Trademark Licensees Beware: License At Risk In Franchisor Bankruptcy

by Fox Rothschild LLP
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A concern for franchisees is the impact on license agreements for intellectual property when the licensor files bankruptcy and seeks to shed itself of burdensome obligations under license agreements. The impact on the licensee is different depending on the type of IP licensed. And, to further complicate matters, with regard to impact on trademarks the results can be different depending upon where the licensor files for bankruptcy.

Rejection of Executory Contracts – An Overview

The scenario arises because Section 365 of the U.S. Bankruptcy Code allows the debtor party to reject certain contracts that are burdensome.

License agreements can be rejected, and this includes licenses for trademarks and other intellectual property. Under Section 365, when a license is rejected, the debtor party is excused from all obligations.

In 1985, in a case involving intellectual property licensed by Lubrizol Enterprises, the 4th Circuit Court of Appeals in Virginia allowed the rejection of the license agreement and ruled that the rejection by the licensor terminated the licensee’s right to use the intellectual property.

As can be imagined, this caused a stir in the business community, particularly in sectors like the franchise business.

In reaction, Congress amended Section 365 by adding subsection (n) to give licensees of certain types of intellectual property protection – under 365(n) the licensee of IP can either treat the license as terminated or continue to use the IP for the balance of the term of the contract provided all royalties are paid without the right of set off, and without the ability of the licensee to receiver any support from the licensor.

Impact on Trademark Licenses

When Congress amended Section 365 by adding 365(n), it also defined what it meant by the term intellectual property. The definition found at Bankruptcy Code Section 101(35A) does not include a reference to trademarks. The result is that cases are all over the board on whether trademark licenses have the protection from rejection codified in Section 365(n).

Some bankruptcy courts in the 4th Circuit and elsewhere hold that since the definition of IP does not include trademarks, the 4th Circuit’s analysis in Lubrizol dictates that the rejection of a trademark license terminates the rights of the licensee to use the trademark, i.e., no 365(n) protection. Courts in other jurisdictions hold that to treat trademark licenses differently cannot be supported, and these courts find equitable reasons to allow licensees to continue to use trademarks after license rejection.

The equitable approach was discussed in the 3rd Circuit’s 2010 ruling in Exide Techs. The 3rd Circuit did not decide the issue in Exide. But in a concurring opinion, Judge Ambro wrote that bankruptcy courts can fashion equitable protections for rejected trademark licensees. That judge is a former business bankruptcy lawyer whose opinions on bankruptcy are often cited favorably, and his concurrence in Exide was applied by at least one judge in New Jersey to support the equitable protections approach.

In 2012, the 7th Circuit weighed in in a case involving the bankruptcy of Sunbeam Products, when it held that the rights of the trademark licensee “do not vaporize” by rejection. The 7th Circuit rejected the analysis of the 4th Circuit in Lubrisol setting up a clear circuit split.

In 2016, a case from New Hampshire, involving licenses for all sorts of IP granted by Tempnology, LLC, started in the Bankruptcy Court, went to a 3-judge Appellate Panel and then to the full 1st Circuit. By the time the Tempnology case got to the full circuit court of appeals, two judges had ruled against the trademark licensee (Bankruptcy and BAP dissent) and two others had ruled in favor. The Bankruptcy Appellate Panel majority of two judges relied heavily on the 7th Circuit’s analysis in Sunbeam in finding that trademark licensees have the same protections as licensees of other IP.

In a split decision, the full 1st Circuit held that:

  1. Licensees of trademarks do not have protection under 365(n).
  2. It is not appropriate to craft equitable remedies to protect trademark licensees – rejecting the Judge Ambro approach
  3. The analysis of the 7th Circuit in Sunbeam was rejected
  4. The analysis of the 4th Circuit in Lubrizol was followed.
  5. The rights of the trademark licensee were rejected.

Conclusion

If you are a franchisee or other license holder and your franchisor/licensor files bankruptcy, until the Supreme Court resolves the split between the Circuit Courts, the outcome and impact on future rights to use trademarks may very well depend on the state in which you find yourself litigating the issues.

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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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