On July 9, 2012, the U.S. Court of Appeals for the Seventh Circuit issued its decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC (“Sunbeam”). It is a landmark opinion for trademark licensees whose licenses are rejected in bankruptcy by trademark owners.
Lakewood Engineering & Manufacturing Co. made and sold a variety of consumer products, including box fans, which were protected by its patents and trademarks. However, Lakewood was losing money manufacturing these fans. So in 2008 Lakewood contracted their manufacture to Chicago American Manufacturing (“CAM”). The contract authorized CAM to practice Lakewood’s patents and put its trademarks on the completed fans. However, because CAM was concerned about Lakewood’s ability to perform under the contract, the parties agreed that CAM would be authorized to sell the 2009 run of box fans for its own account if Lakewood did not purchase them.
Several months later an involuntary bankruptcy case was commenced against Lakewood. A trustee was appointed who decided to sell Lakewood’s business. Sunbeam Products, doing business as Jarden Consumer Solutions, bought Lakewood’s assets, including its patents and trademarks. However, Jarden did not purchase CAM’s inventory of box fans because those fans would compete with Jarden’s own products. The trustee also rejected the executory portion of the CAM contract under §365(a) of the Bankruptcy Code. However, CAM continued to manufacture box fans under the contract. Jarden commenced an adversary proceeding to enjoin CAM from making and selling fans once Lakewood stopped having requirements for them.
The bankruptcy court concluded that as a matter of equity CAM was entitled to make as many fans per Lakewood’s estimate for the entire 2009 selling season. On appeal the district court affirmed and Jarden appealed to the Seventh Circuit Court of Appeals.
Circuit Court Ruling
The Seventh Circuit affirmed, but on different grounds--- finding that rejection of an executory contract constitutes a breach of such contract, but does not terminate the rights of a counterparty to such contract--- or in this case CAM’s right to practice Lakewood’s patents and put its trademarks on completed box fans. The Seventh Circuit rejected the bankruptcy court’s ruling that CAM could continue using the Lakewood marks on “equitable grounds,” noting that what the Bankruptcy Code provides a judge cannot override by declaring that enforcement would be inequitable.
One challenging issued faced by the Seventh Circuit was the efficacy of Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. 756 F. 2d 1043 (4th Cir. 1985) as it relates to trademarks. Lubrizol holds that, when an intellectual property license is rejected in bankruptcy, the licensee loses the ability to use any licensed copyrights, trademarks, and patents. In 1988, however, Congress remedied this harsh result by enacting §365(n) of the Bankruptcy Code which allows licensees to continue using “intellectual property” after rejection, provided that they meet certain conditions.
Unfortunately, intellectual property is defined under §101(35) of the Bankruptcy Code as including patents, copyrights and trade secrets. It does not mention trademarks. According to a Senate committee report Congress wanted to study the trademark issue more carefully before deciding whether or not to include trademarks in the statute. Nothing has happened since 1988 to resolve this matter. Thus, the issue as to whether rejection of intellectual property licenses ends the licensee’s right to use trademarks remained an open issue in many courts ---at least until Sunbeam.
The Seventh Circuit framed the issue as whether Lubrizol correctly understood §365(g) of the Bankruptcy Code, which specifies the consequences of a rejection under §365(a). Relying on a concurring opinion of Third Circuit Judge Ambro in In re Exide Technologies, 607 F. 3d 957 (3rd Cir. 2010), where he concluded that had the contract in question in that case been eligible for rejection under §365(a), the licensee could have continued using the trademarks, the Seventh Circuit thought Lubrizol was mistaken ---noting that rejection constitutes a breach of a contract and that outside of bankruptcy, a licensor’s breach does not terminate a licensee’s right to use intellectual property.
In other words, Lakewood could not have ended CAM’s right to manufacture and sell box fans by failing to perform its own duties. Rejection simply converts the debtor’s contractual obligations into damages and is not the functional equivalent of a recission rendering void the contract and requiring the parties to be put back in the positions they occupied before the contract was formed. Rejection merely frees the estate from the obligation to perform and has absolutely no effect upon the contract’s continued existence.
What are the implications of this decision? First, it clarifies the treatment of trademarks in bankruptcy cases where a licensor rejects an executory contract involving a trademark. Second, Sunbeam creates transparency not only with respect trademarks, but also provides a reasoned analysis as to how the rights of non-debtor parties to rejected exectory contracts should be treated. However, while helpful in framing this issue, Sunbeam does not clarify exactly how other types of executory contracts such as insurance contracts should be treated under the Bankruptcy Code where the insurance contract is rejected in a bankruptcy case.
For example, if the insured rejects an insurance contract, arguably its obligation to perform under the contract ceases since rejection frees the estate from performing. However, rejection has absolutely no effect upon the contract’s continued existence. Thus, the open question is whether the debtor is still required to cooperate with the insurer, assist in the defense of its cases, provide information or make persons available to participate in litigation If the debtor’s obligations to perform end upon rejection, these contractual obligations arguably are over. This result seems at odds with what happens outside of bankruptcy with respect to insurance contracts is a very meaningful way, especially for insurers. The absence of any provisions in the Bankruptcy Code to address this issue suggests that a legislative remedy similar to §365(n) (intellectual property) as noted in Sunbeam and §365(h) (real property leases) seems necessary.