Restructuring

If you were to walk down Fifth Avenue and see a store displaying a white apple suspended in a large glass case, more likely than not you would immediately think of the California-based tech giant who shares its name with the nutritious snack. Similarly, if the person walking in front of you on your way to the Apple store lifted her heel to reveal a candy-apple red shoe sole, more likely than not the name Christian Louboutin would pop into your head. How is it that we can so easily forget the name of a person we were just introduced to, yet simple ideas like a picture of fruit or the color of a shoe bottom could instantly trigger a specific company in your mind? The answer: branding.

Companies collectively spend billions of dollars on branding each year to make symbols like Louis Vuitton’s “LV” and Nike’s famous swoosh synonymous with their respective brands and the reputation that accompanies them. The troves of money invested in branding appears to be well spent, as trademarks are afforded strong legal protections and are accompanied by the profitable prospect of licensing those unique marks to third parties. Licensing has become such a profitable revenue stream that it is now some designers’ main source of profit. As of 2015, roughly 90 percent of Calvin Klein Inc.’s $160 million worth of annual sales came from trademark licensing.¹
Yet, surprisingly, the law stops short of offering special protections to the licensees of those trademarks in the event of a bankruptcy of the licensor—a situation that has the potential to turn a pair of Gucci brand sunglasses into trademark-infringing knock-offs overnight. Vulnerable trademark licensees had a glimmer of hope based on a 2012 Seventh Circuit opinion that was shaping up to be the Greek heroine for this area of intellectual property that has arguably fallen through the cracks of bankruptcy law. But a January opinion fresh out of the First Circuit might just be the arrow into trademark licensees’ Achilles’ “Louboutin” heel that will keep licensees unprotected and at risk in bankruptcy. The resulting circuit split, which leaves trademark licensees wary, could now garner the attention of the Supreme Court.

How did we get into this mess?

To understand how we arrived at this point, it is important to explore briefly the origins of IP protections in bankruptcy law. In 1985, in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., the Fourth Circuit held that a debtor-licensor’s rejection of a patent license denied the licensee any right to continue to use the licensed technology.² The court reasoned that the decision was consistent with the Bankruptcy Code and that it was the job of Congress, not the courts, to offer licensees relief.³ Shortly after Lubrizol, Congress got to work to change that result by enacting section 365(n) of the Bankruptcy Code, which laid out the respective rights of licensors and licensees of “intellectual property” in the event of a license rejection in bankruptcy. Yet, Congress omitted trademarks from the definition of intellectual property (section 105(35A) of the Bankruptcy Code)—the result of which is a lack of any statutory protection for trademark licensees when a licensor decides to reject a license that is an executory contract.
The repercussions of Congress’ action (or lack thereof) were exemplified in 1994 in Licensing by Paolo, Inc. v. Sinatra (In re Gucci).⁴ After leaving the Gucci brand, Paolo Gucci started his own fashion company where he licensed the “Designed by Paolo Gucci” trademark to different product manufacturers. This resulted in numerous lawsuits by other members of the Gucci family who were displeased with Paolo’s use of the Gucci name. When Paolo filed for chapter 11 in 1994, Guccio Gucci (the Gucci Company) submitted a bid to purchase the “Designed by Paolo Gucci” trademark. After Guccio Gucci submitted the winning bid for the trademark, the sale order approved termination of the licensing agreements under the Paolo Gucci name, which included contracts to use the brand name on handbags, wallets, luggage, watches, and belts. When the sale order was appealed on the grounds that Guccio Gucci was not a good faith purchaser under section 363 of the Bankruptcy Code, the court found in favor of Guccio Gucci because the Bankruptcy Code is silent on the issue of whether trademark licensees are entitled to retain their rights post-bankruptcy. The licensees immediately lost the right to use the trademark, whether or not they had invested in inventory that already used the mark. Based on this example alone, it is clear why trademark licensees would be uneasy about the current state of the law—what today is a $300 pair of sunglasses could be worth pennies tomorrow.

The Current Debate

Fast forward to 2012 when Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC enters the runway. In this case, Lakewood, a company that sold brand-name box fans, contracted with Chicago American Manufacturing (“CAM”) to have CAM manufacture the box fans that Lakewood would then sell. Concerned about Lakewood’s financial position, CAM included a licensing provision that permitted it to sell the Lakewood-brand box fans on its own in the event that Lakewood could not fulfill the purchase. Lakewood subsequently filed for bankruptcy and Lakewood’s assets were purchased by Sunbeam Products. Sunbeam had no interest in the box fans but did not want CAM to sell the fans, so as part of the sale of the Lakewood business, the trustee rejected the CAM contract with the license. CAM continued to sell the box fans despite the contract rejection and Sunbeam subsequently filed suit.
The Seventh Circuit, in deciding the case, turned to the legislative history behind Congress’ enactment of section 365(n). A Senate committee report on the bill revealed that Congress did not intend to leave trademarks unprotected, but simply deferred action on the subject until it had more time to study and better comprehend trademark law.
Finding in favor of CAM and utilizing the legislative history to make its point, the Seventh Circuit held that the breach resulting from a contract rejection under section 365(a) was not the functional equivalent of a rescission, but instead allowed the other party’s rights to remain in place—including trademark licensing rights. The court went on to say that a rejection merely frees the estate from the obligation to perform under the contract and has no effect on its continued existence.⁵ The debtor is simply freed from being subjected to an order for specific performance.
What appeared to have been a major win for trademark licensees has now been stunted by the First Circuit’s holding this year in Mission Product Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), which favored the previous categorical approach of leaving all trademark licenses unprotected from court-approved rejections.⁶ The First Circuit justified its ruling by arguing that allowing the licensee to continue to use the trademark would effectively require the debtor to monitor and exercise control over the products for quality assurance—an obligation that arises out of trademark law. The monitoring obligation for trademarks, the court argued, is unlike the licensor’s obligations for other intellectual property because trademarks are “public-facing messages to consumers” and monitoring is required “to ensure that the public is not deceived as to the nature or quality of the goods sold.” A licensor’s failure to monitor and exercise control over a trademark license jeopardizes the continued validity of the license, which makes the licensor’s obligation a real and concrete duty. It is this monitoring obligation that the court found to be too burdensome on the debtor to allow the licensee to retain its rights post-rejection.
Clarification to this prominent circuit split may come sooner than you think. On June 11th, Mission Product Holdings Inc., the harmed licensee in Tempnology, filed a petition for writ of certiorari with the Supreme Court requesting that it review the First Circuit’s opinion—a decision that Mission argues in its petition has worsened the already prominent circuit split. There is an argument that the monitoring obligation that the Tempnology opinion advances is incomplete because of the history of courts relaxing the licensor’s obligations in a trademark licensing agreement. For example, in Syntex Labs., Inc. v. Norwich Pharmacal Co. the Southern District of New York district court held that a licensor’s monitoring and quality control requirements were sufficiently met through reliance on the integrity of the licensee.⁷ In this scenario, allowing the licensee to continue to use the license post-rejection would create no actual obligation to perform on the part of the debtor-licensor—which is a major factor on which the Tempnology holding relies. If the Supreme Court is willing to accept this modified application of the monitoring obligation, it just might result in a pro-licensee decision.
For now, we are left to wonder whether your next pair of designer shoes or eyewear could be turned into a “limited edition” overnight. Stay tuned!
Weil Summer Associate Matthew Rayburn contributed to this post.