Property, intangible

a blog about ownership of intellectual property rights and its licensing

A Circuit Split That Isn’t, At Least Not Yet

Here is a really interesting decision in a bankruptcy case. If those words make you cringe, stop reading now because we’re going into the weeds.

The question is what rights a trademark licensee has when its licensor declares bankruptcy. As a general rule, the trustee can elect to reject an e​xecutory contract under § 365(a). However, because the loss of a license can be so devastating to a licensee, there is a special section of the Bankruptcy Code, § 365(n), that allows licensees to continue to use licensed trade secrets, patents, copyrights and mask works. Trademark are absent from the list, but that wasn’t an oversight. As explained in an earlier post, the quality control requirement for a trademark license meant these licenses were different in character, so trademark rights were excluded from the provision. The Senate Report explained, “Since these matters could not be addressed without more extensive study, it was determined to postpone congressional action in this area and to allow the development of equitable treatment of this situation by bankruptcy courts.” I guess we’re getting that treatment, because the Court of Appeals for the First Circuit just issued an opinion, Mission Product Holdings, Inc. v. Tempnology, LLC, expressly disagreeing with the Seventh Circuit opinion in Sunbeam Products, Inc. v. Chicago American Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).

In Mission Product, the debtor-in-possession/licensor Tempnology sought to reject an agreement with Mission. There were three license grants in the agreement considered by the bankruptcy court: an exclusive distribution license, a non-exclusive “intellectual property” license that excluded trademarks, and a trademark license.

The distribution license gave Mission the exclusive right to distribute certain products manufactured by Tempnology within a specific market (§ 1 if you’re interested). The “intellectual property” license (§ 15(b)) granted Mission the right to make new product, i.e., a “non-exclusive, irrevocable, royalty-free, fully paid-up, perpetual, worldwide, fully-transferable license with the right to sublicense (through multiple tiers), use, reproduce, modify, and create derivative work based on and otherwise freely exploit the [Tempnology] Property in any manner for the benefit of [Mission], its licensees and other third parties.” By the time we reach this decision, Tempnology had conceded that the rejection of the agreement did not apply to this “intellectual property” license grant. The trademark license (§ 15(d)) was a “non-exclusive, non-transferable, limited license” for the term of the Agreement “to use [Tempnology’s] trademark and logo (as well as any other Marks licensed hereunder) for the limited purpose of performing its obligations hereunder, exercising its rights and promoting the purposes of this Agreement.”

Mission unsuccessfully argued that the distribution license was an intellectual property license that should be exempt from rejection. No dice, though:

We start in section 365(a) with the universe of all executory contracts that a debtor may seek to reject; section 365(n)(1) then focuses on a subset of that universe (“executory contract[s] under which the debtor is a licensor of a right to intellectual property”); subsection (n)(1)(B) then says what happens to intellectual property rights granted under such contracts (the licensee may “retain its rights”); and the parenthetical merely makes clear that those rights “to such intellectual property” include any exclusivity attributes of those rights. In this manner, subsection (n)(1)(B) protects, for example, an exclusive license to use a patent, but does not protect an exclusive right to sell a product merely because that right appears in a contract that also contains a license to use intellectual property. … Given that the right to sell a product is clearly not included within the statute’s definition of intellectual property, we are not going to treat it as such merely because of a coincidental practical effect it may have in limiting the scope of the manner in which a patent might be exploited .…

Whether one can reject a trademark license is where the First Circuit differs with the Seventh Circuit. Acknowledging that § 365(n) doesn’t apply:

There is, though, an alternative argument [to §365(n)] for finding that a right to use a debtor’s trademark continues post-rejection. That argument rests not on equitable dispensation from rejection, but instead on an exploration of exactly what rejection means. The argument, as accepted by the Seventh Circuit in Sunbeam, runs thus: Under section 365(g), section 365(a) rejection constitutes a breach of contract that “frees the estate from the obligation to perform.” Sunbeam, 686 F.3d at 377. “But nothing about this process implies that any rights of the other contracting party have been vaporized.” Id. Therefore, reasoned the Seventh Circuit, while rejection converts a debtor’s duty to perform into a liability for pre-petition damages, it leaves in place the counterparty’s right to continue using a trademark licensed to it under the rejected agreement. In so reasoning, the Seventh Circuit found itself unpersuaded by the contrary approach taken by the Fourth Circuit in Lubrizol. Sunbeam, 686 F.3d at 378; see also In re Exide Techs., 607 F.3d 957, 964-68 (3d Cir. 2010) (Ambro, J., concurring).

Of course, to be precise, rejection as Congress viewed it does not “vaporize” a right. Rather, rejection converts the right into a pre-petition claim for damages. Putting that point of vocabulary to one side, and leaving open the possibility that courts may find some unwritten limitations on the full effects of section 365(a) rejection, we find trademark rights to provide a poor candidate for such dispensation. Congress’s principal aim in providing for rejection was to “release the debtor’s estate from burdensome obligations that can impede a successful reorganization.” Bildisco & Bildisco, 465 U.S. at 528. Sunbeam therefore largely rests on the unstated premise that it is possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark. See Sunbeam, 686 F.3d at 377. Judge Ambro’s concurrence in In re Exide Technologies shares that premise. See 607 F.3d at 967 (Ambro, J., concurring) (assuming that the bankruptcy court could allow the licensee to retain trademark rights even while giving the debtor “a fresh start”).

Careful examination undercuts that premise because the effective licensing of a trademark requires that the trademark owner — here Debtor, followed by any purchaser of its assets — monitor and exercise control over the quality of the goods sold to the public under cover of the trademark. See 3 J. Thomas McCarthy, McCarthy on Trademarks & Unfair Competition § 18:48 (5th ed. 2017) (“Thus, not only does the trademark owner have the right to control quality, when it licenses, it has the duty to control quality.”). Trademarks, unlike patents, are public-facing messages to consumers about the relationship between the goods and the trademark owner. They signal uniform quality and also protect a business from competitors who attempt to profit from its developed goodwill. See Societe Des Produits Nestle, S.A. v. Casa Helvetia, Inc., 982 F.2d 633, 636 (1st Cir. 1992). The licensor’s monitoring and control thus serve to ensure that the public is not deceived as to the nature or quality of the goods sold. Presumably, for this reason, the Agreement expressly reserves to Debtor the ability to exercise this control: The Agreement provides that Debtor “shall have the right to review and approve all uses of its Marks,” except for certain pre-approved uses. Importantly, failure to monitor and exercise this control results in a so-called “naked license,” jeopardizing the continued validity of the owner’s own trademark rights. McCarthy, supra, § 18:48; see also Eva’s Bridal Ltd. v. Halanick Enters., Inc., 639 F.3d 788, 790 (7th Cir. 2011) (“[A] naked license abandons a mark.”); Restatement (Third) of Unfair Competition § 33 (“The owner of a trademark, trade name, collective mark, or certification mark may license another to use the designation. … Failure of the licensor to exercise reasonable control over the use of the designation by the licensee can result in abandonment . …”).

The Seventh Circuit’s approach, therefore, would allow Mission to retain the use of Debtor’s trademarks in a manner that would force Debtor to choose between performing executory obligations arising from the continuance of the license or risking the permanent loss of its trademarks, thereby diminishing their value to Debtor, whether realized directly or through an asset sale. Such a restriction on Debtor’s ability to free itself from its executory obligations, even if limited to trademark licenses alone, would depart from the manner in which section 365(a) otherwise operates. And the logic behind that approach (no rights of the counterparty should be “vaporized” in favor of a damages claim) would seem to invite further leakage. If trademark rights categorically survive rejection, then why not exclusive distribution rights as well? Or a right to receive advance notice before termination of performance? And so on.

So the First Circuit held that the trademark license could be rejected.

But hold on, these two cases are not about the same kind of trademark license. In Sunbeam, the licensor, in financial distress, asked the licensee to manufacture 1.2 million box fans. The licensee would only do so with a guarantee that, if the licensor didn’t pay for the fans, the licensee could sell them itself and keep the proceeds. Three months later the licensor was put into involuntary bankruptcy and the trustee sold the assets of the business to Sunbeam Products. Sunbeam didn’t want the licensee to sell the fans so the trustee rejected the contract, the licensee nevertheless sold the fans, and Sunbeam brought an adversary action. Thus, the trademark license in Sunbeam was for a known quantity of fans presumably manufactured to the quality standards of the licensor and no future use after the fans were sold. In contrast in In re Tempnology, Mission has an ongoing license to create whatever products it wants and be immune from a charge of patent, trade secret or copyright infringement brought by Tempnology. But it wanted more, it wants to use the trademark for these products too. The First Circuit reasonably balked at the concept that Tempnology would have to choose between granting a naked license or the burden of continuing to exercise quality control when the point of the bankruptcy was to rid itself of this particular licensee, one Tempnology thought was the reason for its financial woes.

We can recognize the validity of both positions. In Sunbeam, the successor-in-interest to the trademark rights did not have to make that choice; the goods were of known quality and the trademark license of limited term and purpose, to sell 1.2 million fans. In Mission, the licensee, by virtue of retaining the “intellectual property” license, could create new products without any kind of limitation. The difference in the cases is the parameters of the license granted, confirming it was wise on the part of Congress to avoid making any hard-and-fast rules about trademarks.

Mission Product Holdings, Inc. v. Tempnology, No. 16-9016 (1st Cir. Jan 12, 2018).

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