On July 9, 2012, the United States Court of Appeals for the Seventh Circuit issued a decision in Sunbeam Products, Inc. v. Chicago American Mfg., LLC (No. 11-3920), a case that addresses the effect of a bankruptcy trustee's rejection of trademark licenses. For years, the Bankruptcy Code's definition of "intellectual property" has excluded trademarks. But the Code provides very specific guidelines on the treatment of other intellectual property licenses in section 365(n), which was added by Congress in 1988 following the Fourth Circuit's decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985).
In section 365(n), Congress provided, contrary to Lubrizol, that a licensee may continue to use the intellectual property after rejection, as long as certain conditions are met. (Lubrizol had held that after rejection, the licensee loses the ability to use the licensed property.) The Seventh Circuit concluded that the omission of "trademarks" in the definition of "intellectual property" was "just an omission"; all it means is that 365(n) does not affect trademarks one way or the other. This put the Lubrizol decision squarely before the Seventh Circuit.
The Seventh Circuit disagreed with Lubrizol, setting up a clear circuit conflict on the issue. As a matter of statutory interpretation, the Court held that rejection of a trademark license, like the rejection of any other executory contract or unexpired lease, merely constitutes a breach of the contract and does not terminate the licensee's rights. So the licensee in this instance, Chicago American Mfg., could continue using the trademarked property following rejection. Chief Judge Easterbrook authored the opinion.
Though the decision is specific to intellectual property rights, Judge Easterbrook's reasoning has broader implications for bankruptcy practitioners. In the Seventh Circuit, at least, it resolves any doubts about the effect of contract rejection. Some courts, as in Lubrizol, have interpreted rejection as the equivalent of contract termination or rescission; more than a breach. Those decisions have been criticized over the years (one commentator calls Lubrizol “the king of all bad executory contract cases”), but until now no other appellate court had directly addressed Lubrizol.1 Judge Easterbrook put the issue to rest: “nothing about this process [of rejection] implies that any rights of the other contracting party have been vaporized.”
The decision also serves as a cautionary sign for bankruptcy practitioners and judges who argue for and justify results in the name of “equity” or good public policy. The bankruptcy judge (Judge Pamela Hollis, N.D. Ill.) had held that Chicago American Mfg. could continue using the marks "on equitable grounds," citing the licensee’s substantial investments in manufacturing the trademarked products. Judge Easterbrook took her to task for that, saying, "What the Bankruptcy Code provides, a judge cannot override by declaring that enforcement would be 'inequitable.'" That statement will surely be cited in future bankruptcy pleadings and decisions, regardless of the subject matter.