Bankrupt Licensor’s Rejection of Executory Contracts

Bankruptcy of a trademark licensor can be a very unwelcome event for its licensee.  In 1985 the Fourth Circuit Court of Appeals permitted a licensor of technology who had filed for bankruptcy under Chapter 11 to reject the licensee as being an executory contract.  That licensee lost all rights in the license and the licensed technology and was left with solely a monetary damage remedy against an already insolvent debtor.  Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F 2d. 1043 (4th Cir. 1985). 
       
In the case of a financially troubled licensor, rejecting the license may well be in its best interest, for often the value of the licensed technology has grown, and the licensor may be able to relicense it for a higher price.  Sometimes, unfortunately for the licensee, this is due to its efforts. 

Interests convinced Congress that the ability of a technology licensor to reclaim the licensed property through rejection of the license in bankruptcy was unfair.  Congress passed legislation that would allow licensees to avoid this hardship in the future.  The Intellectual Property in Bankruptcy Act of 1988 was intended to allow licensees whose bankrupt licensors rejected their licenses to reclaim rights in the licenses. 11 U.S.C.A section 365(n).  The Act provides that the case of intellectual property, other than a trademark, trade name or service mark, a licensee of a bankrupt licensor can elect to retain its rights under the license for the duration of the license plus extensions and, in exchange, continue to pay royalties due under the license.  Unfortunately, numerous decisions have held, correctly, that the Act, while it covers all other forms of intellectual property, such as copyrights, trade secrets and patents, does not cover trademarks.  Gucci v. Sinatra, 126 F. 3d 380 (2nd Cir. 1998).  As authority for so holding, this court and others have simply reviewed the legislative history of the Act which provides, “the bill does not address the rejection of executory trademark, trade name or service mark licenses.”  Indeed, bankruptcy law does not even define a trademark, service mark or trade name as intellectual property.  11 U.S.C. §101 (35A).  This is a harsh result for the licensee of a trademark who might have built its entire business around the mark.  One court, however, has held that where trademark rights are melded with other intellectual property rights Section 356(n) may apply to trademarks.  In re: Matusalem, 158 B.R. 514 (Bankr. S.D. Fla. 1993).
       
The apparent purpose for excluding trademarks, service marks and trade names from the definition of intellectual property for purposes of Section 356(n) can be found in the Senate Report and heavily implicates the requirement that, to protect the consuming public, a licensor must be able to control the quality of the products or services associated with its licensed mark.  Congress determined that issues of quality control and supervision were well beyond the scope of this corrective legislation and would require extensive study before it could consider making trademarks subject to Section 356(n).  Apparently, this exclusion of trademarks has never been revisited by Congress.
       
Practice Tip:  There really is no way to avoid the exclusion of Section 356(n) when it comes to trademark licensing unless the license is truly not executory; most licenses are, however, as they require quality control and royalty payments.  However, there may be limited circumstances where licensing can be avoided through the use of a coexistence, or “live and let live” agreement by which the parties merely acknowledge the other’s rights without transferring rights via a license.

LexisNexis Emerging Issues Analysis by Jim Astrachan