Trademark License Not Subject To Rejection In Bankruptcy In Certain Circumstances

by Nossaman LLP

Pursuant to 11 U.S.C. § 365, a debtor or bankruptcy trustee has the option, subject to court approval, of electing one of the following three alternatives with respect to an executory contract:  (a) assuming the contract, (b) assuming and assigning the contract to a third party, or (c) rejecting the contract.  Assumption of the contract, or assumption and assignment results in the agreement remaining in effect post-bankruptcy.  A rejection of the contract is treated as a breach of the agreement by the debtor and, in effect relieves the debtor (as well as the non-debtor party) from post-bankruptcy obligations.  In the event of a rejection, the non-bankrupt party’s remedies are limited to a claim for damages resulting from rejection.  (11 U.S.C. § 502(g).)

When a bankrupt licensor rejects an intellectual property license agreement, the licensee faces the possibility of having its rights cut off after rejection.  Section 365(n) of the Bankruptcy Code provides licensees of “intellectual property” with the option to elect to treat rejection of the licensing provisions either as a termination of the licensing agreement, or instead to retain the use/access to the covered intellectual property.  Such retention is “as is” without any right to future enhancements or upgrades, provided that the licensee pays any royalty payments required by the contract.  The statute was enacted in response to the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985) which held that rejection of a technology licensing agreement resulted in the licensee’s loss of the right to continue to use the subject metal coating process technology owned by the debtor.

The problem faced by trademark licensees as opposed to licensees of other intellectual property, however, is the language of 11 U.S.C. § 365(n).  The Bankruptcy Code’s definition of “intellectual property” in 11 U.S.C. § 101(35A) states that the term “means” certain enumerated items.  Those categories listed in the statute are trade secrets, plant varieties, patent applications, inventions, processes, designs or plants protected under Title 35, works of authorship protected under Title 17 and protected mask works under chapter 9 of Title 17.  As defined, intellectual property does not include trademarks.  Courts have held that, as a result, the licensee does not retain trademark rights following rejection by the debtor licensor.  See, e.g., Raima UK Ltd. v. Centura Software Corp. (In re Centura Software Corp.), 281 B.R. 660, 662 (Bankr. N.D. Cal. 2002).

Despite the fact that § 365(n) is inapplicable to trademark licenses, some courts, most notably the Seventh Circuit Court of Appeals in Sunbeam Prods. v. Chi. Am. Mfg., LLC, 686 F.3d 372 (7th Cir. Ill. 2012), have protected trademark licensees by holding that the licensee’s right to continue to use the trademark survives rejection of such a license by the bankrupt licensor.  This approach is based on the position that rejection is not equivalent to a rescission or termination of the license agreement, but merely constitutes a breach, and that a breach by the licensor does not prevent the licensee from continuing to use the trademark.

The recent decision by the Eighth Circuit in Lewis Bros. Bakeries Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), No. 11-1850, 2014 U.S. App. LEXIS 10537 (8th Cir. Mo. June 6, 2014) recognizes another basis for preserving the licensee’s rights notwithstanding a licensor bankruptcy.  To the extent that the license agreement has been substantially performed by both parties at the time of bankruptcy, the license agreement is no longer executory and would not be subject to rejection under 11 U.S.C. § 365.  As the Eighth Circuit noted, in order to be executory, both parties must have material, outstanding obligations.  The trademark license in the Lewis Bros. Bakeries, Inc. was entered into as part of a sale of the debtor’s Butternut and Sunbeam bread operations and assets in Illinois.  The asset purchase agreement provided for the “perpetual, royalty-fee, assignable, transferable, exclusive license to use the trademarks” associated with the sold operations pursuant to the terms of a license agreement between the debtor and the buyer.

The Eighth Circuit held that, under the circumstances in the case including language in both agreements, the asset purchase agreement and the trademark license agreement should be considered together as a single, integrated contract.  The court concluded that the contracts at issue were not executory because the seller already had substantially performed its obligations under the integrated agreements.  The assets already were sold to the buyer and the purchase price had been paid in full to the debtor.  The court found that the only remaining duties to be performed by the seller were what the court characterized as relatively minor compared to the already performed obligations in connection with consummating the asset sale.  The items remaining to be performed all pertained to the trademark license and involved duties to provide notice respecting the trademarks and relating to maintenance and defense of the marks in the context of the parties’ integrated contracts.  The Eighth Circuit concluded that the debtor/seller’s failure to perform its duties under the agreement would not constitute a material breach.  (Because material, unperformed obligations must remain on both sides of the contract, the court did not address the effect of the licensee’s ongoing duties to maintain quality standards with respect to the goods sold under the licensed trademarks.)

The Eighth Circuit’s decision provides another basis for preserving a licensee’s right to continue to use trademarks notwithstanding the licensor’s bankruptcy under similar circumstances.  Although the issue of materiality of unperformed obligation must be addressed on a case by case basis, the decision in Lewis Bros. Bakeries, Inc. offers valuable guidance in evaluating the executory nature of trademark license agreements in bankruptcy, particularly with respect to such contracts entered into in the asset sale context.


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.

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