Greg T. Kupniewski, Esquire

A chain of recent Circuit Court decisions have attempted to provide trademark licensees with the same protections accorded patent and copyright licensees in bankruptcy. This trend has particular importance in the franchise context where an SBA borrower's entire business may be dependent on its trademark license. If the current trend continues, trademark licensees will be able to continue using the licensed marks, even if the licensor files for bankruptcy and rejects the license agreement.

As a general rule, a debtor in bankruptcy can reject unfavorable executory contracts. The debtor's "rejection" of a contract is considered a pre-bankruptcy breach of the agreement (even though the rejection occurs after the bankruptcy filing). The non-debtor party's recourse is to assert a monetary claim for rejection damages. Such claims are typically paid only pennies on the dollar.

A 1985 decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. highlighted the inequity that can result when a debtor rejects an intellectual property license. Richmond had licensed certain metal coating technology to Lubrizol. Richmond ultimately filed for bankruptcy. Richmond rejected its license agreement with Lubrizol so that Richmond could license the same technology to another company for a higher royalty. Lubrizol opposed the rejection on the grounds that the rejection could put Lubrizol, an otherwise healthy company, out of business. The court recognized the inequity of the result, but concluded that the bankruptcy code permitted the rejection.

The Lubrizol decision created an immediate outrage in the intellectual property community. Congress promptly reacted by creating a carveout to a debtor's rejection power for intellectual property licenses. Under the carveout, a debtor can still reject an intellectual property license, but the licensee can elect to continue using the licensed IP in exchange for continuing to pay the royalties.

The problem with the carveout is that it applies to patent and copyright licenses but does not apply to trademark licenses. Congress' notes regarding the carveout state that trademark licenses were not included because that issue required further study. Congress, however, was not revisited the issue.

The Third Circuit attempted to fill this legislative hole by finding that a trademark license is not an "executory" contract under the Bankruptcy Code meaning. That approach, however, has been criticized by the Eighth Circuit and other courts. In a 2012 decision, the Seventh Circuit offered the most compelling support for trademark licesnees. In Sunbeam Products, Inc. v. Chicago American Manufacturers, the court found that the analysis in the Lubrizol decision was erroneous. The Sunbeam court held that a debtor's general rejection power does not cut off a trademark licensee's right to continue using the marks.

Neither Congress nor the Supreme Court have stepped up to settle this issue so far. The growing weight of the case law, however, supports the rights of trademark licensees. The risk associated with lending to a franchisee erodes as the trademark licensee protection grows. The time has come for a definitive answer so that franchisees and their lenders will have one less worry if a franchisor files bankruptcy.

For more information on this issue and creditors' rights in Bankruptcy, please contact Greg at 215.542.7070 or contact Greg at gkupniewski@starfieldsmith.com.  

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