November 7, 2012
U.S. Legislation Subcommittee of the Legislation & Regulatory Analysis Committee
WHEREAS, trademark licenses play an important role in United States commerce, allowing businesses to extend the reach and recognition of their brands, and to provide consumers with the benefits of greater competition and choice;
WHEREAS, the treatment of a trademark license in the event of the bankruptcy of the licensor is currently subject to a split in the federal circuit courts, creating uncertainty for licensees who rely on their ability to use a licensed mark in their business;
WHEREAS, the uncertainty was resolved for other intellectual property licenses in 1988 by the addition of Section 365(n) to the U.S. Bankruptcy Code;
WHEREAS, the resulting uncertainty faced by trademark licensees should be resolved in order to balance the interests of preserving the value of trademark collateral in a bankruptcy and the legitimate interest of licensees in maintaining their business activities; and
WHEREAS, while trustees for bankrupt estates should recognize the importance of maintaining quality control measures to preserve the value of the assets, they should neither be statutorily discharged by virtue of a license rejection, nor statutorily required to exercise such obligations;
BE IT RESOLVED, that it is the position of the International Trademark Association that:
- Section 365(n) of the U.S. Bankruptcy Code should be amended to apply to trademark licenses to the same extent as to other types of intellectual property licenses and, accordingly, trademarks, service marks and trade names should be included in the definition of “Intellectual Property” for purposes of that Section; and
- In light of the unique nature of trademarks as a repository and symbol of goodwill, Section 365(n) should further be amended to explicitly state that the statute does not relieve debtor licensors from any existing contractual obligations or authority to monitor and control the quality of licensed products bearing a licensed trademark.
BE IT FURTHER RESOLVED, that Section 365(n) should not impose a separate statutory obligation of quality control on the debtor licensor.
Origins of Section 365(n)
The Intellectual Property Bankruptcy Act of 1988 added Section 365(n) to the Bankruptcy Code. This section was designed to overrule Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.
, 756 F.2d 1043 (4th Cir. 1985). Lubrizol
had held that when any intellectual property license is rejected in bankruptcy, the license is terminated and the licensee loses the ability to exercise the right granted by the license. Section 365(n) permits a licensee of “intellectual property” to continue exercising its rights notwithstanding the rejection of the license contract by the trustee for a debtor licensor. However, due to concerns (including concerns expressed by INTA) relating to the right and obligation of bankrupt licensors of trademarks to exercise quality control over the goods or services, trademarks were excluded from the definition of “intellectual property.”
INTA Review in 2002
In 2002, the U.S. Legislation Subcommittee examined whether the definition of “intellectual property” should be expanded to include trademarks for purposes of Section 365(n). While acknowledging that the current law created a risk to the businesses of licensees who were heavily dependent upon licensed rights, the subcommittee concluded that “the case law and the anecdotal evidence do not indicate a situation that would provide the momentum for a successful legislative initiative to amend the bankruptcy code,” and therefore recommended against legislative action at the time.
Split in the Circuits in 2012
The issue has arisen again because of the Seventh Circuit’s recent decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC
, 686 F.3d 372 (7th Cir. 2012). In Sunbeam
, the Court of Appeals rejected the notion that absence of “trademarks” from the definition of “intellectual property” subject to Section 365(n) mandated deprivation of a licensee’s rights when a debtor licensor rejects the license. To the contrary, said the Court, “an omission is just an omission,” holding that Section 365(n) “does not affect trademarks one way or the other.” It went on to hold that because Section 365(g) characterizes the rejection of an executory contract as a breach -- not a rescission voiding the contract -- “nothing about this process implies that any rights of the other contracting party have been vaporized.” The rejection “merely frees the estate from the obligation to perform” but has no effect on the contract’s continued existence.
The Seventh Circuit therefore holds that, even without the protection afforded by Section 365(n), a trademark licensee retains its rights to use the licensed mark notwithstanding the rejection of the license by the debtor licensor. This creates a direct conflict with the Fourth Circuit’s decision in Lubrizol
, which still controls in that circuit with respect to trademarks. As a result, the subcommittee was asked by the Executive Committee of the INTA Board to consider whether rejection of a trademark license by a debtor licensor should necessarily terminate the licensee’s rights.
Under the current statute, a trademark licensee does not enjoy the protection that Section 365(n) provides for other intellectual property licensees, even if its business is wholly or substantially dependent on the license. The only protection available is for the licensee to object to the motion for rejection, to present evidence of the harm to the licensee from rejection, to present evidence that this harm outweighs the benefit to the debtor, its estate, and the unsecured creditors from rejection, and to invoke the bankruptcy court’s authority to deal with matters before it equitably. The reported decisions, however, indicate that this approach is likely to succeed only when the licensee’s business will be virtually destroyed and the debtor is unlikely to be rehabilitated successfully or there will be little benefit to the estate and the creditors.
Balanced against the obvious peril to trademark licensees are concerns about the continued validity of a licensed trademark following the debtor-licensor’s rejection. If, as the Sunbeam decision holds, the debtor’s rejection “frees the estate from the obligation to perform,” and therefore eliminates the obligation to monitor and control the quality of the licensee’s goods or services, the result could be a statutorily mandated naked license, which would destroy the trademark asset which the debtor’s trustee is bound to preserve. Therefore, in addition to addressing the protection of trademark licensees against rejection of their licenses in Section 365(n), the Subcommittee also believes that it is necessary to explicitly state in the statute that the trustee is not freed from any existing contractual obligations under the license to exercise quality control.
The subcommittee discussed including a statutory provision in Section 365(n) outlining and imposing quality control obligations on the debtor licensor. Such a statutory duty, however, is likely to be unacceptable to the bankruptcy bar, and the subcommittee prefers instead to rely upon the ability of Trustees to recognize that maintenance of quality control practices is consistent with the trustee’s mandate to preserve the assets of the bankrupt estate. Trustees for debtors-in-possession typically have extensive powers to run the business to maximize revenues, and the quality control obligations in a typical license are well within a trustee’s power to perform. If a particular trustee fails to exercise this obligation, we see no threat to the trademark system any more than the failure to do so by a non-bankrupt licensor would create such a threat. What is critical is that the trustee not be statutorily discharged from its obligation to perform this function by virtue of the rejection, and certainly that the trustee not be deprived of the contractual powers necessary to accomplish the same.
The subcommittee believes that the economic considerations which led to protection for patent and copyright licensees under Section 365(n) apply equally to trademark licensees. We further believe that the uncertainty created by the law as currently written is detrimental to the interests of both trademark owners and their licensees. Finally, we believe that if trademarks, trade names and service marks are included as a type of “intellectual property” for purposes of Section 365(n), the statute must also assure that debtor licensors not be statutorily relieved of any obligation to monitor and control the quality of the licensed products imposed by contract.
Given the above analysis and explanations, the subcommittee recommends that the Board adopt a resolution setting forth its position favoring amending Section 365(n) to: (1) include “trademarks” within the definition of “Intellectual Property,” and (2) explicitly state that the Trustee (acting for the debtor licensor) is not relieved by the statute of any existing contractual obligations and authority to control the quality of goods bearing the licensed trademark. Consistent with INTA’s prior concerns, however, the Subcommittee does not recommend the creation of a separate statutory obligation of quality control on the debtor licensor.