Treatment Of Trademark Licenses In Bankruptcy Proceedings


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Treatment Of Trademark Licenses In Bankruptcy Proceedings

  1. 1. Treatment of Trademark Licenses in Bankruptcy Proceedings Tenesa S. Scaturro I. INTRODUCTION It is a common theme etched into the minds of law students throughout their time in lawschool: legislators cannot draft laws that are neatly and cleanly applicable to every possiblesituation. This being so, it is logical to assume that legislators cannot ensure that all laws areharmonious with all other laws.1 One such example exists within the Bankruptcy Code2 as itpertains to treatment of trademark licenses in bankruptcy proceedings. As one commentatorsummarized “for better or worse, filtering…trademark law through the procedures and processesof the bankruptcy system can result in the creation of a parallel universe: the surroundings arefamiliar, the landmarks are recognizable, but everything is skewed by just a few degrees.”3 Part II of this paper discusses the background and competing purposes of trademark lawcompared to bankruptcy law. Part III outlines the two tests, the hypothetical test and the actualtest, that the Courts have applied to the issue of assignment under section 365(c)(1) and benefitsand drawbacks to each of the tests. Part IV reviews the most current reaction to the use of thehypothetical test found in the Supreme Court’s denial of certiorari in N.C.P. Marketing v. BG1 See Bass, et al., BAPCPA in the Courts: How Judicial Interpretation of the New ProvisionsAffects Your Cases, Am. Bankr. Inst., 19th Annual Leadership Conference, 071206 ABI-CLE 15(Dec. 2007) (“Though drafters try to be crystal clear in writing laws, when those laws are appliedto specific facts, it is not always clear what the words plainly mean or what the drafters intendedor the legislators enacted. In fact, the justices haven’t even always agreed on when the text isambiguous or what method of interpretation should be used when it isn’t”) (citing Bruce A.Markell, Alive at 25? A Short Review of the Supreme Court’s Jurisprudence, 1979-2004, 78AMER. BANKR. L.J. 373, 387 (2004)).2 11 U.S.C. § 101, et seq. (2005).3 Stuart M. Ribak, Intellectual Property Licenses: The Impact of Bankruptcy, Practising LawInst., Understanding the Intellectual Property License 2009, 985 PLI 657, 657 (2009). 1
  2. 2. Star Productions, Inc. Finally, Part V offers suggestions for handling trademark licenses inbankruptcy. II. TRADEMARK LAW VERSUS BANKRUPTCY LAWA. IN THIS CORNER, TRADEMARK LAW . . . Intellectual Property is comprised of copyrights, patents, and trademarks. Each of theseindividual components is codified in its own section of the United States Code4 and each has itsown function and purpose. The Copyright and Patent Acts, respectively, seek to encourageinvention and artistic creation to foster the proliferation of the arts and sciences and ensure thoseindividuals profit from their efforts.5 Trademarks, conversely, are not for the purpose ofencouraging arts and sciences, but rather are to prevent confusion among consumers byidentifying the source of the goods.6 Another significant difference between copyrights, patents,and trademarks is that trademark protection is use-based, rather than for a fixed duration, such ascopyrights and patents.7 Thus, the purpose of trademark law “is to prevent consumer confusionand protect the value of identifying symbols, not to encourage invention by providing a period ofexclusive rights.”8 In addition to preventing consumer confusion, trademark owners usetrademarks to “preserve the value of their business name and products.”9 A trademark “includes any word, name, symbol, or device, or combination thereof … toidentify and distinguish…goods and services…from those manufactured or sold by others and to4 Copyright Act, 17 U.S.C. § 101, et seq. (West 2009); Patent Act, 35 U.S.C. § 101, et seq. (West2009), Lanham Act (governing trademarks), 15 U.S.C. § 1051, et seq. (West 2009).5 Charles H. Jeanfreau, Intellectual Property Issues in Bankruptcy, 1 BLOOMBERG CORP. L.J.371, 371 (2006).6 Id. at 374.7 MARY LAFRANCE, UNDERSTANDING TRADEMARK LAW 12, (Matthew Bender) (2005).8 J. Thomas McCarthy, MCCARTHY ON TRADEMARKS AND UNFAIR COMPETITION, § 6:3 (4th ed.2009).9 N.C.P Mktg. Group, Inc. v. BG Star Prods., 337 B.R. 230, 236 (2005). 2
  3. 3. indicate the source of goods.”10 Trademarks are symbols of good will and the trademark andgood will cannot be separated.11 Good will is a somewhat abstract concept that generally refersto public confidence in a product and name recognition in the trademark and of the trademarkowner as the source of quality goods.12 It is well settled that trademarks and their associatedgood will are property rights.13 Trademark owners can broaden the coverage and use of their trademarks by licensingtheir trademarks to third parties.14 A trademark license allows a licensee to use the trademark forparticular goods or services within a geographic area.15 The trademark licensee pays thetrademark owner royalty fees for the privilege of manufacturing and marketing products bearingthe trademark. The Lanham Act permits a trademark owner to license trademarks where thetrademark “is or may be used legitimately by related companies.”16 Section 1127 of the LanhamAct defines “related company” as “any person whose use of a mark is controlled by the owner ofthe mark regarding the nature and quality of goods or services on or in connection with whichthe mark is used.”17 Thus, the Lanham Act requires the trademark owner, as licensor, has “theaffirmative duty of policing in a reasonable manner the activities of his licensees” to ensure that10 15 U.S.C. § 1127.11 N.C.P. Mktg., 337 B.R. 230, 236; In re The Travelot Co., Inc., 286 B.R. 447, 458 (Bankr. S.D.Ga. 2002) (internal citations omitted) (“good will and trademarks go hand in hand, at least to theextent that an attempted transfer of a trademark is void without a transfer of the good willassociated with the trademark”); J. Thomas McCarthy, MCCARTHY ON TRADEMARKS ANDUNFAIR COMPETITION, §18:20 (4th ed. 2009).12 Id. at § 2:16.13 Id. at § 2:20.14 Xuan-Thao N. Nguyen, Bankrupting Trademarks, 37 U.C. DAVIS. L. REV. 1267, 1276-77(2003).15 Id. at 1275. Licensing arrangements can encompass many types of trademark schemes,including, individual trademarks, character licensing, franchise licensing, and brand licensing,among others. Id. For purposes of this Note, “trademark license” includes all of theaforementioned types of licensing.16 15 U.S.C. § 1055.17 15 U.S.C. § 1127. 3
  4. 4. the public is not being misled or exposed to deceptive uses of the trademark.18 In addition, atrademark owner has an interest in monitoring the quality of goods bearing its trademark toensure that the associated good will maintains a high value.19 Thus, in order to have a validtrademark license, the licensor must grant permission to the licensee to use its trademarks andmust obligate the licensor to maintain quality standards and control.20B. . . . AND IN THIS CORNER, BANKRUPTCY LAW. The purpose of bankruptcy is to provide a “fresh start” for a debtor and as it pertains tobusinesses, attempts to reorganize businesses rather than liquidate in order to save jobs.21 Forcreditors of a bankrupt business, the bankruptcy code serves to “secure a prompt and effectual. . .settlement of the estate . . . within a limited period.”22 I. THE INTELLECTUAL PROPERTY BANKRUPTCY PROTECTION ACT On August 7, 1987, Senator Dennis DeConcini, Chairman of the Senate Subcommitteeon Patents, Copyrights, and Trademarks introduced the Intellectual Property BankruptcyProtection Act (IPBPA).23 In his introduction of the IPBPA, Senator DeConcini expressedconcern over the bankruptcy court’s ability to decide that reselling intellectual property rights18 Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358, 367 (1959). Quality control andinspection provisions need not be expressly set forth within the license agreement to comply withthe Lanham Act. Id. at 368.19 N.C.P. Mktg., 337 B.R. at 236 (noting that the “value of the trademark is entirely based ongood will”).20 In re The Travelot Co., Inc., 286 B.R. at 455 (Bankr. S.D. Ga. 2002) (citing Bunn-O-MaticCorp. v. Bunn Coffee Serv., 88 F. Supp. 2d 914 (C.D. Ill. 2000).21 1-1 COLLIER ON BANKRUPTCY at ¶ 1.01 (Alan N. Resnick & Henry J. Sommer eds., 16th ed.rev.).22 Id.23 S. 1626, 100th Cong. (1988). 4
  5. 5. could yield greater royalties than honoring an existing license.24 Further, Senator DeConcinicited the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.25 asdemonstrating the need for the IPBPA. Lubrizol involved a debtor licensor seeking to reject atechnology license agreement. The technology at issue was the principal asset of the debtor, andthus the source of money that would allow the debtor to emerge from bankruptcy. Rejection ofthe license agreement would strip the licensee of its rights to the agreement. The Court notedthat the outcome of the case could have a “chilling effect” on parties entering into these types ofagreements.26 Senator DeConcini stated that “[t]he Lubrizol ruling occurred because Congressnever considered this issue, because no courts had considered it before the Bankruptcy Reformof 1978 and because it requires the application in bankruptcy cases of the very specialized areaof intellectual property law.”27 The proposed IPBPA legislation included a definition of intellectual property, whichincluded trademarks, trade names, and service marks, and allowed for expansion in to “otherproducts of intellectual or creative effort now or hereafter protected by applicable nonbankruptcylaw.”28 The proposed legislation also included a provision applicable to trademarks, tradenames, and service mark licensees to “continue in concert the quality assurance procedures of the24 S. 1626 at S11654. See also S. Rep. No. 100-505 at *2 (1988), reprinted in 1988U.S.C.A.A.N. 3200, 3201 (acknowledging that it “will nearly always be arguably beneficial tothe bankruptcy estate and any exercise of business judgment” to reject the license agreement); Inre Blackstone Potato Chip Co., Inc., 109 B.R. 557, 560 (Bankr. D. R.I. 1990); Nguyen, supranote 14, at 1268 (stating that “the property value of some trademarks is significantly greater thanthat of the trademark owner’s physical assets”); Jason B. Binford, Supreme Court Passes onAssumption and Assignment of Trademark License Agreements, 28 AM. BANKR. INST. J. 36, 36(2009) (noting that “trademark license agreements are often among the most valuable assets in adebtor’s estate” and “can result in a successful reorganization – or a rapid liquidation”).25 Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1047-48 (4th Cir.1985).26 Id.27 S. 1626 at S11654.28 S. 1626 at S11654, (n)(1)(B). 5
  6. 6. licensor.”29 Despite the stated purpose of “keep[ing] secure the rights of intellectual propertylicensors and licensees…,” the only provision of the proposed legislation dealing with debtorlicensees required them only to maintain the confidentiality of information under the subjectagreement.30 In 1988, President Ronald Regan signed a significantly modified version of the IPBPAinto law. The IPBPA,31 as enacted, states in pertinent part: (n)(1) If the trustee32 rejects and executory contract under which the debtor is a licensor of a right to intellectual property, the licensee under such contract may elect – (A) to treat such a contract as terminated by such rejection if such rejection by the trustee amounts to such a breach as would entitle the licensee to treat such contract as terminated by virtue of its own terms, applicable nonbankruptcy law, or an agreement made by the licensee with another entity; or (B) to retain its rights (including a right to enforce any exclusivity provision of such contract, but excluding any other right under applicable nonbankruptcy law to specific performance of such contract) under such contract and under any agreement supplementary to such contract, to such intellectual property . . . as such rights existed immediately before the case commenced . . .29 S. 1626 at S11654, (n)(2)(C).30 S. 1626 at S11654-55, (n)(3). But see S. Rep. 100-505, *1 (1988), reprinted in 1988U.S.C.A.A.N. 3200, 3200 (stating that the purpose of the amendment to Section 365 is “to makeclear that the rights of an intellectual property licensee to use the licensed property cannot beunilaterally cut off as a result of the rejection of the license… in the event of the licensor’sbankruptcy”) (emphasis added); see also S. Rep. No. 100-505, *4 (1988), reprinted in 1988U.S.C.A.A.N. 3200, 3204 (explicitly stating “[t]he bill does not deal with debtor licensees”).31 11 U.S.C. § 365(n).32 Reviewing Section 365 in the context of a Chapter 11 proceeding, in most cases the term“trustee” would be substituted for “debtor in possession.” 11 U.S.C. § 1107, 1108; N.C.P. Mktg.Group v. BG Star Prods., Inc., 556 U.S. ___, 129 S. Ct. 1577, 1577 (2009) (“a debtor inpossession operates its business and performs many functions that would fall to the trustee underother chapters of the Bankruptcy Code”). But see In re Footstar, 323 BR. 566, 572 (Bankr.S.D.N.Y. 2005) (stating that only a trustee, and not a debtor in possession, can assume or assigna contract because Section 1107 “does not provide in words or substance that ‘trustee’ means orincludes ‘debtor in possession’”). 6
  7. 7. The language of the IPBPA parallels the language of 365(h)(1) pertaining to the treatment of realproperty leases.33 Congress noted a similarity between intellectual property licenses and realestate leases34 because in both circumstances, the property at issue is unique and when“threatened with the loss of use . . . it is not possible to obtain precise cover from anothersource.”35 As indicated in Section 365(n)(1), the IPBPA applies only in the case of a debtor-licensor and provides that a licensee can treat the rejection as a termination of the agreement andcan elect to retain rights under the agreement.36 If the licensee elects to retain its rights under thelicense agreement, the licensee is obligated to continue to pay royalties,37 waives any right to aset-off,38 and waives the right to a claim under Section 503(b).39Congress also included a definition of intellectual property as part of the IPBPA:40 (35A) The term “intellectual property” means – (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. . .Notably absent from the definition of intellectual property is trademarks; this was not byaccident. The Senate Report sheds some light on the omission: …trademark, trade name and service mark licensing relationships depend to a large extent on control of the quality of products or services sold by the licensee. Since these matters could not be addressed without more extensive study, it was33 S. Rep. No. 100-505 at *3 (1988), reprinted in 1988 U.S.C.A.A.N. 3200, 3203.34 Id.35 Id.36 11 U.S.C. § 365(n)(1)(B).37 11 U.S.C. § 365(n)(2)(B).38 11 U.S.C. § 365(n)(2)(C)39 11 U.S.C. § 365(n)(2)(C).40 11 U.S.C. § 101(35A). 7
  8. 8. determined to postpone congressional action in this area and to allow the development of equitable treatment of this situation by bankruptcy courts.41 II. SECTION 365(A) AND SECTION 365(C) As a threshold issue to determine whether a license falls under the ambit of Section 365,the court must determine whether the license agreement is an executory contract. An executorycontract is a contract “on which performance remains due to some extent on both sides.”42Intellectual property licenses have consistently been held to be executory contracts due to theongoing nature of customary obligations such as the payment of royalties and maintenance ofintellectual property.43 Under Section 365(a), subject to court approval, a debtor can assume or reject anexecutory contract.44 Although the court is required to approve the assumption or rejection ofthe agreement,45 the court is deferential to the choice of the debtor as long as the choice meetssound business judgment.46 Under the business judgment standard, rejection of an executorycontract (in this case, a trademark license) is appropriate if rejection of the agreement wouldbenefit the estate47 and if it is not “so manifestly unreasonable that it could not be based on sound41 S. Rep. No. 100-505 at *4 (1988), reprinted in 1988 U.S.C.A.A.N. 3200, 3204.42 NLRB v. Bildisco & Bildisco, 456 U.S. 513, 522 n.6 (1984).43 In re Exide Techs., 340 B.R. 222, 239 (Bankr. Del. 2006) (listing examples of cases wheretrademark licenses found to be executory contracts); Darren W. Saunders, Should the BankruptcyCode be Amended to Protect Trademark Licensees? 22 AM. BANKR. INST. J. 44, 44 (2004).44 11 U.S.C. § 365(a).45 Id.46 Riback, supra note 3, at I(B)(1); Debra A. Dandeneau, The Interplay Between IntellectualProperty Rights and Bankruptcy, Practising Law Inst., Handling Intellectual Property Issues inBankruptcy in Business Transactions 2009, 956 PLI 127, 141 (2009) (noting that it is difficult tochallenge debtor’s business judgment). But see In re Petur U.S.A. Instr. Co., Inc., 35 B.R. 561(Bankr. W.D. Wash. 1983) (balancing equities, rather than analyzing debtor’s business judgmentin determining whether to approve rejection of contract).47 Id. 8
  9. 9. business judgment, but only on bad faith, or whim or caprice.”48 If a debtor elects to reject acontract, the nondebtor is left only with a claim for damages for breach of contract as of the dateof the filing of the bankruptcy petition.49 Upon rejection of a trademark license agreement by adebtor licensor, the licensee must stop use of the trademark.50 The licensor’s rejection of atrademark license acts to restore the licensor’s right to use the trademark for the goods andservices and/or geographic location previously designated to the licensee.51 Exclusion from 365(a), that is, when a trademark license agreement may not be assumedor assigned, is governed under Section 365(c)52 of the Code, which states in part: (c) The trustee may not assume or assign any executory contract…of a debtor, whether or not such contract…prohibits or restricts assignment of rights or delegation of duties, if – (1)(A) applicable law excuses a party, other than the debtor, to such contract…from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract…prohibits or restricts assignment of rights or delegation of duties; and (B) such party does not consent to such assumption or assignment…Thus, the debtor in possession cannot assume an agreement if “applicable law” excuses thenondebtor from accepting performance from an entity other than debtor and if the nondebtordoes not consent to the assumption of the agreement.5348 Lubrizol Enters., 756 F.2d at 1047.49 11 U.S.C. § 365 (g)(1); 11 U.S.C. § 502(g)(1). See also In re Chipwhich, Inc., 54 B.R. 427,431 (Bankr. S.D.N.Y. 1985).50 In re HQ Global Holdings, Inc., 290 B.R. 507, 513 (Bankr. Del. 2003) (noting that sincetrademarks do not fall under Section 365(n), Lubrizol controls and thus trademark use mustcease).51 In re Exide Techs., 340 B.R. at 250.52 11 U.S.C. § 365(c) (emphasis added).53 Id.; In re Wellington Vision, Inc., 364 B.R. 129, 136 (S.D. Fl. 2007). 9
  10. 10. C. TRADEMARK AND BANKRUPTCY CONVERGE When trademark law and bankruptcy law converge, there are several sub-issues that arekey to analyzing the treatment of trademark licenses. First, under 365(c) what is “applicablelaw” in the context of trademark licenses? Second, is the trademark license exclusive or non-exclusive, and what difference does it make? Third, how do the circumstances change in thecase of a debtor licensor versus a debtor licensee? I. “APPLICABLE LAW” As it pertains to trademarks, “applicable law” under Section 365(c) has been generallysplit into two categories: analysis as a personal service contract or analysis under the LanhamAct.54 A. PERSONAL SERVICE CONTRACT A personal service contract involves contracting for the unique services of a particularperson; services that could not “equally be performed by another.”55 For example, contractingwith a famous singer to perform a concert would be considered a personal services contract. Atcommon law, personal service contracts are not assignable without consent.56 Thus, the singercould not assign her duties to perform under the contract because her services are unique to herand are a material aspect of the contract.5754 Binford, supra note 24, at 82 (2009).55 3-365 COLLIER ON BANKRUPTCY at ¶ 365.06(1)(b) (Alan N. Resnick & Henry J. Sommer eds.,16th ed. rev.).56 HD Supply Facilities Maint., Ltd. v. Bymoen, 210 P.3d 183, 186 (D. Nev. 2004); 3-365COLLIER ON BANKRUPTCY at ¶ 365.06(1)(b) (Alan N. Resnick & Henry J. Sommer eds., 16th ed.rev.).57 Michelle Morgan Harner, et al., Debtors Beware: The Expanding Universe of Non-Assumable/Non-Assignable Contracts in Bankruptcy, 13 AM. BANKR. INST. L.R. 187, 204(2005). 10
  11. 11. Some courts have used personal service contract analysis in the context of assignment inbankruptcy to determine whether the rights and obligations under the license constitute personalservices, which involve “the exercise of special knowledge, judgment, taste, skill, or ability” thatwould not be assignable without the consent of the licensor.58 Analysis of a trademark license asa personal service contract has unpredictable results.59 Generally, however, the theory is that ifthe license is treated as a personal service contract, the identity of the licensee is a materialelement of the license, and thus the license would not be assignable absent licensor consent.60 Atleast one commentator argues that applying the personal services contract analysis to trademarklicenses would serve to balance the rights of licensors and of debtor licensees.61 B. THE LANHAM ACT Although courts have cited the Lanham Act as “applicable law,” the Lanham Act’s onlyrestriction regarding assignment is that assignments be in writing.62 This restriction, however,applies to the assignment of actual trademarks and does not pertain to trademark licenses.63Courts have thus cited the Lanham Act’s requirement for licensors to control the use of theirtrademarks as the basis for determining that trademark licenses cannot be assigned without theconsent of the licensor.64 One commentator notes that it would be more accurate for courts to58 In re Rooster, 100 B.R. 228, 232 (E.D. Pa. 1989). Some have argued that since corporationsdelegate duties to individuals, the corporation’s duties should always be assignable. However,when a corporation enters into a contract based on the “personal performance of individualswithin that company,” delegation would prove fruitless. Id. at 233, n. 12.59 Stuart M. Riback, Trademark Issues in Bankruptcy, 93 TRADEMARK REP. 867, 887 (2003)(discussing whether personal services contracts were found in cases of an automobile dealership,Burger King franchise, and Bill Blass ties).60 Binford, supra note 24, at 83.61 Id.62 15 U.S.C. § 1060(a)(3); Binford, supra note 24, at 82.63 Id.64 Binford, supra note 24, at 82. 11
  12. 12. cite trademark common law where it is generally accepted that a trademark licensee cannotsublicense (a situation analogous to assigning a license to a third party) without the consent ofthe licensor.65II. LICENSOR-DEBTOR VERSUS LICENSEE-DEBTOR A debtor licensor can put the licensee in a precarious position by rejecting the licenseagreement, thus preventing the licensee from utilizing the trademarks66 as was the case inLubrizol.67 Clearly, the debtor licensor holds a strong bargaining position with the threat ofrejection looming for the licensee.68 If the debtor licensor opts to reject the license the licensee isrequired to cease use of the trademarks immediately, although some courts will allow a transitionperiod, which may be as short as thirty days.69 A licensee that can show that rejection of thelicense agreement would be devastating to its business, while only providing a small benefit tothe debtor licensor may convince the court to deny the request to reject the agreement.70 Sincethe property at issue (i.e. the trademark) is unique, the licensee does not have the ability to“cover.”71 A debtor licensee can also put the licensor in a difficult position. A debtor is not requiredto perform its obligations under the license agreement, absent a court order to do so, until theagreement is assumed or rejected.72 Since the automatic stay constrains the licensor’s ability toenforce the agreement, quality control standards may be left unsupervised.73 This can subject65 Id.66 Jeanfreau, supra note 5, at 375.67 Lubrizol Enters., 756 F.2d at 1047; see supra Part II(B)(i).68 Riback, supra note 59, at 872.69 In re Exide Techs., 340 B.R. at 250-51; Saunders, supra note 43, at 57.70 Jeanfreau, supra note 5, at 375.71 Riback, supra note 3, at I(B)(2).72 Riback, supra note 59, at 883.73 Riback, supra note 59, at 880-81. 12
  13. 13. the licensor to claims of abandonment for failure to control the quality of products bearing itstrademarks and potentially cause damage to the licensor’s reputation.74 The licensor can seekrelief from stay for “cause” under Section 362(d)(1) to terminate the license for lack of adequateprotection under Section 361.75 Arguably, there is no adequate protection available when alicensor’s reputation is at stake.76 In practice, however, it appears that a court is unlikely to grantrelief from stay for cause unless the licensor timely demonstrates that quality control is a realconcern.77III. EXCLUSIVITY VERSUS NON-EXCLUSIVITY Whether an intellectual property license agreement is exclusive can make a difference inwhether the license will be assumable in a bankruptcy proceeding. For example, underapplicable copyright law, an exclusive license acts as a transfer of the copyright since thelicensee gains a property interest in the copyright,78 thus consent for assignment is not required.Conversely, since non-exclusive copyright licenses confer no ownership rights to the licensee,they are not assignable absent licensor consent.79 Under patent law, neither exclusive nor non-exclusive patent licenses are assignable absent the licensor’s consent and, as such, licenses areconsidered to be personal to the licensee.8074 Id.75 Jeanfreau, supra note 5, at 377.76 In re B-K of Kansas, Inc., 69 B.R. 812, 815 (D. Kan. 1989) (“trademarks and servicemarks…[are] such a type [of property] that money may never adequately protect the movant.The movant’s reputation to the general public is at stake”); Riback, supra note 3, at I(C)(4).77 Riback, supra note 59, at 884.78 In re Golden Books Family Entm’t, Inc., 269 B.R. 300, 309 (2001).79 Id. at 310.80 In re Hernandez, 285 B.R. 435, 440 (Bankr. D. Ariz. 2002) (exclusive patent); In re CatapultEntm’t, Inc., 165 F.3d 747, 750 (1999) (internal citations omitted) (non-exclusive patent); In reCFLC, Inc., 89 F.3d 673, 679 (9th Cir. 1996) (internal citations omitted) (non-exclusive patent). 13
  14. 14. In the trademark context, only a few courts have addressed the non-exclusive versusexclusive issue. The most recent cases held a non-exclusive license is personal to the assigneeand not assignable to a third party.81 As such, a “a licensor need not accept performance from orrender performance to an entity other than the licensee.”82 If an exclusive license is treated as atransfer of rights, then the license is not an executory contract and is thus does not fall under theambit of Section 365.83 III. THE DEBATE BETWEEN THE HYPOTHETICAL AND ACTUAL TESTS The assignment of trademark licenses by a debtor licensee in bankruptcy is at the heart ofthe trademark versus bankruptcy issue. The manner in which trademark licenses are treated inbankruptcy proceedings could have a devastating effect on the parties to the agreement.84 As onecommentator points out, “when a party is suddenly forced to stop use of a trademark that hasbecome associated with a product and develop a new commercial identity, there will be anobvious detrimental impact on sales of the product.”85 As discussed in Part II(B)(ii), supra,under Section 365(a), the trustee has the ability to assume or reject an executory contract, subjectto the exceptions found in Section 365(c). Confusion arises depending on how the courtinterprets Section 365(c)(1)’s “assume or assign” language. Courts interpreting the statute’sbased on its disjunctive, plain meaning follow the “hypothetical test,” while courts interpretingthe statute as conjunctive (i.e., “assume and assign”) follow the “actual test.”81 In re The Travelot Co., Inc., 286 B.R. at 455. But see Riback, supra note 3, at I(C)(5)(c)(i)(noting that this is dicta and appears to be contrary to other case law).82 Id.83 11 U.S.C. § 365(a) (“the trustee, subject to the court’s approval, may assume or reject anyexecutory contract”) (emphasis added).84 In re Centura Software Corp., 281 B.R. 660, 674 n. 26 (internal citations omitted) (“rejectionof a trademark license can potentially destroy licensee’s business”); Saunders, supra note 42, at58. See supra Part II(C)(ii).85 Saunders, supra note 43, at 58. 14
  15. 15. A. THE HYPOTHETICAL TEST The Third,86 Fourth,87 and Ninth88 Circuits follow the hypothetical test.89 Followingstatutory language, the hypothetical test “examin[es] whether, hypothetically, without looking tothe individual facts of the case, any executory contracts could be assumed under applicablefederal law.”90 Applying the plain meaning of the statute, assumption and assignment are twoseparate events, each requiring the nondebtor’s consent, before the agreement can be assigned.91Courts applying the hypothetical test hold that Section 365(c)(1) prohibits the debtor fromassuming the trademark license without licensor consent, even if the debtor does not intend toassign the license to a third party, but rather intends to continue using the license.92 Thehypothetical test prevents “the debtor from assuming an executory contract where the licensorwould be excused from accepting performance from a hypothetical third party.”93 Thus if,hypothetically, the debtor would be prohibited from assigning the trademark license without thenondebtor’s consent outside of bankruptcy, then the debtor cannot assume the agreement withinthe bankruptcy.94 It does not matter if the debtor wants to perform under the agreement, ratherthan actually assign the license to a third party.9586 In re West Elec., Inc., 852 F.2d 79 (3d Cir. 1988).87 In re Sunterra Corp., 361 F.3d 257 (4th Cir. 2004) (refusing to allow assumption of a softwarelicense agreement even though the debtor did not intend to assign the agreement and the licensorhad consented to an assignment).88 Catapult Entm’t, 165 F.3d 747 (refusing assignment of a non-exclusive patent license andacknowledging that the “weight of lower court authority” follows the actual test); N.C.P. Mktg.,337 B.R. 230.89 It is unclear whether the Eleventh Circuit applies the hypothetical or actual test. See Jeanfreau,supra note 5, at n. 48 (noting that the court in In re James Cable Partners, L.P. articulated thehypothetical test but appears to have applied the actual test)90 N.C.P. Mktg., 337 B.R. at 234 (internal citations omitted).91 Sunterra Corp., 361 F.3d at 267.92 Jeanfreau, supra note 5, at 377.93 N.C.P. Mktg., 337 B.R. at 234 (internal citations omitted); Jeanfreau, supra note 5, at 377.94 Riback, supra note 59, at 888.95 Id. 15
  16. 16. Courts following the hypothetical test explain that they are adhering to settled rules ofstatutory interpretation because the language of Section 365(c)(1) is clear and unambiguous (“thetrustee may not assume or assign”)96 and does not lead to absurd results.97 Or, put another way,the Bankruptcy Code does not give any special override to trademark license assignments, as itdoes to other assignments in Section 365(f).98 Critics of the hypothetical test point to the Sunterra case as an example of the “mischief”that the hypothetical test can cause.99 In RCI Technology Corporation v. Sunterra Corp. (In reSunterra Corp.),100 the Fourth Circuit, applying the hypothetical test, found that a fully paid,irrevocable, perpetual non-exclusive software license agreement could not be assumed eventhough the licensor had consented to the assignment in the license agreement and the debtor didnot propose assigning the license to a third party, but rather intended to assume the agreement asdebtor in possession.101 The basis for the court’s reasoning is that the assignment provision ofthe agreement did not address assumption, and since assignment and assumption are two distinctevents, consent is required for both.102 Although this result was “quite unreasonable,” it did notreach the level of absurdity required for the court to consult legislative history.10396 11 U.S.C. § 365(c)(1) (emphasis added).97 Catapult Entm’t, 165 F.3d at 754.98 11 U.S.C. § 365(f)(1) states in pertinent part “except as provided in subsection (b) and (c) ofthis section, notwithstanding a provision in an executory contract…of the debtor, or in applicablelaw, that prohibits, restricts, or conditions the assignment of such contract…, the trustee mayassign such contract…”99 David H. Kennedy, Bankruptcy Issues in Intellectual Property Transactions, Practising LawInst., Handling Intellectual Property Issues in Bankruptcy in Business Transactions 2009, 956PLI 151, 191 (2009).100 Sunterra Corp., 361 F.3d 257.101 Id. at 263.102 Id. at 271-72.103 Id. at 268. 16
  17. 17. B. THE ACTUAL TEST The First104 and Second105 Circuits follow the actual test, which examines “whether theexecutory contract at hand, in actuality, can be assumed when applying the applicable federallaw.”106 Thus, in these Circuits, the assignment of a license is only relevant if the debtor wishesto actually assign the agreement.107 Courts following the actual test explain that following the hypothetical test would cause adebtor to “lose its option to assume the contract, even though it never intended to assign thecontract.”108 In essence, these courts adhere to a case-by-case factual inquiry to determine“whether the nondebtor …actually was being ‘forced to accept performance…from someoneother than the debtor . . . with whom it originally contracted.’”109 In other words, the actual testacts to protect a nondebtor from “being forced to accept service from or render service to entitiesother than the entities which they originally contracted.”110 Critics of the actual test argue that the actual test rewrites Section 365(c)(1) to prohibit“assumption and assignment, as opposed to assumption or assignment,”111 while proponentsargue that reading the statute as conjunctive, rather than disjunctive, is “more harmonious” withbankruptcy policy.112 Citing canons of statutory interpretation, at least some courts are unwillingto foray into an area that is reserved for the legislative branch.113104 Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489 (1st Cir. 1997).105 Footstar, 323 B.R. 566.106 N.C.P. Mktg., 337 B.R. at 234 (internal citations omitted).107 Riback, supra note 59, at 888.108 Institut Pasteur, 104 F.3d at 493 (emphasis in original). This was the case in In re Sunterra,see supra Part III(A).109 Institut Pasteur, 104 F.3d at 493 (emphasis in original).110 Rudolph J. Di Massa, Jr. & Matthew E. Hoffman, Assumption and Assignment of IP LicenseAgreements in Bankruptcy: Circuit Split Continues, 27 AM. BANKR. INST. J. 20, 55 (2008).111 Id. (emphasis in original).112 Sunterra Corp., 361 F.3d at 268-69 (internal citations omitted).113 Id. at 269 (internal citations omitted). 17
  18. 18. In summary, under the hypothetical test, a debtor could not assume an agreement if thenondebtor was excused from accepting performance from a hypothetical third party. Conversely,applying the actual test, the debtor would be allowed to assume the agreement if it did not intendto assign, because the nondebtor would not actually be forced to accept performance from a partyother than debtor.114 The debate between the hypothetical and actual tests was presented to the Supreme Courtin N.C.P. Marketing v. BG Star Productions, Inc. IV. N.C.P. MARKETING V. BG STAR PRODUCTIONS, INC. In the late 1990s, Billy Blanks appeared on the scene with the then novel idea ofcombining martial arts with boxing, resulting in the pop culture fitness phenomenon known asTae Bo®.115 Blanks and his wife own the Tae Bo® trademark, among others, through theircompany BG Star.116 In August 1999, BG Star entered in to an agreement with N.C.P.Marketing for the sale and marketing of Tae Bo® branded products.117 Shortly thereafter, adisagreement arose over the parties’ obligations under the agreement.118 In 2001, the partiessettled their differences via settlement agreement which confirmed BG Star’s ownership in theTae Bo® trademark. In 2002, the parties entered in to a license agreement outlining how thetrademark was to be used in marketing and selling the related products.119 N.C.P. failed to pay royalties to BG Star under the license, thereby materially breachingthe agreement.120 BG Star arbitrated its claim against N.C.P. and won a $2.1 million114 Sunterra Corp., 361 F.3d at 263.115 What is Tae Bo – Billy Blanks, (last visited Dec. 14, 2009).116 N.C.P. Mktg., 337 B.R. at 232.117 Id.118 Id.119 Id. The Court found that the 2001 and 2002 agreements superseded the 1999 agreement. Id.120 Id. at 233. 18
  19. 19. judgment.121 N.C.P., unable to pay the judgment, filed for Chapter 11 protection.122 In itsdisclosure statement, N.C.P. claimed ownership of the Tae Bo® brand, which the Blanks, onbehalf of BG Star, disputed.123 BG Star moved for an order compelling the rejection of thelicense agreement, which the bankruptcy court granted and N.C.P. appealed.124 On appeal to the United States District Court, District of Nevada, the court affirmed thebankruptcy court’s order and concluded that BG Star had only granted N.C.P. a non-exclusivelicense giving N.C.P. the right to assign a non-exclusive license.125 The district court held thatunder trademark law, “trademarks are personal and non-assignable without the consent of thelicensor” and thus N.C.P. could not assume the agreement.126 N.C.P. appealed the district court’s decision and the Ninth Circuit Court of Appealsaffirmed without oral argument.127 N.C.P. petitioned the Supreme Court for a writ ofcertiorari.128 In denying certiorari, the Supreme Court issued a statement acknowledging theimportance of resolving the dispute between the hypothetical and actual test, but reserving thedecision for a more appropriate case.129 Justice Kennedy joined by Justice Breyer, appeared to suggest a preference for the actualtest, stating that non-debtors under the hypothetical test receive a windfall:121 Id.122 Id.123 Id.124 Id. at 232.125 Id. at 237.126 Id. It appears from the district court’s opinion that there may have been confusion aboutwhether N.C.P. could assign the non-exclusive trademark license agreement as opposed toassigning the actual trademarks (“NCP does not have the consent of the Blanks to license to thirdparties at this time and therefore cannot assume the trademarks under Section 365(c)(1)”). Id. at238 (emphasis added).127 N.C.P. Mktg. Group, Inc. v. BG Star Prods., 279 Fed. Appx. 561 (2008).128 N.C.P. Mktg. Group, Inc. v. BG Star Prods., 2008 WL 4525353 (Oct. 6, 2008).129 N.C.P. Mktg., 556 U.S. __ , 129 S. Ct. 1577. 19
  20. 20. [i]f the debtor is outside of bankruptcy, then the nondebtor does not have the option to renege on its agreement; but if the debtor seeks bankruptcy protection, then the nondebtor obtains the power to reclaim – and resell at the prevailing, potentially higher market rate – the rights it sold to the debtor.130 Justice Kennedy, did, however, acknowledge that the actual test provides its ownchallenges: “[i]t may be argued, for instance, that the actual test aligns with § 365(c) with soundbankruptcy policy only at the cost of departing from at least one interpretation of the plain text ofthe law.”131 V. GOING FORWARD The treatment of trademark licenses in bankruptcy proceedings is not of littleconsequence. In 2008, despite the recent economic downtown, royalty payments for brandlicenses alone topped $5.7 billion.132 Twenty-one years ago when the IPBPA was enacted, theglobal marketplace looked very different than it does today. The Internet as we know it todaywas just beginning to take shape, and certainly most did not imagine that it would become theglobal e-commerce133 resource that it is today. Although there does not appear to be a perfectsolution, there are several options worth investigating further to address the treatment oftrademark licenses in bankruptcy proceedings. First, as a matter of which “applicable law” applies in the case of a true assignment to athird party, the courts could review trademark license agreements as personal service contractssince the identity of the licensee is a material element of the license agreement. It is a130 Id. It appears that the Supreme Court may also have confused the license agreement and theactual trademark since the Court’s statement refers to “resell” and “sold.” Rights under a licenseagreement are just that, a license, and not a sale.131 Id. at 1578.132 Reuters Business Wire, Licensing Royalty Revenues Decline 5.6% in 2008, Brand OwnersLook to Position Themselves for the Future, June 2, 2009, Seesupra n. 14 (discussing the different types of trademark licenses).133 Nguyen, supra note 14, at 1302. 20
  21. 21. foundational principle of trademark law that the trademark owner has the exclusive choice indeciding whom to allow to represent its image, brand, and good will. It would be inequitable todeny the licensor the right to choose its partner in exploiting its valuable trademark assets. As a starting point for any statutory amendment to Section 365(n), the legislature shouldconduct the “extensive study” that is described in the IPBPA legislative history and determinehow trademarks should be handled in light of the results. The study should include solicitinginformation from representatives of licensors and licensees, experts in the field of trademark law,experts in licensing and marketing, representatives from the United States Patent and TrademarkOffice, judges, and attorneys. Given that so much time has passed since the IPBPA was enacted,the study panel can analyze historical information about the importance of quality control andhow trademark law views a lack of quality control, and the effect on the licensor’s rights. Thepanel should also seek information from licensees to determine whether simply amendingSection 365(n) to include trademarks, trade names, and services marks would address licenseeconcerns. The result of the study would provide a basis to determine a workable solution forboth licensees and licensors. As noted above, Section 365(n) could be amended to include trademarks, trade names,and service marks when the court finds that the quality of the goods or services will bemaintained.134 This should provide a workable resolution for licensees when a licensor files forbankruptcy. Additionally, amendment of Section 365(n) should include a section dealing withdebtor licensees. This provision would need to address quality control procedures to ensure (1)the licensee maintains its quality in the case of a licensee bankruptcy, and (2) allows the licensorto continue to monitor quality from the time of filing the bankruptcy petition until any transition134 Saunders, supra note 43, at 58. 21
  22. 22. period expires, without need to seek relief from stay to do so. This resolution would addressquality control issues when a licensee rejects a license agreement. In the alternative, the Code could provide for the appointment of a trademarkombudsman, similar to the consumer privacy (Section 332) and patient care ombudsman(Section 333) may be an appropriate solution. The trademark ombudsman would monitor thequality of products produced by the licensee and report to the court whether the quality meetsappropriate quality standards. The trademark ombudsman would be a disinterested third partyknowledgeable or expert in trademark law that would be appointed by the court in casesinvolving trademark licenses. The cost of the trademark ombudsman could be subsidized by anominal fee increase for the filing of trademark applications. The hypothetical test versus actual test debate does not appear to have an easy resolutionabsent revision to the code or interpretation from the Supreme Court. The Supreme Court isreluctant to address this important issue because of the specialized and sometimes complicatedapplication of trademark law in the bankruptcy context.135 A true assumption and assignment situation presents problems. Presumably, prior toentering into a licensing arrangement with a licensee, the licensor investigates the licensee’screditworthiness and general suitability. If the licensee is allowed to assign the agreement to athird party without the licensor’s consent, the licensee is denying the licensor the ability toperform its due diligence as to suitability, this potentially materially increasing the licensor’srisk. Thus, under contract principles, the assignment of the agreement should be prohibited.136The actual test, employing a case-by-case analysis to determine whether there is proposedperformance by a third party, appears to be the least problematic and aligns with bankruptcy135 N.C.P. Mktg., 556 U.S. at __, 129 S. Ct. at 1578.136 Restatement (2d) of Contracts § 317(2)(a). 22
  23. 23. policy. In a pure assumption situation, absent any legitimate quality control or adequateprotection concerns, it would be inequitable to allow a licensor to use the licensee’s bankruptcyas a “second bite at the apple” to get out of the agreement. Finally, the courts can analyze the treatment of trademark licenses under equitableprinciples, balancing licensor and licensee concerns to reach a fair result. Although Congressexplicitly encouraged the bankruptcy courts to determine equitable principles for handlingtrademark licenses,137 few have elected to do so.138 Courts have cited the plain, unambiguouslanguage of the Code as the reason they need not consult legislative history.139 However, iffollowing the plain meaning of the statute would lead to absurd results or a result “demonstrablyat odds with the intent of the drafters” the courts should consult legislative history and othermethods of statutory interpretation to reach the correct result.140 As one group of commentatorspoint out, canons of statutory construction in bankruptcy court decisions “do not necessarilycompel consistent conclusions.”141 CONCLUSION The “parallel universe” created by forcing trademark law and bankruptcy law to meshtogether creates numerous nuanced issues and little consistency in application. It is clear thatCongress needs to undertake an extensive study to deal with each of these trademark issues in thecontext of the bankruptcy proceeding to ensure that licensors maintain their reputation with theconsuming public and associated goodwill, while protecting licensees who depend on alicensor’s trademarks for the survival of its business. Until these issues are investigated more137 See supra Part II(B)(i).138 Jeanfreau, supra note 5, at 374.139 In re Centura Software Corp., 281 B.R. 660, 670 (Bankr. N.D. Cal. 2002); Saunders, supranote 43, at 58.140 Bass, supra note 1; Catapult Entm’t, 165 F.3d at 753 (internal citations omitted).141 Bass, supra note 1. 23
  24. 24. fully, there will continue to be a disconnect between the two universes rather than a manageable,if not more harmonious co-existence. 24