Key Tool for Non-Bankrupt Licensees
In 1988 Congress amended the Bankruptcy Code to add section 365(n) and a definition of “intellectual property” in order to protect the rights of licensees of intellectual property in response to the decision of the Fourth Circuit Court of Appeals in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers Inc. which allowed termination of an IP license by a bankrupt licensor, even where doing so drastically disrupted the licensee’s operations. To mitigate this risk, section 365(n) provides that licensees of “intellectual property” have two options when a debtor or trustee 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 intellectual property for the duration of the license subject to certain limitations (including that the licensee pay all royalty payments under the terms of the contract and that the licensee will be deemed to waive certain rights of setoff and any allowable post-petition claim arising from the performance of the contract.) However, the term “intellectual property” does not include trademarks, tradenames, logos and certain other intellectual property and as a result the rights of trademark licensees in the case of rejection of a trademark license agreement have remained unclear.
The recent decision of the Bankruptcy Appellate Panel for the First Circuit (the “BAP”) in Mission Products Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC) appears to have found a middle ground for licensees of trademarks from bankrupt licensors. On appeal, the BAP agreed with the bankruptcy court that section 365(n) does not apply to trademarks, but also held that notwithstanding the debtor’s rejection of the distribution agreement, the licensee’s rights in trademarks and logos continued under the license agreement and applicable non-bankruptcy law.
In In Re Crumbs Bake Shop the bankruptcy court for the District of New Jersey held that, based on the equities of a case, a court may hold that section 365(n) applies to trademark licenses. In Crumbs the purchaser of substantially all of the debtor’s assets, including its trademarks but not its trademark licenses, maintained that the licensees’ rights under section 365(n) were extinguished in connection with the free and clear sale because the licensees failed to object to the sale. The court found that the notice of the sale was inadequate with respect to the treatment of trademarks and licenses and therefore held that in the absence of the licensees’ consent, a sale under section 363 of the Bankruptcy Code does not trump the licensees’ rights under section 365(n).
The existence of section 365(n) and its questionable applicability to trademarks mean three things for licensee clients: (i) when negotiating an IP license of any kind, it is essential that it contains requisite language allowing the licensee the full benefits of section 365(n) if the licensor were to become a bankruptcy debtor, (ii) perform appropriate due diligence on your counterparty to reduce the likelihood of financial problems coming into play, including the risk of loss of use of a trademark if the licensor becomes a debtor and rejects the license agreement, and (iii) if the licensor becomes a debtor, consult with knowledgeable counsel who can help the licensee navigate the bankruptcy process.
Protections Available to Trademark Licensors
While section 365(n) only protects the rights of a debtor’s licensees, other provisions of the Bankruptcy Code address the rights of licensors of a debtors’ trademarks in the case that a debtor seeks to assume or assign a license agreement and the licensor seeks to block such assumption on reputational or other grounds. For example, in In re Trump Entertainment Resorts, Inc., the bankruptcy court for the district of Delaware held that where a licensor did not consent to the assignment of its trademark license, the debtor could not assume the license under section 365(c)(1) of the Bankruptcy Code and accordingly, granted the licensor’s motion to lift the automatic stay imposed upon the debtors’ filing for bankruptcy, so that the licensor could proceed with an action in state court seeking termination of the trademark license agreement.
The bankruptcy court held that the federal trademark law generally bans assignment of trademark licenses absent the licensor’s consent because the identity of the licensee is crucially important to the licensor in order to ensure that all products bearing its trademark are of uniform quality.
Other courts have applied simialr analysis in the case of non-exclusive patent licenses.