Chief Judge Frank Easterbrook of the Seventh Circuit recently created a split of authority regarding the rejection intellectual property licenses in bankruptcy by upholding a decision protecting a trademark licensee’s ability to use a debtor licensor’s trademark after the licensing agreement had been rejected. Chicago American Manufacturing’s licensing contract with debtor Lakewood Engineering & Manufacturing authorized CAM to sell fans under Lakewood’s mark. After Lakewood’s involuntary bankruptcy and sale of assets to Sunbeam Products, Lakewood’s trustee sought to reject the contract and bar CAM from using the debtor’s mark. Holding that rejection does not terminate a licensee’s right to use a trademark, the Seventh Circuit disagreed with the Fourth Circuit’s 1985 decision in Lubrizol Enterprises Inc. v. Richmond Metal Finishers, reigniting the debate, twenty-six years after the fact.  Sunbeam Products Inc. v. Chicago American Manufacturing LLC, 2012 U.S. App. LEXIS 12882 (7th Cir. July 9, 2012); Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. 756 F.2d 1043 (4th Cir. 1985).  

In Lubrizol, the Fourth Circuit held that rejection of an intellectual property license results solely in the licensee being able to recover monetary damages. Importantly, the court rejected an approach to rejection resulting in the licensee’s continued right to use of the intellectual property covered by the agreement.  In an effort to assuage concerns about stunting businesses reliant on such licenses, Congress passed section 365(n), which provides that intellectual property licensees can continue using intellectual property after rejection, provided they meet certain conditions. 11 U.S.C. § 365(n).  Notably, section 365(n) is silent as to the effect of rejection on trademark licenses. Accordingly, in the face of this Congressional silence, courts have held that Lubrizol remains the appellate authority on the treatment of trademarks after rejection.

Judge Easterbrook’s decision squarely challenges the Lubrizol court’s approach to rejection, and instead looks to the effect of rejection under section 365(g), which provides that “the rejection of an executory contract constitutes a breach of such contract or lease.” 11 U.S.C. § 365(g).  Judge Easterbrook found that “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.”  Sunbeam, 2012 U.S. App. LEXIS 12882 at *9.  To that end, Judge Easterbrook notes that “scholars uniformly criticize Lubrizol, concluding that it confuses rejection with the use of an avoiding power.” Id. at *11.  Because outside of bankruptcy a licensor’s breach of its license contract would not terminate the licensee’s right to use the intellectual property, breach by rejection would similarly not terminate a trademark licensee’s rights. Indeed, regardless of section 365(n)’s inapplicability to trademarks, if rejection is concomitant to breach, it will not terminate a licensee’s rights, contrary to the Fourth Circuit’s remedy in Lubrizol.  Because Lakewood’s trustee did not contend that Lakewood’s contract with CAM is subject to rescission, rejection of the trademark license agreement merely freed the estate of its obligation to perform with no effect on CAM’s right to sell fans under Lakewood’s mark. Accordingly, CAM was free to continue sales under Lakewood’s mark, despite Lakewood’s rejection of the intellectual property license and pre-rejection sale of its assets.

By its holding, the Seventh Circuit has positioned itself squarely against the Fourth Circuit with regard to the effect of rejection under the Bankruptcy Code, teeing up an issue for clarification by Congress or the Supreme Court.  Moreover, the Seventh Circuit’s decision calls into question the necessity of section 365(n), because if we accept the Seventh Circuit’s approach – that rejection equals breach, and not a termination of licensee rights – it renders section 365(n) superfluous and confusing. Considering the foregoing, the issue is clearly ripe for clarification.