Court Rules That Trademark Licensees Are Protected By Section 365(N) And That Licensees’ Rights Cannot Be Extinguished By Sale Free And Clear Absent Consent

Protections added to the Bankruptcy Code in 1988 that give some intellectual property ("IP") licensees the right to continued use of licensed property notwithstanding rejection of the underlying license agreement do not expressly apply to trademark licenses. As a consequence, a trademark licensee faces a great deal of uncertainty concerning its ability to continue using a licensed trademark if the licensor files for bankruptcy. This uncertainty has been compounded by inconsistent court rulings addressing the ramifications of rejection of an executory trademark license by a chapter 11 debtor-in-possession ("DIP") or a bankruptcy trustee.

In a positive development for trademark licensees, a New Jersey bankruptcy court ruled in In re Crumbs Bake Shop, Inc., 2014 BL 309030 (Bankr. D.N.J. Oct. 31, 2014), that trademark licensees are entitled to the protections of section 365(n) of the Bankruptcy Code, notwithstanding the omission of "trademarks" from the Bankruptcy Code definition of "intellectual property." The court also held that a sale of assets "free and clear" under section 363(f) does not trump or extinguish the rights of a third-party licensee under section 365(n), unless the licensee consents.

Special Rules Governing Rejection of Certain IP Licenses in Bankruptcy

Absent special statutory protection, the rejection by a DIP or trustee of an IP license, particularly a license of IP that is critical to a licensee's business operations, could have a severe impact on the licensee's business and leave the licensee scrambling to procure other IP to keep its business afloat. This concern was heightened by the Fourth Circuit's ruling in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), that if a debtor rejects an executory IP license, the licensee loses the right to use any licensed copyrights, trademarks, and patents.

In order to better protect such licensees, Congress amended the Bankruptcy Code in 1988 to add section 365(n). Under section 365(n), licensees of some (but not all) IP licenses have two options when a DIP or trustee rejects the license. The licensee may either: (i) treat the agreement as terminated and assert a claim for damages; or (ii) retain the right to use the licensed IP for the duration of the license (with certain limitations). By adding section 365(n), Congress intended to make clear that the rights of an IP licensee to use licensed property cannot be unilaterally cut off as a result of the rejection of the license.

However, notwithstanding the addition of section 365(n) to the Bankruptcy Code, the legacy of Lubrizol endures—since by its terms, section 365(n) does not apply to trademark licenses and other kinds of "intellectual property" outside the Bankruptcy Code's definition of the term. In particular, trademarks, trade names, and service marks are not included in the definition of "intellectual property" under section 101(35A) of the Bankruptcy Code. Due to this omission, courts continue to struggle when determining the proper treatment of trademark licenses in bankruptcy.

Circuit Courts Weigh In on Trademark Licenses After Lubrizol

Several federal courts of appeal have had the opportunity during the last few years to weigh in on how rejection in bankruptcy of a trademark license impacts the rights of the nondebtor licensee.

For example, in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010), a Third Circuit panel could have considered but sidestepped the issue, concluding that a trademark license agreement was not executory because the nondebtor licensee had materially completed its performance under the agreement prior to the debtor's bankruptcy filing. Thus, the court held that the agreement could not be assumed or rejected at all. As a consequence, the Third Circuit never addressed whether rejection of the agreement (had it been found to be executory) would have terminated the licensee's right to use the...