Sunbeam Eclipsed

In Sunbeam Products, the Seventh Circuit Court of Appeals rejected the Lubrizol holding in the trademark context, and explained that “nothing about [the contract rejection] process implies that any rights of the other contracting party have been vaporized.” Id. at *3. The court reasoned that Section 365(n) is not implicated when trademarks are involved. Rather, the court found that because a non-breaching party retains its rights under a breached contract pursuant to applicable non-bankruptcy law, so too would a non-breaching counterparty to a rejected contract retain its rights under the rejected contract. This holding was widely seen as expanding the rights of non-debtor intellectual property licensees.

Qualitech

But almost a decade before its Sunbeam holding, the Seventh Circuit Court of Appeals decided the seminal case, Precision Industries, Inc. v. Qualitech Steel SBQ, L.L.C. (In re Qualitech Steel Corp. & Qualitech Steel Holdings Corp.), 327 F.3d 537 (7th Cir. 2003). In Qualitech, the court analyzed a somewhat different, yet closely analogous topic to one of concern to intellectual property licensees ' the intersection between Sections 363(f) and 365(h) of the Bankruptcy Code.

Section 363(f) provides for circumstances under which an asset can be sold “free and clear of any interest in such property,” but the Bankruptcy Code fails to define the term “interest,” thus leaving many to speculate what exactly can be overridden by this Section. This power to sell assets free and clear of competing interests is a highly important device in the bankruptcy court's toolbox to maximize the benefits to the debtor's estate and promote an expeditious liquidation of the debtor's assets, without the need to first resolve issues relating to disputed interests in the property.

Section 365(h)(1) provides that, if a trustee or debtor in possession rejects an unexpired real property lease, the non-debtor lessee has the option to retain its rights under the lease for the remainder of the lease term. If the debtor desires to sell the real property free and clear of the leasehold interest, the rights of the tenant under Section 365(h)(1) seem to conflict with the “free and clear” provisions of Section 363(f). This conflict was addressed as a matter of first impression by the Seventh Circuit Court of Appeals in Qualitech, where the debtor sold its assets to the mortgagee of the property. The sale order provided that the assets were to be conveyed “free and clear of all liens, claims, encumbrances, and interests,” and consequently the lessee's lease agreement was rejected by the debtor in its Chapter 11 plan. The lessee then sought a determination that it retained a possessory interest in the real property despite its “free and clear” sale.

Reversing the lessee-friendly ruling of the lower court, the Seventh Circuit held that a debtor-lessor of real estate may sell the underlying property “free and clear” of encumbrances, despite the lessee protections of section 365(h). In other words, the lessee had to leave the property. The Qualitech court concluded that a ' 363(f) sale of real estate extinguished the lessee's possessory rights under ' 365(h), which it deemed to fall under the broad and undefined term “interest.”

Qualitech is the only circuit court decision to date that addresses the relationship between Section 363(f) and 365(h). Lower courts' holdings are split on the issue. Some courts have supported the Qualitech holding. See, e.g., In re R. J. Dooley Realty, Inc., 2010 Bankr. LEXIS 1761 (Bankr. S.D.N.Y. May 21, 2010); South Motor Co. v. Carter-Pritchett-Hodges, Inc. (In re MMH Automotive Group, LLC), 385 B.R. 347 (Bankr. S.D. Fla. 2008); The Compak Companies, LLC v. Johnson, 415 B.R. 334 (N.D. Ill. 2009). However, other courts have disagreed with this holding. See, e.g., In re Haskell, L.P., 321 B.R. 1 (Bankr. D. Mass. 2005); In re Samaritan Alliance LLC, 2007 Bankr. LEXIS 3896 (Bankr. E.D. Ky. Nov. 21, 2007).

Section 365(h) or Section 365(n)?

Commentators in the years following Qualitech conjectured that Section 365(h) could be just as easily replaced with Section 365(n) in the context of this analysis, thus a sale free and clear of all of a licensee's rights in the intellectual property would be possible. However, no reported decisions have taken up this issue yet, leaving observers to continue to speculate.

Very recently, the bankruptcy court for the Eastern District of Virginia joined the courts disagreeing with Qualitech and holding in favor of the lessee. In re Zota Petroleums, LLC, 2012 Bankr. LEXIS 4570 (Bankr. E.D. Va. Oct. 1, 2012). While not in itself a new or unusual decision, and one which is certainly favorable to non-debtor counterparties, the Zota Petroleums case has once again brought to the surface the possible analogous connection between the overriding of lessees' rights by a free and clear sale, and the potential overriding of intellectual property licensees' rights by the same Bankruptcy Code provision.

As mentioned, no court has taken up this point as of yet. However, if the “free and clear” provision of Section 363(f) is held to override licensees' rights pursuant to Section 365(n), then not only will the Sunbeam holding likely become moot, but Congress' entire enactment of Section 365(n) will be rendered virtually meaningless, given the frequency with which Section 363(f) is invoked in bankruptcy cases. Such a result would take intellectual property licensors and licensees back to the days of Lubrizol, a direct contradiction with Congress's intent when it enacted Section 365(n).

Another Point of View

However, in the Section 365(h) context, some courts have found that a sale free and clear trumps lessees' rights because Congress did not directly specify that those rights trump a free and clear sale. For example, in In re MMH Automotive Group, LLC, the court found that because there is nothing in Section 365(h) that specifically prohibits a Section 363 sale when there is a tenant in possession, the plain meaning of Section 363 allowing a sale free and clear prevails. 385 B.R. at 366. The court found that omission compelling, remarking that “if Congress intended section 365(h) to trump a debtor's right to sell property, it could have expressly provided that limitation.” Id.

Similarly, nothing in Section 365(n) specifically trumps Section 363(f)'s “free and clear” provision. While courts have read the legislation of Section 365(n) to specifically prevent a Lubrizol-type result, there is nothing in the statute or the legislative history indicating that Congress even considered Section 363(f) when enacting Section 365(n). This omission can be interpreted by courts in the same manner as MMH Automotive Group, supra, interpreted the analogous 365(h) omission ' that is, such omission means that Congress did not mean for Section 365(h) to trump Section 363(f). However, it can also be argued that this omission is to be read in the same way as the Sunbeam court read the omission of trademarks from the Bankruptcy Code's definition of intellectual property, that is, as a mere gap in the logical flow of protection for non-debtor parties, which should be rectified by courts addressing the matter. As the Sunbeam decision so succinctly put it, “an omission is just an omission.” Sunbeam Prods., 686 F.3d at 375. It should be noted that Congress did not simply “forget” to address trademarks; as the legislative history indicates, “since these matters could not be addressed without more extensive study, it was determined to postpone Congressional action in this area and to allow the development of equitable treatment of this situation by Bankruptcy Courts.” S. Rep. 100-505, at 5.

Additionally, courts have looked to the statutory interpretation cannon that calls on courts to “avoid conflicts between them if such construction is possible and reasonable.” In re Zota Petroleums, LLC, 2012 Bankr. LEXIS 4570 at 14 (citing Qualitech, 327 F.3d at 544). These courts have reasoned that Section 363(e) of the Bankruptcy Code provides lessees a right to seek adequate protection, and therefore they are protected despite a sale free and clear of their leasehold interests in the real property. Adequate protection “does not necessarily guarantee a lessee's continued possession of the property,” explained the Seventh Circuit Court of Appeals, “but it does demand, in the alternative, that the lessee be compensated for the value of its leasehold ' typically from the proceeds of the sale.” Qualitech, 327 F.3d at 548. Very similarly, it might be held by a court that intellectual property licensees are adequately protected by Section 363(e), and therefore there is no need to be concerned with the nullification of licensees' Section 365(n) rights by a 363(f) free and clear sale.

In contrast, courts that have disagreed with Qualitech have based their reasoning, at least in part, on the “statutory construction principle that the more specific provision should prevail over the general.” Zota Petroleums, 2012 Bankr. LEXIS 4570 at 17 (citing In re Churchill Props. III, Ltd. P'ship, 197 B.R. 283, 288 (Bankr. N.D. Ill. 1996)). According to that statutory construction principle, since Section 365(h) ' and analogously, Section 365(n) ' is specific in providing for certain rights available to the non-debtor lessee/licensee after rejection of the contract, a general provision such as Section 363(f) should not be allowed to override Congress's purpose in enacting the specific provision. Id.

Conclusion

This analysis should not put intellectual property licensees into a panic. As mentioned, no court has yet published an opinion that addresses the intersection between Sections 363(f) and 365(n), and the Sunbeam decision is favorable to non-debtor intellectual property licensees, thus setting the stage for potential future favorable holdings. Further, even the recent Virginia decision, which brought these concerns to the surface, held in favor of the non-debtor counterparty and found that it maintained its Section 365(h) rights despite the Section 363(f) sale. However, intellectual property licensees should keep in mind that their rights under Section 365(n) and decisions like Sunbeam are not written in stone, and may in the future be interpreted as trumped by a free and clear sale of a bankruptcy debtor's intellectual property assets. Congress may react to such holding as it did to Lubrizol ' by corrective legislation ' but until such developments take place, licensees should not take it for granted that they will be able to retain their 365(n) rights, or rights under Sunbeam, if their license is rejected by the debtor.

Kevin J. Walsh is a member and Ella Shenhav is an associate in the Boston office of Mintz Levin in the in the firm's Bankruptcy, Restructuring & Commercial Law Section. They may be reached at [email protected] and [email protected], respectively.

A recent decision of the Seventh Circuit Court of Appeals, Sunbeam Prods. v. Chi. Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012), has been viewed by many, including the authors of this article, as signaling a potential trend in favor of non-debtor licensees of intellectual property. This decision, described in more detail below, permits the non-debtor licensee to retain trademark rights under a rejected license agreement. Trademarks do not fall within the scope of Section 365(n) of the Bankruptcy Code, which protects certain intellectual property rights of a licensee when a licensor files for bankruptcy and rejects the license. But just as intellectual property licensees may have begun to breathe easier, a reminder came from a Virginia bankruptcy court that their sigh of relief may be, after all, premature, because it may be that a bankruptcy sale free and clear of competing interests in the intellectual property pursuant to Section 363(f) may override all 365(n) and similar rights of non-debtor licensees of intellectual property.

Section 365(n) of the Bankruptcy Code was promulgated by Congress as a direct response to the Fourth Circuit Court of Appeal's decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. , 756 F.2d 1043 (4th Cir. 1985). In Lubrizol, the court held that when a debtor rejects an intellectual property license, the non-debtor party retains no rights in the intellectual property, but rather it is merely entitled to a money damages remedy. In the aftermath of this controversial decision, Congress amended the Bankruptcy Code by adding Section 365(n), which allows licensees to continue using the licensed intellectual property under certain circumstances after the debtor rejects the license. However, the amendment was not a perfect fix, as the Bankruptcy Code's definition of intellectual property (and thus the scope of those property rights protected by Section 365(n)) includes patents, copyrights and trade secrets, but does not include trademarks or franchise agreements.

Sunbeam Products

In Sunbeam Products, the Seventh Circuit Court of Appeals rejected the Lubrizol holding in the trademark context, and explained that “nothing about [the contract rejection] process implies that any rights of the other contracting party have been vaporized.” Id. at *3. The court reasoned that Section 365(n) is not implicated when trademarks are involved. Rather, the court found that because a non-breaching party retains its rights under a breached contract pursuant to applicable non-bankruptcy law, so too would a non-breaching counterparty to a rejected contract retain its rights under the rejected contract. This holding was widely seen as expanding the rights of non-debtor intellectual property licensees.

Qualitech

But almost a decade before its Sunbeam holding, the Seventh Circuit Court of Appeals decided the seminal case, Precision Industries, Inc. v. Qualitech Steel SBQ, L.L.C. (In re Qualitech Steel Corp. & Qualitech Steel Holdings Corp.), 327 F.3d 537 (7th Cir. 2003). In Qualitech, the court analyzed a somewhat different, yet closely analogous topic to one of concern to intellectual property licensees ' the intersection between Sections 363(f) and 365(h) of the Bankruptcy Code.

Section 363(f) provides for circumstances under which an asset can be sold “free and clear of any interest in such property,” but the Bankruptcy Code fails to define the term “interest,” thus leaving many to speculate what exactly can be overridden by this Section. This power to sell assets free and clear of competing interests is a highly important device in the bankruptcy court's toolbox to maximize the benefits to the debtor's estate and promote an expeditious liquidation of the debtor's assets, without the need to first resolve issues relating to disputed interests in the property.

Section 365(h)(1) provides that, if a trustee or debtor in possession rejects an unexpired real property lease, the non-debtor lessee has the option to retain its rights under the lease for the remainder of the lease term. If the debtor desires to sell the real property free and clear of the leasehold interest, the rights of the tenant under Section 365(h)(1) seem to conflict with the “free and clear” provisions of Section 363(f). This conflict was addressed as a matter of first impression by the Seventh Circuit Court of Appeals in Qualitech, where the debtor sold its assets to the mortgagee of the property. The sale order provided that the assets were to be conveyed “free and clear of all liens, claims, encumbrances, and interests,” and consequently the lessee's lease agreement was rejected by the debtor in its Chapter 11 plan. The lessee then sought a determination that it retained a possessory interest in the real property despite its “free and clear” sale.

Reversing the lessee-friendly ruling of the lower court, the Seventh Circuit held that a debtor-lessor of real estate may sell the underlying property “free and clear” of encumbrances, despite the lessee protections of section 365(h). In other words, the lessee had to leave the property. The Qualitech court concluded that a ' 363(f) sale of real estate extinguished the lessee's possessory rights under ' 365(h), which it deemed to fall under the broad and undefined term “interest.”

Qualitech is the only circuit court decision to date that addresses the relationship between Section 363(f) and 365(h). Lower courts' holdings are split on the issue. Some courts have supported the Qualitech holding. See, e.g., In re R. J. Dooley Realty, Inc., 2010 Bankr. LEXIS 1761 (Bankr. S.D.N.Y. May 21, 2010); South Motor Co. v. Carter-Pritchett-Hodges, Inc. (In re MMH Automotive Group, LLC), 385 B.R. 347 (Bankr. S.D. Fla. 2008); The Compak Companies, LLC v. Johnson , 415 B.R. 334 (N.D. Ill. 2009). However, other courts have disagreed with this holding. See, e.g., In re Haskell, L.P., 321 B.R. 1 (Bankr. D. Mass. 2005); In re Samaritan Alliance LLC, 2007 Bankr. LEXIS 3896 (Bankr. E.D. Ky. Nov. 21, 2007).

Section 365(h) or Section 365(n)?

Commentators in the years following Qualitech conjectured that Section 365(h) could be just as easily replaced with Section 365(n) in the context of this analysis, thus a sale free and clear of all of a licensee's rights in the intellectual property would be possible. However, no reported decisions have taken up this issue yet, leaving observers to continue to speculate.

Very recently, the bankruptcy court for the Eastern District of Virginia joined the courts disagreeing with Qualitech and holding in favor of the lessee. In re Zota Petroleums, LLC, 2012 Bankr. LEXIS 4570 (Bankr. E.D. Va. Oct. 1, 2012). While not in itself a new or unusual decision, and one which is certainly favorable to non-debtor counterparties, the Zota Petroleums case has once again brought to the surface the possible analogous connection between the overriding of lessees' rights by a free and clear sale, and the potential overriding of intellectual property licensees' rights by the same Bankruptcy Code provision.

As mentioned, no court has taken up this point as of yet. However, if the “free and clear” provision of Section 363(f) is held to override licensees' rights pursuant to Section 365(n), then not only will the Sunbeam holding likely become moot, but Congress' entire enactment of Section 365(n) will be rendered virtually meaningless, given the frequency with which Section 363(f) is invoked in bankruptcy cases. Such a result would take intellectual property licensors and licensees back to the days of Lubrizol, a direct contradiction with Congress's intent when it enacted Section 365(n).

Another Point of View

However, in the Section 365(h) context, some courts have found that a sale free and clear trumps lessees' rights because Congress did not directly specify that those rights trump a free and clear sale. For example, in In re MMH Automotive Group, LLC, the court found that because there is nothing in Section 365(h) that specifically prohibits a Section 363 sale when there is a tenant in possession, the plain meaning of Section 363 allowing a sale free and clear prevails. 385 B.R. at 366. The court found that omission compelling, remarking that “if Congress intended section 365(h) to trump a debtor's right to sell property, it could have expressly provided that limitation.” Id.

Similarly, nothing in Section 365(n) specifically trumps Section 363(f)'s “free and clear” provision. While courts have read the legislation of Section 365(n) to specifically prevent a Lubrizol-type result, there is nothing in the statute or the legislative history indicating that Congress even considered Section 363(f) when enacting Section 365(n). This omission can be interpreted by courts in the same manner as MMH Automotive Group, supra, interpreted the analogous 365(h) omission ' that is, such omission means that Congress did not mean for Section 365(h) to trump Section 363(f). However, it can also be argued that this omission is to be read in the same way as the Sunbeam court read the omission of trademarks from the Bankruptcy Code's definition of intellectual property, that is, as a mere gap in the logical flow of protection for non-debtor parties, which should be rectified by courts addressing the matter. As the Sunbeam decision so succinctly put it, “an omission is just an omission.” Sunbeam Prods., 686 F.3d at 375. It should be noted that Congress did not simply “forget” to address trademarks; as the legislative history indicates, “since these matters could not be addressed without more extensive study, it was determined to postpone Congressional action in this area and to allow the development of equitable treatment of this situation by Bankruptcy Courts.” S. Rep. 100-505, at 5.

Additionally, courts have looked to the statutory interpretation cannon that calls on courts to “avoid conflicts between them if such construction is possible and reasonable.” In re Zota Petroleums, LLC, 2012 Bankr. LEXIS 4570 at 14 (citing Qualitech, 327 F.3d at 544). These courts have reasoned that Section 363(e) of the Bankruptcy Code provides lessees a right to seek adequate protection, and therefore they are protected despite a sale free and clear of their leasehold interests in the real property. Adequate protection “does not necessarily guarantee a lessee's continued possession of the property,” explained the Seventh Circuit Court of Appeals, “but it does demand, in the alternative, that the lessee be compensated for the value of its leasehold ' typically from the proceeds of the sale.” Qualitech, 327 F.3d at 548. Very similarly, it might be held by a court that intellectual property licensees are adequately protected by Section 363(e), and therefore there is no need to be concerned with the nullification of licensees' Section 365(n) rights by a 363(f) free and clear sale.

In contrast, courts that have disagreed with Qualitech have based their reasoning, at least in part, on the “statutory construction principle that the more specific provision should prevail over the general.” Zota Petroleums, 2012 Bankr. LEXIS 4570 at 17 (citing In re Churchill Props. III, Ltd. P'ship, 197 B.R. 283, 288 (Bankr. N.D. Ill. 1996)). According to that statutory construction principle, since Section 365(h) ' and analogously, Section 365(n) ' is specific in providing for certain rights available to the non-debtor lessee/licensee after rejection of the contract, a general provision such as Section 363(f) should not be allowed to override Congress's purpose in enacting the specific provision. Id.

Conclusion

This analysis should not put intellectual property licensees into a panic. As mentioned, no court has yet published an opinion that addresses the intersection between Sections 363(f) and 365(n), and the Sunbeam decision is favorable to non-debtor intellectual property licensees, thus setting the stage for potential future favorable holdings. Further, even the recent Virginia decision, which brought these concerns to the surface, held in favor of the non-debtor counterparty and found that it maintained its Section 365(h) rights despite the Section 363(f) sale. However, intellectual property licensees should keep in mind that their rights under Section 365(n) and decisions like Sunbeam are not written in stone, and may in the future be interpreted as trumped by a free and clear sale of a bankruptcy debtor's intellectual property assets. Congress may react to such holding as it did to Lubrizol ' by corrective legislation ' but until such developments take place, licensees should not take it for granted that they will be able to retain their 365(n) rights, or rights under Sunbeam, if their license is rejected by the debtor.

Kevin J. Walsh is a member and Ella Shenhav is an associate in the Boston office of Mintz Levin in the in the firm's Bankruptcy, Restructuring & Commercial Law Section. They may be reached at [email protected] and [email protected], respectively.