The First Circuit Bankruptcy Appellate Panel aligned itself with the Seventh Circuit by holding that rejection of a trademark license does not strip the licensee of the right to use the mark, contrary to the controversial 1985 holding by the Fourth Circuit in Lubrizol Enterprises v. Richmond Metal Finishers Inc.
The BAP’s Nov. 18 opinion by Bankruptcy Judge Melvin S. Hoffman adopted the reasoning employed by Seventh Circuit Judge Frank Easterbrook, who said in Sunbeam Products Inc. v. Chicago American Manufacturing LLC in 2012 that nothing in Section 365 forces the non-bankrupt party to stop using trademarks when the license is rejected.
The controversy has persisted because Congress has been flummoxed by Lubrizol when it comes to trademarks.
In Lubrizol, the Fourth Circuit ruled that rejection of an executory contract licensing intellectual property halted the non-bankrupt’s right to use patents, trademarks and copyrights. Three years later, Congress responded by adding Section 365(n), which, in conjunction with the definition of “intellectual property” in Section 101(35A), provides that the non-debtor can elect to continue using patents, copyrights and trade secrets despite rejection of a license.
The amendment conspicuously omitted reference to trademarks. The Senate Report said that the amendment did not deal with trademarks because the issue “could not be addressed without more extensive study.” According to the report, Congress decided to postpone action “to allow the development of equitable treatment of this situation by bankruptcy courts.”
Since then, courts split into two camps. One group takes a negative inference from the omission of trademarks from Section 365(n) by holding that rejection terminates the right to use a trademark, although the licensee could elect to continue using patents covered by the same agreement.
The opposing camp is exemplified by the Seventh Circuit, where the appeals court acknowledged that Section 365(n) does not preserve the right to use trademarks, but at the same time does not prescribe the consequences of rejection. Instead, Circuit Judge Easterbrook relied on Section 365(g), which teaches that rejection “constitutes a breach” of contract.
Judge Easterbrook reasoned that a licensor’s breach outside of bankruptcy would not preclude the licensee from continuing to use a trademark. He ruled that rejection converted the debtor’s unfulfilled obligations into damages. He said that “nothing about this process implies than any other rights of the other contracting party have been vaporized.” He added that Lubrizol has been “uniformly criticized” by scholars and commentators.
Adopting the approach in Sunbeam and reversing the bankruptcy court, Judge Hoffman called Lubrizol “draconian” and said that rejection does not “vaporize” trademark rights. He also noted that Lubrizol is not binding on courts in the First Circuit and mentioned that the bankruptcy court had not cited Sunbeam in ruling that the licensee could not use trademarks after rejection.
Judge Hoffman’s decision upheld the bankruptcy court’s ruling that the license agreement did not confer distribution rights that would survive rejection. Intellectual property lawyers should consult the decision for hints about how to draft licenses so that distribution rights might survive rejection.