“Crumbs” of Hope for Trademark Licensees

By: Jessica Mendelson

You are a trademark licensee, and your licensor suddenly declares bankruptcy. Then, to make matters worse, the bankruptcy trustee rejects your licensing agreement. What does this mean for you? Although intellectual property rights are protected under Section 365(n) of the Bankruptcy Code, trademarks are not covered under this provision, calling into question the trademark licensee’s right to continue to use the mark where the licensor has gone into bankruptcy and the license has been rejected by the bankruptcy trustee. However, a recent New Jersey bankruptcy court decision suggests that trademark licensees may avail themselves of the protections of Section 365(n) after all. In the case of In re Crumbs Bake Shop Inc., Case No. 14-24287 (Bankr. D. N.J. Oct. 31, 2014) (ECF No. 288), the court did what Congress failed to do, finding that trademark licensees are entitled to protection under Section 365(n) of the Bankruptcy Code, and allowing licensees to continue to use their intellectual property following the rejection of their licensing agreements by a bankruptcy trustee.

Trademarks and Bankruptcy
When an entity files for bankruptcy, all of its properties, including intellectual property, become part of the bankruptcy estate available to creditors. Under traditional bankruptcy law, contracts are either considered executory or non-executory. The key distinction between these types of contracts is that an executory contract can be rejected by the bankruptcy trustee, while a non-executory contract cannot. In determining whether a contract is executory, the court looks to whether the parties to the contract have ongoing performance obligations: if so, the contract is considered executory, and can be rejected. When a contract is rejected, the creditor may only sue for damages, and cannot sue for specific performance. For trademark licensees, however, this creates a problem: if a trademark licensing agreement is rejected in a bankruptcy proceeding, the licensee would lose the right to use the mark in commerce and with it, significant business investments and profits.

The Traditional Approach under Lubrizol
Traditionally, licensees whose intellectual property licenses were rejected as executory contracts lost their rights under the license to use the trademark. In the widely cited and relied on case, Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc.,756 F.2d 1043 (4th Cir. 1985), the Fourth Circuit held that a non-exclusive patent licensee whose patent license had been rejected as an executory contract could not continue to use the technology following the rejection. According to the Fourth Circuit, the Bankruptcy Code only permitted the licensee to sue for damages, rather than specific performance.

In response to the Lubrizol ruling, Congress enacted the Intellectual Property Licenses in Bankruptcy Act (“IPLBA”), which provided intellectual property licensees with special protections to ensure their rights continued in the event of bankruptcy. However, Congress’ definition of intellectual property for purposes of this statute inexplicably excluded mention of trademarks, leading to significant confusion among the courts in determining how to analyze such licensing agreements in the event of bankruptcy.

With no protection under Section 365(n) and with the Lubrizol decision repeatedly adopted in bankruptcy cases dealing with trademark licenses, trademark licensees have continued to face the possible loss of license rights to a trademark if the licensor files for bankruptcy and the trustee rejects the trademark license as an executory contract.

The Crumbs Approach
The case of In re Crumbs Bake Shop Inc., Case No. 14-24287 (Bankr. D. N.J. Oct. 31, 2014) (ECF No. 288), is noteworthy in suggesting a willingness to extend 365(n) to trademark licenses. There, the debtors sold cupcakes, among other baked goods, and licensed the rights to their trademarks from Crumbs. When Crumbs filed for bankruptcy in 2014, they filed a motion to sell almost all of their assets to a buyer, Lemonis Fischer Acquisition Company LLC. Once the sale was approved, the debtors’ bankruptcy trustee moved to reject certain executory contracts, including the license agreements.

Rather than adopt the traditional Lubrizol approach in Crumbs, Judge Kaplan held that licensees whose trademark licenses had been rejected were entitled to 365(n) protection, and thus, could continue to use their trademarks following rejection. Relying on principles of equity, the court determined that Congress did not mean to outright exclude trademarks under 365(n) but instead, the bankruptcy courts could decide on a case by case basis whether the licensee could rely on section 365(n) to protect their rights to use the trademarks following a rejection.

In making this decision, the court relied on two well-known circuit court decisions: In Re Exide, 607 F.3d 957 (3d Cir. 2010) and Sunbeam Products, Inc. v. Chicago American, Mfg., 686 F. 3d 372 (7th Cir. 2012). In particular, Judge Kaplan relied on Judge Ambro’s concurring opinion in In Re Exide, where the Third Circuit found a perpetual, exclusive, royalty free trademark license to be non-executory, and thus, could not be rejected. According to Judge Kaplan, Judge Ambro’s logic required the courts to decide on a case by case basis whether trademark licensees may retain their rights under 365(n). In making this decision, the court also addressed, but ultimately declined to follow, a Seventh Circuit case, Sunbeam. Sunbeam also held that a bankruptcy trustee's rejection of the license does not cut off the licensee's ability to continue to use the licensed trademark. However, the Seventh Circuit relied on Section 365(g) of the Bankruptcy code and not Section 365(n). Unlike §365(n), §365(g) characterizes the rejection as a breach, rather than a termination, allowing the non-breaching party’s rights to remain in place and providing the non-breaching party with a claim for damages.

The Crumbs court ultimately rejected the Seventh Circuit’s approach, opting instead to follow Judge Ambro’s concurrence from In Re Exide. In doing so, the court ultimately found that it would be inequitable to deny the licensees the rights to use the trademarks following the debtors’ rejection, because the debtors “bargained away” those rights, and “allowing a licensor to take back trademark rights it bargained away. . . makes bankruptcy more a sword than a shield, putting debtor-licensors in a catbird seat they often do not deserve.” Id. Furthermore, the court found that the debtors were not permitted to sell the trademark rights without the licensee’s informed consent, and any royalties generated as a result of the licensees’ 365(n) election would go to the debtors, not the buyer or the licensing agent.

Conclusion
Unless the Crumbs decision is adopted broadly or Congress passes a bill to include trademarks within Section 365(n)’s protections, trademark licensees whose licenses are rejected by a bankruptcy trustee are not out of the woods yet. Trademark licensees ought to be aware that their intellectual property rights may be limited by the current state of the law and should continue to take steps to protect those rights, such as acquiring the trademarks if possible, or taking a security interest in the licensed marks. Alternatively, licensees may also want to structure their payments so as to create a disincentive for the trustee to reject the license.