The Bankruptcy Strategist ® Volume 32, Number 4 • February 2015 IP Trademark Licensees May Be Able to Have In Bankruptcy Their (Cup)Cake and Eat It, Too Navigating the Maze NJ Bankruptcy Court Extends Section 365(n) Protection to Trademark Licensees on Equitable Grounds By Timothy W. Walsh, Gregory Kopacz and By Frank J. Azzopardi, Timothy Graulich, Brian Resnick and David R. Bauer Darren Azman ollowing a recent line of high-profile and notable decisions that have sought Legal uncertainty abounds for to protect the rights of trademark licensees in a trademark licensor’s bank- intellectual licensees ruptcy, the United States Bankruptcy Court for the District of New Jersey and licensors when their F has issued a significant decision that, for the first time, extends the protections of counterparties enter the murky Section 365(n) of the Bankruptcy Code, 11 U.S.C. § 365(n), to trademark licensees waters of bankruptcy. When on equitable grounds. In re Crumbs Bake Shop, Inc., No. 14-24287 (Bankr. D.N.J. a licensor hits the skids, a li- Oct. 31, 2014) (Crumbs). censee’s two primary concerns Given that intellectual property licenses are generally considered to be execu- should include: 1) whether the protections afforded by Bank- tory that may be rejected pursuant to Section 365(a) of the Bankruptcy ruptcy Code section 365(n) are Code, Section 365(n) serves to mitigate an intellectual property licensee’s expo- available if the debtor-licensor sure to the risk of the licensor’s bankruptcy by allowing the licensee to treat a rejects the license; and 2) pro- rejected license as terminated or to elect to retain certain of its rights under the tecting its rights if the debtor- license. If the licensee accepts termination of its license, it can file a claim in the licensor seeks to sell the intel- bankruptcy case, which would typically be treated as a pre-petition general un- lectual property. By contrast, secured claim. If the licensee makes an election under Section 365(n) to retain when a licensee considers filing its rights, the debtor-licensor must comply with the confidentiality and exclusiv- for bankruptcy, it must consider ity provisions of the license agreement and continue to provide access to the whether it can assume or assign licensed intellectual property as it existed immediately before the bankruptcy the license. filing. Assuming, Rejecting, and However, when Congress enacted Section 365(n), it excluded trademarks from Assigning IP Licenses the definition of “intellectual property” under the Bankruptcy Code for the pur- A key decision for any debtor poses of Section 365(n) (see 11 U.S.C. § 101(35A)), and consequently, courts have is whether to reject, or assume traditionally reasoned by negative inference that a trademark licensee’s rights to and assign its “executory con- licensed trademarks are vulnerable if a trademark licensor in bankruptcy elects tracts.” By assuming a , continued on page 2 a debtor reaffirms the contract and agrees to honor its obliga- In This Issue tions going forward. To assume a contract, the debtor must cure Trademark Licenses... 1 or provide “adequate assurance” IP Licenses...... 3 that all defaults will be cured, Secured Lender Primes and provide adequate assur- Earlier Tax ...... 3 ance of future performance. By rejecting a contract, the debtor disavows the contract and re- fuses to continue performing thereunder. A rejection is treat- ed as a prepetition breach of the contract, and the counterparty continued on page 7 Trademark Licensees allowed them to use the Crumbs trademark and trade secrets, and sell The Bankruptcy continued from page 1 products under the Crumbs brand. ® to reject the trademark license un- In July 2014, due to severe liquidity Strategist EDITOR-IN-CHIEF ...... Adam J . Schlagman der Section 365(a). See, e.g., In re constraints, Crumbs ceased opera- EDITORIAL DIRECTOR . . . . . Wendy Kaplan Stavinoha tions and filed a voluntary petition for MARKETING DIRECTOR . . . . Jeannine Kennedy Old Carco LLC, 406 B.R. 180, 211 GRAPHIC DESIGNER ...... Evelyn Fernandez bankruptcy under Chapter 11 of the (Bankr. S.D.N.Y. 2009); In re HQ BOARD OF EDITORS Global Holdings, Inc., 290 B.R. 507, Bankruptcy Code. WILLIAM R . BALDIGA . . . . Brown Rudnick LLP On the same date that Crumbs New York 513 (Bankr. D. Del. 2003). TED A . BERKOWITZ . . . . Farrell Fritz, P .C . filed for bankruptcy, Crumbs (as Uniondale, NY Recently, courts within the Third MICHAEL A . BLOOM . . . . Morgan, Lewis & Bockius LLP and Seventh Circuits have provided debtors-in-) entered into Philadelphia a credit bid Asset Purchase Agree- ROSANNE CIAMBRONE . . . . Duane Morris LLP trademark licensees with protec- Chicago ment (the APA) for the sale of sub- MICHAEL L . COOK . . . . . Schulte, Roth & Zabel LLP tions against this vulnerability — New York and the court’s decision in Crumbs stantially all of its assets to Lemonis MARK G . DOUGLAS ...... JonesDay Fischer Acquisition Company (LFAC) New York extends this trend. Relying on the ROBERT W . DREMLUK . . . Culhane Meadows PLLC and after LFAC emerged from a sale New York reasoning articulated by Judge TINAMARIE FEIL ...... BMC Group, Inc . Thomas L. Ambro in his concurring auction process as the successful New York stalking-horse bidder, the court sub- ROBERT M . FISHMAN . . . . Shaw Gussis Fishman Glantz opinion in In re Exide Technologies, Chicago sequently entered a sale order that ADAM H . FRIEDMAN . . . . Olshan Frome Wolosky LLP 607 F.3d 957, 964−68 (3d Cir. 2010) approved the sale of Crumbs’ assets New York (Ambro, J., concurring) and citing JEFF J . FRIEDMAN . . . . . Katten Muchin Rosenman LLP to LFAC free and clear of all , New York the legislative history of Section DION W . HAYES ...... McGuireWoods LLP claims, encumbrances and interests. Richmond, VA 365(n), the court in Crumbs con- Subsequently, the debtors filed a JOEL H . LEVITIN ...... Cahill Gordon & Reindel LLP cluded that even if Section 365(n) New York motion to reject certain executory DANIEL A . LOWENTHAL . . Patterson Bellknap Webb & does not expressly apply to trade- Tyler LLP contracts, including the trademark New York marks, the court has the equitable licenses granted to Crumbs’ licens- JEFF J . MARWIL ...... Proskauer Rose LLP power to apply Section 365(n) to Chicago ees. A representative of the licens- MARK A . MCDERMOTT . . . Skadden Arps trademark licenses. Crumbs, No. 14- New York ees filed a response arguing that HARVEY R . MILLER . . . . . Weil, Gotshal & Manges LLP 24284 at 8-9. In addition, the court the trademark licensees could elect New York concluded that the trademark li- TODD L . PADNOS . . . . . Sheppard Mullin Richter & to maintain their licensed rights Hampton LLP censees’ Section 365(n) rights were San Francisco under Section 365(n). The debtors ADAM C . ROGOFF . . . . . Kramer Levin Naftalis & not vitiated by a Section 363 “free withdrew their rejection motion Frankel LLP and clear” sale of the licensed trade- New York to the extent that it related to the ADAM L . ROSEN ...... Silverman Acampora LLP mark because it did not have the Jericho, NY trademark licenses and LFAC filed PAUL RUBIN ...... Rubin LLC consent of the trademark licensees. a motion seeking clarification on New York Id. at 12. Finally, because the appli- MICHAEL J . SAGE . . . . . Dechert LLP the parties’ rights under the license New York cable licenses were excluded from JEFFERY L . SCHWARTZ . . . Hahn & Hessen, LLP agreements. New York the Section 363 sale, the debtors RUSSELL C . SILBERGLIED . . Richards, Layton & Finger, P .A . Bankruptcy Court Opinion were entitled to collect future royal- Wilmington, DE In evaluating LFAC’s motion, the JACK L . SMITH ...... Holland & Hart LLP ties from the licensees. Id. at 21. Denver court considered three issues: STEVEN B . SMITH . . . . . Dickstein Shapiro LLP Background New York 1. whether trademark licenses fall BENNETT SPIEGEL . . . . . Jones Day Crumbs Bake Shop, Inc. (“Crumbs”) under the protective scope of Los Angeles specialized in the retail sale of cup- JAMES H .M . SPRAYREGEN . . Kirkland & Ellis LLP Section 365(n), notwithstanding Chicago cakes as well as other baked goods GRANT T . STEIN ...... Alston & Bird that “trademarks” are not explic- Atlanta and beverages. As part of its busi- itly included in the definition of AMY M . TONTI ...... Reed Smith LLP Pittsburgh, PA ness, Crumbs entered into licensing “intellectual property” under agreements with third parties, which The Bankruptcy Strategist® (ISSN 0747-8917) is published by the Bankruptcy Code; Journal Newsletters, a division of ALM .© 2015 ALM Media, LLC . 2. whether a sale of the debtors’ as- All rights reserved . No reproduction of any portion of this Frank Azzopardi (frank.azzopardi issue is allowed without written permission sets pursuant to Section 363(b) from the publisher . Telephone: (877) 256-2472 @davispolk.com) is head of Editorial e-mail: wampolsk@alm .com and (f) trumps and extinguishes Circulation e-mail: customercare@alm .com Davis Polk’s Intellectual Property Reprints: www .almreprints .com the rights of third-party licens- and Technology Group, and David ees under Section 365(n); and POSTMASTER: Send address changes to: Bauer ([email protected]) ALM 3. which party is entitled to the 120 Broadway, New York, NY 10271 is a senior associate in that group. collection of any ongoing roy- Published Monthly by: Timothy Graulich (timothy. Law Journal Newsletters alties generated as a result of 1617 JFK Boulevard, Suite 1750, Philadelphia, PA 19103 [email protected]) and Brian third-party licensees’ use of li- www .ljnonline .com Resnick (brian.resnick@davispolk. com) are partners in Davis Polk’s In- censed intellectual property. solvency and Restructuring Group. continued on page 5 2 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy February 2015 Secured Lender had arisen months before the lender lien on Feb. 11, 2005 would relate made the secured loan. back to Jan. 4, 2005 and thus prime Primes Restivo has relevance beyond the the IRS lien, which was not record- Earlier Federal tax lien context. The Pension Ben- ed until Jan. 10, 2005. More impor- efit Guaranty Corporation (PBGC) tant, the Bank also claimed a prior Tax Lien will obtain a lien on a debtor’s as- “equitable lien” under Maryland’s doctrine of equitable Fourth Circuit Split Decision sets to secure the payment of its claims arising from the termination conversion. By Michael L. Cook of an underfunded pension plan. The Bankruptcy Court and 29 U.S.C. § 4068(a). That lien will District Court The U.S. Court of Appeals for the be treated as a tax lien. 29 U.S.C. The bankruptcy court held for the Fourth Circuit, on Oct. 31, 2014, § 4068(c)(2). Bank, reasoning that its recorded held in a split decision that a lend- Facts lien had, as a matter of Maryland er’s unrecorded lien primed an ear- The following dates are critical in law, related back to Jan. 4, 2005, six lier unrecorded federal tax lien on Restivo: days before the IRS had recorded its a Chapter 11 debtor’s . • The debtor failed to pay fed- tax lien. The district court affirmed In re Restivo Auto Body, Inc., 2014 eral employment taxes in 2003- on the same ground. More signifi- WL 5488166 (4th Cir. Oct. 31, 2014) 04, giving rise to a U.S. tax lien cant is the district court’s further (2-1). Relying on “Maryland[’s] com- on all of the debtor’s assets on holding that the Bank’s lien would mon law … doctrine of equitable Sept. 20, 2004, after the IRS had have primed the federal tax lien un- conversion,” the court reasoned that issued a notice and demand for der Maryland law even if the Bank the lender was entitled “to the same payment. had never recorded its lien. As the protections as a [good faith] pur- • The debtor borrowed $1 million district court read Maryland’s doc- chaser for value who takes free from the lender (Bank) on Jan. trine of equitable conversion, the and clear of all subsequent liens re- 4, 2005, six days before the IRS Bank had the same protections as a gardless of recordation.” Id. at *2. “filed notice of its [earlier] feder- good faith purchaser for value who The dissent, however, argued that al tax lien” and gave “the Bank a would be able to take “title free and federal law governs “the priority of note and a of trust on two clear of all subsequent liens regard- federal tax liens”; the debtor taxpay- adjacent parcels of real property less of recordation.” The district er had no “unencumbered title to … … to secure repayment of the court specifically relied on Internal give” the lender; and that the major- loan, but [the Bank] delayed in Revenue Code (Tax Code) Section ity erred by applying “state law to the .” 2014 WL 6323(h)(1)(A), which gives the fed- determine the priority of the IRS’s 5488166, at *2. eral tax lien the status of a subse- tax lien to the property,” an issue • In the meantime, “six days lat- quent judgment lien “arising out of to be “determined solely by federal er, on Jan. 10, 2005, the IRS an unsecured obligation,” which is law.” Id. The Restivo case reassures filed notice of a federal tax lien subordinate to an earlier good faith secured lenders unaware of a bor- against” the debtor “for unpaid purchase for value. Id. at *2. rower’s preexisting tax lien, how- employment taxes.” Id. at *1 The Court of Appeals ever, as it protects them against the (emphasis in original). The Fourth Circuit reversed the government’s nondisclosure. • The Bank eventually recorded district court’s holding that Mary- Relevance of the Case its deed of trust on Feb. 11, land law gave the Bank retroactive To protect itself against compet- 2005. priority over the recorded federal ing lienors, such as federal tax liens, • The debtor later filed its Chap- tax lien, relying on Section 6323(h) a secured lender will promptly re- ter 11 petition in April 2011. Af- (1)(A). Nevertheless, it affirmed the cord its security interest as soon as ter the IRS filed a claim against district court on the ground that its borrower signs a security agree- the debtor for taxes, interest Maryland’s common law doctrine ment or mortgage. Any delay in re- and penalties, the Bank sued of equitable conversion gave the cording may enable an intervening the IRS in the bankruptcy court, Bank an “equitable security inter- secured lender, judgment creditor seeking a est in” the debtor’s real property on or bankruptcy trustee to prime the that its lien primed the federal Jan. 4, regardless of the Bank’s fail- earlier lender. In Restivo, however, tax lien. ure to record its lien at that time. the lender inexplicably delayed re- The Bank’s Legal Position It reasoned that the Bank’s inter- cording its lien by five weeks and The Bank relied on a provision est became “protected … against a was still able to prime the interven- in Maryland’s Real subsequent lien arising out of an ing recorded federal tax lien that that “relates back a deed of trust’s unsecured obligation” on that date, Michael L. Cook, a member of this effective date upon recordation to giving it “priority over the federal Newsletter’s Board of Editors, is a the date when the deed of trust was tax lien.” Id. at *1, citing Tax Code partner at Schulte Roth & Zabel LLP executed.” Id. at *2. Under this rea- §§ 6323(a) and (h)(l). in New York. soning, the Bank’s recording of its continued on page 4 February 2015 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy 3 Secured Lenders applying the Maryland “doctrine of corded tax liens ineffective against equitable conversion.” Id. at *8. It holders of security interests … .” Id. continued from page 3 agreed with the district court that In short, the Tax Code “subordinates “under Maryland law, … the holder unrecorded tax liens to security in- Federal Law of an equitable title or interest in terests, and it defines security inter- Federal law determines the prior- property, by virtue of an unrecord- ests according to their protection ity of a federal tax lien, the court ed contract of sale, has a claim su- under state law against subsequent stressed. A federal tax lien will or- perior to that of a creditor obtaining judgment liens.” Id., citing Tax Code dinarily prime a later arising lien a judgment subsequent to the ex- § 6323(h)(1)(A). Maryland law, too, under the established principle that ecution of the contract.” Moreover, confirmed that “recordation” of an “the first in time is the first in right.” “the doctrine [of equitable conver- such as the one Id. at *3. But the tax lien will not sion] applies to lenders whose in- held by the Bank here “is irrelevant be valid against any later holder of terests are secured by mortgages to the [equitable] doctrine’s applica- a security interest until the IRS files or deeds of trust.” Id., quoting Steb- tion.” Id. notice of its tax lien. Id., citing Tax bins-Anderson Co. v. Bolton, 117 The majority of the Fourth Cir- Code § 6323(a). The existence of a A.2d 908, 910 (Md. 1955). In short, cuit panel rejected the dissent’s ar- “security interest” that will prime a federal law (Tax Code § 6323(h)(1) gument that “the IRS’s tax lien ‘was federal lien turns on whether “the (A)) makes Maryland law applica- not a subsequent lien.’” Id. at *10n. interest has become protected un- ble, and under that law, “judgment Instead, the majority held that the der local law against a subsequent creditors [are} ‘subject to prior, un- “Tax Code subordinates unrecord- judgment lien arising out of an un- disclosed equities.’” Id., quoting ed tax liens to security interests” secured obligation.” Id., citing Tax Wash. Mut. Bank v. Homan, 974 that are protected “under state law Code § 6323(h)(1)(A). A.2d 376, 389 (Md. Ct. Spec. App. against subsequent judgment liens.” The Bank’s Late Recorded 2009), citing Stebbins-Anderson. Id. at *10, citing Tax Code § 6323(h) Lien Did Not Relate Back Maryland law thus “protects equi- (1)(A). The Bank argued, in reliance on table security interests against sub- The dissent accused the majority Maryland case law, that its record- sequent judgment-creditor liens.” of mistakenly applying state law, ing of its lien on Feb. 11, 2005 re- Id. at *8. The Bank, as a good-faith “blurr[ing] the line between the lated back to Jan. 4, 2005, when the holder of a deed of trust, would be IRS and a judgment creditor and debtor had signed the deed of trust. “entitled to the protections avail- between a tax lien and a judgment Disagreeing, the Fourth Circuit able to a good faith purchaser for lien without citing any precedent held that the district court “misin- value.” Id., citing Wash. Mut. Bank, that allows it to do so.” Id. at *13. terpreted § 6323(h)(1)(A) in ruling 974 A.2d at 396-98. The dissent stressed that there was that [Maryland’s statutory law] gave Moreover, reasoned the Fourth “no judgment lien here. There is a … [the Bank] a prior security inter- Circuit, Maryland is not unique. tax lien. And its priority … is deter- est” because the Tax Code “explic- Both Texas and New York courts mined solely by federal law.” Id. Be- itly” precluded “the application of have held that a lender with a deed cause the federal tax lien “predates” a relation-back rule.” Id. at *7. The of trust primed a debtor’s subse- the Bank’s lien, explained the dis- vague language of the relevant sec- quent judgment lien creditor. Id. at sent, it “arose and became protected tion “requires … the evaluation of” *10. at an earlier date” and was “not a the Bank’s “security interest … as subsequent lien.” Id. at *14. Federal Law Makes of the date that notice of the fed- Comment eral tax lien was filed.” Id. at *6. Be- State Law Applicable The Bank here took equitable title The dissent was right about one cause the Bank “had not, as of that principle: “the priority of federal tax date [Jan. 10, 2005], recorded its” to the debtor’s real property when the debtor signed the deed of trust liens is governed by federal law.” lien, “the relation back provision” Id. at *13. But that principle does in the Maryland Real Property stat- on Jan. 4, 2005, giving the Bank “pri- ority over” any of the debtor’s later not mean the federal government ute did not yet apply. Id. In other “judgment-creditor lienholders.” Id. always wins or even that it should words, the Bank’s lien could only Because the Tax Code subordinates win in Restivo. According to the relate back to a prior time if the a federal tax lien to a deed of trust U.S. Supreme Court, “[u]nless some Bank had perfected (i.e., recorded) “that has become protected ‘against federal interest requires a different that lien at a point prior to the re- a subsequent judgment lien arising result, there is no reason why [prop- cording of the federal tax lien. out of an unsecured obligation,’” Tax erty] interests should be analyzed Maryland’s Doctrine of Code § 6323 (h)(1)(A), the Bank’s differently simply because an inter- Equitable Conversion “equitable security interest,” aris- ested party is involved in a bank- The Fourth Circuit affirmed the ing on Jan. 4, 2005, primed the later ruptcy [case].” Raleigh v. Ill. Dept. district court, however, on the federal tax lien recorded on Jan. 11, of Revenue, 530 U.S. 15, 20 (2000), ground that the Bank had a prior 2005. Id. Regardless of when the quoting Butner v. United States, 440 “security interest,” consistent with federal tax lien rose, “Congress … U.S. 48, 55 (1979). Tax Code Section 6323(h)(1)(A), by amended § 6323(a) to make unre- continued on page 5 4 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy February 2015 Secured Lenders eral Tax Lien Act of 1966 estab- has been the practice of tax lished the priorities of the Gov- authorities to exercise forbear- continued from page 4 ernment as compared to other ance in filing notices of lien in creditors, both secured and un- Federal law here gave the Bank cases when there appears to be secured. IRC § 6323 sets forth a “semi-super priority” under Tax a reasonable possibility that the the rules to apply in determin- Code § 6323(a): A federal tax lien is business can regain financial ing priority amongst creditors. not “valid against any purchaser [or] stability. A general creditor is It divides creditors into four holder of a security interest … until” anyone who has not perfected classes. 1). The first level of the IRS files notice of its lien. Section their interest in the debtor’s creditor is those creditors who 6323(h)(i) defines “security interest” assets, either by mortgage, se- receive priority status only if to include “any interest in property curity interest, or judgment. It their liens are perfected before … for the purpose of securing pay- has been contended that the the Notice of Federal Tax Lien IRS, assured in any event of a ment … .” That “security interest” is filed. 2) The second level of exists when, among other things, it priority over general unsecured creditors is given “semi-super” creditors, has preferred to in- “has become protected under local priority status in IRC § 6323(c). law against a subsequent judgment duce them, by nondisclosure, to They have limited priority over provide the financing that will lien arising out of an unsecured ob- a perfected federal tax lien, ligation.” Maryland law in Restivo, ex- improve the taxpayer’s chances provided that their interests are of at least paying off the federal pressly made applicable by Tax Code created pursuant to a written Section 6323(h)(l), enabled the Bank taxes. Taxpayers are first en- agreement which is entered into couraged to borrow the money to prime the unrecorded federal tax before filing of the Notice of Fed- lien. See generally Steven R. Mather from an outside source before eral Tax Lien, and is protected exploring other payment pos- & Paul H. Weisman, 637-2nd T.M., under local law against subse- sibilities. Federal Tax Collections Procedure – quent judgment lien creditors. D. A. Schmudde, Federal Tax Liens Liens, Levies, Suits and Third Party Li- … 67-68; 73 (4th rev. ed. 2001) (empha- ability A-29–A-32 (2013), citing Trea- … The Government knows that sis added). In Restivo, the IRS may sury Regs. § 301.6323(h)-(l)(a)(2). if it publicizes a taxpayer’s tax have failed to record its lien with One commentator’s explanation obligations by filing notice of the hope that a lender like the Bank of the federal tax lien priority, 13 liens, the taxpayer’s credit will would help the debtor regain its vi- years ago, shows why the Bank had evaporate and the chances of ability and pay its outstanding taxes. to prevail in Restivo: earning enough to pay off the As a general rule, “first in time, tax obligation will be signifi- ❖ first in right” prevails. The Fed- cantly impaired. Therefore, it — — Trademark Licensees by-case basis whether a trademark mark, trade name and service licensee may rely upon Section mark licensing relationships continued from page 2 365(n) to repel attempted rejection depend to a large extent on Equitable Power to Apply of the license that it has obtained control of the quality of the from a debtor-licensor. Crumbs, No. products or services sold by the Section 365(n) licensee. Since these matters On the question of whether 14-24284 at 8−10. In particular, the could not be addressed without Crumbs’ trademark licensees were court pointed to the following dis- more extensive study, it was de- eligible to retain their licensed cussion in the Senate committee re- termined to postpone congres- rights pursuant to Section 365(n), port on the bill for Section 365(n) as sional action in this area and to the court was not convinced that persuasive authority for exercising allow the development of equi- Congress’ omission of trademarks the court’s discretion and : table treatment of this situation from the Bankruptcy Code’s defini- [T]he bill does not address the tion of “intellectual property” evi- rejection of executory trade- by bankruptcy courts. … Nor denced an intent by Congress for mark, trade name or service does the bill address or intend Section 365(n) not to apply when a mark licenses by debtor-licen- any inference to be drawn con- debtor-licensor rejects a trademark sors. While such rejection is cerning the treatment of execu- license. Id. at 8. Instead, relying on of concern because of the in- tory contracts which are unre- Judge Ambro’s concurring opinion terpretation of section 365 by lated to intellectual property. in In re Exide Technologies, 607 the Lubrizol court and others, Id. at 8 (quoting S. Rep. No. 100- F.3d at 964−68 (Ambro, J., concur- see, e.g., In re Chipwich, Inc., 505, at 5 (1988) (emphasis in the ring), and the legislative history of 54 [B.R.] 427 (Bankr. S.D.N.Y. original)). Section 365(n), the court concluded 1985), such contracts raise is- Noting that the debtors had that Congress intended for bank- sues beyond the scope of this bargained away rights for their ruptcy courts to decide on a case- legislation. In particular, trade- continued on page 6 February 2015 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy 5 Trademark Licensees to cause them to believe that an ob- Nevertheless, given that there jection was necessary to retain their remains a split in federal circuit continued from page 5 Section 365(n) rights. Id. at 12-17. court authority on this question, licensees to use the licensed trade- Confident that the licensees would until such time as either the United marks, the court concluded that it have objected to the extinguishment States Supreme Court elects to re- would be inequitable to strip the li- of their Section 365(n) rights if they view the issue or Congress amends had notice of the sale of the licensed censees of those rights in the event the Bankruptcy Code to expressly trademarks, the court concluded of a rejection of the license agree- clarify whether trademark licenses ments by the debtors. The court that it would be inequitable to hold are within the purview of Section agreed with Judge Ambro that Sec- otherwise. Id. at 17. The court also 365(n), practitioners should contin- tion 365 may be used by courts as held that, in the absence of consent, a “shield” to “free a bankrupt trade- nothing in the language of Section ue to employ traditional strategies mark licensor from burdensome 363(f) expressly trumps the rights for mitigating the risks associated duties that hinder its reorganiza- granted to licensees under Section with licensors entering bankruptcy. tion,” but that Section 365 should 365(n), and that the legislative his- Such strategies include having the not be used as a “sword” to permit tory of Section 365 supports such licensee: a “licensor [to] take back trademark an interpretation. Id. at 17-20. • acquire the licensed trademarks rights it bargained away.” Crumbs, Rights to Royalties if possible; No. 14-24284 at 9 (quoting In re Ex- Finally, on the third question con- • take a security interest in the li- ide Technologies, 607 F.3d at 967-68 sidered, the court concluded that censed trademarks; (internal quotations omitted)). because the license agreements at • allocate payments under the li- Section 365(n) vs. Section 363 issue were explicitly excluded from cense in a manner that would On the second question con- the sale to LFAC, LFAC was not a create a disincentive for the sidered, the court concluded that party to those agreements and thus trustee to reject the license; and the Section 365(n) interests of the had no rights under them. Id. at 21. • request that the licensor place trademark licensees were not extin- Accordingly, the associated post- the licensed trademarks in a guished by the Section 363 sale of closing royalty rights deriving from special purpose entity isolated the debtors’ assets to LFAC because future use of the licensed intellec- in the absence of any express or tual property by the licensees re- from any bankruptcy filing. implied consent of the trademark mained with the debtors, while the The Crumbs decision also high- licensees, the Section 363 sale did actual intellectual property that was lights the importance of placing not trump the rights granted to the subject of the license would be intellectual property licensees on the trademark licensees by Section owned by LFAC. Id. at 21-22. adequate notice of any proposal to 365(n). Id. at 12. LFAC, relying on a Conclusions and effect a sale of the licensed intel- line of cases that included Future- Implications for lectual property pursuant to Section Source LLC v. Reuters Ltd., 312 F.3d Practice 363, as the failure to do so may result 281 (7th Cir. 2002), argued that the in the purchaser of such licensed trademark licensees had impliedly For approximately 25 years, it was intellectual property taking such consented to the vitiation of their widely understood under Lubrizol rights subject to the Section 365(n) Section 365(n) rights by failing to Enterprises, Inc. v. Richmond Metal object to the debtors’ motion seek- Finishers, Inc., 756 F.2d 1043 (4th rights of the licensee. In addition, ing approval of the sale of the debt- Cir. 1985), that trademark licenses purchasers of a debtor-licensor’s as- ors’ assets to LFAC. Crumbs, No. were vulnerable in the event of a li- sets should be careful to receive an 14-24284 at 12. However, the court censor’s bankruptcy, in part because from the debtor-licensor distinguished the FutureSource line trademark licensees could not avail of applicable licenses (including the of cases as all involving non-object- themselves of the protections of Sec- right to receive royalties) to account ing parties being provided with ade- tion 365(n) of the Bankruptcy Code. for the possibility that the licenses quate notice of the relevant free and Within the last few years, there has survive the sale or are unable to be been a growing trend among courts clear sale that would vitiate their rejected under Section 365. rights. Id. within the Third and Seventh Cir- The court then found that the cuits to provide trademark licensees —❖— trademark licensees’ failure to object with protections against such risk. to the Section 363 sale to LFAC was See, e.g., Sunbeam Products, Inc. v. The publisher of this newsletter is not engaged in rendering understandable given that the APA Chicago American Manufacturing, legal, accounting, financial, investment advisory or other was unclear as to the specific as- LLC, 686 F.3d 372 (7th Cir. 2012); In professional services, and this publication is not meant to constitute legal, accounting, financial, investment advisory sets being sold and neither the APA re Exide Technologies, 607 F.3d 957. or other professional advice. If legal, financial, investment nor the sale motion put the trade- The court’s decision in Crumbs fur- advisory or other professional assistance is required, the services of a competent professional person should be sought. mark licensees on adequate notice ther extends this trend. 6 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy February 2015 IP Licenses izol and held that the licensee of a WL 5508177. [See article by Azzopar- trademark, while outside the Bank- di, et al., infra, page 1.] Phrased dif- continued from page 1 ruptcy Code’s definition of “intellec- ferently, even if a licensee does not is entitled to a general unsecured tual property,” could continue using have a lien on the licensed property claim, which may be paid only cents the trademark. See Sunbeam Prod- to be sold, it may still be entitled to on the dollar. Last, the debtor may ucts v. Chicago Am. Mnfc., 686 F.3d use the licensed property under sec- assign a contract to such party, not- 372 (7th Cir. 2012); In re Crumbs tion 365(n). withstanding any contractual pro- Bake Shop Inc., No. 14-24287, 2014 Assumption and Assignment vision prohibiting assignment, so WL 5508177 (Bankr. D.N.J. Oct. 31, By Debtor-Licensees Similar to the rights afforded to long as a debtor provides adequate 2014). a debtor-licensor, a debtor-licensee assurance that the assignee can per- Only a limited number of cases may assume, reject, or assume and form the contractual obligations. have addressed the holding of Lu- assign intellectual property licenses. But a debtor’s ability to assign ex- brizol and its progeny, and thus un- However, the implications of doing ecutory contracts is not unfettered. certainty remains. However, courts have recently rejected the hardline so are different when the licensee Rather, Bankruptcy Code section decision in Lubrizol in favor of a is in bankruptcy. Specifically, section 365(c) provides that a debtor may broader and more practical inter- 365(n) does not apply when a debtor- not assume or assign an executory pretation of “intellectual property.” licensee rejects an intellectual proper- contract if applicable law excuses Nonetheless, licensees should con- ty license — the licensor retains own- the counterparty from accepting per- tinue to anticipate potentially ad- ership of the intellectual property, formance from or rendering perfor- verse outcomes in this context and and thus there are no concerns about mance to a new party. This restriction plan accordingly. the licensor’s ability to continue us- protects counterparties from being Sales of Intellectual ing the intellectual property after re- forced to accept performance by a Property by a jection. However, a debtor-licensee’s different party when non-bankruptcy Debtor-Licensor ability to assume and assign an intel- law would prevent such a result. Taken together, Bankruptcy Code lectual property license will vary de- Debtor-Licensor’s Rejection sections 363(b) and (f) permit a pending on several factors, including: Of an ‘Intellectual debtor to sell assets (including intel- 1) whether the license is exclusive or Property’ License lectual property) “free and clear” of nonexclusive; 2) the type of intellec- The Fourth Circuit in Lubrizol all liens, claims, and encumbrances. tual property; and 3) the jurisdiction Ent., Inc. v. Richmond Metal Finish- In other words, a debtor can sell of the bankruptcy case. ers, Inc. (In re Richmand Finishers, property, even if another party as- Courts have generally held that Inc.), 756 F.2d 1043 (4th Cir. 1985), serts an interest in the property to be a debtor-licensee may not assign a held that a patent licensee loses its sold. However, an intellectual prop- nonexclusive patent license because license rights when a licensor re- erty licensee may have two special such licenses are deemed personal jects the license in bankruptcy. In rights in connection with such a sale. and non-assignable under federal response to Lubrizol, Congress en- First, if a licensee has a lien on law. Everex Sys., Inc. v. Cadtrak acted section 365(n) to provide ad- the property to be sold, the licensee Corp. (In re CFLC, Inc.), 89 F.3d 673, ditional protection to intellectual can generally “credit bid” its indebt- 679 (9th Cir. 1996). Of course, if the property licensees. Under section edness in connection with the sale. license contains a provision permit- 365(n), if a debtor rejects an intel- Distilled to its basics, credit bidding ting assignment by the licensee, then lectual property license, the licens- allows a lienholder to bid for the as- assignment would likely be permit- ee may elect to retain its right to use set to which its lien attaches by using ted. With regard to the assignability the licensed property (though the the debt it is owed to offset the pur- of exclusive patent licenses, federal debtor is relieved of all affirmative chase price. Credit bidding provides law has not been definitively estab- obligations under the agreement). a lienholder two primary benefits: lished, and application of such law Section 365(n) applies to “intellec- 1) it protects the lienholder against in the bankruptcy context is limited. tual property,” yet the Bankruptcy the risk that its collateral will be sold Even though a debtor-licensee of an Code’s definition of that term ex- at a depressed price; and 2) it can exclusive patent has much broader cludes foreign patents and copy- provide an advantage at the auction rights than the licensee of a non- rights, trademarks, service marks, because, unlike other bidders, a lien- exclusive patent (e.g., the right to trade names, and rights of publicity. holder needs to commit new capital sue for patent infringement), some Fortunately for licensees, courts in only if its bid exceeds the amount of courts have held that such licenses two recent decisions rejected Lubr- its secured claim. are also non-assignable without the licensor’s consent. In re Her- Timothy W. Walsh is a partner and Second, a New Jersey bankruptcy nandez, 285 B.R. 435, 440 (Bankr. the head of the Restructuring & In- court recently held that 363 sales are D. Ariz.2002); ProteoTech, Inc. v. solvency practice of McDermott Will not free and clear of a licensee’s right Unicity Int’l, Inc., 542 F. Supp. 2d & Emery LLP. Gregory Kopacz and under section 365(n) to continue use 1216, 1219 (W.D. Wash. 2008); In re Darren Azman are associates in the of the debtor-licensor’s intellectual continued on page 8 practice. property. Crumbs Bake Shop, 2014 February 2015 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy 7 IP Licenses have expressly adopted the actual ruptcy filing are beyond the scope test, while the Third, Fourth, Ninth, of this article, such agreements continued from page 7 and Eleventh Circuits use the hypo- may help to ensure the licensee’s Aerobox Composite Structures, LLC, thetical test. In re Aerobox Composite continued access to the licensed 373 B.R. 135, 141 (Bankr. D.N.M. Structures, LLC, 373 B.R. 135, 140, n.7 property after the licensor’s bank- 2007). (Bankr. D.N.M. 2007). ruptcy filing. Similar to patent licenses, courts As a result of the foregoing as- • Obtain a security interest in the have generally held that a debtor-li- signment issues, debtor-licensees intellectual property as security censee may not assign a nonexclusive must use care in connection with for the licensor’s obligations. This copyright license because such licens- any contemplated sale under sec- reduces the likelihood of rejec- es do not transfer rights, tion 363 that includes assignment of tion by the licensor in bankrupt- thus rendering the license “personal” intellectual property licenses. And cy, which would trigger damages to the licensee. In re Patient Educ. even where a debtor-licensee merely in the form of a secured claim. Media, Inc., 210 B.R. 237, 240-43 seeks to assume an intellectual prop- • Structure the payment of royalties (Bankr. S.D.N.Y. 1997). However, erty license, it may not be able to do over the course of the license’s some courts have permitted a debtor- so. These uncertainties make it that term, rather than paying most or licensee to assign exclusive copyright much more difficult for a debtor to all royalties up-front. A debtor-li- licenses because such licenses convey navigate the choppy waters of Chap- censor is less likely to forego the an ownership interest. In re Golden ter 11. Further, the compressed time- continued stream of revenue by Books Family Entm’t, Inc., 269 B.R. line for 363 sales and the Chapter 11 rejecting the license. 311, 319 (Bankr. D. Del. 2001). process in general often leaves debt- • Vigilantly defend its rights in Finally, courts have generally held or-licensees in a difficult position. connection with a 363 sale by a that a debtor-licensee may not as- Licensors and Licensees debtor-licensor, lest it be deemed sign a trademark license because Both licensees and licensors to consent to the sale free and such licenses are deemed personal should consider the above issues clear of its interest. See Future- under non-bankruptcy law. N.C.P. pre-bankruptcy and take measures, Source LLC v. Reuters Ltd., 312 Mktg. Group, Inc. v. Blanks (In re some which are discussed below, to F.3d 281, 285 (7th Cir. 2002). N.C.P. Mktg. Group, Inc.), 337 B.R. mitigate risks in the event of a bank- • Include in its license agreements 230, 237 (D. Nev. 2005). ruptcy filing. language permitting assignment. Although the above limitations on Licensors should consider the fol- At least one court has held that assignment would seemingly not af- lowing: such language operates as con- fect a debtor-licensee’s ability to as- • Limit the term of any exclusive sent by the licensor to assign- sume an intellectual property license, license, subject to renewal at the ment, notwithstanding appli- such is not the case. The source of licensor’s discretion. A debtor-li- cable non-bankruptcy law. In re confusion lies in the interpretation censee may assume an executory Glycogenesys, Inc., 352 B.R. 568 of Bankruptcy Code section 365(c), contract only as it existed prior to (Bankr. D. Mass. 2006). which refers to a debtor’s inability to the bankruptcy filing, and thus a Additionally, given the discrepan- “assume or assign” executory con- license agreement that expires by cies in recent court decisions and the tracts that are non-assignable under its own terms cannot be assumed ever-changing landscape, a licensor non-bankruptcy law. In addressing (or assigned) by a debtor-licensee. or licensee seeking bankruptcy pro- this issue, courts utilize what have • Include in its license agree- tection should carefully consider the become known as the “hypothetical ments specific requirements for jurisdiction in which it files. test” and the “actual test.” adequate protection in the event Conclusion Under the actual test, a court con- of a bankruptcy filing. Although Consideration of bankruptcy is- siders whether the debtor will actu- such provisions are not neces- sues during the negotiation of intel- ally assign the otherwise non-assign- sarily binding, they may influ- lectual property licenses is under- able contract. If the debtor does not ence a bankruptcy court’s deter- standably not a priority for some. intend to assign the contract, then mination of adequate assurance, Yet many licensors and licensees de- assumption is permitted. Under the either by the debtor-licensee or pend to a significant degree on the hypothetical test, the court disregards its purported assignee. use of intellectual property in their the debtor’s actual intent, and simply Licensees should consider the fol- day-to-day operations, and thus par- deems the contract non-assumable lowing: ties should be aware of the troubled because of the hypothetical possibil- • Use an intellectual property es- roads that lie ahead in the event of a ity that the debtor could attempt to crow agreement. Although the en- bankruptcy filing, however unlikely. assign the contract after assumption forceability and usefulness of such —❖— occurs. The First and Fifth Circuits agreements in the event of a bank-

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8 The Bankruptcy Strategist ❖ www.ljnonline.com/ljn_bankruptcy February 2015