United States: All IP Is Not Created Equal

Originally published in Trademark World, June 5, 2007

Most trademark attorneys may never encounter a bankruptcy case as part of their practice, but all trademark attorneys should be aware of Bankruptcy Code section 365(a) and the potential risks it may generate for their clients who license trademarks. Under section 365(a), a trademark licensor who declares bankruptcy and files for Chapter 11 may be permitted to reject—that is, to breach—a trademark license agreement where rejection could benefit the estate. Although bankruptcy law protects other intellectual property license agreements against rejection (e.g., licenses for patents and trade secrets), Congress purposely rejected extending a similar safeguard to trademark licensees, leaving them uniquely vulnerable to the loss of all or part of their business if the company licensing them a trademark declares bankruptcy.

Section 365(a) allows the debtor in possession or the trustee of a bankrupt estate to reject any executory contract where rejection benefits the estate. 11 U.S.C. § 365(a). Although the Bankruptcy Code does not define "executory contract," courts have held that "a contract is executory if performance is due to some extent on both sides." See , e.g. , In re Blackstone Potato Chip Co., 109 B.R. 557, 560 (Bankr. D.R.I. 1990); In re Chipwich, Inc., 54 B.R. 427, 429-30 (Bankr. S.D.N.Y. 1985). Courts have found intellectual property licenses, including trademark licenses, to be executory contracts because such agreements typically require continuing obligations by both parties, i.e., the licensor maintains the intellectual property while the licensee pays royalties. See, e.g., Exide Techs., 340 B.R. at 239; In re HQ Global Holdings, Inc., 290 B.R. 507 (Bankr. D. Del. 2003); Blackstone Potato Chip, 109 B.R. at 560; Chipwich, 54 B.R. at 430.

Determining Rejection

In determining whether a rejection would benefit the estate, courts have applied the lenient "business judgment standard," under which courts will not interfere with a debtor’s business judgment without a showing of bad faith or abuse of business discretion. See, e.g., Exide Techs., 340 B.R. at 239-40; HQ Global Holdings, 290 B.R. at 511; Blackstone Potato Chip, 109 B.R. at 560; Chipwich, 54 B.R. at 430-31. Arguably, because rejecting a trademark license agreement will transfer valuable intellectual property rights back to the licensor, rejection will nearly always be considered beneficial to the estate.

Before Congress’s enactment in 1988 of the Intellectual Property Bankruptcy Protection Act (IPBPA), debtors were able to reject any intellectual property license agreement with relative ease under section 365(a). See, e.g., Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985); In re Petur U.S.A. Instrument Co., Inc. , 35 B.R. 561 (Bankr. W.D. Wash. 1983). Following successful lobbying by the patent bar, and in recognition of the negative impact on the market generally and on individual companies in particular of permitting licensors to strip their licensees of rights to use licensed intellectual property, Congress enacted the IPBPA and with it, section 365(n).

Under section 365(n), a licensee is no longer without recourse. If a court approves rejection of an intellectual property license, the licensee may either:

• treat the rejection as a breach and seek possible damages, or

• retain the rights to the intellectual property under the license. 11 U.S.C. § 365(n).

In defining "intellectual property" as trade secrets, patents, and copyrights, Congress specifically excluded trademarks and trade names from protection. 11 U.S.C. § 101(35A). As a result, trademark licensees remain unprotected from the rejection of trademark license agreements as executory contracts.

"Issues Beyond the Scope"

While declining to extend protection to trademarks under section 365(n), Congress simultaneously acknowledged its concerns over the potential impact on licensees and the marketplace generally caused by the rejection of executory trademark licenses by debtor-licensors. S. REP. NO. 100-505, at 6 (1988). According to Congress, however, trademark licensing agreements raised "issues beyond the scope" of the IPBPRA due, in large part, to the requirement that a licensor continue to exercise quality control over licensed merchandise throughout the term of the license.¹ Id. Accordingly, "[i]t was determined to postpone congressional action in this area and to allow the development of equitable treatment of this situation by bankruptcy courts." Id.

Since the enactment of section 365(n), the majority of courts facing this issue have allowed trademark licensors to reject trademark license agreements as executory contracts. See, e.g., HQ Global Holdings, 290 B.R. at 513-514; In re Centura Software Corp., 281 B.R. 660, 675 (Bankr. N.D. Cal. 2002); Blackstone Potato Chip Co., 109 B.R. at 562. Most recently, in In re Exide Techs., 340 B.R. 222 (Bankr. D. Del. 2006), the court determined that because section 365(n) expressly excludes trademarks, trademark licensees cannot use that provision to elect to retain their rights to use a mark after rejection. The Exide court allowed the licensor to reject the licensee’s perpetual, exclusive, royalty-free license to use the EXIDE mark because the debtor wanted to unify its corporate image and regain the EXIDE mark for all its products. The court determined that the debtor had spent considerable time and effort in studying its business operations, and that brand unification and elimination of confusion were sufficient reasons to support the debtor’s decision to reject. The court also held that the impact of the debtor’s potential rejection damage claim on the estate was relevant, but that there should be no balancing of the interests of the estate against the interests of other parties to the contract being rejected. Thus, a court does not weigh the interest to the debtor’s estate against the potential harm to the licensee.

The only case where a trademark licensee has been successful in retaining use of a licensed trade name after rejection is In re Matusalem, 158 B.R. 514 (Bankr. S.D. Fla. 1993). In that case, however, the licensor granted the licensee the exclusive right to use the name MATUSALEM for the sale of rum products in addition to rights to use certain secret processes and formulas for the same products. Irrespective of the licensee’s right to use the trademark, the court held that under section 365(n), the licensee still had the right after rejection to use the trade secret processes and formulas. Moreover, the court determined that the debtor failed to demonstrate good business judgment because there was no economic benefit to the estate or debtor’s creditors by rejecting the franchise agreement. As a result, the licensee was allowed to continue its use of both the secret formula and the MATUSALEM name.

What can trademark licensees learn from the recent case law? MATUSALEM demonstrates that including other forms of intellectual property in a licensing agreement, e.g., patents or trade secrets, may be one option to help protect the rights of trademark licensees. If various forms of intellectual property are intertwined in a single license agreement, a court may hesitate to allow rejection of the agreement in its entirety. Another option for licensees may be to avoid paying significant license fees up front in favour of annualised payments. At the very least, trademark licensees can protect themselves by investigating the financial standing of companies from which they desire to license trademarks.

Trademark attorneys may not need to familiarise themselves with the entire Bankruptcy Code, but they should at least be aware of section 365(a). Given the significant impact that section 365(a) can have on trademark licenses, trademark attorneys should keep the section in mind when drafting license agreements for their clients.

Footnotes

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