On Oct. 31, 2014, Hon. Michael B. Kaplan of the U.S. Bankruptcy Court for the District of New Jersey issued an opinion addressing the rights of trademark licensees following a sale of substantially all assets under § 363 of the Bankruptcy Code.[1] The decision arose out of the Crumbs Bake Shop bankruptcy case and the sale of substantially all of the debtors’ assets to Lemonis Fischer Acquisition Co. LLC (LFAC), which was approved by the bankruptcy court in August 2014.
While operating, the debtors sold cupcakes, baked goods and other products in retails stores. They also licensed their trademark and trade secrets through certain license agreements to Coastal Foods Baking LLC, Pelican Bay Ltd., White Coffee Co., Uncle Harry’s Inc., Mystic Apparel LLC, and POP! Gourmet (the “licensees”). The license agreements were procured by Brand2 Squared Licensing (BSL) under a representation agreement with the debtors. Following approval of the sale to LFAC, the debtors filed motions seeking to reject the license agreements, but later withdrew that motion (as it related to the license agreements) following responses from BSL asserting the licensees’ rights under § 365(n) of the Bankruptcy Code. LFAC then filed a motion for an order in aid of the sale order to determine the effect of that order on each of the parties’ rights.
As an initial matter, the court addressed the issue of whether the license agreements fell within the ambit of § 365(n). Section 365(n) provides relief to licensees of intellectual property (IP) licenses and was enacted in the wake of the Fourth Circuit’s decision in Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc.,[2] wherein the court held that a debtor/licensor could freely reject an intellectual property license and thereby deprive the licensee of the rights previously granted. In response, Congress added § 365(n) of the Bankruptcy Code, which allows the licensee of any IP license to elect to retain its rights under a license upon rejection, subject to, among other things, a requirement that the licensee pay royalties. However, the definition of “intellectual property” in § 101(35A) of the Bankruptcy Code does not expressly include trademarks, defining “intellectual property” as:
(A) trade secret;
(B) invention, process, design, or plant protected under title 35;
(C) patent application;
(D) plant variety;
(E) work of authorship protected under title 17;
(F) mask work protected under chapter 9 of title 17; or to the extent protected by applicable nonbankruptcy law.[3]
In addressing this language, the court noted that some bankruptcy courts have reasoned that trademark licenses were not protected under § 365(n) due to the omission of trademarks from the statutory definition. The court rejected this line of authority, and instead adopted the reasoning articulated in the concurring opinion of Hon. Thomas Ambro in In re Exide Technologies[4] and a Senate Report[5] for the legislation that adopted § 365(n). The court found that “Congress intended the bankruptcy courts to exercise their equitable powers to decide, on a case-by-case basis, whether trademark licensees may retain the rights listed under §365(n).”[6] Again citing Exide, Judge Kaplan found “that it would be inequitable to strip the … Licensees of their rights in the event of a rejection, as those rights had been bargained away by Debtors.”[7]
The court also rejected the argument posited by LFAC that equitable considerations were not applicable in a case where the debtor sells its assets to a bona fide purchaser. In doing so, the court noted that § 363 sales currently dominate in retail cases with most recoveries benefiting secured and administrative creditors, and declined to adopt the position that “Congress intended to sacrifice the rights of licensees for the benefit of the lending community.”[8] The court also rejected LFAC’s argument that the exercise of rights under § 365(n) would place LFAC in a licensor/licensee relationship that it did not intend to assume because LFAC, or any other purchaser, could engage in due diligence and adjust the purchase price for existing licenses such that the Licensees’ trademark rights should not “be vitiated completely to aid in LFAC’s recovery under its credit bid.”[9] Regardless of the equitable considerations, the Court then relied on the Seventh Circuit’s decision in Sunbeam Products Inc. v. Chicago Am. Mfg., LLC,[10] wherein that court determined that the rejection of a trademark license did not eliminate the licensee’s right to use the trademark since rejection is simply a breach and outside of bankruptcy, a licensor’s breach would not terminate the right to use intellectual property. Lastly, the court noted pending legislation in Congress[11], to support the notion that the legislature was aware of the issues involved and attempting to remedy the situation.
Next, the court addressed whether the licensee’s rights to use the trademarks might have been eliminated by virtue of § 363(b) and (f) through a free and clear conveyance of those rights to LFAC in which case § 365(n) would not apply. LFAC argued that the licensee’s failure to object to the sale constituted implied consent to the free and clear sale. However, the court found that the licensees were not provided with “adequate notice that their rights were at risk of being stripped away as a consequence of the sale.”[12] This was due to the complexity of the motion to approve the sale and the asset-purchase agreement, which made it difficult to determine exactly what assets were being sold. The motion and purchase agreement included “no clear discussion as to what rights were purported to be taken away as a result of the sale.”[13] The license agreements were also listed as “excluded assets” on at least one schedule. As such, the court concluded that the licensees had no reason to believe that an objection would be necessary to protect their rights. In support of its ruling, the court relied upon the Third Circuit’s decision in In re Lower Bucks Hospital,[14] in which that court excised a third-party release that was buried in a single paragraph in a reorganization plan. Under this reasoning, the court found that language in the proposed order referencing that licenses would be expunged was insufficient to provide adequate notice to trigger implied consent due to the lack of objection.
The court also discussed the interplay between § 363 and § 365(n), holding that “nothing in § 363(f) trumps, supersedes, or otherwise overrides the rights granted to Licensees under § 365(n).”[15] Under the traditional methods of statutory construction, the specific language in § 365(n) granting protections for licensees governed the general language allowing free and clear sales in § 363(f). In support of this conclusion, the court also relied on the legislative history of § 365(h), which protects tenants where leaseholds are rejected. Specifically, the court declined to follow the decision of the Seventh Circuit in Precision Indus. Inc. v. Qualitech Steel SBQ LLC,[16] which held that § 365(h) rights could be extinguished in a § 363 sale, finding the other authority more persuasive.
After concluding that the licensees retained rights under § 365(n), the court was faced with the issue of which party was entitled to collect royalties that were associated with a retention of the licensees continued use of the trademark. The trademark had been sold to LFAC but the applicable license agreements were excluded from the sale. However, the language of § 365(n) links royalty payments with the rejected contract not the underlying intellectual property. Thus, the court concluded that the right to receive royalties remained with the debtors.
The court’s treatment of trademarks as intellectual property entitled to protections under § 365(n) might be part of a paradigm shift away from the conclusions drawn in Lubrizol and subsequent opinions. Indeed, the growing trend seems to be that trademark licensees are entitled to protection and that rejection of a license cannot strip away the right to use a trademark. LFAC has appealed[17] the decision, and it is possible that the Third Circuit or the U.S. Supreme Court may provide further guidance in the near future. In addition, the court’s conclusions regarding the less-than-adequate notice provided may serve as guidance to counsel in future cases proposing to eliminate rights through § 363 sales.
[1] In re Crumbs Bake Shop, Inc. et al., __ B.R. __, 2014 WL 5508177 (Bankr. D.N.J. October 31, 2014).
[2] 756 F.2d 1043 (4th Cir. 1985).
[3] 11 U.S.C. § 101(35A).
[4] 607 F.3d 957 (3d Cir. 2010).
[5] S. Rep. No. 100-505 at 5 (1988).
[6] 2014 WL 5508177 at *4.
[7] Id.
[8] Id.
[9] Id. at *5.
[10] 686 F.3d 372 (7th Cir. 2012).
[11] Innovation Act of 2013, H.R. 3309, 113th Cong. § 6(d) (2013).
[12] 2014 WL 5508177 at *6.
[13] Id. at *7.
[14] 571 F. App’x. 139 (3d Cir. 2014).
[15] 2014 WL 5508177 at *8.
[16] 327 F.3d 537 (7th Cir. 2003).
[17] In re Crumbs Bake Shop, Inc., Case No. 3:14-cv-07577-JAP (D.N.J).