The Seventh Circuit Court of Appeals recently held that the rejection of a trademark license by the trustee did not abrogate the licensee’s rights under a prepetition agreement to use the debtor’s trademark. Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, __F.3d __, 2012 WL 2687939 (7th Cir. July 9, 2012). The Seventh Circuit decision is contrary to a prior decision by the Fourth Circuit in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). In Lubrizol, the Fourth Circuit held that rejection of a license agreement by a debtor/licensor leaves the licensee with only money damages. The result is a split among the Circuit Courts which, if appealed by Sunbeam, could provide the basis for a review by the Supreme Court.

In the Seventh Circuit case, Lakewood Engineering & Manufacturing Co. (“Lakewood”) made and sold a variety of consumer products, including box fans. After years of losing money in the manufacture of the box fans, Lakewood contracted with Chicago American Manufacturing (“CAM”) for the manufacture of the box fans (the “CAM Contract”). As a part of the CAM Contract, CAM was licensed to use the Lakewood patents and to place the Lakewood’s trademark on the completed fans. Due to Lakewood’s financial distress, the contract also authorized CAM to sell the season’s production of box fans if Lakewood did not purchase them.

Three months after the agreement was executed, several of Lakewood’s creditors filed an involuntary bankruptcy against Lakewood. Lakewood’s chapter 7 trustee decided to sell Lakewood’s business to Sunbeam Products (dba Jarden Consumer Solutions (“Jarden”)). The assets purchased included the Lakewood patents and trademarks. As a part of the sale, Lakewood’s trustee rejected the executory portion of the CAM Contract (obligations where performance was still due by both CAM and Lakewood). CAM, however, continued to manufacture and sell Lakewood-branded fans causing Jarden to sue CAM in the Bankruptcy Court for the Northern District of Illinois to try to stop CAM from using the Lakewood patents and trademarks. After a trial in the Bankruptcy Court, the Court held the CAM Contract was ambiguous and relying upon extrinsic evidence concluded that CAM was entitled, on equitable grounds, to continue manufacturing box fans with the Lakewood trademark to satisfy the requirements for the season covered under the CAM Contract. Jarden made a direct appeal to the Seventh Circuit contending that CAM must stop making and selling fans bearing the Lakewood trademark.

The Appellate Court, noting that this was a matter of first impression , examined Lubrizol, the primary decision interpreting the rejection of intellectual property agreements. The Lubrizol case, decided prior to the addition of §365(n) to the Bankruptcy Code holds that when an intellectual property license is rejected in bankruptcy, the licensee loses the ability to use any licensed copyrights, trademarks or patents. Congress added Section 365(n) shortly after the Lubrizol decision to allow licensees, after rejection of the underlying license, to decide whether to continue to use the intellectual property or terminate the license, provided they satisfied certain conditions. The Bankruptcy Code defines intellectual property as including copyrights, patents and trade secrets but conspicuously omits trademarks from the definition. The Seventh Circuit Court explained that as a result of the omission, trademarks are not affected one way or the other.

As a result of the addition of Section 365(n) the Court held that the trustee’s rejection of the Lakewood Contract did not abrogated CAM’s rights as licensee of the trademarks and entered judgment in CAM’s favor. Section 365(g) classifies rejection as a breach, just as it would be outside of bankruptcy, where the other party’s rights remain in place. The debtor’s unfulfilled obligations are converted to damages and are treated as a prepetition obligation.

While the recent Seventh Circuit opinion is critical of the Fourth Circuit and its holding that the licensee only has a claim for money damages upon rejection, what does this decision mean to trademark licensees or to lenders relying upon a license agreement as a part of its collateral?

The Seventh Circuit views the rejection of a license agreement as a breach and treats the breach the same way under the Bankruptcy Code as it would be in a non-bankruptcy situation. When the licensor breaches, the licensee continues to retain its right to use the trademark under the terms of the license. Parties entering into trademark licenses may want to state that upon rejection in bankruptcy they will be able to continue using the mark through the end of the contract term. Lenders taking a security interest in trademarks may want to consider whether the trademarks could be an asset in a bankruptcy in the Seventh Circuit or elsewhere. Because this issue has been addressed in only two of the circuits, the outcome elsewhere is very uncertain.