Bankruptcy Code § 365(n) provides significant protections to licensees under intellectual property licenses that are rejected by debtor-licensors.[1] Section 365(n) permits a licensee to retain its rights in licensed intellectual property post-rejection in exchange for the continued payment of royalties.[2] Where the licensee elects to retain its rights, the debtor-licensor has no continuing obligations under the license.[3]
The definition of “intellectual property” in Bankruptcy Code § 101(35A) does not reference trademarks or trade names. This omission raises the question: Does § 365(n) protect trademark licensees, or can licensees be stripped of their trademark rights by rejection of the license? Courts are split on this issue. Some have ruled that the plain language of § 101(35A) bars trademark licensees from the protections of § 365(n).[4] Others have ruled that trademark licensees can retain their rights post-rejection.[5]
Asset sales have become more prevalent in bankruptcy cases. This development raises an additional question about § 365(n): Do the protections of § 365(n) survive the “free and clear” sale of a debtor’s intellectual property assets under § 363(f)?
In a recent decision in the Crumbs Bake Shop Inc., et al. chapter 11 cases, Judge Kaplan of the U.S. Bankruptcy Court for the District of New Jersey grappled with both of these issues, determining that § 365(n) did apply to the Crumbs trademark licenses and that the specific protections of § 365(n) trump the more general “free and clear” provisions of § 363(f), absent consent of the licensee.[6]
Background
The debtors-in-possession (debtors) formerly comprised the bankrupt cupcake Crumbs Bake Shop. In addition to operating retail and wholesale distribution businesses, the debtors had licensed the company’s brand name to third-party sellers.
After their bankruptcy filing, the debtors entered into a credit-bid asset purchase agreement (APA) with Lemonis Fischer Acquisition Company, LLC (LFAC). Under the terms of the APA, the debtors agreed to sell substantially all of their assets (including trademarks) to LFAC “free and clear” of liens, claims, encumbrances and interests under § 363(f).
Upon entry of the sale order, the debtors moved to reject certain trademark licenses. A representative for the licensees objected, insisting that the licensees could elect, under § 365(n), to retain their rights under the licenses, notwithstanding the proposed rejection of the licenses and the “free and clear” sale of the trademarks and other under § 363(f).
Trademark Licensees Are Protected by § 365(n)
In determining that § 365(n) protected the instant trademark licensees, the court rejected LFAC’s contention that the omission of trademarks from the definition of intellectual property marked a congressional intent to exclude trademark rights from § 365(n)’s purview. Instead, the court determined that Congress had deferred judgment on the trademark issue to permit the bankruptcy courts to develop an equitable solution.[7]
Employing this “equitable” approach, the court found “that it would be inequitable to strip the within Licensees of their rights in the event of a rejection, as those rights had been bargained away by Debtors.”[8] In support of this ruling, the court stated that “in sale cases ... monetary recoveries primarily benefit the pre-petition and post-petition lenders and administrative claimants.”[9] In that context, the court found that “it was questionable that Congress had intended to sacrifice the rights of licensees for the benefit of the lending community.”[10]
LFAC attempted to counter these points by maintaining that it should not be placed in a licensor-licensee relationship it never intended to assume, and if the licensees were permitted to use the trademarks, LFAC would have no ability to ensure the quality of the services and products offered by the licensees.[11]
The court had little sympathy for these arguments, finding that LFAC had entered into the transaction “with eyes wide-open” and could have, through due diligence, adjusted the purchase price to account for the licenses.[12] The court further noted that non-bankruptcy protections exist, including unfair competition laws and market forces, to ensure that licensees preserve the brand.[13]
Finally, the court looked to the Innovation Act of 2013 — an act focused primarily on patent reform that passed by a resounding margin in the House of Representatives last December. The Innovation Act, if enacted, would amend the Code’s definition of intellectual property to include trademarks, service marks and trade names.[14] The court stated that the “fact [that] this legislation is pending suggests that Congress is aware of the prejudice to trademark licensees from the approach espoused by LFAC, and is attempting to remedy the omission of ‘trademarks’ from its definition of intellectual property.”[15]
Licensees’ Trademark Rights Survived “Free and Clear” Sale under § 363(f)
The court further held that, in the absence of consent, § 363(f) cannot trump a licensee’s rights under § 365(n), rejecting LFAC’s argument that it acquired the debtors’ trademarks and other assets “free and clear” of any § 365(n) rights.
The court acknowledged the existence of a line of cases equating failure to file a sale objection with consent for purposes of § 363(f).[16] However, the court ruled that no consent could be implied here as a result of the licensees’ failure to object to the sale, since the APA was extremely convoluted and lacked “any lucid and specific language that would place Licensees on notice that their rights were to be vitiated upon the execution of the contemplated sale.”[17] Moreover, the court excused the licensees’ failure to object on the grounds that the sale motion stated nothing about the treatment of the licensees and appeared to be “a calculated effort to camouflage the intent to treat the License Agreements as vitiated without raising the specter of § 365(n) rights.”[18] Looking to the analogous case law on § 365(h) and basic canons of statutory interpretation, the court further held that the specific provisions of § 365(n) trump the more general provisions of § 363(f).[19]
Conclusion
This decision is a win for trademark licensees, whose rights have long been at risk in bankruptcy. If the Crumbs precedent is followed, trademark licensees could retain their trademark rights post-rejection, even through a “free and clear” sale of the underlying trademark. However, trademark licensees cannot take these protections for granted, since courts have taken varying approaches to this issue and the equities of any particular case may not be as compelling as Judge Kaplan found them to be here. Trademark licensees also need to diligently review any bankruptcy sale documents and object to any sale purporting to cut off their rights under § 365(n). While the licensees in Crumbs did not suffer for their failure to object to the sale, this was largely because the debtors failed adequately to disclose the proposed treatment of licensees in the sale motion or the APA. Taking a wait-and-see approach can result in being deemed to have consented to adverse treatment.
This decision also serves as a lesson to credit-bidding lenders and other purchasers of assets from bankruptcy estates to be vigilant in their diligence and analysis to ensure that any potential impact of third parties continuing to use the acquired trademarks and trade names is priced into their offers.
[1] Congress enacted this provision in response to Lubrizol Enters. Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985), in which the Fourth Circuit held that a debtor could reject intellectual property licenses and leave licensees with only a monetary damages claim.
[2] 11 U.S.C. § 365(n) (2006).
[3] Id.
[4] See, e.g., In re Old Carco LLC, 406 B.R. 180, 211 (Bankr. S.D.N.Y. 2009) (Section 363(n) does not apply to trademark licenses because “[t]rademarks are not ‘intellectual property’ under the Code”); In re HQ Global Holdings Inc., 290 B.R. 507, 513 (Bankr. D. Del. 2003) (“[S]ince the Bankruptcy Code does not include trademarks in its protected class of intellectual property ... the Franchisee’s right to use the trademark stops on rejection.”); Raima UK Ltd. v. Centura Software Corp. (In re Centura Software Corp.), 281 B.R. 660, 673 (Bankr. N.D. Cal. 2002) (“Section 365(n) is controlling post-rejection and ... does not protect trademarks.”).
[5] See, e.g., Sunbeam Prods. Inc. v. Chi. Am. Mfg. LLC, 686 F.3d 372, 377-78 (7th Cir. 2012) (permitting trademark licensee to retain trademark rights notwithstanding plain language of § 101(35A); In re Exide Techs., 607 F.3d 957, 967 (3d Cir. 2010) (suggesting that trademark licensee could have continued to use trademark post-rejection had license been subject to rejection).
[6] In re Crumbs Bake Shop Inc., Case No. 14-24287, 2014 Bankr. LEXIS 4568 (Bankr. D.N.J. Oct. 31, 2014).
[7] Id. at 10-11 (quoting S. Rep. No. 100–505, at 5).
[8] Id. at 11-12.
[9] Id. at 12-13.
[10] Id. at 13.
[11] Id. at 13-15.
[12] Id. at 13.
[13] Id. at 15.
[14] Innovation Act of 2013, H.R. 3309, 113th Cong. § 6(d) (2013).
[15] In re Crumbs Bake Shop Inc., No. 2014 Bankr. LEXIS 4568, at *16.
[16] Id. at 18.
[17] Id. at 17-25.
[18] Id. at 25.
[19] Id. at 28-31.