Pointedly disagreeing with the Seventh Circuit, the First Circuit deepened an existing split by adopting the Fourth Circuit’s conclusion in Lubrizol and holding that rejection of a trademark license agreement precludes the licensee from continuing to use the license.
The 2/1 opinion from the First Circuit on Jan. 12 reversed the Bankruptcy Appellate Panel, which, to the contrary, had followed Circuit Judge Frank Easterbrook’s decision in Sunbeam Products Inc. v. Chicago American Manufacturing LLC, 686 F.3d 372 (7th Cir. 2012). In Sunbeam, the Seventh Circuit rejected the Fourth Circuit’s rationale in Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985).
In simple terms, the First Circuit’s decision means that the licensee of patents can continue using the technology after rejection as a consequence of Section 363(n), but the same licensee cannot continue using trademark licenses that went along with the technology.
The Genesis of Section 365(n)
In Lubrizol, the Fourth Circuit ruled in 1985 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 have 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.
In Sunbeam, the Seventh Circuit split with the Fourth in 2012. Judge Easterbrook 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. Judge Easterbrook instead 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.
The First Circuit Case
Before bankruptcy, the debtor in the case before the First Circuit had granted the licensee a non-exclusive, irrevocable, fully paid, transferrable license to its intellectual property including patents. However, the irrevocable license excluded the debtor’s trademarks.
Separately, the license agreement granted a non-exclusive, non-transferable, limited license to use the debtor’s trademarks.
The day after filing a chapter 11 petition, the debtor filed a motion to reject the trademark and patent licenses as executory contracts under Section 365(a). During the ensuing litigation, the debtor conceded that Section 365(n) allowed the licensee to retain its rights in the intellectual property and patents, but not the trademarks.
Ultimately, the bankruptcy court ruled that Section 365(n) did not preserve the licensee’s rights in the trademarks. The bankruptcy judge believed that the omission of trademarks from the definition of intellectual property in Section 101(35A) meant that Section 365(n) does not protect rights in trademarks.
On the first appeal, the BAP followed Sunbeam and reversed the bankruptcy court, calling Lubrizol “draconian” and saying that rejection does not “vaporize” trademark rights. To read ABI’s report on the BAP opinion, click here.
With regard to trademarks, Circuit Judge William J. Kayatta, Jr. reversed the BAP in a 2/1 opinion, holding that the right to use trademarks did not survive rejection.
Judge Kayatta said that Sunbeam “largely rests on the unstated premise that it is possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark.” That premise, he said, is wrong because “effective licensing of a trademark” requires the licensor to continue monitoring and exercising control over the quality of the goods sold under the mark.
Sunbeam is wrong, in Judge Kayatta’s view, because it “entirely ignores the residual enforcement burden it would impose on the debtor just as the Code otherwise allows the debtor to free itself from executory burdens” and “invites further degradation of the debtor’s fresh start options.”
Judge Kayatta therefore favored “the categorical approach of leaving trademark licenses unprotected from court-approved rejection, unless and until Congress should decide otherwise.”
The Dissent
Circuit Judge Juan R. Torruella dissented with regard to trademarks. Like Sunbeam, he would have held that rights in a trademark “did not vaporize” as a result of rejection.
Judge Torruella based his dissent in large part on the legislative history surrounding the adoption of Sections 363(n) and 101(35A). He saw Congress as allowing courts to use their equitable powers to protect trademark licensees.
Rather than eviscerating the licensee’s trademark rights, Judge Torruella said he instead would “be guided by the terms of the [license agreement], and non-bankruptcy law, to determine the appropriate equitable remedy of the functional breach of contract.”
Distribution Rights
The litigation in bankruptcy court also involved the debtor’s license of distribution rights. Affirmed by the BAP, the bankruptcy court had ruled that rejection cut off distribution rights too.
On appeal in the circuit, the licensee mounted several creative arguments aimed at showing that distribution rights were an adjunct to the patents and technology and therefore should survive.
Judges Kayatta and Torruella agreed that rejection cut off distribution rights.
The Next Steps
If the licensee does not throw in the towel, the next step will be a petition for rehearing en banc or a petition for certiorari. The circuit split pits not only the First Circuit against the Seventh. In his concurrence in In re Exide Technologies, 607 F.3d 957, 964 (3d Cir. 2010), Third Circuit Judge Thomas L. Ambro reached the same result as the Seventh Circuit on much the same reasoning.