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Business Bankruptcy Issues Recent Developments

ABI’s Industry Viewpoint Interview: Intellectual Property And Bankruptcy

 

I recently had the honor of talking with the American Bankruptcy Institute’s Editor-at-Large Bill Rochelle about the intersection of intellectual property and bankruptcy, as part of ABI’s Industry Viewpoints video series.

Bill and I discussed issues ranging from the U.S. Supreme Court’s Tempnology decision involving trademark licenses, to Section 365(n) of the Bankruptcy Code, to the very different issues posed when a licensee files bankruptcy and wants to assume or assign an inbound IP license.

You can watch the video by following this YouTube link. I hope you enjoy it.

Photo courtesy of the American Bankruptcy Institute

Business Bankruptcy Issues Recent Developments

Throwing Shade At Sunbeam: Following Lubrizol And Not The Seventh Circuit, The First Circuit Leaves Another Trademark Licensee Rejected And Out Of Luck

The Tempnology Trademark Saga. When it comes to decisions on bankruptcy and trademark licenses, the In re Tempnology LLC bankruptcy case is the gift that keeps on giving.

  • The Original. It all started in November 2015. Following Tempnology’s rejection of an agreement containing a trademark licensee, the New Hampshire Bankruptcy Court ruled that the licensee could no longer use the licensed trademarks.
  • The Sequel. Then, in November 2016, the First Circuit Bankruptcy Appellate Panel (“BAP”) became the first appellate court to follow the Seventh Circuit’s 2012 decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 382 (7th Cir. 2012) on the effect of rejection of a trademark license — namely, that rejection did not terminate the licensee’s rights to use the trademarks.
    • In Sunbeam, the Seventh Circuit had expressly rejected the Lubrizol decision and its analysis of the effects of rejection (follow the link for a full discussion of the Sunbeam decision).
    • The Sunbeam court held that rejection is a breach by the debtor and does not terminate the agreement or “vaporize” the rights of the non-breaching party. Critically, the Seventh Circuit allowed the non-debtor trademark licensee to continue using the licensed trademarks despite the debtor’s rejection of the trademark license.
    • The BAP’s decision to follow Sunbeam raised the prospect that other courts might follow suit and start a trend away from Lubrizol.
  • The Final Installment. Fast forward to January 12, 2018 when, on appeal from the BAP, the U.S. Court of Appeals for the First Circuit issued a 2-1 decision, reversing the BAP and affirming the Bankruptcy Court’s decision. Follow this link for a copy of the First Circuit’s full 34 page majority opinion and 7 page concurring and dissenting opinion.
  • Keep reading for the juicy details but, to cut to the chase, the First Circuit unequivocally sided with Lubrizol on the impact of rejection, deepening the circuit split created by the Seventh Circuit’s Sunbeam decision.

Before turning to the First Circuit’s decision, let’s set the stage with a brief review of the underlying facts, a few more highlights from the Bankruptcy Court’s original decision, and the BAP’s subsequent take on these important issues.

The Bankruptcy Court’s Decision. In November 2015, the New Hampshire Bankruptcy Court issued a decision involving the effects of rejection by the debtor, Tempnology LLC, of a Co-Marketing and Distribution Agreement (“Agreement”). In re Tempnology, LLC, 541 B.R. 1 (Bankr. D.N.H. 2015). In the Agreement, Tempnology had granted Mission Product Holdings, Inc. (“Mission”) (1) a non-exclusive license to certain of Tempnology’s copyrights, patents, and trade secrets, (2) an exclusive right to distribute certain cooling material products that Tempnology manufactured, and (3) an associated trademark license. With one of its first motions in the bankruptcy case, Tempnology rejected the Agreement.

  • The Bankruptcy Court held that the non-exclusive license to Tempnology’s copyright, patent, and trade secret rights was a license of “intellectual property” as defined in Section 101(35A) of the Bankruptcy Code, and that Mission’s right to continue to use that IP was protected under Section 365(n). However, the Bankruptcy Court held that Mission’s exclusive distribution rights were not “intellectual property” under Section 101(35A) and were not protected under Section 365(n).
  • The Bankruptcy Court also held that because trademarks were not included in Section 101(35A)’s definition of intellectual property, Mission’s trademark license rights were not protected by Section 365(n).
  • On the impact of rejection, the Bankruptcy Court followed the Lubrizol decision and held that the rejection of the Agreement meant that Mission lost both the exclusive distribution rights and the trademark license rights.
  • The details on the Bankruptcy Court’s decision are at this prior post, entitled “A Reminder Of The Limits Of Section 365(n)’s Licensee Protection.”

The Bankruptcy Appellate Panel Decision. Mission appealed the Bankruptcy Court’s decision to the BAP. On November 18, 2016, the BAP issued a decision affirming in part and reversing in part the Bankruptcy Court’s decision. In re Tempnology LLC, 559 B.R. 809 (1st Cir. BAP 2016).

  • The BAP affirmed the Bankruptcy Court’s holding that the exclusive distribution rights in the Agreement were not intellectual property as defined in the Bankruptcy Code and were not protected by Section 365(n).
  • The BAP also agreed that Section 365(n) did not protect Mission’s rights as a trademark licensee, ruling that the Bankruptcy Court had correctly held that Section 101(35A)’s definition of “intellectual property” excludes trademarks.
  • On the trademark point, Mission urged the BAP to follow the equitable approach that Judge Ambro suggested in his concurring opinion in the Third Circuit’s decision in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010). That would let bankruptcy courts fashion equitable protections for rejected trademark licensees.
  • The BAP declined to follow either that approach or the one taken by the New Jersey Bankruptcy Court in In re Crumbs Bake Shop, 522 B.R. 766 (Bankr. D.N.J. 2014), which had effectively applied Section 365(n) to trademarks. (For more on the Crumbs Bake Shop and Exide Techs. decisions, take a look at this earlier post.)
  • The BAP then considered the Seventh Circuit’s Sunbeam decision and, in a major shift, followed its analysis on the effect of rejection on a trademark license agreement. It thus held that Mission could continue to use the licensed trademarks.
  • For more information on the BAP decision, you can read this prior post, entitled “A Beam Of Sun For Trademark Licensees: Another Appellate Court Holds Rejection Does Not Terminate A Trademark Licensee’s Rights.”

The Main Event: The First Circuit’s Decision. With the background covered, let’s dig into the First Circuit’s decision. The BAP made Sunbeam front and center, so a big question was whether the First Circuit would follow Sunbeam and affirm the BAP’s decision, follow Lubrizol and affirm the Bankruptcy Court’s decision, or perhaps go with the equitable approach discussed by Judge Ambro.

A Notable Section 365(n) Analysis. Before turning to Sunbeam, the First Circuit started with a fairly extensive Section 365(n) analysis, worth examining given how few circuit court decisions address Section 365(n) at all.

  • The Court first agreed with the BAP and the Bankruptcy Court that neither the exclusive distribution rights nor the trademarks are “intellectual property” under Section 101(35A) and therefore neither has Section 365(n) protections.
  • The First Circuit likewise concluded that the exclusivity rights protected by Section 365(n) are limited to IP license rights only and do not extend to distribution rights.
  • The Court also held that a licensee’s right to the “embodiment of such intellectual property” in Section 365(n)(1)(b) is a limited concept (and a term of art) that does not extend to all the goods Mission sought to distribute:

A few common themes appear in these explanations. First, the pre-petition agreement must give the licensee access to the embodiment of intellectual property. Second, an embodiment of intellectual property is a tangible or physical object that exists pre-petition. Third, an embodiment of intellectual property is something inherently limited in number — it is a prototype or example of a product, but does not include all products produced using the intellectual property. Finally, we can infer that the purpose of this provision is to allow the licensee to exploit its right to the underlying intellectual property.

The Negative Covenant Issue. The First Circuit dismissed Mission’s arguments that the case implicated the enforceability of all negative covenants. The Court commented that the Bankruptcy Code might protect from rejection some negative covenants such as confidentiality, but only if they do not materially restrict the debtor’s reorganization, are closely tied to the IP license, and are necessary to implement the terms of the IP license.

The Equitable Treatment Discussion. After agreeing with the BAP (and also Sunbeam) that Sections 101(35A) and 365(n) do not protect trademark licensees, the Court held that courts could not use equitable considerations to protect trademark licensees.

  • The majority opinion rejected the dissent’s contrary view, which was based on Congress’s decision to defer action on trademark licenses in Section 365(n) “to allow the development of equitable treatment of this situation by bankruptcy courts,” as the Senate Report had stated.
  • The First Circuit held that when Congress intended courts to use equitable powers, it included specific language in the text of the relevant Bankruptcy Code section, and it had not done that in Section 365(n).
  • The Court also believed it would be difficult to weigh the equities, given the long-term nature of a trademark license relationship, and courts could misjudge how those burdens might play out in the future.

Taking On Sunbeam. The First Circuit’s biggest divergence from the BAP was on the issue of the effect of rejection under Section 365(g). The Court’s main rationale for following Lubrizol and not Sunbeam was its view that the Sunbeam approach would burden the debtor, as trademark owner, with monitoring and controlling the quality of the trademarked goods — duties imposed under trademark law — despite having already rejected the trademark license. It is worth reviewing the First Circuit’s analysis on this crucial point at some length:

Of course, to be precise, rejection as Congress viewed it does not “vaporize” a right. Rather, rejection converts the right into a pre-petition claim for damages. Putting that point of vocabulary to one side, and leaving open the possibility that courts may find some unwritten limitations on the full effects of section 365(a) rejection, we find trademark rights to provide a poor candidate for such dispensation. Congress’s principal aim in providing for rejection was to “release the debtor’s estate from burdensome obligations that can impede a successful reorganization.” Bildisco & Bildisco, 465 U.S. at 528. Sunbeam therefore largely rests on the unstated premise that it is possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark. See Sunbeam, 686 F.3d at 377. Judge Ambro’s concurrence in In re Exide Technologies shares that premise. See 607 F.3d at 967 (Ambro, J., concurring) (assuming that the bankruptcy court could allow the licensee to retain trademark rights even while giving the debtor “a fresh start”).

Careful examination undercuts that premise because the effective licensing of a trademark requires that the trademark owner — here Debtor, followed by any purchaser of its assets — monitor and exercise control over the quality of the goods sold to the public under cover of the trademark. See 3 J. Thomas McCarthy, McCarthy on Trademarks & Unfair Competition § 18:48 (5th ed. 2017) (“Thus, not only does the trademark owner have the right to control quality, when it licenses, it has the duty to control quality.”). Trademarks, unlike patents, are public-facing messages to consumers about the relationship between the goods and the trademark owner. They signal uniform quality and also protect a business from competitors who attempt to profit from its developed goodwill. See Societe Des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633, 636 (1st Cir. 1992). The licensor’s monitoring and control thus serve to ensure that the public is not deceived as to the nature or quality of the goods sold. Presumably, for this reason, the Agreement expressly reserves to Debtor the ability to exercise this control: The Agreement provides that Debtor “shall have the right to review and approve all uses of its Marks,” except for certain pre-approved uses. Importantly, failure to monitor and exercise this control results in a so-called “naked license,” jeopardizing the continued validity of the owner’s own trademark rights. McCarthy, supra, § 18:48; see also Eva’s Bridal Ltd. v. Halanick Enters., Inc., 639 F.3d 788, 790 (7th Cir. 2011) (“[A] naked license abandons a mark.”); Restatement (Third) of Unfair Competition § 33 (“The owner of a trademark, trade name, collective mark, or certification mark may license another to use the designation. . . . Failure of the licensor to exercise reasonable control over the use of the designation by the licensee can result in abandonment . . . .”).

The Seventh Circuit’s approach, therefore, would allow Mission to retain the use of Debtor’s trademarks in a manner that would force Debtor to choose between performing executory obligations arising from the continuance of the license or risking the permanent loss of its trademarks, thereby diminishing their value to Debtor, whether realized directly or through an asset sale. Such a restriction on Debtor’s ability to free itself from its executory obligations, even if limited to trademark licenses alone, would depart from the manner in which section 365(a) otherwise operates.

The Court also raised the specter of a slippery slope:

And the logic behind that approach (no rights of the counterparty should be “vaporized” in favor of a damages claim) would seem to invite further leakage. If trademark rights categorically survive rejection, then why not exclusive distribution rights as well? Or a right to receive advance notice before termination of performance? And so on.

The First Circuit concluded its Sunbeam analysis this way:

In sum, the approach taken by Sunbeam entirely ignores the residual enforcement burden it would impose on the debtor just as the Code otherwise allows the debtor to free itself from executory burdens. The approach also rests on a logic that invites further degradation of the debtor’s fresh start options. Our colleague’s alternative, “equitable” approach seems similarly flawed, and has the added drawback of imposing increased uncertainty and costs on the parties in bankruptcy proceedings. For these reasons, we favor the categorical approach of leaving trademark licenses unprotected from court-approved rejection, unless and until Congress should decide otherwise. See James M. Wilton & Andrew G. Devore, Trademark Licensing in the Shadow of Bankruptcy, 68 Bus. Law. 739, 771-76 (2013).

Where Does Tempnology Leave Trademark Licensees? The First Circuit’s decision is bound to cause trademark licensees to worry anew about the risks of a licensor bankruptcy, after what had seemed to be a trend toward protecting trademark licensees. Although the circuit split remains, and at least two circuit judges have written separate opinions to argue for protecting trademark licensees through a court’s equitable powers, the First Circuit’s decision is a forceful endorsement of Lubrizol and the complete termination of a licensee’s trademark rights upon rejection.

Is there any hope for trademark licensees?

  • Other circuits, notably the Second and Third Circuits where many business bankruptcy cases are filed, have yet to weigh in.
  • Congress has from time to time proposed changes to Sections 101(35A) and 365(n) that would give some Section 365(n) protection to trademark licensees, but to date all of those bills have stalled.
  • With a now more prominent circuit split, the U.S. Supreme Court might consider taking up the issue, possibly even in the Tempnology case if a certiorari petition were filed. That said, cert petitions are rarely granted so the split could remain for some time.

Conclusion. The First Circuit’s decision to follow Lubrizol and reject Sunbeam reinforces the existing circuit split. Will its extensive trademark analysis be more persuasive to subsequent courts? It will be interesting to see how other courts, especially Courts of Appeals, come down on the effects of rejection and the rights of trademark licensees. Stay tuned.

 

Image courtesy of Flickr by Blondinrikard Fröberg

Business Bankruptcy Issues Recent Developments

A Beam Of Sun For Trademark Licensees: Another Appellate Court Holds Rejection Does Not Terminate A Trademark Licensee’s Rights

The In re Tempnology LLC bankruptcy case in New Hampshire has produced yet another important decision involving trademarks and Section 365(n) of the Bankruptcy Code. This time the decision is from the United States Bankruptcy Appellate Panel for the First Circuit (“BAP”). Although the BAP’s Section 365(n) discussion is interesting, even more significant is its holding on the impact of rejection of a trademark license. The decision is also further evidence of the continuing trend of courts seeking ways to protect trademark licensees in bankruptcy.

Before we get ahead of ourselves, let’s take a quick look back at the Bankruptcy Court’s decision.

The Bankruptcy Court’s Decision. Just about a year ago the New Hampshire Bankruptcy Court issued a decision involving the effects of rejection by the debtor, Tempnology LLC, of a Co-Marketing and Distribution Agreement (“Agreement”). In re Tempnology, LLC, 541 B.R. 1 (Bankr. D.N.H. 2015). In the Agreement, Tempnology had granted Mission Product Holdings, Inc. (“Mission”) (1) a non-exclusive license to certain of Tempnology’s copyrights, patents, and trade secrets, (2) an exclusive right to distribute certain cooling material products that Tempnology manufactured, and (3) an associated trademark license. With one of its first motions in the bankruptcy case, Tempnology rejected the Agreement.

  • The Bankruptcy Court held that the non-exclusive license to Tempnology’s copyright, patent, and trade secret rights was a license of “intellectual property” as defined in Section 101(35A) of the Bankruptcy Code, and that Mission’s rights to continue to use that IP was protected under Section 365(n). However, the exclusive distribution rights were not “intellectual property” under Section 101(35A) and the Bankruptcy Court held Mission’s distribution rights were not protected under Section 365(n).
  • The Bankruptcy Court also held that because trademarks were not included in Section 101(35A)’s definition of intellectual property, Mission’s trademark license rights were not protected by Section 365(n).
  • In considering the impact of rejection, the Bankruptcy Court followed the 1985 decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). The Bankruptcy Court held that due to the rejection of the Agreement, Mission lost both the exclusive distribution rights and the trademark license rights.
  • You can get the details on the Bankruptcy Court’s decision at this prior post, entitled “A Reminder Of The Limits Of Section 365(n)’s Licensee Protection.”

Why No Mention Of The Seventh Circuit’s Sunbeam Decision? In that earlier post, I noted that given Circuit level decisions over the last few years involving trademarks and bankruptcy, it was interesting that the Bankruptcy Court’s decision did not mention the Seventh Circuit’s 2012 decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 382 (7th Cir. 2012).

  • In Sunbeam, the Seventh Circuit expressly rejected the Lubrizol decision and its analysis of the effects of rejection (follow the link for a full discussion of the Sunbeam decision). In contrast to Lubrizol, the Sunbeam court held that rejection is a breach by the debtor and does not terminate the agreement or the rights of the non-breaching party.
  • As a result, the Seventh Circuit allowed the non-debtor trademark licensee to continue using the licensed trademarks despite rejection of the trademark license.

At the time I speculated that if the Bankruptcy Court in the Tempnology case had applied the Sunbeam decision, the result might have been different.

The Bankruptcy Appellate Panel Decision. Mission appealed the Bankruptcy Court’s decision to the BAP. On November 18, 2016, the BAP issued its decision, affirming in part and reversing in part the Bankruptcy Court’s decision. Follow this link for a copy of the BAP’s November 18, 2016 decision.

  • The BAP affirmed the Bankruptcy Court’s holding that the exclusive distribution rights in the Agreement were not intellectual property as defined in the Bankruptcy Code and were not protected by Section 365(n).
  • The BAP also affirmed the Bankruptcy Court’s decision that Section 365(n) did not protect Mission’s rights as a trademark licensee, ruling that the Bankruptcy Court had corrected held that Section 101(35A)’s definition of “intellectual property” excludes trademarks.
  • On the trademark point, Mission urged the BAP to follow the equitable approach that Judge Ambro had suggested in his concurring opinion in the Third Circuit’s decision in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010), which would let bankruptcy courts fashion equitable protections for trademark licensees. The BAP declined to follow either that approach or the one taken by the New Jersey Bankruptcy Court in In re Crumbs Bake Shop, 522 B.R. 766 (Bankr. D.N.J. 2014), which had effectively applied Section 365(n) to trademarks.
  • For more on the Crumbs Bake Shop and Exide Techs. decisions, take a look at this earlier post.

The BAP Discusses, And Then Follows, Sunbeam. Had the BAP stopped there, it would have affirmed the Bankruptcy Court’s holding. The BAP, however, did not stop there. Instead, it considered the Sunbeam decision and ultimately followed its analysis on the effect of rejection on a trademark license agreement. In so doing, the BAP became the first appellate court outside the Seventh Circuit to adopt the Sunbeam decision’s rejection analysis.

The BAP turned to the Lubrizol decision first:

We must part company with the bankruptcy court, however, on the effect the Debtor’s rejection of the Agreement had on Mission’s licensee rights in the Debtor’s trademark and logo. The bankruptcy court ruled that, because the Debtor’s trademark and logo were not protected by Mission’s election under § 365(n), Mission did “not retain rights to the Debtor’s trademarks and logos post-rejection.” This conclusion endorses Lubrizol’s approach to the rejection of executory contracts, namely that rejection terminates the contract. Lubrizol, however, is not binding precedent in this circuit and, like the many others who have criticized its reasoning [footnote omitted], we do not believe it articulates correctly the consequences of rejection of an executory contract under § 365(g). We adopt Sunbeam’s interpretation of the effect of rejection of an executory contract under § 365 involving a trademark license.

The BAP went on with its analysis:

Applying Sunbeam’s rationale, we conclude that, while the Debtor’s trademark and logo were not encompassed in the categories of intellectual property entitled to special protections under § 365(n), the Debtor’s rejection of the Agreement did not vaporize Mission’s trademark rights under the Agreement. Whatever post-rejection rights Mission retained in the Debtor’s trademark and logo are governed by the terms of the Agreement and applicable non-bankruptcy law.

Thus, we conclude that the bankruptcy court did not err in ruling that Mission’s § 365(n) election failed to protect its rights under the Agreement as licensee of the Debtor’s trademark and logo, but it erred in ruling that Mission’s rights in the Debtor’s trademark and logo as set forth in the Agreement terminated upon the Debtor’s rejection of the Agreement.

Sunbeam, Now Joined By Tempnology, Raises A Number Of Questions. If followed by other courts, the Sunbeam and Tempnology decisions raise a variety of issues. These include the following:

  • Aside from the right to use the licensed trademarks, does the licensee keep other rights under the trademark license, such as exclusivity if applicable?
  • Does the licensee have rights to use the trademarks for the full term of the license agreement plus any extensions, or some shorter period?
  • If payment of royalties is required under a trademark license, must the trademark licensee continue to pay them post-rejection to use the licensed trademarks, as an IP licensee covered by Section 365(n) is required to do?
  • Can the trademark licensee instead argue that rejection is a material breach by the debtor and excuses the obligation to pay royalties?
  • Under Sunbeam and Tempnology, if rejection does not terminate trademark license rights, is the same true for intellectual property licenses other than trademarks, such as patents and copyrights, covered by Section 365(n)?
  • Is the Section 365(g) analysis of Sunbeam and Tempnology just limited to trademark license rights? Can a non-debtor party to an executory contract argue that other of its contract rights are also preserved, as long as they don’t impose affirmative performance obligations on the debtor? If so, in Tempnology, would that extend to Mission’s exclusive distribution rights?
  • Are licensees of patents, copyrights, or trade secrets, otherwise protected by Section 365(n), required to follow Section 365(n)’s statutory scheme to retain their rights, or can they rely on the analysis in Sunbeam and Tempnology as a complete alternative?
  • How will purchasers of trademarks and other assets react to the potential continued use of trademarks by licensees under rejected trademark licenses?

Conclusion. The BAP’s Tempnology decision marks the first time an appellate court other than the Seventh Circuit has applied the Sunbeam analysis to a trademark license.

  • It remains to be seen if other courts will start to follow suit or, alternatively, if the Lubrizol decision’s approach to the consequences of rejection will continue to hold sway.
  • If many courts followed the Sunbeam/Tempnology approach and rejected Lubrizol, the omission of trademarks from Section 365(n) protection could matter less than in the past. In addition, the license agreement’s provisions governing the licensee’s rights upon the licensor’s breach could become much more significant.

Given the broad implications of the Lubrizol/Sunbeam split on rejection of executory contracts, and especially on trademark licenses, be sure to stay tuned.

 

Image Courtesy of Flickr by discutant

Business Bankruptcy Issues Recent Developments

The Trend Of Protecting Trademark Licensees In Bankruptcy Continues: For The First Time A Court Extends Section 365(n) Protections To Trademark Licensees On Equitable Grounds

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If you doubted it before, you can stop now. The trend of courts finding ways to protect trademark licensees from the harsh effects of losing their trademark license rights in bankruptcy is in full swing.

The latest example comes in the Crumbs Bake Shop, Inc. Chapter 11 bankruptcy case in New Jersey. On October 31, 2014, Judge Michael B. Kaplan of the U.S. Bankruptcy Court for the District of New Jersey rejected a motion by the buyer of the assets of Crumbs to clarify, among other things, that it purchased the Crumbs trademarks free of trademark licenses previously entered into by Crumbs. In a 22-page revised decision dated November 3, 2014, Judge Kaplan identified three issues facing the court:

I. Whether trademark licensees to rejected intellectual property licenses fall under the protective scope of 11 U.S.C. § 365(n), notwithstanding that “trademarks” are not explicitly included in the Bankruptcy Code definition of “intellectual property”;

II. Whether a sale of Debtors’ assets pursuant to 11 U.S.C. § 363(b) and (f) trumps and extinguishes the rights of third party licensees under § 365(n); and

III. To the extent there are continuing obligations under the license agreements, which party is entitled to the collection of royalties generated as a result of third party licensees’ use of licensed intellectual property.

Let’s examine how the court addressed these three issues, one by one. As discussed below, the court’s Section 365(n) analysis raises the most questions.

Another Lubrizol Rejection. Before turning to the Section 365(n) question, the court first looked at the impact of rejection on an intellectual property license. The court examined the 1985 Fourth Circuit decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), which held that, upon rejection of a license agreement by a debtor-licensor, the licensee loses its rights to the intellectual property. The Crumbs bankruptcy court stated that it “is not persuaded by the decision.” It cited the Seventh Circuit’s decision in the Sunbeam Products case (which disagreed with Lubrizol‘s interpretation of the effect of rejection under Section 365(g)), and noted that it is “not alone in finding that its reasoning has been discredited.” The Crumbs court decided not to follow Lubrizol but did not adopt the Seventh Circuit’s approach to the issue. Instead, it turned to Section 365(n) and equitable considerations.

Section 365(n) And Trademarks. The court reviewed the language and legislative history of Section 365(n) of the Bankruptcy Code and its companion definition of “intellectual property” in Bankruptcy Code Section 101(35A). Looking at Third Circuit precedent, it examined Judge Ambro’s concurrence in the Third Circuit’s 2010 decision in In re Exide Technologies. The Crumbs court then considered the consequences of the congressional decision not to include trademarks in Section 101(35A)’s definition of intellectual property.

  • Like Judge Ambro in Exide Technologies, the bankruptcy court pointed to the passage in the legislative history of Sections 365(n) and 101(35A) about postponing congressional action on trademark licenses “to allow the development of equitable treatment of this situation by bankruptcy courts.”
  • The Crumbs court stated that reasoning by negative inference — and thereby to hold that Congress’s omission of trademarks from Section 101(35A)’s definition of intellectual property means that Section 365(n)’s protections do not extend to trademarks and trademark licensees lose their rights — would be improper.
  • The court concluded that “Congress intended the bankruptcy courts to exercise their equitable powers to decide, on a case by case basis, whether trademark licensees may retain the rights listed under § 365(n)” and found “it would be inequitable to strip” the trademark licensees “of their rights in the event of a rejection, as those rights had been bargained away by Debtors.”
  • The Crumbs court also commented on the passage of the Innovation Act by the House of Representatives, which if enacted would add trademarks to Section 101(35A)’s definition of intellectual property. While not dispositive, the court noted that the legislation showed that Congress was aware of the prejudice to trademark licensees that would result from the position advanced by the buyer.
  • Without explicitly holding that Section 365(n) itself applies to all trademark licenses, the Crumbs court granted the trademark licensees Section 365(n)’s protections on equitable grounds.

A Closer Look At The Court’s Section 365(n) Analysis. The Crumbs decision appears to be the first holding that Section 365(n)’s protections can be extended to trademark licensees, despite Section 101(35A)’s intentional omission of trademarks. The other courts protecting trademark licensees, including the Third and Eighth Circuits, found the trademark licenses at issue no longer executory, while the Seventh Circuit in Sunbeam Products held that rejecting a trademark license does not terminate the licensee’s IP rights. Although the Crumbs court did not expressly hold that Section 365(n) applies to trademark licenses in all cases, the court held it could invoke the specific protections of Section 365(n) (and that section’s royalty requirements) for trademark licensees on equitable grounds.

Does “Means” Mean Anything? Although the Crumbs court’s result is consistent with the recent trend, its analysis is questionable. Extending Section 365(n) rights to trademark licenses, even on an equitable basis, appears to conflict with the statute’s language. Section 101(35A), the definition of intellectual property on which Section 365(n) is based, begins with “The term ‘intellectual property’ means” and then lists six specific categories of intellectual property. As we know, trademarks, service marks, and trade names are not among them. Section 101(35A)’s use of the word “means” is significant, notwithstanding the legislative history about the development of equitable treatment, a subject on which the statute itself is silent. The bankruptcy court’s decision in Crumbs did not discuss the use of the term “means” in Section 101(35A), but that term and its significance has been construed by the U.S. Supreme Court in another context.

  • In Burgess v. United States, 128 S.Ct. 1572 (2008), citing 2A N. Singer & J. Singer, Statutes and Statutory Construction § 47:7, pp. 298-299, and nn. 2-3 (7th ed. 2007), the Supreme Court held, in the context of a criminal statute: “‘As a rule, [a] definition which declares what a term `means’ … excludes any meaning that is not stated.’ Colautti v. Franklin, 439 U.S. 379, 392-393, n. 10, 99 S.Ct. 675, 58 L.Ed.2d 596 (1979) (some internal quotation marks omitted).”
  • In footnote 3 of the Burgess decision the Court actually examined several Bankruptcy Code definitions, two of which used the term “means,” in support of its statutory construction that “means” is exclusive.
  • Although the Crumbs decision did not hold that Sections 101(35A) and 365(n) apply to trademarks in all cases, it extended Section 365(n) rights, expressly by name, to trademark licensees on equitable grounds. Given Congress’s use of the restrictive term “means” in the statutory definition, and its intentional omission of trademarks, service marks, and trade names from Section 101(35A), extending Section 365(n)’s statutory protections to trademark licensees seems to create an unnecessary conflict with the language of the statute.
  • Instead of invoking Section 365(n), the Crumbs court could have used alternatives approaches to protect the trademark licensees and avoided a conflict with Section 101(35A)’s language. It could have ruled, as Judge Ambro suggested in his Exide Technologies concurrence, that on equitable grounds rejection of a trademark license does not deprive the licensee of its rights. Likewise, it could have held, as the Seventh Circuit did in Sunbeam Products, that rejection does not terminate a counterparty’s license rights at all.

Was The Sale Free And Clear Of The Trademark Licenses? Having concluded that the protections of Section 365(n) should apply to the trademark licensees in this case, the Crumbs court addressed whether the asset sale under Sections 363(b) and (f), which included the trademarks, was “free and clear” of the licensees’ interests. The buyer argued that the licensees were given notice of the proposed “free and clear” sale but failed to object, thereby impliedly consenting to the extinguishment of their Section 365(n) rights. However, after examining the notice given in the case, the Crumbs court concluded that the licensees were not provided with adequate notice that the sale put their rights at risk.

  • The court observed how a party had to “traverse a labyrinth of cross-referenced definitions and a complicated network of corresponding paragraphs with annexed schedules” to determine what was being sold. The court admitted that it had difficulty following the “definitional maze” and observed that “there is no clear discussion as to what rights were purported to be taken away as a result of the sale,” meaning that the trademark licensees had no apparent reason to believe that an objection was needed to retain their rights under Section 365(n).
  • The court acknowledged that a proposed order was part of the Debtors’ moving papers, and “addressed that the sale was to be clear of licensees’ rights.” However, the court noted that this reference was “a mere ten words, buried within a single twenty-nine page document, which itself was affixed to a CM/ECF filing totaling one hundred twenty-nine pages.”
  • Under these circumstances — with no other express reference to the licensees, Section 365(n) rights, or the stripping of those rights — the Crumbs court held it would be inequitable to find that the licensees consented to the termination of their rights.
  • The Crumbs court also held, as a matter of statutory construction, that Section 365(n), a more specific provision, is not overcome by the broad text of Section 363(f) and its free and clear language. “Nothing in § 363(f) trumps, supersedes, or otherwise overrides the rights granted to Licensees under § 365(n).” This ruling again raises the issue whether Section 365(n) can be applied to trademark licenses in the first place.

Which Party Is Entitled To Royalties Under The License Agreements? The court also addressed whether the buyer, as the new owner of the trademarks, or the debtor, as the party to the trademark licenses that were not assigned to the buyer, was entitled to payment of ongoing royalties under those agreements. The court cited the Third Circuit’s decision in In re CellNet Data Sys., Inc., 327 F.3d. 242 (3d Cir. 2003), and its ruling that Section 365(n) links royalties to the license agreement rather than the intellectual property. The Crumbs court concluded that because the license agreements had not been assigned, the buyer did not obtain royalty rights under the licenses going forward (although it did purchase any unpaid pre-closing royalties through its acquisition of accounts receivable). However, since the Debtors no longer owned the trademarks, the court questioned how anyone other than the buyer could perform under the trademark license agreements and, accordingly, concluded that rejection likely is necessary.

Conclusion. Over the past four years, one of the most significant developments at the intersection of IP and bankruptcy law has been how courts have used factual, legal, and equitable approaches to protect trademark licensees from the harsh effects of rejection. The Crumbs case, pending in New Jersey in the Third Circuit, built on Judge Ambro’s concurring opinion in Exide Technologies and extended, on an equitable basis, the protections of Section 365(n) to trademark licensees. However, the Crumbs court seems to have gone too far in applying Section 365(n) itself to trademark licenses — despite the fact that Section 101(35A)’s definition of intellectual property does not include trademarks. Given Section 101(35A)’s use of the restrictive term “means,” the Crumbs court’s statutory interpretation, and its reliance on legislative history, is questionable. Although the Crumbs decision is further evidence of the continuing trend of courts protecting trademark licensees in bankruptcy, courts would be on stronger ground if they did so without applying Section 365(n) itself to trademark licenses.

 

Image Courtesy of Flickr by Steve Snodgrass

Business Bankruptcy Issues Recent Developments

A Closer Look At Recent Trends At The Intersection Of Intellectual Property And Bankruptcy Law

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I had the honor of being a panelist at the American Bankruptcy Institute‘s 22nd Annual Southwest Bankruptcy Conference last Friday, speaking on current developments in business bankruptcy. My part of the discussion focused on recent intellectual property and bankruptcy law trends. Among the topics I covered were:

  • the direction U.S. Courts of Appeals have been taking over the last few years in protecting trademark licensees from the harsh effects of rejection of their trademark licenses by a licensor in bankruptcy,
  • whether Section 365(n) of the Bankruptcy Code protecting (non-trademark) IP licensees applies in cross-border cases under Chapter 15 of the Bankruptcy Code, and
  • recent Congressional efforts to reform how IP is treated in bankruptcy cases.

For those who couldn’t attend the conference, you can follow the link in this sentence for a copy of the article I prepared on these topics. I hope you find it of interest.

Image Courtesy of Flickr by BusinessSarah

Business Bankruptcy Issues Recent Developments

In A Reversal, Eighth Circuit Sitting En Banc Protects Trademark Licensee Whose Licensor Went Bankrupt

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Image courtesy of  Kazuhisa Otsubo

Trademark Licenses At Risk. I have written a number of times on the blog about the impact of bankruptcy on trademark licenses, with a special focus on the risk that trademark licensees face if their licensors file bankruptcy. Trademark licensees have no protection under Section 365(n) of the Bankruptcy Code, and legislative efforts to give that protection have stalled. As a result, if a trademark license is determined to be executory and it’s rejected by the licensor or bankruptcy trustee, the licensee could find itself without any further rights to the trademark.

Some Rays Of Hope For Licensees In Third And Seventh Circuits. A series of decisions over the past few years from various U.S. Courts of Appeals has given some hope to trademark licensees. First, in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010), the Third Circuit held a trademark license that was part of a long-completed sale of assets was not executory and could not be rejected. Then in Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), the Seventh Circuit went much farther and held that rejection does not terminate the licensee’s rights to continue to use the trademark, refusing to follow the 1985 Fourth Circuit decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Follow the links in the prior sentences for more details.

At First, A Setback For Licensees In Interstate Bakeries Case. Just when the Third Circuit decision was starting to give hope to trademark licensees in asset sales, the Eighth Circuit went the other way and held that a trademark license entered into as part of an asset sale was executory and could be rejected. In In re Interstate Bakeries Corp., 690 F.3d 1069 (8th Cir. 2012), a case with facts very similar to Exide, a three-judge panel of the U.S. Court of Appeals for the Eighth Circuit examined whether an exclusive license to use brands and trademarks belonging to Interstate Brands Corporation (“IBC”), which subsequently filed for bankruptcy, was an executory contract.

  • Prior to bankruptcy, IBC entered into a $20 million asset purchase agreement and license agreement with Lewis Brothers Bakeries (“LBB”), and certain baking and business operations in the Chicago area to LBB. Following IBC’s bankruptcy, LBB sought a declaratory judgment that the license agreement was not an executory contract. The bankruptcy court and district court both found the agreement executory, with unperformed obligations on both sides.
  • Although the relevant aspects of the license agreement appeared at first blush to be nearly identical to those in Exide, the Eighth Circuit panel found the license agreement in Interstate Bakeries to be materially different. Specifically, the Eighth Circuit panel found LBB’s obligation to maintain quality standards, and IBC’s obligations of notice and forbearance with regard to the trademarks, material and unperformed. As such, it held the license agreement was executory and could be rejected.
  • The Eighth Circuit panel distinguished Exide because there, “the parties had not even contemplated or discussed any quality standards. . . . Here, it cannot be argued the parties did not contemplate any quality standards, as it is an explicit provision of the License Agreement. Moreover, the plain language of the agreement provides a breach of the quality provision would be material.”

A Rehearing And A Reversal. But the story did not end there. The panel decision was split 2 to 1, and the Eighth Circuit ultimately granted a rehearing en banc. That meant all eleven of the Eighth Circuit judges would consider the case, not just the three judges on the original panel. On June 6, 2014, the full Eighth Circuit issued an 8-3 decision holding that the license agreement was no longer executory. After concluding that intervening events had not rendered the appeal moot, the Eighth Circuit held the proper focus to be on the entire transaction, not just on the license agreement:

The essence of the agreement here was the sale of IBC’s Butternut bread and Sunbeam bread business operations in specific territories, not merely the licensing of IBC’s trademark. The agreement called for LBB to pay $20 million for IBC’s assets. The parties allocated $11.88 million for tangible assets, such as real property,machinery and equipment, computers and licensed computer software, vehicles, office equipment, and inventory. They allocated another $8.12 million toward intangible assets, including the license. IBC has transferred all of the tangible assets and inventory to LBB, executed the License Agreement, and received the full $20 million purchase price from LBB.

IBC’s remaining obligations concern only one of the assets included in the sale—the license. They involve such matters as obligations of notice and forbearance with regard to the trademarks, obligations relating to maintenance and defense of the marks, and other infringement-related obligations. When considered in the context of the entire agreement, these remaining obligations are relatively minor and do not relate to the central purpose of the agreement to sell the Butternut and Sunbeam bread operations and assets to LBB in certain territories.

Unlike the three-judge panel, the full Eighth Circuit commented on the similarity of the facts to the Exide case and found the Third Circuit’s decision persuasive:

We find useful guidance on analogous facts in the Third Circuit’s decision in In re Exide. At issue there was the $135 million sale of Exide’s industrial battery business to EnerSys, which included a trademark license agreement. 607 F.3d at 960. Along with the license, Exide sold to EnerSys physical manufacturing plants, equipment, inventory, and certain items of intellectual property. Id. The Third Circuit held that Exide’s remaining obligations, which included duties to maintain quality standards, to refrain from use of the trademark outside the industrial battery business, and to indemnify EnerSys, did not “outweigh the substantial performance rendered and benefits received by EnerSys.” Id. at 963–64. The court observed that the remaining contractual obligations did not relate to the purpose of the agreement—the sale of Exide’s industrial battery business—and that the trademark license agreement was therefore not executory. Id. at 964. For similar reasons, we conclude that the License Agreement between IBC and LBB is not executory.

In a footnote, the Eighth Circuit noted the circuit split between the Fourth Circuit’s Lubrizol decision and the Seventh Circuit’s Sunbeam decision on whether rejection of a trademark license terminates the licensee’s rights to use the trademark. However, given its holding that the license agreement was not executory, the Eighth Circuit did not need to reach the rejection issue.

The Trend Continues. The full Eighth Circuit’s decision in Interstate Bakeries is yet another ray of hope for trademark licensees. It continues the recent trend of Courts of Appeals finding ways to protect trademark licensees from the harsh result of losing all rights to use a trademark via rejection. Still, unless the Sunbeam decision is adopted broadly or Congress passes one of the bills proposing to include trademarks within Section 365(n)’s protections, trademark licensees whose licensors file bankruptcy — and especially those whose licenses were granted outside of an asset sale context — are by no means out of the woods.

Business Bankruptcy Issues Recent Developments

Patent Reform Bill, And Its Revisions To Bankruptcy Code Section 365(n), Stalls In The Senate

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Image courtesy of Matt H. Wade

In December 2013 I wrote about the Innovation Act, H.R. 3309, a bill focused on patent infringement litigation and other patent law reforms that passed the House of Representatives on a bipartisan basis. My interest in the bill was because it would make the most sweeping changes to the treatment of intellectual property licenses in bankruptcy since the 1988 enactment of Section 365(n) of the Bankruptcy Code. Follow the link in this sentence for a full discussion of the proposed law.

Proposed Changes In The House-Passed Innovation Act. To bring you up to date, here are the four major changes the Innovation Act would make to Section 365(n)’s protections for IP licensees.

  • First, it would extend Section 365(n)’s protections, including through an amendment to Section 101(35A) of the Bankruptcy Code’s definition of intellectual property, to licenses of trademarks, service marks, and trade names.
  • Second, rejection of a trademark, service mark, or trade name license would not relieve the trustee (or presumably a debtor in possession in a Chapter 11 case) of the debtor’s contractual obligations to monitor and control the quality of a licensed product or service.
  • Third, it would expand the payments that a licensee would have to continue to make to the estate, if it elected to retain its license rights, to include not only “royalty” payments but also “other” payments under the license.
  • Fourth, it would amend Section 1522 of the Bankruptcy Code to make Section 365(n) directly applicable to Chapter 15 cases, providing that if a foreign representative rejects or repudiates an IP license, the licensee would be entitled to elect to retain its IP rights under Section 365(n).

If enacted and signed by the President, the Innovation Act’s revisions would apply as of the date of enactment to pending and future cases.

After House Passage, Action On A Senate Version. After passing the House, the Innovation Act moved to the Senate and was referred to the Senate Committee on the Judiciary. Senator Patrick Leahy, the Senate Judiciary Committee Chairman, had introduced a similar bill, S. 1720, the “Patent Transparency and Improvements Act of 2013.”  As introduced, that bill would have made many of the same changes to Section 365(n) and the Bankruptcy Code definition of intellectual property (specifically, adding in coverage of trademarks as discussed above) as in the House-passed Innovation Act. The Senate bill would have also addressed the applicability of Section 365(n) in Chapter 15 cases, but by amending a different section of Chapter 15.

The Legislation Hits A Roadblock. The Senate Judiciary Committee held a hearing on S. 1720, and a number of discussions and negotiations involving companies affected by patent litigation ensued. However, those efforts reached an impasse and on May 21, 2014, Senator Leahy announced:

We have been working for almost a year with countless stakeholders on legislation to address the problem of patent trolls who are misusing the patent system. This is a real problem facing businesses in Vermont and across the country.

Unfortunately, there has been no agreement on how to combat the scourge of patent trolls on our economy without burdening the companies and universities who rely on the patent system every day to protect their inventions.  We have heard repeated concerns that the House-passed bill went beyond the scope of addressing patent trolls, and would have severe unintended consequences on legitimate patent holders who employ thousands of Americans.

I have said all along that we needed broad bipartisan support to get a bill through the Senate. Regrettably, competing companies on both sides of this issue refused to come to agreement on how to achieve that goal.

Because there is not sufficient support behind any comprehensive deal, I am taking the patent bill off the Senate Judiciary Committee agenda.  If the stakeholders are able to reach a more targeted agreement that focuses on the problem of patent trolls, there will be a path for passage this year and I will bring it immediately to the Committee.

We can all agree that patent trolls abuse the current patent system.  I hope we are able to return to this issue this year.

Conclusion. Senator Leahy’s statement makes clear that the focus of this legislation is on patent litigation reform, not bankruptcy and IP licenses. The fate of the legislation will depend on whether the interested parties can reach agreement on those patent issues. However, the stalling of the patent legislation also means the bankruptcy provisions, at least for now, will stay on hold; it seems unlikely the bankruptcy provisions would move forward in legislation separate from the overall patent reform effort. Stay tuned, but the odds now seem considerably lower that these changes to the treatment of IP licenses in bankruptcy will be enacted.