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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Ninth Circuit affirmed the District Court’s judgment "for the reasons provided by that court" in an order designed as "not for publication."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.

 

Business Bankruptcy Issues Recent Developments

Assumption Of Trademark Licenses In Bankruptcy: An Update On The N.C.P. Marketing Case

Over a year ago, I posted on a first of its kind decision in In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), in which the U.S. District Court for the District of Nevada held that trademark licenses are personal and nonassignable 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 the 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. In December 2005, the parties appealed this decision to the Ninth Circuit. The appeal was fully briefed and had been scheduled for oral argument on November 5, 2007.

  • In July 2007, however, the N.C.P. Marketing Chapter 11 case was converted to Chapter 7. 
  • On October 24, 2007, the Chapter 7 trustee asked the Ninth Circuit to reschedule the oral argument because of a pending settlement in the case.
  • In response, the Ninth Circuit took the oral argument off calendar and directed the parties to move to dismiss the appeal if the settlement is approved by the Bankruptcy Court.

Still No Court Of Appeals Decision. If the settlement is approved, no Ninth Circuit decision will be issued. Instead, this case seems to be headed to an ending similar to that in In re Wellington Vision, Inc. (see this earlier post on the Wellington Vision case for more details), perhaps the only other bankruptcy decision to date to address this trademark issue. There, conversion of the case to Chapter 7 also led to a settlement without an appellate decision. With these recent developments in the In re N.C.P. Marketing case, trademark licensors and licensees will have to wait longer still for an appeals court decision on this important issue at the intersection of trademark and bankruptcy law.

Business Bankruptcy Issues Recent Developments

Patent Law Collides With Bankruptcy: Federal Circuit Denies Bankruptcy Liquidation Trust Standing To Sue For Patent Infringement

The United States Court of Appeals for the Federal Circuit has jurisdiction over, among other areas, patent appeals, so it’s not every day that a Federal Circuit decision appears on this business bankruptcy blog. (Actually, it’s been about a year since this post discussing another Federal Circuit decision.) However, a September 19, 2007 opinion (available here) of the Federal Circuit rested largely on the intersection of patent law and the terms of a Chapter 11 plan of reorganization. Since the decision denied a trust created under the plan standing to bring the debtor’s patent infringement claims, it’s a significant one for debtors and creditors alike. After discussing the court’s decision I’ll conclude with my suggested take-away from the case.

The At Home Corporation Plan And Liquidation Trusts. The litigation arose in the At Home Corporation Chapter 11 bankruptcy case, which was filed in September 2001. As part of the confirmed plan of liquidation, a general unsecured creditor liquidation trust (called GUCLT) was created to pursue various claims for the benefit of creditors, including certain patent infringement claims against Microsoft Corporation. A separate liquidation trust (called AHLT) received ownership of the At Home patent at issue in the litigation, among other assets. GUCLT was not granted a license to the patent.

The Patent Litigation And Federal Circuit Decision. The patent litigation reached the Federal Circuit in 2006. Although the plan and related documents granted GUCLT the express right to pursue the patent litigation claims at issue, the Federal Circuit found that to be insufficient to confer standing. It held that the patent statutes provide protection to the party with a right to exclude, not the party with a right to sue. Because the right to exclude others from practicing the patent (part of AHLT’s rights) had been separated from the right to sue for infringement (GUCLT’s rights), GUCLT was not protected under the patent statutes. The Federal Circuit summed up the situation this way:

The problem for GUCLT and AHLT is that the exclusionary rights have been separated from the right to sue for infringement. The liquidation plan contractually separated the right to sue from the underlying legally protected interests created by the patent statutes—the right to exclude. For any suit that GUCLT brings, its grievance is that the exclusionary interests held by AHLT are being violated. GUCLT is not the party to which the statutes grant judicial relief. See Warth, 422 U.S. at 500. GUCLT suffers no legal injury in fact to the patent’s exclusionary rights. As the Supreme Court stated in Independent Wireless, the right to bring an infringement suit is “to obtain damages for the injury to his exclusive right by an infringer.” 269 U.S. at 469; see also Sicom, 222 F.3d at 1381 (“Standing to sue for infringement depends entirely on the putative plaintiff’s proprietary interest in the patent, not on any contractual arrangements among the parties regarding who may sue…”); Ortho, 52 F.3d at 1034 (“[A] right to sue clause cannot negate the requirement that, for co-plaintiff standing, a licensee must have beneficial ownership of some of the patentee’s proprietary rights.”).

Since GUCLT had the right to sue but not the right to exclude others from practicing the patent, and since AHLT had the right to exclude others but not the right to sue for infringement, neither liquidating trust could sue for the infringement alleged in the GUCLT’s underlying lawsuit. The Federal Circuit ruled that the problem could not be solved by the typical practice of joining the legal title holder, here AHLT, to the patent litigation as a party. Although such joinder solves prudential standing requirements, the court held that it does not solve the constitutional standing requirement of actual legal injury. GUCLT did not suffer legal injury because it had no right to exclude others from practicing the patent.

The Federal Circuit’s majority opinion prompted an interesting dissent, which ended with the following:

While I do not read any precedent as directly governing the peculiar circumstances of this case, I also do not read any as precluding co-plaintiff standing for GUCLT. I believe that, in denying all possibility for enforcing the patent, the majority opinion extends limitations on co-plaintiff standing without a reasoned basis. Accordingly, while neither GUCLT nor AHLT individually may pursue infringement litigation, I would not deprive the patent of all value. Because I would allow GUCLT and AHLT, as co-plaintiffs, standing to sue Microsoft, I respectfully dissent.

The View From IP Bloggers. Dennis Crouch of the Patently-O patent law blog has an interesting post on the case, and he gets special thanks for first reporting on the decision. For another view, you may find this post from the Patry Copyright Blog published by William Patry, Google’s Senior Copyright Counsel, of interest.

Important Lessons. On his patent law blog, Dennis Crouch gives the practice pointer that he believes patent lawyers should learn from the decision: "A non-title-holder must be granted an exclusive license as well as full litigation rights in order to have standing to sue for patent infringement." That is helpful advice for patent lawyers, but I have a suggestion of my own.

  • When intellectual property such as patents, copyrights, or trademarks is involved in a bankruptcy case, get expert advice from IP counsel, in addition to bankruptcy advice. The problem may be separating exclusionary rights from the right to sue for patent infringement one day and transferring a trademark without its goodwill the next.
  • This suggestion applies when dealing with, for example, the transfer of IP in a bankruptcy case, whether by liquidation trusts, Section 363 asset sales, or something else, or assessing the risk of continuing patent infringement when purchasing IP assets.
  • As the Federal Circuit’s decision shows, the interplay between IP issues and bankruptcy cases can be complex and the possible outcomes surprising. Getting expert advice can help you avoid these and other traps for the unwary.
Business Bankruptcy Issues Recent Developments

Another Court Follows The Footstar Decision On Assumption Of IP Licenses In Bankruptcy

Intellectual property licenses continue to be significant to companies across a wide range of industries. This fact makes their treatment in business bankruptcy cases a topic of keen interest. 

Can A Debtor Licensee Retain IP License Rights? When the debtor in possession is a licensee under a patent, copyright, or trademark license, a key question arises: Can the license be assumed (bankruptcy-speak for kept) or will the bankruptcy filing put the licensor in a position to force rejection of the license — resulting in the ultimate termination of the debtor’s right to use the licensed IP?  A new case, discussed below, recently sided with the debtor in possession.

One Statute, Three Tests. This issue has led to a significant split of authority among bankruptcy courts and courts of appeal around the country, stemming from different interpretations of the language in Section 365(c)(1) of the Bankruptcy Code. That section provides as follows:

(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.

Some courts, including the U.S. Court of Appeals for the Ninth Circuit, have sided with the licensor and interpret Section 365(c)(1) to prohibit both assignment and assumption. Other courts, including the First Circuit, have permitted such licenses to be assumed.

  • Despite the split, most courts agree that Section 365(c)(1) prohibits assignment of executory contracts without the non-debtor contracting party’s consent if "applicable law" requires such consent because that would require the non-debtor party to accept performance from a new party. 
  • A number of courts have held that when the "applicable law" is federal patent, copyright, or trademark law, such consent is required.
  • Courts diverge, however, on whether the statute’s language should be read to prohibit a debtor in possession from assuming such executory contracts or only from assigning them.

Rather than cover that ground here, if this topic is new to you I suggest reading an earlier post entitled "Assumption Of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?" It discusses in detail how different courts have interpreted Section 365(c)(1), leading to the licensor-favorable "hypothetical test," the debtor-favorable "actual test," and the newer, debtor-favorable Footstar analysis. 

A Word On Footstar. Before moving on to the new decision, a brief word about the Footstar case may be helpful. In In re Footstar, Inc,, 323 B.R. 566 (Bankr. S.D.N.Y. 2005), Judge Adlai Hardin of the U.S. Bankruptcy Court for the Southern District of New York took a somewhat different approach in analyzing the statute. He concluded that Section 365(c)(1)’s use of the word "trustee" does not (as other courts had taken for granted) include the debtor or debtor in possession when assumption is sought because assumption does not require the non-debtor party to accept performance from a new party other than the debtor or debtor in possession. A trustee is a new party and the statute logically provides that a trustee may not "assume or assign" such an executory contract.

A Common Scenario. How does this issue come up in Chapter 11 cases? Well, here’s a typical situation. The debtor is the licensee under a prepetition patent license. The patent licensor files a motion to compel the debtor in possession to reject the patent license agreement or alternatively to have the automatic stay lifted to permit the licensor to cancel the agreement. The licensor argues that under the "hypothetical test" interpretation of Section 365(c)(1), the debtor in possession cannot assign the license and, as a result, cannot assume the license either. With neither option open, the licensor argues, the debtor in possession should be compelled to reject the license.

The Aerobox Decision. This was the situation that recently played out in the In re Aerobox Composite Structures, LLC Chapter 11 bankruptcy case. Ruling on just such a motion by a patent licensor, on July 27, 2007, Judge Mark B. McFeeley of the U.S. Bankruptcy Court for the District of New Mexico issued an 11-page decision holding that the actual test, and Judge Hardin’s analysis in Footstar, was the correct interpretation of Section 365(c)(1). As such, he denied the licensor’s motion and held that the debtor in possession was not barred by Section 365(c)(1) of the Bankruptcy Code from assuming the prepetition patent license at issue in that case. The Bankruptcy Court summed up its holding as follows:

Similarly, the bankruptcy court in Footstar reasons that it makes perfect sense for the statute, which uses the term, “trustee,” to prohibit the trustee from assuming or assigning a contract, because the trustee is an “entity other than the debtor in possession” but it makes no sense to read “trustee” to mean “debtor in possession.” Footstar, 323 B.R. at 573. Doing so

would render the provision a virtual oxymoron, since mere assumption [by the debtor in possession] (without assignment) would not compel the counterparty to accept performance from or render it to “an entity other than” the debtor.

Id.

This Court agrees.

Thus, where the debtor-in-possession seeks to assume, or, as is the situation in the instant case, where the debtor-in-possession has neither sought to assume nor reject the executory contract but simply continues to operate post-petition under its terms, 11 U.S.C. § 365(c)(1) does not prohibit assumption of the contract by the debtor-in-possession and cannot operate to allow the non-debtor party to the executory contract to compel the Debtor to reject the contract. In reaching this conclusion, the Court finds that the “actual test” articulated in Cambridge Biotech, and the reasoning of the court in Footstar, is the better approach to § 365(c)(1) when determining whether a debtor-in-possession is precluded from assuming an executory contract.

Venue Still Matters. The decision is interesting because it represents another bankruptcy court, this time outside of the Southern District of New York, endorsing the analysis in the Footstar decision. That said, Judge McFeeley wrote on something of a clean slate because the Tenth Circuit has not yet taken a view on whether the hypothetical test, the actual test, or the Footstar analysis controls. As this circuit-by-circuit chart of Section 365(c)(1) decisions shows (last updated in March 2007), many other circuits have staked out a position on the issue. Absent a Supreme Court decision or new legislation resolving the circuit split, where a debtor files bankruptcy will continue to make a big difference in the relative rights of licensors and debtors over intellectual property licenses in Chapter 11 cases.

Business Bankruptcy Issues Recent Developments

A Second District Court Decides Whether A Trademark License Can Be Assumed In Bankruptcy

Once again, a district court has faced the issue of whether a non-exclusive trademark license can be assumed by a debtor in possession. Before the November 2005 decision in In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), no court had directly addressed that question. The decision in the N.C.P. Marketing case, now on appeal to the Ninth Circuit, held that trademark licenses are personal and nonassignable, absent a provision in the trademark license to the contrary, and in a hypothetical test jurisdiction such as the Ninth Circuit, they cannot be assumed by the debtor in possession. For a more detailed discussion on the N.C.P. Marketing case, you may find this post of interest. For an analysis of some recent trends on the broader topic of assumption of IP licenses, try this post.

The Wellington Vision Case. Earlier this year, a second district court, this time the U.S. District Court for the Southern District of Florida, faced the same question in an appeal in the In re Wellington Vision, Inc. Chapter 11 bankruptcy case.

  • Pearle Vision sought relief from the automatic stay to terminate a franchise agreement with Wellington Vision, arguing that Wellington could not assume the agreement because it Included a non-exclusive license of Pearle Vision trademarks.
  • The U.S. Bankruptcy Court for the Southern District of Florida granted the motion for stay relief by this two-page order, holding that the inclusion in the franchise agreement of a trademark license made the agreement, under federal trademark law, non-assignable absent consent by Pearle Vision.

Appeal To The District Court. Wellington Vision filed an appeal from the Bankruptcy Court’s decision.

  • In its opening brief, Wellington argued that (1) Pearle Vision had failed to establish that the franchise agreement included a trademark license, (2) a provision in the franchise agreement allowing for assignments on consent that cannot be unreasonably withheld meant that the parties had opted out of applicable law, and (3) Section 365(c)(1) of the Bankruptcy Code only prohibits assumption or assignment by a trustee, not by a debtor in possession, citing the Footstar case.
  • Pearle Vision argued in its answer brief that "applicable law" is the federal Lanham Act, which makes trademark licenses personal and non-assignable, and that Section 365(c)(1) creates a hypothetical test and precludes assignment or assumption of the license.
  • Wellington’s reply brief asserted that the District Court should not apply Section 365(c)(1) to debtors in possession and further that it should hold that this license was assignable by its terms.

The District Court’s Decision On Appeal. On February 20, 2007, Judge Alan S. Gold of the U.S. District Court for the Southern District of Florida affirmed the Bankruptcy Court’s decision in this 14-page decision. The District Court first held that the franchise agreement expressly included a non-exclusive license to certain Pearle Vision trademarks, making the Lanham Act the "applicable law" to be considered under Section 365(c)(1). It then held that the agreement’s provisions contemplating assignment under certain conditions did not constitute consent to any specific assignment or an "opt out" of the Lanham Act’s general restrictions on assignment, distinguishing In re Quantegy, 326 B.R. 467 (Bankr. M.D. Ala. 2005), relied on by Wellington. Finally, the District Court held that Section 365(c)(1) did apply to debtors in possession and not just to trustees, citing the Eleventh Circuit’s decision in City of Jamestown v. James Cable Partners, L.P., 27 F.3d 534 (11th Cir. 1994).

No Further Appeal Has Been Filed. Unlike the N.C.P. Marketing case, the District Court’s decision in this case will not be appealed. While the appeal was pending, the Wellington case was converted to a Chapter 7 case. Also, within the past two months litigation between Pearle, Wellington, and a guarantor of certain debt owed to Pearle was settled, resolving the issues decided by the District Court.

Trademark Owners Win Another One. Although it did not cite the N.C.P. Marketing decision, the Wellington Vision court becomes only the second district court to address the assumability of trademark licenses — and the second to hold that they are not assumable when the hypothetical test applies. This is more good news for trademark owners, who typically want as much control as possible over licenses to their marks, but bad news for debtors, who face the prospect of losing valuable trademark licenses (and franchise agreements including them) if they file bankruptcy. Stay tuned for more developments on this issue, including the Ninth Circuit’s decision in N.C.P. Marketing, which is likely still months away.

Special thanks to Warren Agin of the Tech Bankruptcy blog, whose post entitled The Descent Into Darkness Continues, first discussed the Wellington Vision case. The title of that post also gives you a sense of how many bankruptcy lawyers feel about the hypothetical test, its application to IP licenses, and its impact on debtors.