The Bankruptcy Code definition of “intellectual property” does not explicitly include “trademarks.”1 This has led to trademark licensees losing their rights to use the trademark upon rejection of the license in bankruptcy.
A recent decision in the Crumbs2 bankruptcy case in New Jersey addressed this and related issues, finding that trademark licenses can be afforded the protections of § 365(n) based on a court’s equitable powers, notwithstanding their absence from the definition of “intellectual property.” Without consent from licensees to have their rights affected in a § 363 sale, these rights are preserved.
Some licensees are therefore permitted to continue using any intellectual property under such license agreements for the duration of their terms. Any royalties generated under these license agreements are payable directly to the debtor until the sale closes, provided the purchaser purchases the debtor’s accounts receivable, or until rejected or assumed and assigned.
As with many Chapter 11 cases in recent years, the Crumbs bankruptcy was sold pursuant to § 363 almost two months after the petition date pursuant to a credit bid Asset Purchase Agreement (APA) entered into on the petition date with Lemonis Fischer Acquisition Company, LLC (LFAC).
Following Court approval of the sale to LFAC, the Debtors moved to reject certain executory contracts, including six license agreements (the License Agreements) for use of the Debtors’ “Crumbs” trademark and trade secrets (the IP).3 The License Agreements were originally procured for the Debtors by Brand Squared Licensing (BSL), which also provided certain ancillary licensing services to the Debtors. BSL replied to the rejection motion, asserting the Licensees could elect to retain their rights under the License Agreements pursuant to § 365(n), and that BSL would be entitled to royalties derived from the Licensees’ continued use of the IP. The Debtors withdrew the rejection motion as to the License Agreements. LFAC then moved for an order in aid of the Court’s sale order to clarify several open issues concerning the effect of the sale order on the parties’ respective rights with regard to the License Agreements.
In a written opinion filed on October 31, 2014 (the Crumbs Opinion),4 the Court denied LFAC’s motion and considered: (i) whether trademark licensees are within the scope of § 365(n) upon rejection of their respective trademark licenses, even though “trademarks” are not explicitly included in the Bankruptcy Code definition of “intellectual property”; (ii) whether a sale under § 363(b) and (f) trumps and extinguishes rights of third party licensees under § 365(n); and (iii) which party is entitled to collect royalties from the Licensees’ use of the IP, to the extent continuing obligations exist.
Trademark Licenses Are Within the Scope of § 365(n)
Section 365(n) addresses rejection of rights pertaining to intellectual property. The Bankruptcy Code’s definition of “intellectual property” does not specifically include “trademarks.” To determine whether § 365(n) should include trademark licenses within its scope, the Court held it is improper to draw a negative inference from the Bankruptcy Code’s omission of “trademarks” from the definition of “intellectual property.” Citing legislative history and In re Exide Technologies,5 the Court found that Congress intended bankruptcy courts to use their equitable powers and decide, on a case-by-case basis, whether trademark licensees may retain rights under § 365(n).6
The Court refused to invalidate the Licensees rights under § 365(n). It determined it would be inequitable to strip the Licensees’ rights if the License Agreements were rejected, since those rights were already bargained away by the Debtors. The Court also noted that this holding would not prejudice the purchaser, LFAC, who entered the transaction after performing due diligence and could have adjusted its purchase price to account for the License Agreements.
The Court further rejected LFAC’s argument that allowing the Licensees to retain their rights would provide LFAC with little control over the quality of products or services provided under its newly-acquired IP. The Court noted that protections exist outside bankruptcy which provide Licensees incentive to maintain a certain standard of quality, including the possibility of trademark infringement and unfair competition claims for deteriorating quality.
A Sale Under § 363 Does Not Extinguish or Trump Rights Under § 365(n), Absent Consent
The Court held that a sale free and clear of all liens, claims, and encumbrances under § 363(b) and (f) does not extinguish or trump the rights of parties under § 365(n), absent consent. Little case law exists addressing the interplay of §§ 363 and 365(n), so the Court referenced analogous case law interpreting §§ 363 and 365(h).7
In statutory construction, the specific governs the general. Section 365(h) specifically allows lessees to remain in possession after lease rejection. In comparison, § 365(n) allows the licensees to remain subject to the license agreements for their duration. The Court noted that the specific language of § 365(n) should not be overridden by the more general and broad § 363(f), absent consent of the Licensees.
The Bankruptcy Code allows an interest to be extinguished by a sale with consent of the interest holder. Here, the Court found that the Licensees could not consent, as they were not provided with adequate notice that the potential sale put their rights under the License Agreements at risk. Indeed, the APA and sale documents did not include any specific language placing the Licensees on notice that the sale jeopardized their rights.8 Ultimately, the Judge addressed the consent issue as follows:
The Court posits that the content of the Sale Motion was a calculated effort to camouflage the intent to treat the License Agreements as vitiated without raising the specter of § 365(n) rights. Thus it would be inequitable for this Court to find that the Licensees consented to the termination of their rights.9
Only the Debtors are Entitled to Royalties Derived from the License Agreements
The License Agreements were neither sold, nor assumed and assigned to LFAC, which received no portion of the rights under the License Agreements. Those rights therefore remained with the Debtors, and any post-closing royalties generated under the License Agreements would be owed to the Debtors. LFAC did, however, acquire all accounts receivable related to the business, which would include unpaid, post-closing royalties.
BSL, which offered to purchase an assignment of rights under the License Agreements, could not perform the owners’ obligations because it did not own the Crumbs trademark. Neither could the Debtors — only LFAC could perform under the License Agreements, yet LFAC was not a party to those Agreements. Therefore, the Court found that rejection of the License Agreements would be necessary. But until such time as the Agreements were rejected, all royalties generated were payable to the Debtors until assumption, assignment, or rejection.
Conclusion and Consequences
Bankruptcy courts have, in recent years, looked to protect trademark licensees’ rights from the potentially harsh effects of rejection. The Crumbs Court has continued that trend, affording trademark licensees protections under § 365(n), but only to the extent a court chooses to exercise its equitable powers in bankruptcy. However, the explicit exclusion of “trademarks” from the definition of “intellectual property” in § 101(35A) makes the Crumbs Opinion vulnerable as an authority, as future courts may interpret the definition of “intellectual property” to contain an exhaustive list. Even courts accepting the Crumbs Opinion’s analysis may decline to exercise their equitable power to protect licensees under § 365(n).10
1 11 U.S.C. § 101(35A).
2 In re Crumbs Bake Shop, Inc., et al., Bankr. D.N.J. Case No. 14-24287-MBK.
3 The licensees include: Coastal Foods Baking, LLC; Pelican Bay LTD; White Coffee Company; Uncle Harry’s, Inc.; Mystic Apparel, LLC; and Pop! Gourmet (collectively, the “Licensees”).
4 Bankr. D.N.J. Case No. 14-24287-MBK, Docket No. 288 [corrected version at Docket No. 296].
5 In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010).
6 The Court also noted that there exists pending legislation which will remedy Congress’s omission of “trademarks” from the “intellectual property” definition; though it noted the pending legislation was not dispositive to its decision.
7 Section 365(h) is concerned with lease rejection in bankruptcy and has some similarities in purpose with § 365(n).
8 Only the proposed sale order included any language that would suggest the Licensees rights were being affected, and this language was dismissed by the Court as “a mere ten words, buried within a single twenty-nine page document, which itself was affixed to a CM/ECF filing totaling one hundred twenty-nine pages.” Crumbs Opinion at p.16.
10 The views expressed in this article do not necessarily represent the views of Arent Fox LLP, its attorneys, or its clients.