Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012)

CASE SNAPSHOT

In a matter of first impression in the Seventh Circuit, the court held that a chapter 7 trustee’s rejection of an executory contract did not terminate the trademark license contained therein.

FACTUAL BACKGROUND

Lakewood Engineering & Manufacturing Co. made and sold a variety of consumer products, including box fans, which were covered by its patents and trademarks. In 2008, losing money on every fan it made, Lakewood contracted their manufacture to Chicago American Manufacturing. The contract authorized CAM to use Lakewood’s patents and put its trademarks on fans while producing fans for the 2009 season. Lakewood would then take orders from retailers, and CAM would ship directly to those customers. Because Lakewood was in financial difficulty, it provided assurances to CAM by authorizing CAM to sell the 2009 run of fans (projected to be 1.2 million fans) for its own account if Lakewood failed to purchase them.

Three months into the contract, Lakewood’s creditors filed an involuntary bankruptcy petition against it, a trustee was appointed, and the trustee decided to sell Lakewood’s business. Sunbeam Products, Inc. bought the assets, including patents and trademarks, but Sunbeam did not want the Lakewood-branded fans that CAM had in inventory, nor did it want CAM to sell those fans in competition with its fans. Thus, the trustee rejected the executory portion of the CAM contract. CAM, however, continued to make and sell Lakewood-branded fans, and Sunbeam filed an adversary action, alleging patent and trademark infringement.

COURT ANALYSIS

The Court of Appeals first noted that section 365(n) of the Bankruptcy Code allows a licensee to continue to use licensed intellectual property after rejection of the license, provided certain conditions are met. "Intellectual property," as defined in section 101(35A), includes patents, copyrights, and trade secrets, but does not mention trademarks. While some courts have inferred that the omission of trademarks from these statutory provisions means that Congress intended to exclude trademark licenses from section 365(n), other courts, including the court here, concluded that Congress intended to leave the question open in order to study the issue further.

The court then examined the statutory provision dealing with rejection of executory contracts, section 365(g). The court examined specifically "the opening proposition: that rejection ‘constitutes a breach of contract.’" The court noted that outside of bankruptcy, a licensor’s breach does not terminate a licensee’s right to use intellectual property. Such a breach would entitle the non-breaching party either to terminate its own performance, or complete performance and seek damages from the breaching party.

Here, CAM had bargained for the security of being able to sell Lakewood-branded fans for its own account if Lakewood defaulted. "Outside of bankruptcy, Lakewood could not have ended CAM’s right to sell the box fans by failing to perform its own duties, any more than a borrower could end the lender’s right to collect just by declaring that the debt will not be paid. What section 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. [N]othing about this process implies that any rights of the other contracting party have been vaporized." The court noted that the trustee had never contended that Lakewood’s contract was subject to rescission and that rejection is not the functional equivalent of a rescission. Rejection "merely frees the estate from the obligation to perform" and has no effect upon the continued existence of the contract. Thus, the court held that rejection of the contract did not terminate the trademark license contained therein.

PRACTICAL CONSIDERATIONS

The court completed the work begun by Congress in section 365(n) and, in doing so, rejected what was left of the holding in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., a 1985 Fourth Circuit case. Even after Congress enacted section 365(n), Lubrizol still stood for the proposition that trademark licensees lose their rights upon the rejection of the trademark license. In reaching the opposite conclusion, the Seventh Circuit has created a split of authority on the issue, though it appears to have the more persuasive argument.