New Jersey Bankruptcy Court Extends Unusual Protection to Trademark Licensees Under Section 365(n)

by Foley & Lardner LLP
Contact

A recent Bankruptcy Court decision in New Jersey took an unusual approach in determining the rights of the debtors’ trademark licensees following the debtors’ rejection of the licenses as executory contracts. In In re Crumbs Bake Shop, Inc., Case No. 14-24287 (10/31/14), Judge Michael Kaplan held that the debtors’ licensees were protected by Section 365(n) of the Bankruptcy Code and could continue to use the licensed marks notwithstanding the rejection, even though that section – which expressly protects licensees of other types of intellectual property – makes no mention of trademarks. The decision has been appealed to the Third Circuit. If affirmed, the holding would diverge from the Fourth and Seventh Circuit’s approaches to the same issue and could lead to either a Supreme Court review or legislative action by Congress.

Debtors sold baked goods through a chain of retail shops. Through a licensing agent, the debtors licensed certain of their trademarks and trade secrets to six different licensees. Debtors filed bankruptcy in July 2014. In August, the Court approved the sale of substantially all of the debtors’ assets to Lemonis Fischer Acqusition Company LLC (the “Buyer”), free and clear of liens and other encumbrances, pursuant to Section 363(f) of the Bankruptcy Code. Following the sale, the Buyer moved to reject the trademark license agreements. In response, the licensing agent asserted that the licensees could elect to retain their rights under Section 365(n).

This subsection was added to the Bankruptcy Code in 1988 with the express purpose of overruling Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Lubrizol had held that when any intellectual property license is rejected in bankruptcy, the license is terminated and the licensee loses the ability to exercise the right granted by the license. Section 365(n) permits a licensee of “intellectual property” to continue exercising its rights notwithstanding the rejection of the license contract by the trustee for a debtor licensor.

The subsection’s definition of “intellectual property” includes patents, copyrights and trade secrets, but does not include trademarks. This was intentional. As noted in the legislative history, trademark licensing relationships – unlike licenses for patents or copyrights — “depend to a large extent on control of the quality of the products or services sold by the licensee.”[1] There were concerns about whether debtor-licensors would have the means or incentive to exercise this function, as well as a reluctance to impose any additional obligations on trustees. “Since these matters could not be addressed without more extensive study,” said the Senate Report, “it was determined to postpone congressional action in this area and to allow the development of equitable treatment of this situation by bankruptcy courts.”

Since then, courts have treated debtors’ rejections of trademark licenses in a variety of ways. In most cases, the licensee’s rights are simply extinguished. See, e.g., In re Global Holdings, Inc., 290 B.R. 507, 513 (Bankr. Del. 2003). In some exceptional cases, licensees were able to obtain relief by showing that their businesses would be virtually destroyed and/or that rejection would be of little benefit to the state and the creditors.

The Seventh Circuit took an entirely different approach in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC 686 F.3d 372 (7th Cir. 2012). Sunbeam held that that because Section 365(g) characterizes the rejection of an executory contract as a breach — not a rescission voiding the contract — “nothing about this process implies that any rights of the other contracting party have been vaporized.” The rejection “merely frees the estate from the obligation to perform” but has no effect on the contract’s continued existence. Therefore, the Seventh Circuit’s position is that, even without the protection afforded by Section 365(n), a trademark licensee retains its rights to use the licensed mark notwithstanding the rejection of the license by the debtor licensor.

In Crumbs, Judge Levine followed the reasoning previously articulated by Judge Ambro’s concurrence in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010). He agrees with Judge Ambro (as well as the Seventh Circuit) that the mere absence of “trademarks” from the list of intellectual property in Section 365(n) does not prohibit a judge from granting “equitable treatment” to trademark licensees, as envisioned by the legislative history. Judge Levine went on to hold that “it would be inequitable to strip the within Licensees of their rights in the event of a rejection, as those rights had been bargained away by Debtors.”

The Buyer argued that these equitable considerations are irrelevant where, as here, the debtors sold their assets, to a bona fide purchaser, under Section 363(f). Judge Levine disagreed. He saw no reason to augment the already considerable benefit of allowing bankruptcy estates to assume or reject executory contracts at the expense of third parties. Noting that monetary recoveries in Chapter 11 cases primarily benefit pre- and post-petition lenders and administrative claimants rather than unsecured creditors, he held that “[i]t is questionable that Congress intended to sacrifice the rights of licensees for the benefit of the lending community.”

The Court also rejected Buyer’s argument that, because the licensees failed to object to the sale, the asset sale under Section 363(f) was a free and clear conveyance of the trademark rights, unencumbered by the licenses. It held that, in the absence of consent, a Section 363(f) sale does not trump the Section 365(n) rights owned by the licensees. The failure to object in this case was not an implicit consent in this case, said the Court, because the sale of IP rights in the Asset Purchase Agreement was so convoluted and impenetrable that the licensees had no reasonable notice. The court posited “that the content of the Sale Motion was a calculated effort to camouflage the intent to treat the License Agreements as vitiated without raising the specter of §365(n) rights. Thus, it would be inequitable for this Court to find that the Licensees consented to termination of their rights.”

Judge Levine glossed over the Buyer’s concerns that it would have little ability to control the quality of products or services sold by licensees, as the law of trademark licensing demands. It cited only to a law review article which discussed the licensees’ incentive to maintain quality, and to a pending bill in the House of Representatives which would add “trademarks” to Section 365(n) and also provide that bankruptcy trustees must not be relieved of any contractual obligation to monitor and control quality.

The shotgun marriage of the Buyer and the licensees is made even more awkward by the Court’s holding that, since the license agreements were excluded from the asset sale, post-closing royalties generated by the licensees are owed to the Debtors, not the Buyer. In support of this holding, the Court cited In re Cellnet Data Sys., Inc., 327 F.3d 242 (3d Cir. 2003), which reached the same result. But CellNet involved patent licenses, which require no ongoing business relationship between licensor and licensee. It is anomalous, to say the least, to have one party be responsible for quality control while another party collects the royalties. That said, the Buyer will have a motive to undertake this obligation, since its failure to do so would threaten the validity of the trademarks themselves – assets the Buyer paid for and presumable wishes to preserve.

The Buyer has filed a notice of appeal to the Third Circuit. If the decision is affirmed, the Third Circuit would join the Seventh in holding that the exclusion of “trademarks” from the definition of intellectual property in Section 365(n) does not, by “negative inference,” preclude a court from granting protection to licensees under that subsection. A reversal, however, would put the circuits in conflict. While this decision should give some comfort to trademark licensees of debtor companies, their status will remain highly uncertain so long as the statute is silent. Ideally, Congress will finally clarify the statute and finish the job it “postponed” 25 years ago.

[1] Senate Report No. 100-505, 100th Cong., 2d Sess. (Sept. 14, 1988)

View This Blog

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Foley & Lardner LLP | Attorney Advertising

Written by:

Foley & Lardner LLP
Contact
more
less

Foley & Lardner LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.