Two Recent Decisions From Courts of Appeals Address Important Intellectual Property Issues in Bankruptcy

by Davis Wright Tremaine LLP

In the last two weeks, the 6th Circuit and 7th Circuit Court of Appeals each issued decisions on important intellectual property issues in bankruptcy.

In the first decision, the 6th Circuit held that bankruptcy's automatic stay may not protect a debtor from lawsuits to stop ongoing trademark and service mark infringement. The decision will be welcomed by persons with valuable intellectual property portfolios because infringers will not be able to shield ongoing infringement through bankruptcy.

In the second decision, the 7th Circuit held that a bankrupt licensor’s rejection of a trademark license does not terminate the licensee’s right to use the intellectual property. The decision will reassure trademark licensees that they may be able to continue to use the licensed trademarks, even after the licensor rejects the license through bankruptcy.

6th Circuit’s Decision in Dominic's Restaurant of Dayton, Inc. v. Mantia (In re Shirley's Village Inn), No. 10-3376/3377 (6th Cir. July 5, 2012)
Dominic's involved a restaurant that used trademarks and service marks belonging to someone else. The owners of the intellectual property brought infringement claims in federal district court. The owners sought and obtained a series of injunctions, as well as contempt citations for violations of those injunctions.

During the course of the litigation, one of the defendants filed for bankruptcy and argued that the automatic stay prevented continuation of the infringement action against him. The district court disagreed, and concluded that the automatic stay does not apply to protect a debtor's tortious (i.e., infringing) use of property. While the stay would bar an assessment of damages, it would not bar injunctive relief against the debtor-defendant.

The matter then went to the 6th Circuit Court of Appeals, which affirmed the judgment of the district court. The court of appeals held that "application of the automatic stay would permit [the defendant] to continue to commit this tort [of trademark and service mark infringement]. [The defendant's] commission of a tort is not protected by the Bankruptcy Code." The court of appeals cited cases for the proposition that the automatic stay does not preclude post-petition suits to enjoin infringing conduct. Also, the stay does not necessarily relieve a debtor of its obligations to comply with the orders of non-bankruptcy courts entered before the bankruptcy filing.

An argument might be made that the case’s unique facts dilute the decision’s precedential value. The owners of the intellectual property had obtained several pre-petition injunctions against infringing conduct, and were attempting, among other things, to enforce those injunctions post-bankruptcy. While an argument potentially might be made, given those facts, that the decision pertains to the post-petition enforcement of pre-petition court orders as much as to the infringing conduct, the language of the court’s holding seems to extend more broadly than that. On its face, the court’s holding would apply to any use of estate property to commit a tort, including trademark infringement.

This decision nevertheless helps intellectual property owners who need to protect their rights against debtors in bankruptcy. Although they must act carefully to avoid accidentally violating the automatic stay, owners can cite this decision when seeking injunctive relief against an infringing debtor.

7th Circuit’s Decision in Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, No. 11-3920 (7th Cir. July 9, 2012)
Sunbeam involved a manufacturing company that licensed the right to produce Lakewood-branded fans. When Lakewood entered bankruptcy, its trustee rejected the license using section 365 of the Bankruptcy Code. That provision generally allows a debtor to breach a pre-bankruptcy agreement while limiting the counterparty’s remedies to an unsecured, non-priority claim. Lakewood’s trustee sold Lakewood’s assets to Sunbeam Products, which sued to stop the licensee from continuing to use the Lakewood trademarks.

The 7th Circuit held that the licensee was entitled to continue using the Lakewood trademarks, despite the rejection of the license. Although Congress enacted section 365(n) of the Bankruptcy Code to protect the rights of patent and copyright licensees to continue to use licensed intellectual property after rejection, Congress neglected to include trademarks within the scope of section 365(n). The 7th Circuit concluded that Congress’s omission of trademarks was immaterial because rejection merely entails a debtor breach, with bankruptcy-specific remedies then made available to the non-breaching party. But nothing about simple rejection (as distinguished from an attempt to rescind, or to avoid transfers made under the contract) typically affects the validity of the contract, or causes the non-breaching party’s rights to be, as the court of appeals put it, “vaporized.” Accordingly, because a licensor’s simple breach outside of bankruptcy typically would not cause the licensee to lose the use of the licensed property under non-bankruptcy law, there is no reason why the non-debtor licensee should lose that right in a licensor bankruptcy.

In reaching this conclusion, the 7th Circuit rejected Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). That decision holds (incorrectly, in the view of the 7th Circuit) that when an intellectual property license is rejected in bankruptcy, the licensee loses the ability to use licensed copyrights, trademarks, and patents.

Although Lubrizol’s holding on this issue has been criticized in academic circles, the 7th Circuit’s decision in Sunbeam represents the first time that another court of appeals has squarely rejected it. Sunbeam does not change the law in the 4th Circuit (which must adhere to Lubrizol), but it is binding within the 7th Circuit, and should prove persuasive in other jurisdictions. The decision would mean that trademark licensees are not subject to losing their rights just because the licensor files for bankruptcy and rejects the license.


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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