United States: Connecticut Bankruptcy Court Adds Fuel To The Fire In Debate Over Effect Of Rejection Of Trademark License

In In re SIMA Int'l, Inc., 2018 WL 2293705 (Bankr. D. Conn. May 17, 2018), the U.S. Bankruptcy Court for the District of Connecticut ruled that a chapter 7 trustee's rejection of an intellectual property license agreement did not deprive the licensee of the continuing right to use the licensed intellectual property, including a trademark, because the licensee made a timely election under section 365(n) of the Bankruptcy Code. According to the court, rejection of the agreement, of which the trademark license was an integral component, resulted in a nonmaterial breach, rather than termination, and the section 365(n) election "indisputably" preserved the licensee's exclusive right to use the intellectual property during the remaining term of the license agreement.

In so ruling, the bankruptcy court embraced the approach articulated by the U.S. Court of Appeals for the Seventh Circuit in Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012), and rejected the contrary view endorsed by the Fourth and First Circuits—the only other circuit courts of appeals that have directly addressed the issue—in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers, Inc.), 756 F.2d 1043 (4th Cir. 1985), and Mission Product Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), 879 F.3d 389 (1st Cir. 2018).

The widening rift among the courts on this issue may be an invitation to U.S. Supreme Court review.

Special Rules Governing Rejection of Certain Intellectual Property Licenses in Bankruptcy

Absent special statutory protection, the rejection of an intellectual property ("IP") license by a chapter 11 debtor-in-possession ("DIP") or a bankruptcy trustee 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. In that case, 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. The court also concluded that the licensee's only remedy was to file a claim for money damages, since the licensee could not 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. Because of this omission, courts continue to struggle when determining the proper treatment of trademark licenses in bankruptcy.

Sunbeam Gives Trademark Licensees a Glimmer of Hope

In Sunbeam, the Seventh Circuit expressly rejected the Lubrizol court's approach to trademark licenses. Focusing on the impact of section 365(g) of the Bankruptcy Code (which specifies 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 reasoned 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. Rather, the Seventh Circuit wrote, the legislative history indicates that "the omission was designed to allow more time for study, not to approve Lubrizol."

The Third and Eighth Circuits also have had the opportunity to weigh in on the validity of the Lubrizol approach but declined to reach the issue for a variety of reasons. See Lewis Bros. Bakeries Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), 751 F.3d 955 (8th Cir. 2014) (ruling 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 re Exide Technologies, 607 F.3d 957 (3d Cir. 2010) (sidestepping the issue and concluding that a trademark license agreement was not executory; in a concurring opinion, Judge Ambro noted that Congress's decision to leave treatment of trademark licenses to the courts signals nothing more than Congress's inability, when it enacted section 365(n), to devote enough time to consideration of trademarks in the bankruptcy context).

First Circuit Takes Opposite Approach in Tempnology

A divided First Circuit rejected the Sunbeam approach in Tempnology. According to the First Circuit majority, the "unstated premise" of Sunbeam is flawed because freeing a debtor from any continuing performance obligations under a trademark license, while preserving the licensee's right to use the trademark, simply does not comport with Congress's principal aim in providing for rejection of a contract—namely, to "release the debtor's estate from burdensome obligations that can impede a successful reorganization" (citing NLRB v. Bildisco & Bildisco, 465 U.S. 513, 528 (1984)).

The majority explained that the effective licensing of a trademark requires the trademark owner (or any purchaser of its assets) to monitor and exercise control over the quality of the goods sold to the public under cover of the trademark, failing which the trademark owner would be left with a "naked license" that would jeopardize the continued validity of its trademark rights. The Sunbeam approach, the majority emphasized, would allow the licensee to retain the use of licensed trademarks "in a manner that would force the company to choose between performing executory obligations under the license or risk the permanent loss of its trademarks."

Such a restriction on the licensor's ability to free itself from its executory obligations, even if limited to trademark licenses, the majority wrote, "would depart from the manner in which section 365(a) otherwise operates."

In a dissenting opinion, circuit judge Juan R. Torruella disagreed with the majority's "bright-line rule that the omission of trademarks from the protections of section 365(n) leaves a non-rejecting party without any remaining rights to use a debtor's trademark and logo." Instead, Judge Torruella would follow Sunbeam in concluding that a licensee's rights to use the licensed trademark "d[o] not vaporize" because of rejection of the agreement.

The First Circuit majority was critical of the dissent, writing that "our dissenting colleague seems to reject [Sunbeam's] categorical approach in favor of what Sunbeam itself rejected—an 'equitable remedy' that would consider in some unspecified manner the 'terms of the Agreement, and non-bankruptcy law' " (quoting Sunbeam, 686 F.3d at 375–76). According to the majority, the dissent accorded too much weight to a few lines in the legislative history and overlooked the fact that when Congress otherwise intended to grant bankruptcy courts the ability to "equitably" craft exceptions to rules set forth in the Bankruptcy Code, "it did so in the statute itself" (citing sections 365(d)(5), 502(j), 552(b)(1), 557(d)(2)(D), 723(d), 1113(c), and 1114(g)).

Other Recent Case Law

In the six years since Sunbeam was decided, only a handful of reported decisions have discussed the impact of the rejection of a trademark license on the licensee's ability to use licensed trademarks. In addition to the First Circuit (and lower courts) in Tempnology, only two courts have actually decided the issue.

In In re Crumbs Bake Shop, Inc., 522 B.R. 766 (Bankr. D.N.J. 2014), the U.S. Bankruptcy Court for the District of New Jersey followed Sunbeam in ruling 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. See also Interstate Bakeries, 751 F.3d at 963 (a trademark license agreement was not executory and thus could not be assumed or rejected); Harrell v. Colonial Holdings, Inc., 923 F. Supp. 2d 813, 818 n.4 (E.D. Va. 2013) (noting the disagreement between Lubrizol and Sunbeam, but also that the parties had not raised the issue of the impact which the debtor's rejection of a trademark license had on the licensee's rights).

Another bankruptcy court recently joined the fray in SIMA Int'l.

SIMA Int'l

SIMA International, Inc. ("SIMA") owns certain copyrights, trademarks, and other IP relating to a process that analyzes motivational patterns to assist individuals and employers in making career and employment decisions. Prior to filing a chapter 7 petition on November 17, 2017, in the District of Connecticut, SIMA, in exchange for royalties, licensed the process, including associated trademarks, to various parties under agreements that allowed the licensees or sublicensees to use the IP to create or develop derivative works, modifications, adaptations, or other improvements relating to the technology.

Such a license agreement with Marlys Hanson, Inc. ("MHI") provided in relevant part that the licensed technology "includes but is not limited to the [scheduled] trademarks and copyrights" in relation to product adaptations developed by MHI, and the agreement required SIMA's approval for any usage of the license in connection with adaptations. The agreement also provided that any licensed products must carry an attribution statement indicating SIMA's ownership of the technology.

Shortly after entering into the license agreement, MHI developed valuable software incorporating the licensed technology.

SIMA's chapter 7 trustee moved to reject the license agreement with MHI in December 2017. MHI objected and filed a notice pursuant to section 365(n) of its election to retain its rights under the license agreement. The parties did not dispute that the license agreement was an executory contract or that rejection of the agreement would benefit SIMA's estate by enhancing the value of the IP in a bankruptcy sale.

Instead, the parties disputed whether: (i) the section 365(n) election entitled MHI to the continued use of the licensed trademark; and (ii) the election preserved MHI's exclusive rights under the license agreement to develop and sell products using the licensed technology.

The Bankruptcy Court's Ruling

After examining the language of section 365(n), its historical context, and relevant case law, the bankruptcy court noted that "[t]his Court, like many others, does not endorse the reasoning in Lubrizol and is not alone in concluding that its reasoning is flawed" (citing Sunbeam, 686 F.3d at 377–78).

Instead, the bankruptcy court aligned itself "with the plain language reading of Section 365(g) advanced" by the Seventh Circuit in Sunbeam. First, the court explained, under section 365(g), the rejection of a contract constitutes a breach rather than termination of the contract. Under Connecticut law (the law governing the license agreement), a counterparty is relieved of continued performance under a contract if the breach is material. In this case, the court concluded, the "rejection breach" was not material. Because "the Section 365(n) election indisputably preserves MHI's right to the intellectual property and exclusivity, ... the core of the bargain and substantial purpose of the License Agreement [have] been preserved."

Second, the bankruptcy court noted, the use of the trademark was "directly imbedded within, supplemental to, and integral to the intellectual property license."

Finally, the court explained, the chapter 7 trustee conceded that he was more concerned about the bid-chilling impact of the license agreement's exclusivity provisions than MHI's use of the trademark, as he understood that the trademark was intertwined with the IP license.

On the basis of these findings, the bankruptcy court ruled that MHI's section 365(n) election entitled it to the continued use of the trademark throughout the duration of the license agreement. In addition, because of the plain language of section 365(n), the court held that: (i) the election preserved MHI's exclusive rights to prevent the development of competing products; and (ii) all royalty and payment provisions due under the license agreement remained in full force and effect.

Outlook

After the alarm bells resulting from Tempnology, the bankruptcy court's ruling in SIMA Int'l is welcome news to trademark licensees, even if the decision does not carry the same weight as the First Circuit's ruling. To be sure, the unsettled state of the law on this important issue is not a positive development for trademark licensors or licensees. As the case law currently stands, to the extent a potential licensor has a choice of venue for a bankruptcy filing, that choice can have significant consequences for the fate of licensed trademarks.

Despite its refusal to review Sunbeam in 2012, the U.S. Supreme Court may finally agree to weigh in on this important issue because of the widening rift in lower and appellate courts.

On June 14, 2018, Mission Product Holdings Inc. ("MPH") filed a petition for a writ of certiorari requesting that the Supreme Court review the First Circuit's January 2018 ruling in Tempnology. According to the petition filed by MPH, which was stripped of its right to use licensed trademarks by rejection of its license agreement, the First Circuit "worsen[ed]" the circuit split on this issue, and its decision undermined the effectiveness of a provision that Congress enacted to protect licensor rights, "cast[ing] a cloud of uncertainty over significant commercial transactions that are central to our nation's system for encouraging and rewarding innovation."

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mark G. Douglas
Similar Articles
Relevancy Powered by MondaqAI
Masuda, Funai, Eifert & Mitchell, Ltd.
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Masuda, Funai, Eifert & Mitchell, Ltd.
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions