A major trend in insolvency law over the past 10 years is the increase in assets sales through bankruptcy. Instead of a confirming a reorganization plan under chapter 11, a majority of debtors market and sell substantially all their assets through a §363 sale. A major challenge for potential buyers in this situation is the ability to accurately value the assets to be purchased. This uncertainty can be especially pronounced when intellectual property (IP) rights, such as trademarks, are involved since their value depends, in large part, on the ability of the owner to enforce its monopoly. Accordingly, a potential IP purchaser will want to know (1) the status of any licensing agreements the debtor may have with respect to the IP (i.e., if it is an executory contract), (2) if the debtor has rejected the licensing agreements, and (3) the effect of that rejection on the licensee.
Generally, license agreements for IP constitute executory contracts. See, e.g., In re Valley Media Inc., 279 B.R. 105, 135 (Bankr. D. Del. 2002). The debtor has the opportunity to reject them pursuant to §365. See 11 U.S.C. §365. The debtor’s rejection of a license agreement constitutes a prepetition breach by the debtor, but not necessarily a termination of the license agreement. Accordingly, what impact does the debtor’s breach have on the nonbreaching licensee? Can the licensee continue to sell goods using the IP? Is that answer different with respect to trademarks, as opposed to other IP, such as patents? The answer to that question has a significant impact on the price a potential purchaser of IP will pay in a 363 sale.
In Lubrizol Enter. Inc. v. Richmond Metal Finishers Inc. (In re Richmond Metal Finishers Inc.), 756 F.2d 1043, 1048 (4th Cir. 1985), the U.S. Court of Appeals for the Fourth Circuit held that the rejection of a license agreement terminated the licensee’s rights in the IP, leaving it only with a claim against the debtor for money damages, even though the licensee would ordinarily have the right to specific performance for a breach of this kind outside of bankruptcy. Many viewed the holding in Lubrizol as a harsh solution. As a result, Congress enacted the Intellectual Property Licenses in Bankruptcy Act (IPLBA) in 1988, which introduced §365(n) to the Bankruptcy Code, which provides, in relevant part, that:
If the trustee rejects an executory contract under which the debtor is a licensor of a right to intellectual property, the licensee under such contract may elect to retain its rights (including a right to enforce any exclusivity provision of such contract, but excluding any other right under applicable nonbankruptcy law to specific performance of such contract) under such contract…as such rights existed immediately before the case commenced, for the duration of such contract; and any period for which such contract may be extended by the licensee as of right under applicable nonbankruptcy law.
11 U.S.C. §365(n).
“Intellectual property” is defined in §101(35A) as trade secret, invention, process, design, plant, patent application, work of authorship or mask work, but noticeably absent from that definition is trademark. Consequently, even after the IPLBA’s passage, the question remained regarding the effect of a debtor’s rejection of a license agreement for trademarks.
In Raima UK Ltd. v. Centura Software Corp. (In re Centura Software Corp.), 281 B.R. 660, 669 (Bankr. N.D. Cal. 2002), the U.S. Bankruptcy Court for the Northern District of California addressed this question as a matter of first impression. In Centura Software, a software company, Centura U.S., granted a license to Raima UK to use its software and trademarks in Raima UK’s business. Id. at 662-63. After filing for bankruptcy, Centura U.S. rejected the license agreement with Raima UK, which filed a complaint seeking a determination by the court that they could continue to use the software and trademarks of Centura U.S., pursuant to §365(n). Id. at 662. The bankruptcy court held that §365(n) did not apply to the software trademarks and Raima UK could not continue to use the marks after the license agreement was rejected. Id. at 673. The court reasoned that:
[b]ecause §365(n) is controlling postrejection and it does not protect trademarks, the court holds that Raima UK cannot retain any trademark rights under the rejected Raima UK Trademark Agreement. It cannot continue to use Raima Trademarks in its sale of Raima Software but, as discussed in the next section, it is entitled to file an unsecured prepetition claim for damages resulting from not being able to use such trademarks.
Id.
The rule established by the Centura Software court has been endorsed by two subsequent decisions. In In re HQ Global Holdings Inc., 290 B.R. 507 (Bankr. D. Del. 2003), the debtors rejected certain licensing agreements for the use of trademarks associated with their business of renting full-service office space. The franchisees argued that the debtors’ rejection did not terminate the licensing agreement, but instead merely constituted a prepetition breach by the debtors and thus, the franchisees could continue to use the trademarks. Id. at 513. The bankruptcy court disagreed, stating:
This argument misses the mark entirely. The essence of the Agreements was the Debtors’ affirmative grant to the Franchisees of the right to use their proprietary marks. As a result of the rejection, that affirmative obligation of the Debtors to allow the Franchisees to use the marks is excused.
The result of the Debtors’ rejection of the Agreements is that they are relieved from the obligation to allow the Franchisees to use their proprietary marks and the Franchisees' rights to use the marks are thereby extinguished.
Id. At the debtors’ suggestion, the court imposed a 30-day transition period for the franchisees to discontinue their use of the marks. Id. at 514.
Likewise, in In re Exide Tech., 340 B.R. 222 (Bankr. D. Del. 2006), the bankruptcy court held that the debtor’s rejection of a license agreement for trademarks terminated the licensee’s ability to continue to use the mark. As part of a sale of its industrial battery division, Exide granted the purchaser an exclusive, perpetual, royalty-free license to use the Exide mark in the industrial battery market. Id. at 227-28. The license agreement provided that upon termination, the licensee shall discontinue using the mark within a reasonable period of time not to exceed two years. Id. at 231. As part of its subsequent reorganization in bankruptcy, Exide rejected the license agreement. Id. at 228. As with the franchisees in HQ Global Holdings, the licensee argued that Exide’s rejection of the license agreement in bankruptcy did not terminate the license agreement, but instead amounted to a breach of the agreement by the debtor. Id. at 248-49. Citing Centura Software and HQ Global Holdings, the court disagreed, reasoning,
The primary benefit to rejecting a trademark license is reacquiring the right to use the mark in whatever capacity or market in which use by the licensor was previously excluded and extinguishing the licensee’s right to use it. Taken to its logical end, [the licensee]’s argument that a licensee’s right to use a trademark does not revert back to the licensor upon rejection means that a rejection of a trademark license would never offer meaningful relief to the debtor. This would be an absurd result. Under these circumstances, Exide’s obligation to allow [licensee] to use the Exide mark is extinguished upon rejection.
Id. at 250. However, the court further reasoned that,
Since the exclusive use of the Exide mark in connection with industrial battery market will revert back to Exide, it is appropriate to fashion a transition period to mitigate any potential damage and business disruption that [licensee] may suffer as a result of losing the Exide mark.
Id. Accordingly, the court adopted the debtor’s proposal and ordered a two-year transition period “based on the termination provision in the Trademark License” for the licensee to discontinue the use of the mark. Id.
In Beckerman v. M. Hidary & Co. Inc., 324 B.R. 434 (D. Conn. 2005), the debtor proposed to sell its assets in bankruptcy, including more than 30 registered trademarks. The asset purchase agreement provided that upon closing, the debtor was deemed to reject all existing licensing agreements. Id. at 438-39. The court ruled that a licensee whose trademark agreement had been rejected in bankruptcy could not dispose of its inventory and goods in process despite a provision in the trademark agreement providing for a 120-day sell-off period after termination. The court held that the rejection of the license agreements “also left [the licensee] with no option for disposing of its inventory and goods in process other than to enter into an agreement with the new owner of trademarks.” Id.
As these cases demonstrate, there is strong support for the general conclusion that rejection of a license agreement for trademarks terminates the licensee’s rights to continue to use the trademark. Some courts have provided a transition period after rejection for a licensee’s continued use of the mark, but only with the debtor’s agreement, while the Beckerman court did not, despite a provision in the license agreement that provided for such a sell-off period. In the end, it is essential for potential purchasers of trademarks out of bankruptcy to understand the effect of a debtor’s rejection of a license agreement for those trademarks in order to value that property appropriately.