In our Intellectual Property Law Update of December 2016 we advised you of the recent decision of the Bankruptcy Appellate Panel for the First Circuit Court of Appeals (the “BAP”) in Mission Products Holdings, Inc. v. Tempnology (In re Tempnology, LLC) upholding the rights of a licensee of trademarks to continue use of trademarks after the debtor’s rejection of the trademark license. As set forth below, the First Circuit recently reversed that decision.  

In 1988, Congress amended the Bankruptcy Code to add section 365(n) and a definition of “intellectual property” to protect licensees of intellectual property in response to a decision of the Fourth Circuit Court of Appeals in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers Inc. The Fourth Circuit in Lubrizol held that the rejection of an intellectual property license by a bankrupt licensor terminated the licensee’s rights, even where doing so drastically disrupted the licensee’s operation. 

Section 365(n) of the Bankruptcy Code provides that a licensee of “intellectual property” (notably, not including trademarks) has two options when a debtor seeks to reject an intellectual property 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, subject to certain requirements (including payment of all royalties under the terms of the contract and that the licensee will be deemed to have waived certain rights of setoff and any allowable postpetition claim arising from its performance of the contract). 

The BAP’s decision in Tempnology reversed in part the decision of the Bankruptcy Court below. The BAP agreed with the Bankruptcy Court that section 365(n) did not apply to trademarks but held that the licensee’s rights in trademarks and logos continued under the license agreement and applicable nonbankruptcy law. In doing so the BAP followed the decision of the Seventh Circuit Court of Appeals in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC in which the Seventh Circuit concluded that section 365(a) of the Bankruptcy Code, which applies to executory contracts generally, only terminates the obligation of the debtor to perform under the license agreement but does not strip away the licensee’s rights to use the trademark.

The First Circuit reversed the holding of the BAP, and came to the same conclusion as the Lubrizol court, rejecting the rationale of Sunbeam and concluding that a trademark licensee had no right to continue to use the trademarks after the license was rejected. The rationale for the First Circuit’s conclusion was that effective licensing of a trademark required the owner to monitor and exercise control over the quality of the goods sold to the public or else the licensor would be creating a “naked license” which could result in the licensor risking the permanent loss of its trademark. The First Circuit decided that the licensor should not have that burden.

Thus, the First Circuit’s decision in Tempnology places the risk on the solvent trademark licensee that in a bankruptcy it will lose the benefit of the license. Given the split among the First and Fourth Circuits versus that of the Seventh Circuit it is possible that the Supreme Court will be petitioned to resolve the issue. Meanwhile licensees will be well-advised to contact counsel to assess what their rights may be if a licensor were to reject a trademark license depending upon the venue in which a licensor may file for bankruptcy.