In a recent decision authored by Chief Judge Easterbrook, the United States Court of Appeals for the Seventh Circuit (Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, Docket No. 11-3920 (7th Cir. July 9, 2012)) held that the licensee of a trademark does not necessarily lose the right to use the licensed marks when a debtor-licensor rejects the underlying license agreement in its bankruptcy case.  In so holding, the Court rejected a contrary decision reached by the United States Court of Appeals for the Fourth Circuit in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.  756 F.2d 1043 (4th Cir. 1985).  In reaching its holding, the Court relied on principles governing the rejection of contracts in bankruptcy generally and not on the particular nature of the contract at issue or the statutory language of section 365(n) of the Bankruptcy Code, which protects a licensee of intellectual property in the event its licensor rejects the license agreement.  Thus, while it is now settled law in the Seventh Circuit that the licensee of a rejected trademark license agreement retains its right to use the licensed marks, the scope and extent of that retained right is still not wholly clear.

Background: The facts surrounding the case are relatively straightforward.   In 2008, Lakewood Engineering and Manufacturing Co. (“Lakewood”) and Chicago American Manufacturing (“CAM”) entered into a contract in connection with Lakewood’s manufacture of box fans.  Of relevance here, the contract permitted CAM to use Lakewood’s patents in constructing the fans and to affix Lakewood’s trademarks to the finished products.  In addition, Lakewood would take orders directly for the fans from retailers and direct CAM to ship the finished box fans to the retailers.  In entering into the contract, CAM was concerned about the cost of manufacturing the estimated 1.2 million box fans Lakewood estimated it would need during 2009 without assurances of payment.  To allay this concern, the contract also authorized CAM to sell the entire run of 2009 box fans for its own account if Lakewood did not purchase them.  Three months later, several of Lakewood’s creditors filed an involuntary bankruptcy case against Lakewood.

Upon the involuntary filing, the bankruptcy court appointed a trustee, who sold Lakewood’s assets, including its patents and trademarks, to Sunbeam Products d/b/a Jarden Consumer Solutions (“Jarden.”).  Jarden did not want to purchase CAM’s inventory of Lakewood-branded fans nor did it want CAM to sell those fans on the market where they would compete with similar Jarden fans.  Accordingly, Lakewood’s bankruptcy trustee rejected the CAM contract pursuant to section 365(a) of the Bankruptcy Code.  Despite this rejection, CAM continued to manufacture and sell Lakewood-branded box fans, prompting Jarden to file an adversary proceeding against CAM in the bankruptcy court.

The bankruptcy court ruled that CAM was entitled to make and sell as many of the Lakewood-branded box fans as Lakewood estimated it would need for the 2009 season.  Pursuant to section 365(n) of the Bankruptcy Code, the bankruptcy court found that CAM could still use Lakewood’s patents in manufacturing the box fans.  However, because trademarks are not included within the Bankruptcy Code’s definition of “intellectual property” protected by section 365(n), the bankruptcy court held, on equitable grounds only, that CAM could continue to use Lakewood’s trademarks.  This left open the issue of whether Lakewood’s rejection of the contract under section 365(a) of the Bankruptcy Code terminated CAM’s right to use the licensed trademarks.

Analysis: The Seventh Circuit affirmed the bankruptcy court’s order permitting CAM to sell the Lakewood-branded fans even after rejection of the underlying contract, but found the bankruptcy court’s reasoning wanting.  Specifically, Judge Easterbrook noted that the bankruptcy court’s reliance on what it considered “inequitable,” was not a workable standard and contrary to Supreme Court precedent.  The Court also considered, and expressly rejected, the notion that because Congress did not include trademarks within the Bankruptcy Code’s definition of “intellectual property” in adopting section 365(n) of the Bankruptcy Code, Congress intended to codify the holding in Lubrizol, noting that the omission of the term “trademark” “does not affect trademarks one way or the other.”   Instead, the Court grounded its holding on section 365(g) of the Bankruptcy Code, which provides, in relevant part, that “the rejection of an executory contract . . . constitutes a breach of such contract. . . .”

The Court noted that because the rejection of a contract in bankruptcy constitutes only a breach and not a recission of the agreement, a court must look to relevant law to determine the rights of the parties post-rejection.  Under relevant law, a licensor’s breach of a license would not normally terminate a licensee’s right to use the licensed intellectual property and that post-rejection a debtor can no longer be subject to an order for specific performance.  Based on this reasoning, the Court concluded that the trustee’s rejection of the CAM agreement did not rescind CAM’s contractual rights to exploit Lakewood’s trademarks.

Conclusion: The Sunbeam decision makes clear that in the Seventh Circuit, a licensee of trademarks does not necessarily lose its rights to use such marks when the underlying license agreement is rejected by a debtor-licensor.  This holding expressly rejects the Fourth Circuit’s holding in Lubrizol and leaves open for another day the scope and extent of the retained right.