In Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, Case No. 11-3920, 2012 WL 2687939 (7th Cir. July 9, 2012) (“Sunbeam”), the Seventh Circuit split with the Fourth Circuit by issuing a decision that could have far-reaching implications for the bankruptcy rights of trademark licensees and for all licensees of intellectual property. The Seventh Circuit affirmed, on direct appeal, a decision of the Bankruptcy Court for the Northern District of Illinois (the Bankruptcy Court), which held that a trademark licensee whose licensor rejected the license agreement in bankruptcy could continue to use the licensed trademark. As a result of this recent decision, in the Seventh Circuit, a trademark licensee has comparable protections afforded to licensees of other forms of intellectual property under Section 365(n), which provides licensees the option either to retain their license rights as they existed on the bankruptcy petition date and continue performance under the agreement, or to treat the license as terminated.
Lakewood Engineering & Manufacturing Co. (Lakewood) was one of the three largest manufacturers of box fans in the United States. In 2008, Lakewood entered into a supply agreement with its manufacturer, Chicago American Manufacturing (CAM), under which CAM had rights to use Lakewood’s patents and trademarks to produce and distribute box fans for Lakewood in accordance with the supply agreement. On February 19, 2009, several of Lakewood’s creditors commenced an involuntary bankruptcy against it. Thereafter, the Chapter 7 trustee for Lakewood rejected the supply agreement with CAM under Section 365(a) of the Bankruptcy Code and sold certain of Lakewood’s assets, including its patents and trademarks, to an affiliate of Sunbeam Products.
Initially, the Bankruptcy Court addressed whether CAM’s right to use Lakewood’s trademarks survived Lakewood’s rejection of the supply agreement.1 Consistent with past cases and legislative history, the Bankruptcy Court noted that Section 365(n) did not apply to trademark licenses.2 However, the Bankruptcy Court adopted the rationale of Judge Ambro’s concurrence in In re Exide Technologies and determined “on equitable grounds” that the licensee was not stripped of its “fairly procured trademark rights.”3
The Seventh Circuit’s Decision
The Seventh Circuit affirmed the Bankruptcy Court’s ruling, but rather than basing its holding on the "equitable powers" of the Bankruptcy Court, held that rejection of the license agreement constitutes a breach of the agreement by the debtor-licensor but does not mean "that any rights of the [non-debtor licensee] have been vaporized." In reaching this conclusion, the Seventh Circuit disagreed with the Fourth Circuit’s landmark decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), in which the Fourth Circuit, prior to the enactment of Section 365(n), found that when a debtor rejected a patent license in bankruptcy, the patent licensee lost its license rights.
In Lubrizol, the Fourth Circuit reasoned that by rejecting an executory patent license, the debtor-licensor avoided the licensee’s right to use the licensed patent. The decision was based on Section 365(g) of the Bankruptcy Code, which provides that, unless an executory contract previously has been assumed by the debtor, rejection of an executory contract (such as an intellectual property license) under Section 365(a) of the Bankruptcy Code constitutes a breach of the contract as of the bankruptcy petition date and provides certain remedies for such breach. The Lubrizol court held that under Section 365(g), a licensee could treat a debtor-licensor’s rejection as a breach and seek money damages; however, the licensee could not "seek to retain its contract rights in the technology by specific performance even if that remedy would ordinarily be available upon breach of this type of contract."4 It was this adverse effect on licensees and the concurrent chilling effect on the development of technology that prompted Congress to enact Section 365(n) of the Bankruptcy Code.
In Sunbeam, the Seventh Circuit held that CAM, as licensee, was entitled to continue using the Lakewood trademarks, despite Lakewood’s rejection of the supply agreement that granted the trademark license. Although Congress enacted Section 365(n) of the Bankruptcy Code to protect the rights of patent and copyright licensees to continue to use licensed intellectual property after rejection, Congress did not include trademarks within the scope of Section 365(n). Congress’s omission of trademarks from the definition of "intellectual property" referenced in Section 365(n) did not mean, in the Seventh Circuit’s view, that Congress intended to adopt Lubrizol where trademark licenses were involved.
The Seventh Circuit went on to hold that Lubrizol’s analysis was based on an incorrect reading of Section 365(g) of the Bankruptcy Code. Outside of bankruptcy, the Seventh Circuit noted, a breach of the contract by the trademark licensor would not operate to strip the licensee of its rights. The Seventh Circuit held that the result was no different in bankruptcy — rejection of a license agreement relieved the debtor-licensor of its obligation to perform under the license, but did not otherwise strip the licensee of its bargained-for rights.5
Key Takeaways for Licensees
The Sunbeam decision means that, at least in the Seventh Circuit, trademark licensees do not lose their rights simply because the licensor files for bankruptcy and rejects the license under Section 365 of the Bankruptcy Code. The Sunbeam case could result in benefits to licensees of other intellectual property as well, beyond those rights protected by Section 365(n) of the Bankruptcy Code. For example, consistent with prior case law holding that rejection of an executory contract constitutes a breach of the contract rather than a termination or rescission of the non-debtor counterparty’s rights under the contract, the Seventh Circuit’s decision could be extended to argue that a licensee’s use rights in foreign patents (which, like trademarks, may be outside the scope of Section 365(n)) survive rejection, because a debtor-licensor’s rejection of a contract constitutes merely a breach of the contract rather than a termination or rescission of the non-debtor counterparty’s contractual rights.
Moreover, debtor-licensors interested in selling trademark assets in bankruptcy should consider the Sunbeam decision, as, absent the consent of the licensee, it may limit their ability to sell these assets free and clear of a licensees’ trademark rights — even in situations where the agreement granting the trademark license has been rejected. Accordingly, debtors looking to maximize value from the disposition of a trademark portfolio may not be able to realize the same value in a jurisdiction that follows Sunbeam as in a jurisdiction that follows Lubrizol.
Although Lubrizol’s holding on this issue has been criticized by legal scholars, the Seventh Circuit’s decision in Sunbeam represents the first time that a court of appeals has rejected Lubrizol’s holding regarding the legal consequence of a debtor-licensor’s rejection of a license agreement. We expect that the Seventh Circuit’s analysis in Sunbeam on the consequences of contract rejection may prove persuasive outside of the Fourth Circuit.
1 Before even reaching the issue of whether rejection terminated CAM’s rights to use the trademarks, the Bankruptcy Court held that, as a matter of contract interpretation, CAM’s remedy for breach was not limited to retaining certain Lakewood equipment but also provided CAM a trademark license to sell the fans that were the subject of the agreement. As the Seventh Circuit noted, nothing about the debtor-licensor’s rejection of an agreement “implies that any rights of the other contracting party have been vaporized.” Sunbeam, 2012 WL 2687939, at *3.
2 Section 365(n) was enacted in response to Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), in which the Fourth Circuit held that a licensee of patents, copyrights and trademarks lost its rights if the trustee or debtor in possession rejected a license under the Bankruptcy Code under which the debtor was the licensor. Section 365(n) provides that if the debtor is the licensor under a patent or copyright license that is rejected in bankruptcy, the licensee has the option to either retain its rights as they existed on the bankruptcy petition date and continue its performance, or to treat the license as terminated. On its face, Section 365(n) does not apply to trademarks. See, e.g., In re Centura Software Corp., 281 B.R. 660, 670-71 (Bankr. N.D. Cal. 2002) (referencing legislative history); HQ Global Holdings, 290 B.R. 507, 513 n.5 (Bankr. D. Del. 2003).
3 In re Lakewood Engineering & Manufacturing Co., Inc., 459 B.R. 306, 344-47 (Bankr. N.D. Ill. 2011) (referencing In re Exide Technologies, 607 F.3d 957 (2010) (Ambro, J., concurring)).
4 Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d at 1048.
5 “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.” Sunbeam, 2012 WL 2687939, *3 (7th Cir. July 9, 2012).
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