives. Only 6 years after the ‟IP pledge financing” programme was launched by CIPO in 2008, CIPO reported that Chinese companies had secured over GBP6 billion in IPRs-backed loans since the programme launched. The Chinese government having way more direct control and input into commercial bank lending policy and capital adequacy requirements, it can vigorously and potently implement its strategic goal of increasing IPRs-backed lending.
It is high time Europe follows suit, at least by putting in place some loan guarantees that would increase lender’s confidence in making investments by sharing the risks related to the investment. A guarantor assumes a debt obligation if the borrower defaults. Most loan guarantee schemes are established to correct perceived market failures by which small borrowers, regardless of creditworthiness, lack access to the credit resources available to large borrowers. Loan guarantee schemes level the playing field.
The proposed risk sharing loan guarantee scheme set up by the European Commission or by a national government fund (in particular in the UK, who is brexiting) would be specifically targeted at commercial banks in order to stimulate intangibles-secured lending to innovative SMEs. The guarantor would fully guarantee the intangibles-secured loan and share the risk of lending to SMEs (which have suitable IPRs and intangibles) with the commercial bank.
The professional valuer serves an important purpose, in this future loan guarantee scheme, since he or she will fill the knowledge gap relating to the IPRs and intangibles, as well as their value, in the bank’s loan procedure. If required, the expert intangibles’ valuer provides intangibles’ valuation expertise and technology transfer to the bank, until such bank has built the relevant capacity to perform intangible assets’ valuations. Such valuations would be performed, either by valuers and/or banks, according to agreed, consistent, homogenised and accepted methods/standards and a standardised intangible asset’s valuation methodology.
To conclude, in this era of ultra-competitiveness and hyper-globalisation, France and the UK, and Europe in general, must immediately jump on the saddle of progress, by reforming outdated and obsolete accounting and reporting standards, as well as by implementing all the above-mentioned new measures and strategies, to realistically and consistently value, report and leverage intangible assets in the 21st century economy.
 ‟Lingard’s bank security documents”, Timothy N. Parsons, 4th edition, LexisNexis, page 450 and seq.
 ‟Taking security – law and practice”, Richard Calnan, Jordans, page 74 and seq.
Where does Netflix stand, in terms of expanding its business model, content and distribution channels, worldwide? Where is it heading towards, in the current content distribution ecosystem?
1. Netflix’s state of play in 2018
On 15 May 2015, during the ‟In conversation with Ted Sarandos” event at the Cannes Film Festival, I asked Netflix’s chief content officer why not acquiring some major film studios in order to have more power and clout, while negotiating the shortening, or even removal, of the ‟first theatrical window” to release audiovisual content into the public domain worldwide. Surely, through vertical integration, Netflix would be able to successfully convince countries’ governments and theatre owners, around the world, that adopting its day-and-date release strategy is a win-win solution for all?
Ted Sarandos was visibly annoyed by my question at the time, dismissed it entirely by saying something to the effect that buying independent or major studios would not work because Netflix would not get access to their back catalogue anyway, which was where the real cash was. I was baffled by the narrow-minded approach adopted by Sarandos in his reply to my points, but thought he may have snapped that back at me because I was putting him on the spot in front of an audience of more than 300 people, at the most prestigious film festival on earth!
Three years down the line, and my envisioned best strategy for Netflix to beef up its worldwide presence, not only online, but also in the brick and mortar space, is becoming a reality. I was dead on the money: Netflix reported yesterday that they are in advanced talks to acquire Luc Besson’s EuropaCorp studios.
This is the only way forward, for Netflix, as it has almost reached saturation as far as the distribution of its content on its website and online applications are concerned, worldwide. Indeed, Netflix members with a streaming-only plan can watch TV shows and movies instantly in over 190 countries (Netflix is only not yet available in China, nor is it available in Crimea, North Korea, or Syria due to US government restrictions on American companies there). Moreover, in key markets such as the US, Mexico, Brazil and Argentina, Netflix had a penetration rate as high as 72 percent in the second quarter of 2017.
While more and more consumers subscribe to Netflix streaming plans around the world, with a total number of 117.58 million streaming subscribers worldwide in the fourth quarter of 2017, the average length of subscription to Netflix is 43 months per US broadband households. Therefore, Netflix benefits from a loyal and dutifully paying customer base, which is growing at a 18 percent rate year-on-year. Fixed as well as operating costs, and overheads, are relatively low for Netflix, since it only counts approximately 5,400 employees (by comparison, Microsoft has 124,000 while Apple has 123,000) and since it does not need any plush real estate or other types of tangible assets as part of its successful business strategy. Meanwhile, Netflix’s revenues in 2017 were USD11.69 billion – increasing more than tenfold between 2005 and 2016 – and Netflix’s net income in 2017 was at a comfortable and cushy USD559 million.
Basically, Netflix is swimming in cash, having now successfully implemented its scaling-up strategy in the online space, worldwide. All this disposable income needs being reinvested back into the business, co-founders Reed Hastings and Marc Randolph not being the types of guys slaving for Netflix’s shareholders by splurging into annual dividends’ distributions. In fact, Netflix never paid dividends to its shareholders in the past 10 years!
2. First step of Netflix’s vertical integration strategy: leap into content creation and production
In the last 5 years, 1997 founded Netflix, which started out as a postal DVD rental company, successfully implemented the first steps to its vertical integration strategy, no matter what Sarandos has to say on the subject.
The real decision-maker, here, is co-founder, chairman and CEO Reed Hastings, who has fully grasped that Netflix must own every product or service of its supply chain, to make real money. In this context, vertical integration entails owning distribution as well as content. Hence, the leap into content creation and production for Netflix, as licensing existing content was merely enough to beef up its budding catalogue and render it attractive to a wider and ever more culturally-diversified customer base growing exponentially around the world.
Making beaucoup bucks comes from owning 100 percent of the content, without any licensing royalties to pay back to rightowners. Such fully-owned content can even be licensed back, opening up new revenue streams such as content licensing or even a branded channel with traditional distributors, for Netflix. Films can be easily snatched up at film markets in Sundance, Berlin, Cannes and the American Film Market in Santa-Monica all year round, and Netflix’s deep pockets let it pick the very best of the crop on offer from sales agents and distributors avid to ingratiate themselves with streaming video on-demand services (‟SVoD services”). Film and show projects and productions are also brokered directly between the talent and Netflix, the most notable examples of that being Netflix’s production and commission of House of Cards, Orange is the new Black, The Crown, Making a Murderer, and Stranger Things. In 2018, Netflix Originals’ busy-bee content pipeline is made up of 80 films that the company has either acquired or commissioned, which sounds positively outlandish compared to the 12 films released by Disney, and 20 released by Warner Bros, in 2018.
Owning the content also solves the headache posed by the theatrical distribution model which, according to Ted Sarandos, ‟is pretty antiquated for the on-demand audiences we are looking to serve”. Netflix, he said, is not looking to kill windowing but rather to “restore choice and options” for viewers by moving to day-and-date releases. Indeed, Netflix has brokered many recent theatrical deals – it plans to release the sequel to Ang Lee’s Crouching Tiger, Hidden Dragon day-and-date online and in Inmax theatres. This (overdue) move into day-and-date release positively enrages theatre owners and exhibitors, especially further to the snafu triggered by Netflix managing to get two of its original films, Okja and The Meyerowitz Stories, chosen to compete in the official selection of the 2017 Cannes film festival.
3. Next step of Netflix’s vertical integration strategy: film studios’ acquisitions
Netflix’s vertical integration and expansion strategy does not stop here, though, because it still has so much disposable income to invest and, hey, why not acquiring more content, stakeholders, market share and clout in the films’ and shows’ sectors, if you can, right? SVoD services like Netflix have declared an open war on the fragmented audiovisual content industry which has prospered for decades, grazing on horizontally segmented industry models. Netflix is at the forefront of structuring end-to-end vertical SVoD services, going direct to consumers and ruthlessly bypassing theatres, broadcasters, networks, cable operators and even television manufacturers. This digital revolution transforms television and filmed entertainment, especially traditional broadcast TV, and is fostered by the big and fast-growing inroads of internet and over-the-top (‟OTT”) video platforms such as Netflix, Amazon and Google’s YouTube.
Shaken at its core, a wave of consolidation is subsequently coming to the entertainment content delivery industry, with Netflix ready to snatch up any shaky yet prestigious film studio that comes along, such as Luc Besson’s EuropaCorp studio. Not only does the studio Besson co-founded in 1999 has a rich and high quality original content library and back catalogue (comprising Lucy, Taken, Le Grand Bleu, Valerian and the City of a Thousand Planets, among others), but striking an exclusive direction and production deal with seminal and highly creative Besson would reinforce the prestige of Netflix, while making the platform even more appealing to European, and Asian audiences, in particular.
I predict that, should the right opportunity comes along, Netflix will repeat this vertical expansion masterstroke and acquire more major and/or independent studios.
It is true that vertical expansion has boundaries, in particular due to the anti-competitive risks that it entails, and that the issue of vertical integration in the entertainment business has been the main focus of policy makers since the 1920s. For example, in the United States v Paramount Pictures Inc. case, the US Supreme court ordered on 3 May 1948 that the five vertically integrated major studios, MGM, Warner Bros, 20th Century Fox, Paramount Pictures and RKO, which not only produced and distributed films but also operated their own movie theatres, sell all their theatre chains. However, today, many media conglomerates already own television broadcasters (either over-the-air or on cable), the production companies that produce content for their networks, and also own the services that distribute their content to viewers (such as television and internet service providers). Bell Canada, Comcast, Sky plc and Roger Communications are vertically integrated in such a manner – operating media subsidiaries and providing ‟triple play” services on television, internet and phone services in some markets. Additionally, Bell and Rogers own wireless providers, Bell Mobility and Rogers Wireless, while Comcast is partnered with Verizon Wireless. Similarly, Sony has media holdings through its Sony Pictures division, including film and television content, as well as television channels, but is also a manufacturer of consumer electronics that can be used to consume content from itself and others, including televisions, phones and PlayStation video game consoles.
In this context, it is quite difficult imagining Netflix slapped with any anti-competition lawsuits or investigations, because it goes on a buying spree of film studios, even one of the ‟Big Six” majors.
4. Masterstroke of Netflix’s vertical integration plan: broadcasting networks and theatre chains
The next stage of Netflix’s vertical integration and expansion strategy, in addition to buying, producing and commissioning its own content, and in addition to acquiring film studios, is to delve into distributing its own content in the ‟real” world (i.e. offline sphere), either on other media distribution channels such as a broadcasting network, or in movie theatres.
I predict that, in 10 years, if TV is still a medium used by consumers, Netflix will have its own TV channels and broadcasting networks. In the future, if people still attend movie theatres from time to time, to watch special effects films there in particular, Netflix will also invest in buying back fledging exhibitors’ chains, causing direct competition to China’s Dalian Wanda-owned cinema group which is currently on a buying spree of theatre chains across Europe and the US.
This ‟online to offline strategy” is currently being implemented with brio by originally pure player Amazon, which is currently buying brick and mortar retail spaces all other the world, in order to continue its competitive assaults on traditional grocery stores and malls, increase its market share and get closer to its clients’ base worldwide. Amazon is at a way more mature growth point than Netflix, of course, but provides excellent footprint of the future roadmap that Netflix is undoubtedly going to implement.
5. No space for Apple in Netflix’s vertical integration strategy
Some commentators in the entertainment and finance industries pretend that Apple will buy Netflix but this is an oversight.
Firstly, Netflix has zilch incentive to accept an acquisition offer, even from a tech behemoth like Apple, because it is in such a strong strategical and financing position, and will be in that sweet spot for many more years to come in spite of its lesser-known SVoD competitors, such as Amazon Prime, Hulu and Vudu, tagging along.
Secondly, and thanks to such solid said vertical integration strategy and financials, Netflix’s valuation is simply too high, now. It is trading at all-time highs, with a USD94 billion market cap.
Thirdly, co-founder Reed Hastings, who still very much keeps a tight rein on Netflix as its chairman and CEO and enjoys the ride, is unlikely to sell his business at a meagre premium of 6 percent or so (USD100 billion).
Finally, Apple’s specialty and strength lie in its hardware and products, not so much in its software and services (apart, perhaps, from Apple’s video editing software, Final Cut Pro): the integration of Netflix into Apple will reinforce the latter’s positioning as a serious software and online applications’ provider, but will do absolutely nothing for the former’s vertical integration strategy, which now charges ahead towards film studios’ acquisitions, broadcasting networks’ acquisitions and theatre chains’ acquisitions.