In a decision last month, the First Circuit maintained the relatively narrow scope of protection provided to intellectual property licensees upon rejection of a license in bankruptcy. Focusing on the statute’s language, the court of appeals held that Bankruptcy Code section 365(n) fails to protect either a trademark license or exclusive distribution rights of a debtor’s trademarked goods, even when the trademark-related rights are incorporated into a license containing other protected intellectual property. See Mission Product Holdings, Inc. v. Tempnology LLC, No. 16-9016 (1st Cir. January 16, 2018). The First Circuit’s decision deepens a split among the circuits regarding the rights of trademark licensees when a licensor-debtor rejects a license in bankruptcy.
Background of Section 365
Section 365(a) of the Bankruptcy Code permits a debtor-in-possession to reject executory contracts that it views as not beneficial to the debtor. Upon rejection of a contract, the debtor is freed of the obligation to continue performing under the contract and the counterparty is left with a claim for a pre-petition breach of contract. Bankruptcy Code section 365(n) provides an exception—upon rejection, licensees of intellectual property have the option to retain the intellectual property rights provided by the debtor for the duration of the license. The definition of intellectual property under 11 U.S.C. § 101(35A) includes trade secrets, patents under title 35, patent applications, plant varieties, copyrights and mask work protected under chapter 9 of title 17, but does not include trademarks.
Tempnology, LLC (the “Debtor”), a maker of specialized products designed to remain at low temperatures when used during exercise, filed for bankruptcy on September 1, 2015. The very next day, the Debtor moved to reject a marketing and distribution agreement (the “Agreement”) that granted Mission Product Holdings, Inc. (“Mission”) the following rights: 1) exclusive and non-exclusive distribution rights to certain of the Debtor’s products manufactured within the United States (the “Distribution Rights”); 2) a non-exclusive license to the Debtor’s intellectual property that excluded any rights to the Debtor’s trademarks (the “IP License”); and 3) a non-exclusive, non-transferable, limited license to use the Debtor’s trademarks and logo (the “Trademark License”). The Bankruptcy Court for the District of New Hampshire (the “Bankruptcy Court”) granted the Debtor’s motion to reject the Agreement, subject to Mission’s election to preserve its rights under Bankruptcy Code section 365(n). The Debtor then moved to determine the scope of Mission’s rights under section 365(n). While the parties agreed that Mission could retain its non-exclusive IP License, the parties disagreed as to whether section 365(n) permitted Mission to retain its Trademark License and the exclusive Distribution Rights.
The Bankruptcy Court sided with the Debtor and concluded that section 356(n) did not preserve either the exclusive Distribution Rights or the Trademark License after rejection. The Bankruptcy Court reasoned that section 365(n) clearly excluded trademarks from the definition of protected intellectual property rights, leaving trademark licenses subject to rejection under section 365(a). Likewise, section 365(n) did not extend to Mission’s exclusive Distribution Rights, leading to their termination upon rejection as well. On appeal, the Bankruptcy Appellate Panel (the “BAP”) affirmed the Bankruptcy Court’s decision with respect to Mission’s exclusive Distribution Rights but, as to the Trademark License, the BAP followed the Seventh Circuit’s holding in Sunbeam Products, Inc. v. Chicago American Mfg., LLC, 686 F.3d 372 (7th Cir. 2012), ruling that the effect of rejection is a breach (not termination) of contract and therefore Mission’s rights to use the trademarks could continue post-rejection.
The parties appealed, asking the First Circuit to determine whether section 365(n) protected Mission’s exclusive Distribution Rights and/or its Trademark License post-rejection of the Agreement.
The First Circuit agreed with Bankruptcy Court, holding that neither the exclusive Distribution Rights nor the Trademark License survived rejection of the Agreement.
The court of appeals first considered whether the exclusive Distribution Rights included in the license were protected by section 365(n). Looking both at the statute’s language and its legislative history, the First Circuit held that section 365(n) does not protect an exclusive right to sell a product simply because that right appears in a contract that also includes a license to use intellectual property. The First Circuit also found that the Distribution Rights could not be protected as an “embodiment” of intellectual property, which is also protected under section 365(n). As described by the court of appeals, an “embodiment” is a tangible or physical object that exists pre-petition and is something inherently limited in number. The Distribution Rights simply did not qualify.
Turning to the issue of the Trademark License, the First Circuit noted that Congress expressly listed only six kinds of intellectual property and trademark licenses were notably absent from that list. Moreover, while the court recognized that rejection did not necessarily mean that the non-debtor’s rights under the contract were “vaporized,” it held that trademark rights were not the type of rights that a non-debtor counterparty could continue to use without placing an ongoing burden on the debtor. In so holding, the court disagreed with the Seventh Circuit, which held in Sunbeam that although debtor’s rejection of an agreement frees it from its obligations to perform under the agreement, rejection does not prohibit a licensee from continuing to use the trademark licensed to it under the rejected agreement. The First Circuit reasoned that the holding in Sunbeam undermines the policy reasons behind section 365(a) because it “ignores the residual enforcement burden it would impose on the debtor” because a trademark owner (the Debtor) needs to monitor and exercise control over the quality of goods sold under the licensed trademark. Accordingly, the First Circuit concluded that 365(n) should not protect trademark licenses “unless and until Congress should decide otherwise.”
The First Circuit’s bright-line ruling, which is binding in Maine, Massachusetts, New Hampshire, Puerto Rico and Rhode Island, is clear—trademark licensees should be aware that Bankruptcy Code section 365(n) will not protect trademarks post-rejection in a licensor bankruptcy.