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Business Bankruptcy Issues Recent Developments

First Published Court Of Appeals Opinion Issued Answering Whether Trademark Licenses Are Assignable In Bankruptcy

It’s been a long wait, but we finally have a published decision from a U.S. Court of Appeals answering whether a trademark license is assignable in bankruptcy without the licensor’s consent. On July 26, 2011, the U.S. Court of Appeals for the Seventh Circuit issued an opinion in In re: XMH Corp., written by Circuit Judge Richard A. Posner, and a copy of the opinion is available by following the link in this sentence. Until now, the closest we had come to a Court of Appeals decision on this issue was an unpublished affirmance by the U.S. Court of Appeals for the Ninth Circuit of the district court’s decision in In re N.C.P. Marketing Group, Inc., 337 B.R. 230 (D. Nev. 2005). For more on the Ninth Circuit case  including the Supreme Court’s interest in one of the issues in the case, take a look at these earlier posts on the blog, here, here, and here.

The Context. The dispute that led to the Seventh Circuit’s decision arose in the Chapter 11 bankruptcy case of Hartmarx Corporation (which later changed its name to "XMH"). One of its subsidiaries, Simply Blue ("Blue"), which was also in bankruptcy, sold its assets in a Section 363 sale to two buyers (the "purchasers").

  • Among Blue’s assets was an executory contract with Western Glove Works ("Western"), which Blue sought to assign to the purchasers. Western objected, arguing that the contract could not be assigned because it was a sublicense to Blue of a trademark licensed by Western. The bankruptcy court agreed with Western and XMH appealed. 
  • That’s when things got a little complicated. While XMH’s appeal was pending, Blue and the purchasers amended the contract. Under the amendment, title to the contract was left with Blue but the purchasers assumed all of Blue’s contractual duties, together with the right to receive all fees to which Blue was otherwise entitled. The bankruptcy court approved the amendment and Western appealed from that decision.
  • In the meantime, the district court reversed the bankruptcy court’s original decision holding that the contract could not be assigned, effectively allowing the original contract to be assigned. Western appealed the district court’s decision and that brought the case to the Seventh Circuit. 

The Court’s Decision. After disposing of a few jurisdictional issues springing from the complicated way the case had played out, the Seventh Circuit reached the merits. The Court first looked to Section 365(c)(1) of the Bankruptcy Code, which limits assignment of an executory contract if "applicable law" permits the non-debtor party to the contract to refuse to accept performance from an assignee, regardless of whether the contract prohibits or restricts assignment. In the XMH Corp. case, the contract did not prohibit or restrict assignment (but neither did it permit it). Western argued that "applicable law" was trademark law because the contract stated that Western was a licensee of a trademark for "Jag Jeans." The Court noted that "Jag" is a federally registered trademark, although "Jag Jeans" is not.

The Court held that if the contract included a trademark sublicense when XMH attempted to assign the contract, it was not assignable. This was true regardless of whether federal trademark law applied, any particular state’s trademark law applied, and also, apparently, even if Canadian law applied (Western is a Canadian company). The Seventh Circuit put it this way:

None of this matters, though, because as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment. Miller v. Glenn Miller Productions, Inc., 454 F.3d 975, 988 (9th Cir. 2006)(per curiam); In re N.C.P. Marketing Group, Inc., 337 B.R. 230, 235-36 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43, pp. 18-92 to 18-93 (4th ed. 2010).

After describing how consumers rely on a trademark as an indicator of a good’s quality, the Court explained that if a trademark owner (or licensee sublicensing the mark) allows another company to produce the trademarked goods, it

will not want the licensee to be allowed to assign the license (that is, sublicense the trademark) without the owner’s consent, because while the owner will have picked his licensee because of confidence that he will not degrade the quality of the trademarked product he can have no similar assurance with respect to some unknown future sublicensee.

Because this is the normal reaction of a trademark owner, it makes sense to make the rule that a trademark license is not assignable without the owner’s express permission a rule of contract law–what is called a ‘default’ rule because it is the rule if the parties do not provide otherwise (as they are allowed to do).

Ultimately, the Seventh Circuit held that although the contract included a trademark sublicense, the sublicense had expired and the parties had not designated the contract, post-expiration, as a trademark sublicense. Further, the Court held that the balance of the contract was only a service agreement and not an implied trademark license. The Court also refused to go down the "dark path" of whether a contract could be a trademark license for some purposes but not others. As such, with no actual trademark sublicense in existence at the time of assignment, the default rule discussed above did not apply and the executory contract could be assigned. The Seventh Circuit affirmed the lower courts’ decisions approving the assignment of the contract as amended.

An IP Attorney’s Observations. For the perspective of an in-house intellectual property attorney on the Seventh Circuit’s decision, including helpful links to the trademark and the parties’ underlying agreements, you may find Pamela Chestek’s discussion of the case on her "Property, intangible" blog, interesting reading.

Good News For Trademark Owners. With the Seventh Circuit’s XMH Corp. decision, we now have two Courts of Appeals (the Seventh and Ninth Circuits) on record holding that trademark licenses are not assignable in bankruptcy absent the consent of the trademark owner or sublicensor. While the full force of a decision depends on whether other courts follow its holding, trademark owners will likely find the guidance provided by this decision meaningful, especially given the Seventh Circuit’s observation that the non-assignability of trademark licenses is "the universal rule." That said, how the decision is viewed in other circuits, particularly in Delaware and New York where many large Chapter 11 cases are filed, remains to be seen, so stay tuned. 

Business Bankruptcy Issues Recent Developments

Third Circuit Decision Suggests Another Way For Trademark Licensees To Protect Against License Rejection In Bankruptcy

Trademark licensees have long faced the serious risk of losing all license rights to a trademark if the licensor files bankruptcy and rejects the trademark license as an executory contract. However, a recent decision from the U.S. Court of Appeals for the Third Circuit in the In re: Exide Technologies case may give some trademark licensees new hope of retaining their license rights even in bankruptcy.

Limited protection of Section 365(n). It can be devastating for a licensee to lose access to licensed intellectual property. Often a licensee will build in licensed technology into its products or develop an entire business line or brand around a licensed trademark.  Recognizing how important in-licensed IP can be, in 1988 Congress added Section 365(n) of the Bankruptcy Code, giving licensees of certain types of intellectual property special protections in bankruptcy. These protections allow licensees to retain their rights to the licensed intellectual property – but there’s a catch. The Bankruptcy Code’s definition of “intellectual property” includes, among other things, patents, patent applications, copyrights, and trade secrets, but unfortunately for trademark licensees, it does not include trademarks. Follow the link in this sentence for more on Section 365(n)’s licensee protections other than in the trademark area.

Trademark licensee’s special risk. With no special protection, the trademark licensee faces the risk of having its license, usually considered to be an executory contract, rejected by the trademark owner in bankruptcy. If the trademark owner decides that the license is now unfavorable and a better deal can be had under a new license agreement with someone else, the trademark owner likely will reject the existing trademark license agreement and, generally, terminate the licensee’s rights to use the mark. The enforceability of phase-out provisions, which allow a licensee to continue to use a mark for a limited time period after a license is terminated, is unclear. Regardless, most courts hold that the trademark licensee eventually will lose its rights to the trademark following rejection. In some cases the ability to re-license can be of great value to a trademark owner in bankruptcy, and thus to its creditors, but it puts the licensee at substantial risk. For more on this topic, you may find this earlier blog post on the trademark licensee’s predicament of interest.

The Third Circuit’s Exide Decision. In a June 1, 2010 decision in In re: Exide Technologies (a copy of the decision is available by clicking on the preceding link), the Third Circuit examined a series of agreements, determined to constitute one integrated agreement, pursuant to which Exide Technologies sold an industrial battery business, and licensed certain trademark rights, to EnerSys. When Exide filed Chapter 11 bankruptcy in 2002, it sought to reject the agreement as an executory contract. The bankruptcy court granted Exide’s motion to reject the agreement, and that decision was affirmed by the district court. On appeal to the Third Circuit, that court held that under New York law, which governed the agreement, once a party has substantially performed, a later breach by that party does not excuse performance. The Third Circuit further held that EnerSys had substantially performed the agreement in the more than ten years since it was signed, rendering the agreement no longer an executory contract. 

  • The Third Circuit held that EnerSys had substantially performed by paying the full purchase price and operating under the agreement for ten years, as well as assuming certain liabilities related to the business EnerSys purchased when it obtained the trademark license.
  • The Court of Appeals also held that EnerSys’s obligation not to use the trademark outside of the licensed business was not a material obligation because it was a condition subsequent and, in any event, did not relate to the agreement’s purpose — the transfer of the industrial battery business in return for a $135 million payment.
  • Likewise, the Third Circuit concluded that a quality standards provision was minor because it related only to the standards of the mark for each battery produced and not to the transfer of industrial battery business that was the agreement’s purpose.
  • In addition, an indemnity obligation that had subsequently expired, and a further assurances obligation where no remaining required cooperation was identified, were held not to outweigh the factors supporting a finding of substantial performance.

A Concurring Opinion On The Effect Of Rejection. Judge Ambro wrote a concurring opinion to address the bankruptcy court’s conclusion that rejection of a trademark license left EnerSys without the right to use the Exide mark. In his concurrence, Judge Ambro analyzed the history of Section 365(n), disagreed that the exclusion of trademarks from its reach created a negative inference that rejection of a trademark license should be tantamount to termination, and stated that courts should be able to prevent the extinguishment of all rights upon rejection. As Judge Ambro wrote in his conclusion:

Courts may use § 365 to free a bankrupt trademark licensor from burdensome duties that hinder its reorganization. They should not—as occurred in this case—use it to let a licensor take back trademark rights it bargained away. This makes bankruptcy more a sword than a shield, putting debtor-licensors in a catbird seat they often do not deserve.

It will be interesting to see whether other courts follow Judge Ambro’s views or continue to hold that trademark licensees whose licenses have been rejected no longer retain any rights to use the trademarks at issue.

A New Argument For Trademark Licensees? For trademark licensees looking to preserve their rights in the face of a motion to reject a trademark license, the Exide Technologies decision may provide some additional support.

  • However, before breathing a sigh of relief, trademark licensees should remember that the decision involved a series of agreements that had been largely performed over the decade since they were signed. In many ways, the trademark licensee was just a part of what the Third Circuit found was, chiefly, an agreement to sell a business division. In essence, although the trademark itself was not sold, the trademark license rights went along with the business. 
  • Typically, trademark licenses more often arise not in connection with a sale of a business but as a separate, often stand-alone, license of certain trademarks for commercial exploitation by the licensee. In that context, it may be far more difficult to establish that the agreement has been substantially performed such that it is no longer an executory contract.

Still, for those situations in which the argument is available, the Third Circuit’s decision in Exide Technologies underscores that all trademark licenses are not executory contracts and, at least in some cases, the trademark licensee might just get to keep the license rights after all, even in the face of a rejection motion in bankruptcy. 

Business Bankruptcy Issues Recent Developments

When Worlds Collide: Do Section 365(n) IP Licensee Rights Work In A Chapter 15 Cross-Border Bankruptcy?

Section 365(n) And Licensee Rights. I have discussed in the past how Section 365(n) was added to the Bankruptcy Code to protect licensees of intellectual property in the event the licensor files bankruptcy.

  • Under Section 365(n), if the debtor or trustee rejects a license, a licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payment.
  • The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements.
  • Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.
  • To read more about Section 365(n)’s benefits and protections, follow the link in this sentence.

Limits Of Section 365(n). These protections, however, have their limits. One limitation comes from the fact that the Bankruptcy Code’s special definition of "intellectual property" excludes trademarks from the scope of Section 365(n)’s protections. Another major limitation is that since Section 365(n) is a U.S. Bankruptcy Code provision, it only applies in a U.S. bankruptcy case.

What Happens To Section 365(n) In Chapter 15 Cases? One issue that was less clear was what would happen if a foreign licensor were the subject of a case under Chapter 15 of the U.S. Bankruptcy Code. Would Section 365(n) apply to protect licensees in a Chapter 15 proceeding?

  • Chapter 15 allows an entity’s foreign representative to obtain U.S. bankruptcy protection for assets and interests in the United States. It was was added to the Bankruptcy Code a few years ago to implement certain cross-border insolvency procedures when corporations had assets and interests in more than one country. To read more on Chapter 15 bankruptcy, follow the link in this sentence. 
  • Section 365(n) and Chapter 15 recently collided in the Chapter 15 case of Qimonda AG, and led to a decision by Judge Robert G. Mayer of the United States Bankruptcy Court for the Eastern District of Virginia on that very issue. 
  • The Bankruptcy Court’s decision, discussed below, is available by following the link in this sentence.

The Qimonda Chapter 15 Case. In the Qimonda AG Chapter 15 case, the Bankruptcy Court had previously recognized the pending German insolvency proceeding as a "foreign main proceeding" under Chapter 15 of the U.S. Bankruptcy Code. As part of the Chapter 15 proceeding, the Bankruptcy Court had entered a supplemental order providing, among other things, that Section 365 of the U.S. Bankruptcy Code would apply to the Chapter 15 case.

U.S. Licensees Invoke Section 365(n). Following the Bankruptcy Court’s supplemental order, certain U.S. licensees asserted Section 365(n) rights in an attempt to retain their rights to intellectual property that Qimonda AG had licensed them.

The Bankruptcy Court’s Decision. After considering the motion and opposition, Judge Mayer issued a decision agreeing with Qimonda AG’s foreign representative and he modified the prior supplemental order to exclude the effect of Section 365(n) by providing that it would apply only if the foreign representative "rejects an executory contract pursuant to Section 365 (rather than simply exercising the rights granted to the Foreign Representative pursuant to the German Insolvency Code)." In reaching this decision, the Bankruptcy Court considered the effect of its recognition of the German insolvency proceeding given the purpose of Chapter 15:

The principal idea behind chapter 15 is that the bankruptcy proceeding be governed in accordance with the bankruptcy laws of the nation in which the main case is pending. In this case, that would be the German Insolvency Code. Ancillary proceedings such as the chapter 15 proceeding pending in this court should supplement, but not supplant, the German proceeding.

That objective is particularly relevant in this case where there are many international patents.  The patents themselves are issued under the laws of various nations. While there may be multiple international patents, the multiple international patents protect the same idea, process or invention in the country that issued the patent. If the patents and patent licenses are dealt with in accordance with the bankruptcy laws of the various nations in which the licensees or licensors may be located or operating, there will be many inconsistent results. In fact, the same idea, process or invention may be dealt with differently depending on which country the particular ancillary proceeding is brought. Rather than having a coherent resolution to Qimonda’s patent portfolio, the portfolio may be shattered into many pieces that can never be reconstructed. In this case, Qimonda licensed its patents to companies that are operating in various nations. It is clear that the patent rights are not being exploited solely, and even possibly principally, in the United States. In fact, they are being utilized throughout the world. If the laws of the various nations in which the patents are being used would be applicable, there will be many different treatments of the patents that have been licensed by Qimonda AG and many different and inconsistent results throughout the world. This is detrimental to a systematic bankruptcy proceeding and detrimental to the resolution of the German bankruptcy proceeding itself. It diminishes the value of these assets. It results in an inefficient insolvency administration. It may well be detrimental to parties who are or wish to license the patents. It is not difficult to envision that if the patent portfolio is splintered without overall administration or control, some parties may be left with incomplete patent protection. Holding an American patent without holding a patent enforceable in the Europe may significantly restrict its use and utility. This is at odds with the Congressionally stated purposes in §1501.

                                          *       *        *

All the patents should be treated the same. There should not be disparate results simply because of the location of a factory or research facility or corporate office. This would be the result if the supplemental order were left in place. It is clear that the inclusion of §365 in the supplemental order was improvident. It had unintended consequences that significantly and adversely affect the main proceeding in Germany.

Conclusion. The Qimonda AG decision underscores that although Section 365(n) of the Bankruptcy Code offers significant protection to licensees, its benefits frequently stop at the water’s edge. When the licensor is based outside of the United States, Section 365(n) will be of little help, even if the license covers U.S. issued patents and the foreign licensor obtains protection for its U.S. assets and interests under Chapter 15 of the Bankruptcy Code. Licensees must continue to keep the limits of Section 365(n) in mind when negotiating licenses of intellectual property from foreign licensors.

Business Bankruptcy Issues

Protecting IP Rights From A Licensor’s Bankruptcy: What You Need To Know About Section 365(n)

Many companies rely on in-bound licenses of intellectual property, especially those involving patents or trade secrets, and spend millions of dollars on research, development, and ultimately commercialization of drugs or products incorporating the licensed IP. With so much at stake, licensees frequently ask a critical question: Can our license rights be terminated if the licensor files bankruptcy?

Assumption Or Rejection. A license is typically held to be an executory contract. This means that a licensor in bankruptcy (or its bankruptcy trustee) has the option of assuming or rejecting the license. Generally, a debtor licensor can assume a license if it meets the same tests (cures defaults and provides adequate assurance of future performance) required to assume other executory contracts.  Most licensees will not object to the assumption of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is whether they risk losing their rights to the licensed IP if the license is rejected.

Bankruptcy Code Section 365(n). To address this concern, in 1988 Congress added Section 365(n) to the Bankruptcy Code to give licensees special protections.  If the debtor or trustee rejects a license, under Section 365(n) a licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payment. The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements.  Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.

Some Important Limitations. If the license is rejected, however, the licensor will no longer have to perform under the license. This means the licensor will not have to update or continue to develop the IP, and will not have to make available any updates later developed. In addition, Section 365(n) only applies in a U.S. bankruptcy case. It generally will not be of any help in a bankruptcy or insolvency of a non-U.S. licensor under applicable foreign law.

No Protection For Trademark Licensees. Many people expect intellectual property to include trademarks, but when Section 365(n) was enacted a special, limited definition of "intellectual property" was also added to the Bankruptcy Code. The bankruptcy definition includes trade secrets, U.S. patents and patent applications (less clear as to foreign patents), copyrights, and mask works, but it does not include trademarks. This distinction means that a trademark licensee enjoys none of Section 365(n)’s special protections and is at risk of losing its trademark license rights if the licensor files bankruptcy. For more on the special bankruptcy risk facing trademark licensees, follow the link in this sentence.

Getting The Most Out Of Section 365(n). Although Section 365(n) gives licensees significant comfort within limits, there are a number of approaches a licensee can take to maximize the statute’s benefits while avoiding its pitfalls. Here are a few to consider:

  • Make sure you actually have a granted license. Section 365(n) only applies to actual license rights as they existed at the time the bankruptcy case was commenced. This means that an agreement by the licensor to grant a license to IP at some later date, including a springing license grant on a bankruptcy filing, will likely be unenforceable if a bankruptcy is filed. Get a present grant of a license to any important IP or risk not having a license to it at all.
  • Consider a technology escrow. Licensees sometimes forget that Section 365(n) is not self-executing. This means that Section 365(n) doesn’t require the licensor to deliver the embodiment of the licensed intellectual property to the licensee unless the license or an agreement supplementary to the license expressly provides for such a right. One solution is to include this delivery provision in the license itself. Another common approach is to establish a technology (often a source code) escrow into which the embodiment and updated versions of the embodiment are in fact deposited, to be released to the licensee on specified conditions.
  • Refer to Section 365(n) in the license. Section 365(n) applies to licenses of bankruptcy-defined intellectual property whether it is mentioned in the license or not. That said, including an express reference that the license involves such IP, as the old saying goes, "wouldn’t hurt." A provision in the license that the agreement involves IP covered by Section 365(n), although not binding on the bankruptcy court, may be helpful in persuading a bankruptcy trustee — or the bankruptcy judge — that the IP involved is indeed subject to Section 365(n)’s protections.
  • Save the election until later. If you do include a Section 365(n) reference in the license, it’s usually better to state that no Section 365(n) election is then being made. Things change, and there is always a chance that the IP will turn out to be less important in future years, meaning you might elect to treat a rejected license as terminated.
  • Get bankruptcy advice before you sign the license. As the points above illustrate, even with Section 365(n), protecting your IP license can be tricky if a bankruptcy is later filed. Be sure to seek advice from bankruptcy counsel knowledgeable about IP licenses when the license is being drafted, not just after the licensor gets in financial trouble.

Conclusion. Section 365(n) of the Bankruptcy Code can provide valuable protections for licensees of intellectual property, but those protections have their limitations. Taking steps to maximize your rights when the license is being drafted can make a big difference if the licensor later files bankruptcy.

Business Bankruptcy Issues Recent Developments

U.S. Supreme Court Shows Interest In Deciding Whether The Hypothetical Test Or The Actual Test Should Be Used To Determine If IP Licenses Can Be Assumed In Bankruptcy

It looks like the U.S. Supreme Court, or at least two of the Justices, is interested in deciding whether the "hypothetical test" or the "actual test" should be used in determining whether an intellectual property license can be assumed by a debtor in possession under Section 365(c)(1) of the Bankruptcy Code. That was the clear message from the somewhat unusual statement by Justice Kennedy, with whom Justice Breyer joined, issued on March 23, 2009, in connection with the Supreme Court’s denial of a writ of certiorari in the N.C.P. Marketing Group, Inc. case. You can read a copy of the entire statement by following the link in the prior sentence.

The N.C.P. Marketing Case. As a refresher, in 2005, the U.S. District Court for the District of Nevada issued its first of a kind decision, In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), holding that trademark licenses are personal and nonassignable in bankruptcy absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision and here, here, and here to read earlier posts on the case. Last May, the Ninth Circuit affirmed the District Court’s judgment "for the reasons provided by that court" in an order designed as "not for publication."

Assumption And Assignment. A key basis for the District Court’s decision in the N.C.P. Marketing Group case was the way the Ninth Circuit has interpreted Section 365(c)(1), specifically on the question of whether a debtor in possession can assume an intellectual property license. In bankruptcy parlance, assumption means that the debtor gets to keep the license. Usually, debtors are allowed to exercise their business judgment when deciding whether to assume or reject (read: breach and stop performing) an executory contract, as well as to assume and assign one to a third party. However, Section 365(c)(1) of the Bankruptcy Code puts a limit on a debtor’s ability to assign executory contracts, and perhaps even to assume them, when "applicable law" gives the non-debtor party to the contract the right to refuse to deal with someone else. In the N.C.P. Marketing Group decision, the District Court held that federal trademark law under the Lanham Act was such "applicable law" and rendered non-exclusive trademark licenses nonassignable.

The Key Bankruptcy Code Section. Section 365(c)(1) is so important to this debate that it bears careful review. Here’s what it says:

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if—

(1)(A) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(B) such party does not consent to such assumption or assignment.

Hypothetical Versus Actual Test. If a debtor cannot assign an IP license without consent of the licensor, can it at least assume the license? That question has led courts to examine ever so closely the first seven words of Section 365(c): "The trustee may not assume or assign…"

  • When the statute says that the trustee may not assume or assign an IP license, does the word "or" really mean "and" too?
  • Put differently, what happens when a debtor is only trying to assume (keep) an IP license and is not actually trying to assign it? Does the Bankruptcy Code language mean that it can neither assume nor assign the license or does it only mean that the debtor cannot assign the license?
  • That, in a nutshell, is the difference between the so-called "hypothetical test" (which reads Section 365(c)(1)’s language as asking whether the debtor hypothetically could assign the license even if it’s only proposing to assume it) and the "actual test" (which interprets the statute’s language as asking only what the debtor is actually proposing to do).
  • The U.S. Courts of Appeals for at least three circuits have adopted the hypothetical test. The Ninth Circuit (covering California, Nevada, Arizona, and a number of other Western states), the Third Circuit (which includes Delaware, the venue of many Chapter 11 cases), and the Fourth Circuit (covering Virginia, West Virginia, Maryland, and North and South Carolina), have held that Section 365(c)(1) gives most IP licensors a veto right over proposals by a Chapter 11 debtor to assign — and even to assume — IP licenses.
  • For a more complete discussion of these issues, take a look at this earlier post, entitled "Assumption of Intellectual Property Licenses in Bankruptcy: Are Recent Cases Tilting Toward Debtors?"

Justice Kennedy’s Statement. N.C.P. Marketing Group petitioned the U.S. Supreme Court for a writ of certiorari, seeking review of the decision denying it the ability to assume the trademark license. Although also voting to deny review, Justice Kennedy issued a three-page statement on that decision to express his view, joined in by Justice Breyer, that the Supreme Court should considering granting certiorari in a future case on the "significant question" of whether the hypothetical test or the actual test should be applied in interpreting Section 365(c)(1) of the Bankruptcy Code. Justice Kennedy summed up his analysis this way:

The division in the courts over the meaning of §365(c)(1) is an important one to resolve for Bankruptcy Courts and for businesses that seek reorganization. This petition for certiorari, however, is not the most suitable case for our resolution of the conflict. Addressing the issue here might first require us to resolve issues that may turn on the correct interpretation of antecedent questions under state law and trademark-protection principles. For those and other reasons, I reluctantly agree with the Court’s decision to deny certiorari. In a different case the Court should consider granting certiorari on this significant question.

Justice Kennedy’s discussion of the two tests suggests that he (and perhaps Justice Breyer) may be leaning toward the actual test. Although noting that the actual test "may present problems of its own," including that it aligns Section 365 "with sound bankruptcy policy only at the cost of departing from at least one interpretation of the plain text of the law," Justice Kennedy aimed most of his criticism in the statement at the hypothetical test.

  • Specifically, Justice Kennedy commented that one "arguable criticism of the hypothetical approach is that it purchases fidelity to the Bankruptcy Code’s text by sacrificing sound bankruptcy policy." He stated that the hypothetical test "may prevent debtors-in-possession from continuing to exercise their rights under nonassignable contracts, such as patent and copyright licenses." Continuing, he noted that without these licenses, "some debtors-in-possession may be unable to effect the successful reorganization that Chapter 11 was designed to promote."
  • He also remarked on what he perceived as a "windfall" to nondebtor parties to valuable executory contracts. While outside of bankruptcy the nondebtor cannot renege on its agreement, if the debtor files bankruptcy "then the nondebtor obtains the power to reclaim–and resell at the prevailing, potentially higher market rate–the rights it sold to the debtor." Although most non-exclusive licenses are not treated as a sale of intellectual property, Justice Kennedy appears to view the potential loss of IP license rights due to a bankruptcy filing as an unfair result.

Conclusion. In denying review in the N.C.P. Marketing Group case, the Supreme Court has let stand the decision of the courts below that, where the hypothetical test applies as it does in the Ninth Circuit, a non-exclusive trademark license cannot be assumed by a debtor in possession. However, given the detailed statement issued by Justice Kennedy, and joined in by Justice Breyer, it appears that the chances of the Supreme Court granting certiorari in a future IP license assumption case have increased. If such a case reaches the Supreme Court, the current split in the circuits on this important intersection between bankruptcy and intellectual property law may finally be resolved.

Business Bankruptcy Issues Recent Developments

Ninth Circuit Rules In N.C.P. Marketing Trademark License Case

Back in March I gave an update on In re: N.C.P. Marketing Group, Inc., a case addressing whether a debtor can assume a trademark license over the trademark owner’s objection. In 2005, the U.S. District Court for the District of Nevada issued its first of a kind decision, In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), holding that trademark licenses are personal and nonassignable in bankruptcy absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision and here and here to read earlier posts on the case. 

The N.C.P. Marketing Court’s Analysis. In reaching its conclusion, the District Court held that under the Lanham Act, the federal trademark statute, a trademark owner has a right and duty to control the quality of goods sold under the mark:

Because the owner of the trademark has an interest in the party to whom the trademark is assigned so that it can maintain the good will, quality, and value of its products and thereby its trademark, trademark rights are personal to the assignee and not freely assignable to a third party. 

The trademark owner in that case, Billy Blanks of theBilly Blanks® Tae Bo® fitness program, successfully moved the court to compel rejection of the trademark license because under the "hypothetical test" analysis of Section 365(c)(1) of the Bankruptcy Code adopted by the U.S. Court of Appeals for the Ninth Circuit, contracts that cannot be assigned by the debtor without the nondebtor party’s consent cannot be assumed by the debtor either. (For a full discussion of these issues, take a look at this earlier post entitled "Assumption of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?")  

The Ninth Circuit Appeal. N.C.P. Marketing appealed the decision to the Ninth Circuit, the appeal was fully briefed, and oral argument had been scheduled for November 5, 2007.

  • Prior to the oral argument, the Chapter 7 trustee for N.C.P. Marketing reached a settlement in the case. At the trustee’s request, the Ninth Circuit took the oral argument off calendar and directed the parties to move to dismiss the appeal if the settlement was approved by the Bankruptcy Court.
  • However, instead of approving the settlement the Bankruptcy Court authorized a sale of the appeal rights to certain objecting parties, who then restarted the appeal before the Ninth Circuit and requested an oral argument.

The Ninth Circuit Affirms The District Court’s Decision. In an unpublished order dated May 23, 2008, the Ninth Circuit denied the request for oral argument and affirmed the District Court’s judgment "for the reasons provided by that court." The appellants’ request for a panel rehearing or rehearing en banc was denied by order dated July 9, 2008. The Ninth Circuit designated the May 23, 2008 order affirming the District Court as "not for publication," meaning it is not precedent under the Federal Rules of Appellate Procedure and the Ninth Circuit’s Circuit Rules. Nevertheless, the order may be cited in other cases.

A Final Thought. Precedent or not, the Ninth Circuit’s order has affirmed the District Court’s decision on this important issue. Trademark owners now have a stronger argument in the Ninth Circuit (and also in the Southern District of Florida given the In re Wellington Vision, Inc. decision last year), that non-exclusive trademark licenses may not be assigned, or even assumed, in bankruptcy cases absent consent of the trademark owner.

Business Bankruptcy Issues Recent Developments

Trademark Licenses In Bankruptcy: New Developments In The N.C.P. Marketing Case

Last November I reported on the status of the Ninth Circuit appeal in In re: N.C.P. Marketing Group, Inc., a case addressing whether a debtor can assume a trademark license over the trademark owner’s objection. Back in 2005 the U.S. District Court for the District of Nevada issued its first of a kind decision, In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), holding that trademark licenses are personal and nonassignable in bankruptcy absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision and here to read an earlier post on the case.

The N.C.P. Marketing Court’s Analysis. In reaching its conclusion, the District Court held that under the Lanham Act, the federal trademark statute, a trademark owner has a right and duty to control the quality of goods sold under the mark:

Because the owner of the trademark has an interest in the party to whom the trademark is assigned so that it can maintain the good will, quality, and value of its products and thereby its trademark, trademark rights are personal to the assignee and not freely assignable to a third party.  

The trademark owner in that case, Billy Blanks of the Billy Blanks® Tae Bo® fitness program, successfully moved the court to compel rejection of the trademark license because under the "hypothetical test" analysis of Section 365(c)(1) of the Bankruptcy Code adopted by the U.S. Court of Appeals for the Ninth Circuit, contracts that cannot be assigned by the debtor without the nondebtor party’s consent cannot be assumed by the debtor either. (For a full discussion of these issues, take a look at this earlier post entitled "Assumption of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?")  

The Ninth Circuit Appeal. N.C.P. Marketing appealed the decision to the Ninth Circuit, the appeal was fully briefed, and oral argument had been scheduled for November 5, 2007. Prior to the oral argument, the Chapter 7 trustee for N.C.P. Marketing reached a settlement in the case. At the trustee’s request, the Ninth Circuit took the oral argument off calendar and directed the parties to move to dismiss the appeal if the settlement was approved by the Bankruptcy Court. At the time, I commented that it appeared that no Ninth Circuit decision would be issued in the case due to the settlement.

The Settlement Is Rejected. Back in the Bankruptcy Court, the Chapter 7 trustee filed a motion for approval of the settlement, but N.C.P. Marketing and certain other parties filed an objection and offered a competing bid for the appeal rights. In something of a surprise, on February 28, 2008, the Bankruptcy Court issued a brief order denying the trustee’s motion for approval of the settlement and instead approved a sale of the appeal rights and certain other assets to the objecting parties. The objecting parties thereafter posted the undertaking required by the Bankruptcy Court’s order.

Appeal May Go Forward. As a result, the Ninth Circuit appeal may be revived, although no new oral argument has been scheduled yet. Barring further developments, trademark licensors and licensees may end up seeing a Ninth Circuit decision after all on the important issue of whether trademark licenses can be assumed in bankruptcy. Stay tuned.