United States: Another Appellate Court Rejects Lubrizol Approach To Effect Of Rejection Of Trademark License In Bankruptcy

Only a handful of courts have had an opportunity to address the ramifications of rejection of a trademark license since the U.S. Court of Appeals for the Seventh Circuit handed down its landmark decision in Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012). A bankruptcy appellate panel for the First Circuit recently did so in Mission Prod. Holdings, Inc. v. Tempnology LLC (In re Tempnology LLC), 559 B.R. 809 (B.A.P. 1st Cir. 2016). The panel followed Sunbeam and reversed the ruling of a bankruptcy court that trademark license rights are not protected by section 365(n) of the Bankruptcy Code because trademarks are not included in the Bankruptcy Code's definition of "intellectual property."

Special Rules Governing Rejection of Certain Intellectual Property Licenses in Bankruptcy

Absent special statutory protection, the rejection by a chapter 11 debtor-in-possession ("DIP") or a bankruptcy trustee of an intellectual property ("IP') license, particularly a license of IP that is critical to a licensee's business operations, can have a severe impact on the licensee's business and leave the licensee scrambling to procure other IP to keep its business afloat. This concern was heightened by the Fourth Circuit's 1985 ruling in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers Inc.), 756 F.2d 1043 (4th Cir. 1985). In Lubrizol, the court held that, if a debtor rejects an executory IP license, the licensee loses the right to use any licensed copyrights, trademarks, and patents. It also concluded that the licensee's only remedy is to file a claim for money damages, since the licensee cannot seek specific performance of the license agreement.

In order to better protect such licensees, Congress amended the Bankruptcy Code in 1988 to add section 365(n). Under section 365(n), licensees of some (but not all) IP licenses have two options when a DIP or trustee rejects the license. The licensee may either: (i) treat the agreement as terminated and assert a claim for damages; or (ii) retain the right to use the licensed IP for the duration of the license (with certain limitations). By adding section 365(n), Congress intended to make clear that the rights of an IP licensee to use licensed property cannot be unilaterally cut off as a result of the rejection of the license.

However, notwithstanding the addition of section 365(n) to the Bankruptcy Code, the legacy of Lubrizol endures—since by its terms, section 365(n) does not apply to trademark licenses and other kinds of "intellectual property" outside the Bankruptcy Code's definition of the term. In particular, trademarks, trade names, and service marks are not included in the definition of "intellectual property" under section 101(35A) of the Bankruptcy Code. Due to this omission, courts continue to struggle when determining the proper treatment of trademark licenses in bankruptcy.

Several courts, including three circuit courts of appeal, have had an opportunity since Lubrizol and the enactment of section 365(n) to weigh in on how rejection in bankruptcy of a trademark license impacts the rights of the nondebtor licensee.

In In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010), the Third Circuit could have considered the issue but sidestepped it instead, concluding that a trademark license agreement was not executory because the nondebtor licensee had materially completed its performance under the agreement prior to the debtor's bankruptcy filing. Thus, the court held that the agreement could not be assumed or rejected at all. As a consequence, the Third Circuit never addressed whether rejection of the agreement (had it been found to be executory) would have terminated the licensee's right to use the debtor's trademarks.

However, in a separate concurring opinion, circuit judge Thomas L. Ambro took issue with the bankruptcy court's conclusion that rejection of a trademark license agreement necessarily terminates the licensee's right to use the debtor's trademark. Congress's decision to leave treatment of trademark licenses to the courts, Judge Ambro argued, signals nothing more than Congress's inability, at the time it enacted section 365(n), to devote enough time to consideration of trademarks in the bankruptcy context; no negative inference should be drawn by the failure to include trademarks in the Bankruptcy Code's definition of "intellectual property." The judge wrote that "it is simply more freight than negative inference will bear to read rejection of a trademark license to effect the same result as termination of that license."

In Sunbeam, the Seventh Circuit expressly rejected Lubrizol. In Sunbeam, the court held as a matter of first impression that when a trademark license is rejected in bankruptcy, the licensee does not lose the ability to use the licensed IP.

Focusing on the impact of section 365(g) of the Bankruptcy Code (specifying the consequences of rejection), the Seventh Circuit explained that, outside bankruptcy, a licensor's breach does not terminate a licensee's right to use IP. According to the court, "What § 365(g) does by classifying rejection as breach is establish that in bankruptcy, as outside of it, the other party's rights remain in place." The debtor's unfulfilled obligations under the contract are converted to damages, which, if the contract has not been assumed, are treated as a prepetition obligation. "[N]othing about this process," the court remarked, "implies that any rights of the other contracting party have been vaporized." Instead, rejection "merely frees the estate from the obligation to perform and has absolutely no effect upon the contract's continued existence" (internal quotation marks and citation omitted).

The Seventh Circuit, reasoning that lawmakers' failure to include trademark licenses among the "intellectual property" protected by section 365(n) should not be viewed as an endorsement of any particular approach regarding rejection of a trademark license agreement, observed that "an omission is just an omission." Moreover, the Seventh Circuit wrote, "According to the Senate committee report on the bill that included §365(n), the omission was designed to allow more time for study, not to approve Lubrizol."

In a decision similar to the Third Circuit's holding in Exide Technologies, the Eighth Circuit skirted the issue of the effect of rejection of a trademark license agreement in Lewis Bros. Bakeries, Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), 751 F.3d 955 (8th Cir. 2014). In Interstate Bakeries, the court held that a license agreement was not executory and thus could not be assumed or rejected because the license was part of a larger, integrated agreement which had been substantially performed by the debtor prior to filing for bankruptcy. In a footnote, the Eighth Circuit remarked that "[b]ecause the agreement is not executory, we need not address whether rejection of a trademark-licensing agreement terminates the licensee's rights to use the trademark."

A New Jersey bankruptcy court ruled in In re Crumbs Bake Shop, Inc., 522 B.R. 766 (Bankr. D.N.J. 2014), that trademark licensees are entitled to the protections of section 365(n) of the Bankruptcy Code, notwithstanding the omission of trademarks from section 101(35A)'s definition of "intellectual property." The court also held that a sale of assets "free and clear" under section 363(f) does not trump or extinguish the rights of a third-party licensee under section 365(n), unless the licensee consents.

Tempnology

Tempnology LLC ("Tempnology") was a New Hampshire-based material innovation company that developed chemical-free cooling fabrics for use in consumer products under the brand name "Coolcore." In 2012, Tempnology entered into a Co-Marketing and Distribution Agreement (the "Agreement") with Mission Product Holdings, Inc. ("Mission"), a marketer and distributor of innovative sports technologies. In the Agreement, Tempnology granted Mission a nonexclusive license to certain of Tempnology's copyrights, patents, and trade secrets; an exclusive right to distribute certain cooling material products that Tempnology manufactured; and an associated trademark license.

After filing for chapter 11 protection in the District of New Hampshire in 2015, Tempnology immediately sought to reject the Agreement. Mission objected, arguing, among other things, that notwithstanding rejection of the Agreement, by making an election under section 365(n), Mission retained its exclusive product distribution rights as well as its rights under the IP license and the trademark license and that it could continue to exercise those rights without interference from Tempnology or any purchaser of its assets in the bankruptcy case.

Relying on Lubrizol and without discussing Sunbeam, the bankruptcy court ruled that: (i) the nonexclusive copyright, patent, and trade secret license in the Agreement was a license of IP (as defined in section 101(35A)) and Mission's rights to continue to use the licensed IP were protected under section 365(n); (ii) the Agreement's exclusive distribution rights were not IP and were therefore not protected under section 365(n); (iii) because trademarks are not included in section 101(35A)'s definition of "IP," the Agreement's trademark license rights were not protected by section 365(n); and (iv) due to the rejection of the Agreement, Mission lost both the exclusive distribution rights and the trademark license rights. See In re Tempnology, LLC, 2015 BL 372538 (Bankr. D.N.H. 2015).

On appeal, the bankruptcy appellate panel affirmed the bankruptcy court's holding that the exclusive distribution rights in the Agreement were not IP and were therefore not protected by section 365(n). It also affirmed the decision that section 365(n) did not protect Mission's rights as a trademark licensee. In so holding, the panel declined to follow the approach advocated in Judge Ambro's concurring opinion in Exide Technologies and applied by the court in Crumbs Bake Shop.

The panel found that the bankruptcy court's reliance on Lubrizol was flawed, noting that "Lubrizol . . . is not binding precedent in this circuit and, like the many others who have criticized its reasoning . . . , we do not believe it articulates correctly the consequences of rejection of an executory contract under § 365(g)." Instead, the panel wrote, "We adopt Sunbeam's interpretation of the effect of rejection of an executory contract under § 365 involving a trademark license."

Applying the Sunbeam approach, the panel concluded that, although the trademark and logo were not among the categories of IP specifically protected by section 365(n), "[Tempnology's] rejection of the Agreement did not vaporize Mission's trademark rights under the Agreement." According to the panel, "Whatever post-rejection rights Mission retained in the [Tempnology] trademark and logo are governed by the terms of the Agreement and applicable non-bankruptcy law."

Tempnology has been appealed to the First Circuit, which will now have an opportunity to weigh in on the issue.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Mark G. Douglas
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