Seventh Circuit Recognizes Nonassignability of Trademark Licenses in Bankruptcy—with a Caveat

On July 26, 2011, the U.S. Court of Appeals for the Seventh Circuit issued In re XMH Corp.,[1] recognizing for the first time in a published U.S. Court of Appeals opinion that a trademark license is not assignable in bankruptcy without the licensor’s consent. This recognition, however, comes with a significant caveat. Although the opinion, authored by the respected Judge Richard A. Posner, makes a lengthy exploration of the policies underpinning the rule against nonconsensual assignments of trademarks, virtually everything the court had to say on this topic is, technically speaking, judicial dictum. Ultimately, the case turned on the fact that at the time of the challenged assignment, the trademark license had expired and what remained was only a services contract.

The reasons (Judge Posner’s well-known intellectual curiosity) the court felt it appropriate to explore this issue at the intersection of trademark and bankruptcy law probably owes to the procedural history of the dispute. XMH (then known as Hartmarx), together with several of its subsidiaries, filed a bankruptcy petition under chapter 11 of the Bankruptcy Code in 2009.[2] Shortly after their bankruptcy filing, the debtors commenced a process to sell substantially all of their assets of their apparel business pursuant to § 363 of the Bankruptcy Code. As part of that sale, the debtors sought, pursuant to § 365 of the Bankruptcy Code, to assume and assign to the purchaser an executory contract between Simply Blue (Blue), one of the debtors, and Western Glove Works (“Western”), another apparel company.[3] Western objected to the assumption and assignment, asserting that the agreement contained a trademark license from Western and could not be assigned without Western’s consent. The bankruptcy court sustained Western’s objection and barred assignment of the contract.[4] Meanwhile, the sale to the purchaser closed, following amendments to the transaction documents designed to allow the purchaser to receive the benefits of the contract with Western without taking a formal assignment thereof.[5]

The debtors appealed to the district court, where the purchaser was substituted for the debtors.[6] The district court then ruled that the bankruptcy judge had erred in denying the assignment.[7] Western’s appeal to the Seventh Circuit followed.

Initially, the Seventh Circuit disposed of Western’s contention that the purchaser lacked standing to maintain the appeal, stating that “there is nothing problematic about substituting a party into a litigation because it has succeeded to the interest of the original party.”[8] Moreover, the court was untroubled by the fact that the substitution meant that the debtor had no effective stake in the appeal going forward. The court reasoned that requiring a dismissal of the appeal would waste judicial resources and was not required under longstanding precedent holding that the occurrence of “later events, which would have precluded jurisdiction had they occurred before the case was filed, do not (with immaterial exceptions) deprive the federal court of jurisdiction.”[9]

The court then turned to the two issues at the heart of the appeal. First, it considered whether the contract—if it contained a trademark license—was assignable without Western’s consent.

The contract granted a sublicense from Western to Blue to use the trademark “Jag” in connection with sale of women’s jeanswear, but only for a two-week period expiring on Dec. 31, 2002 (which was later extended retroactively by amendment through June 30, 2003).[10] During the period of the license, Blue was to pay Western a royalty of 12.5 percent of the net sales of the trademarked apparel.[11] The contract further provided that during the year after expiration of the trademark license (and for subsequent years after the contract’s term was extended), Blue would provide a broad array of services related to the apparel, including sourcing services, marketing and sales services, merchandising services and customer service.[12] For these services, Western was to pay Blue a fee equal to 30 percent of the net sales of the trademarked apparel.[13] The contract proved to be a bit of an enigma for the parties and the court. Neither could explain why the parties initially chose to structure the contract with the trademark license lasting only two weeks.[14]

Despite the fact that the trademark license had apparently expired well before the bankruptcy, the court first considered whether assignment would be permitted under the Bankruptcy Code. The court explained that “[s]ection 365(c)(1) of the Bankruptcy Code limits the assignment of an executory contract of the debtor if ‘applicable law’ authorizes the other party to the contract to refuse to accept performance from an assignee ‘whether or not such contract…prohibits or restricts assignment.’”[15] In this instance, the court assumed applicable law to be trademark law.[16] In addition, trademark law would authorize the nondebtor party to refuse to accept performance from an assignee because “the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment.”[17]

At this point in the opinion, Judge Posner takes the opportunity to educate his readers on the policies underlying the ban against nonconsensual assignments of trademark licenses. As the court explains, control by the ultimate holder over the use of the mark is essential to is value:

A trademark is a shorthand designation of a brand. It conveys information that allows the consumer to say to himself, “I need not investigate the attributes of the product I am about to purchase because the trademark is a shorthand way of telling me that the attributes are the same as that of the like-branded product I enjoyed earlier.” If without notice the seller reduces the quality of his brand, the trademark becomes deceptive because its assurance of continuity of quality is no longer truthful. That is why the licensee is not permitted to sublicense the trademark to a seller over whom the trademark owner, having no contract with the sublicensee, will have no control. It’s also the reason that transfers of trademarks “in gross”—that is, apart from the assets used to produce the trademarked product—are prohibited.[18]

The court then analyzed the considerations that come into play when a holder of a mark decides to license it to another, stating:

Normally the owner who does this will not want the licensee to be allowed to assign the license (that is, sublicense the trademark) without the owner’s consent, because while the owner will have picked his licensee because of confidence that he will not degrade the quality of the trademarked product he can have no similar assurance with respect to some unknown future sublicensee.[19]

Based on this analysis, the court concluded that the rule that trademark licenses are not assignable in the absence of a provision authorizing assignment is a sensible rule that should control in the absence of language expressly permitting assignment.[20]

Having completed this examination of trademark licensing policy, the court returned to the question of whether the contract really was a trademark license. Western argued that the trademark license did not expire when the contract said it did, but that an implied license continued throughout the subsequent service contract term.[21] For Judge Posner, this was a reach too far. He wrote: “The contract is explicit that after the expiration of the sublicense to Blue to sell Jag Jeans and pay a license fee to Western, the rights in the trademark revert to Western… The services were extensive, but Western retained control over ‘all other aspects of the production and sale of the Trademarked Apparel’….”[22] Further, the court admonished that it was well within Western’s power to guard against this result by drafting the contract as a continuing sublicense.[23]

One curiously unanswered question is why the parties and the court assumed that trademark law was the only “applicable law” under § 365(c)(1).[24] Courts have held that where “applicable law” makes the identity of the party material to the contract, it establishes a default rule prohibiting nonconsensual assignment. For example, in EBC I Inc. v. America Online Inc. (In re EBC I Inc.),[25]the bankruptcy court held that an agreement under which AOL agreed to provide online advertising and other services for the Internet retailer eToys in the early days of the e-commerce economy was, under Virginia law, an agreement to which no assignment would be permitted without an express provision allowing it.[26]

Whether or not the agreement between Western and Blue involved a technical trademark license, it arguably defined a relationship of trust and confidence between the parties in which very significant responsibilities were delegated to Blue by Western. Even without a formal trademark license, it seems plausible that in this, or a similar case, the expertise and unique attributes of the contract counterparty may be so important as to jeopardize the other party’s ability to realize the benefit of its bargain if the contract is made freely assignable. Accordingly, parties should not assume too quickly that just because an intellectual property license is not expressly part of the contract, a contract that delegates significant responsibilities related to the production or delivery of branded goods or services will in all cases be freely assignable in bankruptcy regardless of its terms.