Alaska Airlines Must Pay to Use Virgin Brand Even Though It Is Not Using the Brand

A recent judgment of the English Court of Appeal demonstrates the importance of examining licence agreements in corporate transactions.

This case was between the Virgin Group and Alaska Airlines. The history goes back to 2018 when the airline Virgin America merged with Alaska Airlines, on which date Virgin America ceased to exist and all rights and obligations were assumed by Alaska Airlines. Thus Alaska became a party to a licence agreement by which the internationally well-known Virgin Group had licensed to Virgin America the rights to use the Virgin brand. The licence included obligations to make royalty payments including minimum royalty payments of about USD 8 million per annum, increasing over the 25 year life of the licence agreement.

As those familiar with U.S. domestic airlines will know, Virgin America subsequently was de-branded, taking instead the Alaska Airlines brand. Within just under one year, Alaska Airlines had ceased any use of the Virgin brand and had ceased making any royalty payments including the minimum royalty payments. Virgin sued.

Key clauses in the licence agreement were:

Cause 3.6 “Subject to Clause 3.7, [Alaska] undertakes that, for as long as it provides the Licensed Activities it shall continue to do so using the Names [i.e. the Virgin brand] and shall use all reasonable efforts to promote its conduct of the Licensed Activities under the Names.”

Clause 3.7 “Notwithstanding any other provision of this Licence nothing in this Licence shall prohibit [Alaska] at any time during the Term from electing to perform the Licensed Activities or any other activities, including, but not limited to, operating flights, code sharing arrangements with any other airlines or entities, or operating flights between any points regardless of where such flights originate or terminate, without the payment of royalties, so long as [Alaska] does not use the Names or Marks while undertaking such activities.” 

Clause 8.1 “In consideration of the Airline Rights granted pursuant to Clause 3, [Alaska] agrees to pay [Virgin]: (a) with effect from the Effective Date and until December 31, 2015, a quarterly royalty which shall be 0.5% of Gross Sales in respect of each Quarter or part of a Quarter; (b) with effect from January 1, 2016 and until the Trigger Date, a quarterly royalty which shall be 0.7% of Gross Sales in respect of each Quarter or part of a Quarter; and (c) with effect from the Trigger Date and for the remainder of the Term, a quarterly royalty which shall be 0.5% of Gross Sales in respect of each Quarter or part of a Quarter In each case, subject to the requirement that [Alaska] will in each financial year during the Term pay at least the annual Minimum Royalty in accordance with Clause 8.6.” 

Clause 8.6 “For the avoidance of doubt, [Alaska’s] obligation in respect of payment of royalties due to [Virgin] in each financial year of [Alaska] is to pay the greater of (a) a royalty based on a percentage of [Alaska’s] Gross Sales in the relevant period, at the rates set out in Clauses 8.1 and 8.3 above, and (b) the Minimum Royalty payment applicable for that period…”

Alaska argued that clause 3.7 expressly provides that it can at any time operate without using the Virgin brand and can do so without paying royalties. In such circumstances, where it is not obliged to pay royalties, it would be a bizarre interpretation (Alaska asserted) for it nevertheless to have to pay minimum royalties. The difficulty for Alaska with such a line is that it rather overlooks clause 3.6 and the obligations there set out to use the Virgin brand, to which Alaska’s response was that clause 3.6 was trumped by the opening words of clause 3.7.

Evidence demonstrated that clause 3.7 was included in response to a U.S. Department of Transport requirement that Virgin America should be entitled to operate free of the control of the Virgin group (based outside of the U.S.), including being able to operate without using the Virgin brand on a royalty-free basis. That requirement would be undermined, Alaska contended, if, in operating without using the Virgin brand, it had to pay the equivalent of 80% of the royalties (as of 2013), which would have been payable if it had used the brand.

The Court of Appeal disagreed, finding that “the language of the Licence, the factual matrix and commercial considerations all point firmly to Virgin being entitled to at least the Minimum Royalty in exchange for the rights Alaska holds for the remainder of the term of the Licence.”

A key point here is that Alaska had no right to terminate the licence, but in any event, a minimum royalty payment is not commercial nonsense when considered as a payment to keep open the possibility of using (and in the Court’s words “sterilise”) the Virgin brand at any time during the remainder of the 25 year licence. Furthermore, “it is plainly of value to Alaska that the well-known Virgin Brand should not be used by one of its competitors in the US airline marketplace.”

Further, the court held that even if there were commercial oddities on a literal interpretation, such commercial oddities carried less weight in contractual interpretation where “the Licence …  is a professionally drawn contract between commercial parties. That is all the more so in circumstances where the parties knew and intended (i) that its terms would be reviewed and had to satisfy a regulator and (ii) a third party might well acquire or merge with Virgin America and assume its rights and obligations under the Licence.”

What could a party in Alaska Airlines’ position have done differently to avoid this ongoing obligation to pay minimum royalties?

• At the time of the merger, carefully check all licence and other on-going agreements and ensure that they are fully aware of the consequences of taking on those agreements, particularly if they are going to materially change the operational arrangements of the target company.
• Consider whether prior to completion there are options to terminate the licence if access to the licensed rights is no longer required. If not, consider whether the licensor will agree how the agreement should be interpreted if there is a lack of clarity, or if there is the possibility to buy-out the licensor’s rights. It is not always possible for the potential acquirer to have such discussions, particularly if the deal is subject to confidentiality terms, but it might be possible for a target company to do so.
• Obtain indemnities from the vendor. This may not be an option in a straight merger situation.

What happened behind the scenes when the Virgin America and Alaska Airlines merger was being negotiated does not form part of the judgment. It may be that at that time Alaska Airlines took, or attempted to take, all these actions, but in the end given the commercial upsides outweighed went ahead fully aware of the risk of having to pay these ongoing minimum royalty payments. Sometimes it is necessary just to take a punt, but what should not be necessary is to take a punt in ignorance of the risks through a failure to fully think through the impact of ongoing contractual obligations.