All you trademark lawyers better sit down, because this may come as a shock: You are not “intellectual property” lawyers . . . at least not according to Section 11 U.S.C. § 101(35A) of the Bankruptcy Code, which intentionally omits trademarks from the definition of “intellectual property.”
Owing in part to this omission, there is an ongoing circuit split as to the rights of a trademark licensee when a licensor declares bankruptcy. Can the licensee keep using the licensed mark even if the debtor-in-possession of the bankrupt estate rejects the license? The Seventh Circuit says yes. The First Circuit says no.
But this split could be resolved soon. Last week, a petition for writ of certiorari to the Supreme Court was filed in Mission Products Holdings, Inc. v. Tempnology, LLC.
The Statutory Framework: Why Trademarks are not Intellectual Property
When a company files for protection under the Bankruptcy Code, the debtor-in-possession or trustee has the right to “assume” or “reject” contracts (see 11 U.S.C. § 365(a)). Rejection allows the debtor to purge itself of contractual obligations that will hinder reorganization. The rejected contract is considered breached, but the breaching party cannot be forced to perform the contract. So, for example, say Party A agrees to supply Party B with widgets, but then Party A files for bankruptcy, seeking to reorganize in such a way that it rids itself of its widget-making obligations. The Court may allow the Party A to “reject” that widget contract. Party B would have a claim for damages for breach of the widget contract (a claim that may or may not be worth anything), but Party B would not be able to compel Party A’s estate to make more widgets.
Prior to 1988, this power to “reject” contracts led to some harsh results. For instance, a company could enter into a long-term license for the use of a patented process, build its business in reliance on that license, and lose the entire enterprise practically overnight if the licensor declared bankruptcy and rejected the license.
In 1988, Congress sought to avoid some of these harsh results by adding an exception to the Bankruptcy Code. This exception, codified at 11 U.S.C. § 365(n), provides that if the debtor rejects an intellectual property license, the licensee may treat the contract as terminated and sue for breach or, in the alternative, elect to “retain its rights” for the duration of the contract, including any rights of exclusivity. In exchange, the licensee must continue to perform under the license. The Bankruptcy Code’s definition of the “intellectual property” covered by this exception includes patents, patent applications, copyrights, trade secrets, plant varieties, and even “mask work,” that obscure category of semiconductor chip IP buried in Chapter 9 of the Copyright Act.
But not trademarks. Why? We don’t know for sure, but a 1988 Senate Report noted that trademark licensing relationships rely to a large extent on the notion that the licensor has supervision or control over the quality of the products sold by the licensee under the mark. What happens to that important quality-control function when the licensor is no longer in the picture . . . or no longer even exists? The Senate Report indicated that Congress would postpone action on the issue of trademark licenses to allow for “more study” and “the development of equitable treatment of this situation by bankruptcy courts.”
Ok, so the trademark licensee, unlike a patent or copyright licensee, is not expressly provided with the option to “retain its rights” under the rejected license. But what does that mean as a practical matter? More to the point, does the trademark licensee have to stop using the mark? The answer to that question depends on the circuit.
The Seventh Circuit Approach: Sunbeam. v. Chicago American
Lakewood Engineering sold box fans, but it was losing money on each fan. Chicago American Manufacturing thought it could make the fans at a profit using Lakewood’s intellectual property, so the two companies entered into an agreement whereby Lakewood supplied the fan motors and licensed the LAKEWOOD mark to Chicago American. Only a few months into the contract, Lakewood’s creditors forced it into involuntary bankruptcy. Sunbeam Products purchased the Lakewood assets, and then rejected the agreement with Chicago American. Despite the rejection, Chicago American kept making the fans, and kept using the LAKEWOOD mark.
Sunbeam argued that, because the Bankruptcy Code did not give the licensee the option to “retain its rights” in a trademark license, that meant that Chicago American had to stop using the LAKEWOOD mark. In 2011, a bankruptcy judge in the Northern District of Illinois disagreed and, apparently relying on the 1988 Senate Report’s reference to “equitable treatment,” ruled that Chicago American could keep using the Lakewood marks on “equitable grounds.”
On appeal, the Seventh Circuit rejected the bankruptcy judge’s application of equity, but affirmed on other grounds. The Court held that, since Chapter 11 did not mention trademarks in its definition of “intellectual property,” it had nothing to say about trademark licenses either way (as Judge Easterbrook put it, “an omission is just an omission”). Just because a license is rejected in bankruptcy, that doesn’t mean that the licensee’s rights have been “vaporized.” Rather, all it means is that the contract has been breached by licensor.
And what happens when a trademark license is breached by the licensor? According to the Seventh Circuit, that breach does not automatically “terminate a licensee’s right to use intellectual property.” For example, what would have happened if, before the bankruptcy, Lakewood had breached the contract by failing to supply the fan motors to Chicago American? Chicago American’s rights to use the LAKEWOOD mark would not have automatically disappeared. According to the Court, Chicago American could have purchased fan motors elsewhere, made the fans using the LAKEWOOD trademark, and then sued Lakewood for the cost of the replacement motors. The Seventh Circuit held that the result should be the same in the bankruptcy context. Therefore, Chicago American could continue to use the LAKEWOOD mark.
The First Circuit Approach: Mission Products Holdings, Inc. v. Tempnology
But the First Circuit, addressing a very similar set of facts earlier this year, disagreed. Tempnology, LLC, doing business under the DR. COOL and COOLCORE marks, made specialized sports accessories (e.g., towels and socks) that stayed cool during exercise. Tempnology licensed certain intellectual property to Mission Products, including trademark and patent rights, as well as exclusive distribution rights. After Tempnology filed for bankruptcy protection, the debtor-in-possession of the Tempnology estate rejected that license.
The First Circuit agreed that rejection of the license does not “vaporize” the licensee’s rights. However, that did not mean that the licensee could continue to use the marks; rather, the licensee’s right is converted into a pre-petition damages claim. The Court justified its interpretation of the statute in large part on policy grounds; it expressed concern that a licensee’s unfettered right to use a mark against the will of the licensor, where that licensor has filed for bankruptcy, would undercut the quality-control function of trademark law, place significant burdens on reorganization, and deny the licensor the full protection of the bankruptcy process.
Judge Torruella, dissenting in part, pointed out that the Bankruptcy Code is meant to provide protection for creditors as well as debtors. To advance both sets of rights, Judge Torruella argued, courts should address the disposition of trademark licenses with equitable considerations in mind, just like the 1988 Senate Report advised.
Mission Products’ Cert. Petition
On June 11, 2018, Mission Products filed a petition for writ of certiorari. The petition urges the Supreme Court to follow the Seventh Circuit’s approach, and articulates the question presented as:
Whether, under §365 of the Bankruptcy Code, a debtor-licensor’s “rejection” of a license agreement— which “constitutes a breach of such contract,” 11 U.S.C. §365(g)—terminates rights of the licensee that would survive the licensor’s breach under applicable nonbankruptcy law.
A second issue on appeal concerns whether the exclusive distribution right granted to Mission Products is an “intellectual property right” under the Bankruptcy Code, where the subject matter of the distribution right is a patented invention. A response to the petition is due July 12, 2018.