In re XMH Corp., Nos. 10-2596, 10-2597, 10- 2598 and 10-2599 (7th Cir. July 26, 2011)  

CASE SNAPSHOT

The Seventh Circuit Court of Appeals recently answered the following questions: (a) whether, under the Bankruptcy Code, a trademark license is assignable (that is, salable) without the licensor’s permission, in the absence of a clause in the agreement stating that it is assignable (NO); and (b) whether a trademark license can be “implied” in an agreement that does not say it’s a trademark license (NO).

FACTUAL BACKGROUND

The Contract in question was entered into between Western Glove Works (a licensee of the trademark, “Jag Jeans”) and Simply Blue (a subsidiary of XMH Corp.). The Contract provided that Western (the Licensor in this arrangement), “hereby grants” to Blue, the Licensee, which “has been formed for the purpose of designing apparel, sourcing apparel (that is, arranging for the manufacture and importation of apparel), and selling apparel,” a license (that is, a sublicense) “to sell women’s jeanswear bearing the Trademark…[until] December 31, 2002.” The Licensee agreed to pay the Licensor a license fee of 12.5 percent of Blue’s net sales of the trademarked apparel during the period in which the Contract was in effect—a period of two weeks.

The Contract further provided that during the year following the expiration of the trademark license, Western would once again “sell, for its own account, the Trademarked Apparel,” while Blue would provide a variety of services related to that apparel, including sourcing services, marketing and sales services, merchandising services, and customer service. The Licensor would “control and…be financially responsible for all other aspects of the production and sale of the Trademarked Apparel, including, by way of example, purchasing the apparel from Licensee’s sources, setting prices, approving the credit of prospective customers, importation, warehousing, shipping, distribution, invoicing, and collection of accounts.” For these services, Western would pay Blue a fee equal to 30 percent of Western’s “Net Sales of Trademarked Apparel.”  

The Licensee became a chapter 11 debtor, and sought to sell its business and assign the Contract to the purchasers. The bankruptcy judge, persuaded by the Licensor, ruled that the contract could not be assigned to Blue’s purchasers because Western would not consent to the assignment. The Licensee appealed the ruling to the District Court. While this appeal was pending, the Licensee entered into a revised sale agreement with the purchasers, whereby the Licensee would retain title to the Contract but the purchasers would assume all the duties that the Licensee had owed to the Licensor under the Contract, and would receive all the fees to which the Licensee had been entitled. Despite the fact that this amended sale contract was merely an attempt to bypass the Bankruptcy Court’s earlier ruling forbidding assignment, the bankruptcy judge allowed the amendment. The Licensor appealed.

While the Licensor’s appeal was pending, the District Court ruled on the Licensee’s appeal, and held that the bankruptcy judge’s order barring assignment of the original Contract between the Licensor and Licensee was erroneous. This ruling disposed of the Licensor’s appeal, precipitating its appeal to the Court of Appeals.  

COURT ANALYSIS

Section 365(c)(1) of the Bankruptcy Code limits the assignment of an executory contract of the debtor if “applicable law” authorizes the other party to the contract to refuse to accept performance from an assignee “whether or not such contract…prohibits or restricts assignment.” The Contract did not prohibit or otherwise restrict assignment—and if it did, the Bankruptcy Court, under section 365(f), could override the restriction unless “applicable law” entitles the other party to refuse to accept the substitution of the assignee for the assignor. See, FutureSource LLC v. Reuters Ltd., 312 F.3d 281, 286-87 (7th Cir. 2002); In re Midway Airlines, Inc., 6 F.3d 492, 495-96 (7th Cir. 1993). Here, the court noted that trademark law was the “applicable law,” and that if the Contract still included a trademark sublicense when the Licensee “attempted to assign the Contract to the purchasers, it was not assignable.”

The Court of Appeals stated that “it makes sense to make the rule that a trademark license is not assignable without the owner’s express permission a rule of contract law—what is called a ‘default’ rule because it is the rule if the parties do not provide otherwise. … Often the owner of a trademark will find that the most efficient way to exploit it is to license the production of the trademarked good to another company, which may have lower costs of production or other advantages over the trademark’s owner. …The rule that trademark licenses are not assignable in the absence of a provision authorizing assignment is a similarly sensible default rule.”

Because the Contract did not contain a provision authorizing assignment, the Licensee could not have assigned the Contract without the Licensor’s permission before the expiration of the trademark license. However, because the Contract was “explicit that after the expiration of the license to Blue to sell Jag Jeans and pay a license fee to Western the rights in the trademark revert to Western; all the trademarked apparel held by Blue has to be returned to Western; Jag Jeans would henceforth be priced and sold by Western; and the license fee would be replaced by a fee for specific services rendered by Blue. The services were extensive, but Western retained control over ‘all other aspects of the production and sale of the Trademarked Apparel.’”

The Licensor argued that it retained the license and merely sublicensed it, and professed to be fearful that the “sublicensees”—the purchasers of Licensee’s assets, who are the assignees of the service agreement—would not maintain the quality of the trademarked product. The court rejected Western’s “implied” trademark license argument, asking, “if the service agreement is really a trademark license, why did the Contract distinguish between a trademark license and a service agreement and make the former expire in 2003? Western has been unable to answer that question. Maybe a contract regarding a trademark could be a trademark license for some purposes but not others, but this is not argued and we are reluctant to go down that dark path. There is no good reason for courts to wrestle with classification issues in contract cases when it is easy for the contracting parties to resolve the issues themselves. If the Licensor wanted to prevent the Licensee from assigning the service contract to another firm without Licensor’s permission, all it had to do was get the Licensee to agree to designate the Contract as a trademark sublicense, thus triggering the default rule that we have discussed and endorsed. That would have headed off a legal dispute that courts are in a poor position to resolve. It would have been more effective than a clause forbidding assignment because it would have survived bankruptcy; anyway there was no such clause either.”  

The Court of Appeals thus affirmed the lower court’s ruling, permitting the assignment of the trademark-now-service agreement to Blue’s purchasers.  

PRACTICAL CONSIDERATIONS

The contract at issue here turned out to be something less than Western probably had envisioned. While Western had the usual concerns of trademark licensors (quality degradation, for example), it failed to ensure that its contract with Blue would be regarded as a trademark license agreement in court. The court laid out the path that the licensor should have taken—getting the licensee to agree to designate the license/service agreement as a trademark sublicense.