Trademark-Licensee Limbo in Bankruptcy Continues, Jones Day Business Restructuring Review
A debtor's decision to assume or reject an executory contract is typically given deferential treatment by bankruptcy courts under a "business judgment" standard. Certain types of nondebtor parties to such contracts, however, have been afforded special protections. For example, in 1988, Congress added section 365(n) to the Bankruptcy Code, granting some intellectual property licensees the right to continued use of licensed property, notwithstanding a debtor's rejection of the underlying license agreement. A ruling recently handed down by the Third Circuit Court of Appeals in In re Exide Technologies highlights an issue that has received some attention but remains unresolved: how are the rights of trademark licensees affected by a debtor's rejection of a trademark-licensing agreement?
Lubrizol and Bankruptcy Code Section 365(n)
In 1985, the Fourth Circuit Court of Appeals in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. held that a debtor could reject an executory agreement pursuant to which it had licensed its intellectual property, and upon rejection, the licensee lost the right to use that intellectual property. Despite recognizing the "chilling effect" its holding might have on intellectual property ("IP") licensing agreements, the court saw no way around the plain language of the Bankruptcy Code as it existed at that time: the licensing agreement was an executory contract, the debtor rejected the executory contract, and it was "clear that the purpose of [section 365] is to provide only a damages remedy for the non-bankrupt party."
In direct response to Lubrizol, Congress added section 365(n) to the Bankruptcy Code to protect the rights of many (but not all) IP licensees. Section 365(n) gives such licensees two options when a debtor rejects an executory license agreement: the licensee may either (i) treat the agreement as terminated (as in Lubrizol) and assert a claim for rejection damages; or (ii) retain the right to use the IP (with certain limitations). The legislative history of section 365(n) reveals that Congress intended to "make clear that the rights of an intellectual property licensee to use the licensed property cannot be unilaterally cut off as a result of the rejection of the license pursuant to Section 365 in the event of the licensor's bankruptcy." But the story does not end there. "Intellectual property," as defined in the Bankruptcy Code, covers only certain types of intellectual property.
The Bankruptcy Code's Definition of "Intellectual Property"
Section 101(35A) of the Bankruptcy Code defines "intellectual property" to mean:
(A) trade secret;
(B) invention, process, design, or plant protected under title 35;
(C) patent application;
(D) plant variety;
(E) work of authorship protected under title 17; or
(F) mask work protected under chapter 9 of title 17;
to the extent protected by applicable nonbankruptcy law.
Notably, trademarks, trade names, and service marks are not included in the definition of "intellectual property." Thus, the protections afforded IP licensees under section 365(n) do not apply to trademark licensees. Since section 365(n) was added to the Bankruptcy Code, courts have struggled to determine the proper treatment of trademark licenses in bankruptcy. Many questions remain largely unanswered, at both the bankruptcy-court and appellate-court levels. For example, do trademark licensees lose the right to use their trademarks when a debtor-licensor rejects the licensing agreement, consistent with Lubrizol? Do bankruptcy courts have the authority to balance the interests of the licensee with those of the debtor in determining whether to allow the debtor to reject the license agreement in the first instance? Might trademark licensees be entitled to the same protection afforded holders of other IP licenses, notwithstanding a lack of explicit statutory authority?
The Third Circuit's recent decision in Exide Technologies highlights the uncertainty faced by trademark licensees when a debtor seeks to reject a trademark-licensing agreement.
Prior to filing for chapter 11 protection in 2002 in Delaware, Exide Technologies, Inc. ("Exide"), one of the world's largest producers, distributors, and recyclers of lead-acid batteries, licensed its "Exide" trademark to EnerSys Delaware Inc. ("EnerSys") for use in the industrial-battery business. Exide, however, wanted to continue to use the Exide mark outside the industrial-battery business. To accommodate the needs of both parties, Exide granted EnerSys a perpetual, exclusive, royalty-free license to use the Exide trademark in the industrial-battery business. This arrangement was satisfactory to both parties for nearly a decade.
However, Exide expressed a desire in 2000 to reenter the North American industrial-battery market. Exide made several attempts to regain its trademark from EnerSys, but EnerSys rebuffed the attempts. For the next two years, Exide, which offered industrial batteries under a different brand, was forced to compete directly against EnerSys, which was selling batteries under the Exide name.
After it filed for bankruptcy in 2002, Exide sought court approval to reject the license agreement. The bankruptcy court held that the trademark license was executory and that upon Exide's rejection of the agreement, the rights of EnerSys to use Exide's trademarks were terminated. The district court affirmed on appeal.
The Third Circuit's Decision
A three-judge panel of the Third Circuit Court of Appeals reversed. The court concluded that the agreement was not executory because EnerSys had materially completed its performance under the contract, and only those contracts as to which there remain material unperformed obligations by both sides are executory. Thus, the court ruled, the agreement could not be assumed or rejected at all. As a consequence, however, the Third Circuit never addressed whether rejection of the agreement (had it been found to be executory) would have terminated the right of EnerSys to use Exide's trademarks.
In a separate concurring opinion, circuit judge Thomas L. Ambro took issue with the bankruptcy court's conclusion that rejection of a trademark-licensing agreement terminates the licensee's right to use the debtor's trademark. Courts have long recognized, Judge Ambro explained, that rejection of an executory contract is not synonymous with termination of that contract. Rejection, he wrote, "is a breach of the executory contract," not "avoidance, rescission, or termination." According to the judge, even if a debtor may reject a trademark-licensing agreement, it does not necessarily follow that such a breach terminates the licensee's right to use the licensed trademarks.
In concluding that the rights of trademark licensees are unprotected in bankruptcy, the bankruptcy court reasoned that "Congress certainly could have included trademarks within the scope of § 365(n) . . . but saw fit not to protect them." On that basis, and consistent with Lubrizol, it ruled that a trademark license is terminated upon rejection, leaving the licensee with, at most, a claim for damages. As Judge Ambro emphasized, however, the legislative history of section 365(n) calls into question this negative inference. Congress was aware that 365(n) does not explicitly protect trademarks. However, according to the legislative history, the reason for the omission was simply that Congress found it needed "more extensive study" to determine the proper treatment of trademark licenses. Rather than make a decision based on inadequate information, Congress elected "to postpone congressional action in this area and to allow the development of equitable treatment of [trademark licenses] by bankruptcy courts."
According to Judge Ambro, Congress's decision to leave treatment of trademark licenses to the courts signals nothing more than Congress's inability, at the time, to devote enough time to consideration of trademarks in the bankruptcy context; no negative inference should be drawn by the failure to include trademarks in the Bankruptcy Code's definition of "intellectual property." As Judge Ambro concluded, "[I]t is simply more freight than negative inference will bear to read rejection of a trademark license to effect the same result as termination of that license."
Despite the passage of significant time since Congress added section 365(n) to the Bankruptcy Code, bankruptcy courts have rarely accepted Congress's invitation to develop an equitable treatment of trademark licenses in bankruptcy, and among the reported decisions on this topic, there is no clear consensus. A majority of courts have followed Lubrizol and concluded that trademark licensees do not have the right to continued use of a debtor-licensor's trademarks after rejection. Consistent with the Exide bankruptcy court's holding, these courts have inferred that the exclusion of trademarks from the Code's definition of "intellectual property" can only lead to the conclusion that trademark licensees lose their rights upon the debtor's rejection of the license agreement.
Other courts, consistent with Judge Ambro's concurring opinion in Exide, have held that rejection of a trademark-licensing agreement does not necessarily deprive a nondebtor-licensee of the right to use the trademark. For example, the bankruptcy court in In re Matusalem balanced the benefits of rejection to the debtor and the harm to be caused to the licensee, holding that the licensee was entitled to continued use of the debtor's trademarks. Likewise, Judge Ambro's decision focuses on the legislative history of section 365(n) and bankruptcy courts' inherent authority to consider the equities.
Lubrizol is binding only on courts within the Fourth Circuit, and it did not involve a trademark-licensing agreement. It is therefore not a foregone conclusion that other courts will follow Lubrizol with respect to the rejection of trademark-licensing agreements. Judge Ambro specifically declined to do so: "Rather than reasoning from negative inference to apply another Circuit's holding to this dispute, the Court here should have used, I believe, their equitable powers to give Exide a fresh start without stripping [the licensee] of its fairly procured trademark rights."
Congress could easily settle the dispute by adding trademarks to the Bankruptcy Code's definition of "intellectual property" or by clarifying that a trademark licensee loses its rights when a license agreement is rejected. But for one reason or another, it has declined to do so, and there remains no definitive authority on an issue that is significant to trademark licensees.
In many instances, an entity's business relies heavily, if not exclusively, on its ability to use intellectual property—its own intellectual property and the intellectual property it has licensed from others. At the very least, Congress recognized the importance of intellectual property when it added section 365(n) to the Bankruptcy Code, giving parties to certain IP licenses protections not afforded to other creditors. It may well be that there are substantive differences between trademarks and, for example, patents and copyrights, which warrant the exclusion of trademarks from the Bankruptcy Code's definition of "intellectual property." But the legislative history of section 365(n) suggests that courts may have some discretion regarding the proper treatment of trademark licenses as opposed to other "intellectual property."
Judge Ambro's concurring opinion is not binding on lower courts in the Third Circuit or elsewhere. It highlights, however, an issue that remains unresolved after more than 20 years. Parties in interest realistically can expect a certain amount of uncertainty regarding their rights and responsibilities in a bankruptcy case. Congress's failure to include trademarks under Bankruptcy Code section 365(n) adds to the uncertainty faced by trademark licensees. Until Congress makes a statutory pronouncement or the courts come to a consensus, the uncertain state of play for trademark licensees will continue.
In re Exide Techs., 607 F.3d 957 (3d Cir. 2010).
Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985).
In re Old Carco LLC, 406 B.R. 180 (Bankr. S.D.N.Y. 2009).
In re HQ Global Holdings, Inc., 290 B.R. 507 (Bankr. D. Del. 2003).
In re Centura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002).
In re Matusalem, 158 B.R. 514 (Bankr. S.D. Fla. 1993).