This article addresses how the decision in In re Crumbs Bake Shop Inc.[1] continues the evolution of trademark licensing in bankruptcy and contributes to an understanding of the fate of Intellectual Property (IP) during a § 363 asset sale.
In bankruptcy, IP assets can be hypothecated in ways that tangible assets cannot. Likewise, IP can be licensed, in whole or in part, exclusively and nonexclusively, worldwide or by territory, with or without license fees or royalties. Thus, when dealing with IP assets in a bankruptcy, all facets of the IP should be taken into account.
Brief Background of Trademark Licenses in Bankruptcy
Section 365(n) gives the nondebtor IP licensee two choices upon rejection. The licensee can treat the IP license as being terminated, thus entitling it to rejection damages,[2] or the IP licensee can choose to retain its rights for the balance of the license.[3]
Trademarks were omitted from the definition of IP for the purposes of §365(n).[4] This omission has been subject of much discussion but little action for many years.
Recent cases have remediated the exclusion of nondebtor trademark licensees from § 365(n). In In re Exide Technologies[5] and In re Interstate Bakeries Corp.,[6] the Third and the Eighth Circuits, respectively, held that a trademark license resulting from the sale of a business was nonexecutory. Therefore, the debtor could not reject the license. In Sunbeam Prod. Inc. v. Chicago Mfg. LLC,[7] the Seventh Circuit held that a nondebtor trademark licensee’s rights survived rejection because Congress did not intend the omission of trademark licenses from § 365(n) to mean that rejection deprived the licensee of its rights under the license. The Seventh Circuit focused on the fact that § 365(g) treats rejection as a breach, which, under nonbankruptcy law, does not deprive a licensee of its rights to the IP.[8] These decisions set the stage for the next step in the development of the treatment of trademark licenses.
In re Crumbs Bake Shop Inc.[9]
Crumbs Bake Shop, Inc. and its affiliates specialized in the retail sale of cupcakes, baked goods and beverages. Crumbs’s trademarks and trade secrets were its most valuable assets. Using a licensing representative, Crumbs entered into a series of pre-petition trademark and trade secret license agreements with third parties (the “IP licenses”). Crumbs obtained a bankruptcy court order permitting it to sell all of its assets, including its IP free and clear of all liens. However, the IP licenses were excluded from the sale. The purchaser was Crumbs’ sole secured creditor, Lemonis Fischer Acquisition Company LLC (LFAC). The day after the bankruptcy court approved the sale, Crumbs filed a motion to reject the IP licenses. The licensing representative filed a notice that the licensees were electing to retain their rights under their respective IP licenses. The licensing representative also sought an order allowing it to retain the royalties paid by the licensees. Crumbs withdrew its motion to reject to the extent that it related to rejection of the IP licenses. LFAC demanded the royalties from the trademark licenses because it had purchased all of Crumbs’s IP. Bankruptcy Judge Michael B. Kaplan had to decide the fate of the trademark licenses and the royalties.
The first issue that the court addressed was whether the rejected trademark licenses fell within the scope of § 365(n). Judge Kaplan adopted the reasoning of the concurring opinion in Exide Technologies, which stated:
In particular, trademark, trade name and service mark licensing relationships depend to a large extent on control of the quality of the products or services sold by the licensee.[10] 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.... Nor does the bill address or intend any inference to be drawn concerning the treatment of executory contracts which are unrelated to intellectual property.[11]
Judge Kaplan held that Congress intended for bankruptcy courts to use equitable powers on a case-by-case basis to determine whether trademark licensees may retain the rights listed in § 365(n). Otherwise, a debtor-licensor could use bankruptcy as a sword rather than a shield to take back trademark rights that were bargained away.[12] This holding also adopted the reasoning of the Seventh Circuit in the Sunbeam Products.[13] By doing so, Judge Kaplan added another voice to equitable treatment of trademark licenses in bankruptcy.
The second issue was whether the sale of the debtor’s assets free and clear of all liens trumped the rights of the nondebtor licensees. Judge Kaplan acknowledged that some courts had allowed that result. However, he refused to follow those cases and held that the sale did affect the IP licenses. Otherwise, a bankruptcy liquidation sale would interfere with a licensing system that Congress sought to protect. LFAC argued that it was being forced into a licensing relationship that it did not intend to assume. Judge Kaplan pointed out that LFAC came to this transaction with its “eyes wide open” after engaging in due diligence. LFAC could have adjusted the price if it did not want to take the risk.[14]
Judge Kaplan also rejected LFAC’s argument that the nondebtor licensees consented to the sale because they failed to object. Judge Kaplan described the sale documents and motion for leave to sell as a “labyrinth of cross-referenced definitions and a complicated network of corresponding paragraphs with annexed schedules.”[15] Since the documents and motion failed to clearly set forth the treatment of the licensees, the licensees could not have consented to the sale. Ultimately, §363(f), which permits sales free and clear of liens, must give way to the specific language of §365(n).[16]
The third issue was the treatment of royalties from the licenses. Judge Kaplan held that Crumbs sold the IP, but that the licenses were specifically excluded from the sale and were not assumed or assigned. Therefore, the licenses and their royalties remained with Crumbs.[17]
Conclusion
Whether by design or accident, Crumbs and LFAC sought to shed the existing IP licenses to give LFAC the unfettered ability to license the IP in the future. The bankruptcy court’s decision frustrated this result. In re Crumbs is a welcome addition to the emerging trend of allowing nondebtor trademark licensees to invoke equitable considerations in order to avoid the draconian effects of a weakness in the current version of § 365(n).
[1] 522 B.R. 766 (Bankr. D.N.J. 2014).
[2] 11 U.S.C.A. § 365(n)(1)(A) and § 365(h)(1)(A); In re Storm Technology Inc., 260 B.R. 152 (Bankr. N.D. Cal. 2001); In re Prize Frize Inc., 150 B.R. 456 (Bk. App. 9th Cir. 1993).
[3] 11 U.S.C.A. § 365(n)(1)(b).
[4] 11 U.S.C. § 101(35A).
[5] 607 F.3d 957 (3d Cir. 2010).
[6] 690 F.3d 1069 (8th Cir. 2012).
[7] 686 F.3d 372 (7th Cir. 2012).
[8] 686 F.3d. 377.
[9] 522 B.R. 766 (Bankr. D.N.J. 2014).
[10] Trademark licenses differ from most IP licenses because trademark law springs from protecting the consuming public from confusion in the marketplace. The licensor’s rights depend on use. In keeping with the goals of trademark law, a trademark licensor must have the right to quality control of the product or service identified by the trademark.
[11] 522 B.R. 772 (emphasis added).
[12] Id.
[13] 522 B.R. 772-773.
[14] 522 B.R. 772.
[15] 522 B.R. 773.
[16] 522 B.R. 778.
[17] LFAC appealed this decision, and the matter was settled. LFAC paid $40,000 in exchange for the right to receive the royalties.