Seventh Circuit Protects Trademark Licensees in Bankruptcy Court

In February 2009, several of Lakewood's creditors forced it into involuntary bankruptcy. The trustee sold Lakewood's assets, including the patents and trademarks, to Jarden Consumer Solutions, a Sunbeam Products company. Because Jarden did not want CAM's Lakewood-branded fan inventory or CAM's competition, the trustee used ' 365(n) to reject the executory portion of the CAM license.

When CAM continued making and selling Lakewood-branded fans, Sunbeam sued CAM for patent and trademark infringement in a bankruptcy adversary proceeding. The bankruptcy judge found that the license was ambiguous, but that CAM was entitled to make and sell the 1.2 million fans Lakewood had estimated it would need for 2009. In re Lakewood Engineering & Manufacturing Co., 459 B.R. 306 (Bankr. N.D. Ill. 2011). The judge held that ' 365(n) applied to permit CAM to continue to use the licensed patents and that it could continue to use Lakewood's trademarks because it would be inequitable to cut off those rights.

The Seventh Circuit's Decision

The Seventh Circuit concluded that the bankruptcy judge correctly interpreted the contract but incorrectly interpreted the effect of the trustee's rejection, observing that a judge cannot override the Bankruptcy Code because enforcement of a provision might be inequitable. Hundreds of bankruptcy judges could have many different ideas about what is equitable, some favoring the reliance interests of licensees and some favoring the creditors, who might be paid a greater portion of their claims if the debtor could terminate its trademark licenses.

Although the Seventh Circuit found the bankruptcy judge's reasoning to be “untenable,” it nevertheless agreed with the outcome, that CAM could continue to make and sell the Lakewood box fans. It noted that no other appeals court had agreed or disagreed with the Lubrizol decision, and held that the Fourth Circuit was mistaken in its ruling because the Bankruptcy Code defines rejection of an executory license as a breach of contract for which the sole remedy is damages. As a breach of a license outside of bankruptcy does not terminate a licensee's right to continue using the licensed intellectual property, it cannot do so in bankruptcy. Although the Seventh Circuit noted that the licensee cannot obtain specific performance of the agreement, that is, it cannot require the debtor to perform any obligations, the licensee's right to continue using the intellectual property is not “vaporized.” The situation, observed the court, is similar to rejection of a lease in bankruptcy, which does not end the tenant's right to possession, although the debtor is no longer obligated to make repairs. A rejection does not void the license, it merely frees the bankrupt estate from any obligation to perform its duties under the license. Therefore, the Seventh Circuit affirmed CAM's right to make and sell the fans under the license.

The Sunbeam decision relied heavily on the concurring opinion of Judge Thomas L. Ambro in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010). In Exide, the majority concluded that a perpetual, exclusive, royalty-free trademark and trade name license for industrial batteries was not an executory contract that the bankruptcy trustee could reject, because neither the debtor nor, the licensee had any unperformed material obligations. The Third Circuit determined that the quality control provision in the trademark license was not a material unperformed obligation of the licensee, because the debtor had never provided any quality control standards nor had the parties ever discussed them. Judge Ambro's opinion considered whether rejection of the license would have ended the licensee's right to use the trademark and concluded that it would not. He relied on the Senate report indicating that Congress had excluded trademarks from the express scope of ' 365(n) because the issue needed further study, in particular, the effect on the extent to which the licensor/debtor was required to control the quality of the licensee's goods or services. Judge Ambro warned against using the rejection right as a sword rather than a shield to put “debtor-licensors in a catbird seat they often do not deserve.” Interestingly, the Third Circuit did not consider the effect of a licensor failing to enforce a quality control provision in a trademark license, which many courts have determined to result in an abandonment of the trademark through “naked licensing.”

The Eighth Circuit

Recently, the Eighth Circuit found that a “perpetual, royalty-free, assignable, transferable, exclusive license” to certain trademarks was an executory license that could be assumed or rejected by the trustee, because the agreement expressly provided that the licensee's failure to maintain the quality of the goods would constitute a material breach of the license. Lewis Brothers Bakeries Inc. v. Interstate Brands Corp., The Eighth Circuit rejected the contrary conclusion of the Third Circuit in Exide. As the plain language of the license made the quality control provision material, and the debtor-licensor also had continuing material duties, such as maintaining and defending the marks, the Eighth Circuit determined that the license was executory and the trustee could assume or reject it. Although the Eighth Circuit did not discuss whether rejection of the license would cut off the licensee's rights, it cited the Lubrizol opinion with approval for the proposition that the debtor-licensor's unperformed, continuing core obligations of notice and forbearance, to defend infringement suits, and indemnify the licensee, made the license executory.

Conclusion

Unless and until the Supreme Court resolves the conflict caused by the Sunbeam decision, trademark license drafters should carefully consider what language they characterize as material and how a license with a company in financial distress should be structured.

Judith L. Grubner is a partner in the IP Practice Group of Arnstein & Lehr LLP and a member of this newsletter's Board of Editors. She may be contacted via e-mail at [email protected].

An executory contract is one where the material obligations of both parties have not yet been substantially performed. Section 365(a) of the Bankruptcy Code allows a bankruptcy trustee to reject the executory portion of contracts made with the debtor. In 1985, the Fourth Circuit concluded that when a trustee in bankruptcy rejects an executory intellectual property license, the licensee loses all rights to use the licensed patents, trademarks or copyrights. Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. , 756 F.2d 1043 (4th Cir. 1985). In 1988, Congress partly overruled that decision by adding ' 365(n) to the Bankruptcy Code. That provision permits a licensee to continue to use the licensed intellectual property (with certain conditions, such as paying royalties) after rejection by the trustee. However, ' 365(n) only covers patent, copyright and trade secret licenses, not trademark licenses. Some courts have inferred from that omission that Lubrizol still applies to trademark licenses, ending the licensee's rights when the license is rejected by the trustee.

The Seventh Circuit has now adopted the conflicting view that ' 365(n) does not affect trademark licenses in one way or another and that Lubrizol was incorrectly decided. Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC , __ F.3d __ (7th Cir. 2012).

The problem arose when Lakewood Engineering & Manufacturing Co., a consumer products company, licensed the patents and trademarks for its unprofitable box fan business in 2008 to Chicago American Manufacturing, LLC (“CAM”) so that CAM could take over manufacturing and shipping the fans to Lakewood's customers. Lakewood estimated that it would need 1.2 million units for 2009. Because CAM was concerned about Lakewood's financial condition, the license permitted CAM to sell the fans made in 2009 to its own customers if Lakewood did not buy them.

In February 2009, several of Lakewood's creditors forced it into involuntary bankruptcy. The trustee sold Lakewood's assets, including the patents and trademarks, to Jarden Consumer Solutions, a Sunbeam Products company. Because Jarden did not want CAM's Lakewood-branded fan inventory or CAM's competition, the trustee used ' 365(n) to reject the executory portion of the CAM license.

When CAM continued making and selling Lakewood-branded fans, Sunbeam sued CAM for patent and trademark infringement in a bankruptcy adversary proceeding. The bankruptcy judge found that the license was ambiguous, but that CAM was entitled to make and sell the 1.2 million fans Lakewood had estimated it would need for 2009. In re Lakewood Engineering & Manufacturing Co., 459 B.R. 306 (Bankr. N.D. Ill. 2011). The judge held that ' 365(n) applied to permit CAM to continue to use the licensed patents and that it could continue to use Lakewood's trademarks because it would be inequitable to cut off those rights.

The Seventh Circuit's Decision

The Seventh Circuit concluded that the bankruptcy judge correctly interpreted the contract but incorrectly interpreted the effect of the trustee's rejection, observing that a judge cannot override the Bankruptcy Code because enforcement of a provision might be inequitable. Hundreds of bankruptcy judges could have many different ideas about what is equitable, some favoring the reliance interests of licensees and some favoring the creditors, who might be paid a greater portion of their claims if the debtor could terminate its trademark licenses.

Although the Seventh Circuit found the bankruptcy judge's reasoning to be “untenable,” it nevertheless agreed with the outcome, that CAM could continue to make and sell the Lakewood box fans. It noted that no other appeals court had agreed or disagreed with the Lubrizol decision, and held that the Fourth Circuit was mistaken in its ruling because the Bankruptcy Code defines rejection of an executory license as a breach of contract for which the sole remedy is damages. As a breach of a license outside of bankruptcy does not terminate a licensee's right to continue using the licensed intellectual property, it cannot do so in bankruptcy. Although the Seventh Circuit noted that the licensee cannot obtain specific performance of the agreement, that is, it cannot require the debtor to perform any obligations, the licensee's right to continue using the intellectual property is not “vaporized.” The situation, observed the court, is similar to rejection of a lease in bankruptcy, which does not end the tenant's right to possession, although the debtor is no longer obligated to make repairs. A rejection does not void the license, it merely frees the bankrupt estate from any obligation to perform its duties under the license. Therefore, the Seventh Circuit affirmed CAM's right to make and sell the fans under the license.

The Sunbeam decision relied heavily on the concurring opinion of Judge Thomas L. Ambro in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010). In Exide, the majority concluded that a perpetual, exclusive, royalty-free trademark and trade name license for industrial batteries was not an executory contract that the bankruptcy trustee could reject, because neither the debtor nor, the licensee had any unperformed material obligations. The Third Circuit determined that the quality control provision in the trademark license was not a material unperformed obligation of the licensee, because the debtor had never provided any quality control standards nor had the parties ever discussed them. Judge Ambro's opinion considered whether rejection of the license would have ended the licensee's right to use the trademark and concluded that it would not. He relied on the Senate report indicating that Congress had excluded trademarks from the express scope of ' 365(n) because the issue needed further study, in particular, the effect on the extent to which the licensor/debtor was required to control the quality of the licensee's goods or services. Judge Ambro warned against using the rejection right as a sword rather than a shield to put “debtor-licensors in a catbird seat they often do not deserve.” Interestingly, the Third Circuit did not consider the effect of a licensor failing to enforce a quality control provision in a trademark license, which many courts have determined to result in an abandonment of the trademark through “naked licensing.”

The Eighth Circuit

Recently, the Eighth Circuit found that a “perpetual, royalty-free, assignable, transferable, exclusive license” to certain trademarks was an executory license that could be assumed or rejected by the trustee, because the agreement expressly provided that the licensee's failure to maintain the quality of the goods would constitute a material breach of the license. Lewis Brothers Bakeries Inc. v. Interstate Brands Corp., The Eighth Circuit rejected the contrary conclusion of the Third Circuit in Exide. As the plain language of the license made the quality control provision material, and the debtor-licensor also had continuing material duties, such as maintaining and defending the marks, the Eighth Circuit determined that the license was executory and the trustee could assume or reject it. Although the Eighth Circuit did not discuss whether rejection of the license would cut off the licensee's rights, it cited the Lubrizol opinion with approval for the proposition that the debtor-licensor's unperformed, continuing core obligations of notice and forbearance, to defend infringement suits, and indemnify the licensee, made the license executory.

Conclusion

Unless and until the Supreme Court resolves the conflict caused by the Sunbeam decision, trademark license drafters should carefully consider what language they characterize as material and how a license with a company in financial distress should be structured.

Judith L. Grubner is a partner in the IP Practice Group of Arnstein & Lehr LLP and a member of this newsletter's Board of Editors. She may be contacted via e-mail at [email protected].