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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 law

school: legislators cannot draft laws that are neatly and cleanly applicable to every possible

situation. This being so, it is logical to assume that legislators cannot ensure that all laws are

harmonious with all other laws.1 One such example exists within the Bankruptcy Code2 as it

pertains to treatment of trademark licenses in bankruptcy proceedings. As one commentator

summarized “for better or worse, filtering…trademark law through the procedures and processes

of the bankruptcy system can result in the creation of a parallel universe: the surroundings are

familiar, 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 law

compared to bankruptcy law. Part III outlines the two tests, the hypothetical test and the actual

test, that the Courts have applied to the issue of assignment under section 365(c)(1) and benefits

and drawbacks to each of the tests. Part IV reviews the most current reaction to the use of the

hypothetical test found in the Supreme Court’s denial of certiorari in N.C.P. Marketing v. BG




1
  See Bass, et al., BAPCPA in the Courts: How Judicial Interpretation of the New Provisions
Affects 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 applied
to specific facts, it is not always clear what the words plainly mean or what the drafters intended
or the legislators enacted. In fact, the justices haven’t even always agreed on when the text is
ambiguous 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, 78
AMER. 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 Law
Inst., Understanding the Intellectual Property License 2009, 985 PLI 657, 657 (2009).

                                                   1
Star Productions, Inc. Finally, Part V offers suggestions for handling trademark licenses in

bankruptcy.

                      II.     TRADEMARK LAW VERSUS BANKRUPTCY LAW


A.     IN THIS CORNER, TRADEMARK LAW . . .
       Intellectual Property is comprised of copyrights, patents, and trademarks. Each of these

individual components is codified in its own section of the United States Code4 and each has its

own function and purpose. The Copyright and Patent Acts, respectively, seek to encourage

invention and artistic creation to foster the proliferation of the arts and sciences and ensure those

individuals profit from their efforts.5    Trademarks, conversely, are not for the purpose of

encouraging arts and sciences, but rather are to prevent confusion among consumers by

identifying 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 as

copyrights and patents.7 Thus, the purpose of trademark law “is to prevent consumer confusion

and protect the value of identifying symbols, not to encourage invention by providing a period of

exclusive rights.”8    In addition to preventing consumer confusion, trademark owners use

trademarks to “preserve the value of their business name and products.”9

       A trademark “includes any word, name, symbol, or device, or combination thereof … to

identify and distinguish…goods and services…from those manufactured or sold by others and to


4
  Copyright Act, 17 U.S.C. § 101, et seq. (West 2009); Patent Act, 35 U.S.C. § 101, et seq. (West
2009), 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
indicate the source of goods.”10 Trademarks are symbols of good will and the trademark and

good will cannot be separated.11 Good will is a somewhat abstract concept that generally refers

to public confidence in a product and name recognition in the trademark and of the trademark

owner as the source of quality goods.12 It is well settled that trademarks and their associated

good will are property rights.13

       Trademark owners can broaden the coverage and use of their trademarks by licensing

their trademarks to third parties.14 A trademark license allows a licensee to use the trademark for

particular goods or services within a geographic area.15       The trademark licensee pays the

trademark owner royalty fees for the privilege of manufacturing and marketing products bearing

the trademark. The Lanham Act permits a trademark owner to license trademarks where the

trademark “is or may be used legitimately by related companies.”16 Section 1127 of the Lanham

Act defines “related company” as “any person whose use of a mark is controlled by the owner of

the mark regarding the nature and quality of goods or services on or in connection with which

the mark is used.”17 Thus, the Lanham Act requires the trademark owner, as licensor, has “the

affirmative duty of policing in a reasonable manner the activities of his licensees” to ensure that

10
   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 the
extent that an attempted transfer of a trademark is void without a transfer of the good will
associated with the trademark”); J. Thomas McCarthy, MCCARTHY ON TRADEMARKS AND
UNFAIR 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 the
aforementioned types of licensing.
16
   15 U.S.C. § 1055.
17
   15 U.S.C. § 1127.

                                                3
the public is not being misled or exposed to deceptive uses of the trademark.18 In addition, a

trademark owner has an interest in monitoring the quality of goods bearing its trademark to

ensure that the associated good will maintains a high value.19 Thus, in order to have a valid

trademark license, the licensor must grant permission to the licensee to use its trademarks and

must obligate the licensor to maintain quality standards and control.20


B.      . . . AND IN THIS CORNER, BANKRUPTCY LAW.

        The purpose of bankruptcy is to provide a “fresh start” for a debtor and as it pertains to

businesses, attempts to reorganize businesses rather than liquidate in order to save jobs.21 For

creditors 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 Subcommittee

on Patents, Copyrights, and Trademarks introduced the Intellectual Property Bankruptcy

Protection Act (IPBPA).23 In his introduction of the IPBPA, Senator DeConcini expressed

concern over the bankruptcy court’s ability to decide that reselling intellectual property rights




18
   Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358, 367 (1959). Quality control and
inspection provisions need not be expressly set forth within the license agreement to comply with
the 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 on
good will”).
20
   In re The Travelot Co., Inc., 286 B.R. at 455 (Bankr. S.D. Ga. 2002) (citing Bunn-O-Matic
Corp. 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
could yield greater royalties than honoring an existing license.24 Further, Senator DeConcini

cited the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.25 as

demonstrating the need for the IPBPA. Lubrizol involved a debtor licensor seeking to reject a

technology license agreement. The technology at issue was the principal asset of the debtor, and

thus the source of money that would allow the debtor to emerge from bankruptcy. Rejection of

the license agreement would strip the licensee of its rights to the agreement. The Court noted

that the outcome of the case could have a “chilling effect” on parties entering into these types of

agreements.26 Senator DeConcini stated that “[t]he Lubrizol ruling occurred because Congress

never considered this issue, because no courts had considered it before the Bankruptcy Reform

of 1978 and because it requires the application in bankruptcy cases of the very specialized area

of intellectual property law.”27

       The proposed IPBPA legislation included a definition of intellectual property, which

included trademarks, trade names, and service marks, and allowed for expansion in to “other

products of intellectual or creative effort now or hereafter protected by applicable nonbankruptcy

law.”28 The proposed legislation also included a provision applicable to trademarks, trade

names, and service mark licensees to “continue in concert the quality assurance procedures of the

24
    S. 1626 at S11654. See also S. Rep. No. 100-505 at *2 (1988), reprinted in 1988
U.S.C.A.A.N. 3200, 3201 (acknowledging that it “will nearly always be arguably beneficial to
the bankruptcy estate and any exercise of business judgment” to reject the license agreement); In
re Blackstone Potato Chip Co., Inc., 109 B.R. 557, 560 (Bankr. D. R.I. 1990); Nguyen, supra
note 14, at 1268 (stating that “the property value of some trademarks is significantly greater than
that of the trademark owner’s physical assets”); Jason B. Binford, Supreme Court Passes on
Assumption 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 a
debtor’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
licensor.”29 Despite the stated purpose of “keep[ing] secure the rights of intellectual property

licensors and licensees…,” the only provision of the proposed legislation dealing with debtor

licensees required them only to maintain the confidentiality of information under the subject

agreement.30

       In 1988, President Ronald Regan signed a significantly modified version of the IPBPA

into 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 1988
U.S.C.A.A.N. 3200, 3200 (stating that the purpose of the amendment to Section 365 is “to make
clear that the rights of an intellectual property licensee to use the licensed property cannot be
unilaterally cut off as a result of the rejection of the license… in the event of the licensor’s
bankruptcy”) (emphasis added); see also S. Rep. No. 100-505, *4 (1988), reprinted in 1988
U.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 in
possession operates its business and performs many functions that would fall to the trustee under
other 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 assign
a contract because Section 1107 “does not provide in words or substance that ‘trustee’ means or
includes ‘debtor in possession’”).

                                                6
The language of the IPBPA parallels the language of 365(h)(1) pertaining to the treatment of real

property leases.33 Congress noted a similarity between intellectual property licenses and real

estate 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 another

source.”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 and

can elect to retain rights under the agreement.36 If the licensee elects to retain its rights under the

license agreement, the licensee is obligated to continue to pay royalties,37 waives any right to a

set-off,38 and waives the right to a claim under Section 503(b).39

Congress 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 by

accident. 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 was


33
   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
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 executory

contract is a contract “on which performance remains due to some extent on both sides.”42

Intellectual property licenses have consistently been held to be executory contracts due to the

ongoing nature of customary obligations such as the payment of royalties and maintenance of

intellectual property.43

       Under Section 365(a), subject to court approval, a debtor can assume or reject an

executory contract.44 Although the court is required to approve the assumption or rejection of

the agreement,45 the court is deferential to the choice of the debtor as long as the choice meets

sound business judgment.46 Under the business judgment standard, rejection of an executory

contract (in this case, a trademark license) is appropriate if rejection of the agreement would

benefit the estate47 and if it is not “so manifestly unreasonable that it could not be based on sound




41
   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 where
trademark licenses found to be executory contracts); Darren W. Saunders, Should the Bankruptcy
Code 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 Intellectual
Property Rights and Bankruptcy, Practising Law Inst., Handling Intellectual Property Issues in
Bankruptcy in Business Transactions 2009, 956 PLI 127, 141 (2009) (noting that it is difficult to
challenge 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 judgment
in determining whether to approve rejection of contract).
47
   Id.

                                                 8
business judgment, but only on bad faith, or whim or caprice.”48 If a debtor elects to reject a

contract, the nondebtor is left only with a claim for damages for breach of contract as of the date

of the filing of the bankruptcy petition.49 Upon rejection of a trademark license agreement by a

debtor licensor, the licensee must stop use of the trademark.50 The licensor’s rejection of a

trademark license acts to restore the licensor’s right to use the trademark for the goods and

services and/or geographic location previously designated to the licensee.51

       Exclusion from 365(a), that is, when a trademark license agreement may not be assumed

or 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 the

nondebtor from accepting performance from an entity other than debtor and if the nondebtor

does not consent to the assumption of the agreement.53




48
   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 since
trademarks do not fall under Section 365(n), Lubrizol controls and thus trademark use must
cease).
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
C.       TRADEMARK AND BANKRUPTCY CONVERGE

         When trademark law and bankruptcy law converge, there are several sub-issues that are

key to analyzing the treatment of trademark licenses. First, under 365(c) what is “applicable

law” 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 the

case of a debtor licensor versus a debtor licensee?


         I.     “APPLICABLE LAW”

         As it pertains to trademarks, “applicable law” under Section 365(c) has been generally

split into two categories: analysis as a personal service contract or analysis under the Lanham

Act.54

                A.     PERSONAL SERVICE CONTRACT

         A personal service contract involves contracting for the unique services of a particular

person; services that could not “equally be performed by another.”55 For example, contracting

with a famous singer to perform a concert would be considered a personal services contract. At

common law, personal service contracts are not assignable without consent.56 Thus, the singer

could not assign her duties to perform under the contract because her services are unique to her

and are a material aspect of the contract.57




54
   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); 3-365
COLLIER 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
Some courts have used personal service contract analysis in the context of assignment in

bankruptcy to determine whether the rights and obligations under the license constitute personal

services, which involve “the exercise of special knowledge, judgment, taste, skill, or ability” that

would not be assignable without the consent of the licensor.58 Analysis of a trademark license as

a personal service contract has unpredictable results.59 Generally, however, the theory is that if

the license is treated as a personal service contract, the identity of the licensee is a material

element of the license, and thus the license would not be assignable absent licensor consent.60 At

least one commentator argues that applying the personal services contract analysis to trademark

licenses 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 only

restriction 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.63

Courts have thus cited the Lanham Act’s requirement for licensors to control the use of their

trademarks as the basis for determining that trademark licenses cannot be assigned without the

consent of the licensor.64 One commentator notes that it would be more accurate for courts to



58
   In re Rooster, 100 B.R. 228, 232 (E.D. Pa. 1989). Some have argued that since corporations
delegate 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 individuals
within 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
cite trademark common law where it is generally accepted that a trademark licensee cannot

sublicense (a situation analogous to assigning a license to a third party) without the consent of

the licensor.65


II.     LICENSOR-DEBTOR VERSUS LICENSEE-DEBTOR
        A debtor licensor can put the licensee in a precarious position by rejecting the license

agreement, thus preventing the licensee from utilizing the trademarks66 as was the case in

Lubrizol.67 Clearly, the debtor licensor holds a strong bargaining position with the threat of

rejection looming for the licensee.68 If the debtor licensor opts to reject the license the licensee is

required to cease use of the trademarks immediately, although some courts will allow a transition

period, which may be as short as thirty days.69 A licensee that can show that rejection of the

license agreement would be devastating to its business, while only providing a small benefit to

the debtor licensor may convince the court to deny the request to reject the agreement.70 Since

the 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 required

to perform its obligations under the license agreement, absent a court order to do so, until the

agreement is assumed or rejected.72 Since the automatic stay constrains the licensor’s ability to

enforce the agreement, quality control standards may be left unsupervised.73         This can subject


65
   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
the licensor to claims of abandonment for failure to control the quality of products bearing its

trademarks and potentially cause damage to the licensor’s reputation.74 The licensor can seek

relief from stay for “cause” under Section 362(d)(1) to terminate the license for lack of adequate

protection under Section 361.75 Arguably, there is no adequate protection available when a

licensor’s reputation is at stake.76 In practice, however, it appears that a court is unlikely to grant

relief from stay for cause unless the licensor timely demonstrates that quality control is a real

concern.77


III.   EXCLUSIVITY VERSUS NON-EXCLUSIVITY

       Whether an intellectual property license agreement is exclusive can make a difference in

whether the license will be assumable in a bankruptcy proceeding.               For example, under

applicable copyright law, an exclusive license acts as a transfer of the copyright since the

licensee 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 are

considered to be personal to the licensee.80




74
   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 service
marks…[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 Catapult
Entm’t, Inc., 165 F.3d 747, 750 (1999) (internal citations omitted) (non-exclusive patent); In re
CFLC, Inc., 89 F.3d 673, 679 (9th Cir. 1996) (internal citations omitted) (non-exclusive patent).

                                                  13
In the trademark context, only a few courts have addressed the non-exclusive versus

exclusive issue. The most recent cases held a non-exclusive license is personal to the assignee

and not assignable to a third party.81 As such, a “a licensor need not accept performance from or

render performance to an entity other than the licensee.”82 If an exclusive license is treated as a

transfer of rights, then the license is not an executory contract and is thus does not fall under the

ambit 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 of

the trademark versus bankruptcy issue. The manner in which trademark licenses are treated in

bankruptcy proceedings could have a devastating effect on the parties to the agreement.84 As one

commentator points out, “when a party is suddenly forced to stop use of a trademark that has

become associated with a product and develop a new commercial identity, there will be an

obvious 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, subject

to the exceptions found in Section 365(c).        Confusion arises depending on how the court

interprets Section 365(c)(1)’s “assume or assign” language. Courts interpreting the statute’s

based on its disjunctive, plain meaning follow the “hypothetical test,” while courts interpreting

the 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 any
executory contract”) (emphasis added).
84
   In re Centura Software Corp., 281 B.R. 660, 674 n. 26 (internal citations omitted) (“rejection
of a trademark license can potentially destroy licensee’s business”); Saunders, supra note 42, at
58. See supra Part II(C)(ii).
85
   Saunders, supra note 43, at 58.

                                                 14
A.      THE HYPOTHETICAL TEST
        The Third,86 Fourth,87 and Ninth88 Circuits follow the hypothetical test.89 Following

statutory language, the hypothetical test “examin[es] whether, hypothetically, without looking to

the individual facts of the case, any executory contracts could be assumed under applicable

federal law.”90 Applying the plain meaning of the statute, assumption and assignment are two

separate events, each requiring the nondebtor’s consent, before the agreement can be assigned.91

Courts applying the hypothetical test hold that Section 365(c)(1) prohibits the debtor from

assuming the trademark license without licensor consent, even if the debtor does not intend to

assign the license to a third party, but rather intends to continue using the license.92 The

hypothetical test prevents “the debtor from assuming an executory contract where the licensor

would 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 the

nondebtor’s consent outside of bankruptcy, then the debtor cannot assume the agreement within

the bankruptcy.94 It does not matter if the debtor wants to perform under the agreement, rather

than actually assign the license to a third party.95


86
   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 software
license agreement even though the debtor did not intend to assign the agreement and the licensor
had consented to an assignment).
88
   Catapult Entm’t, 165 F.3d 747 (refusing assignment of a non-exclusive patent license and
acknowledging 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 the
hypothetical 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
Courts following the hypothetical test explain that they are adhering to settled rules of

statutory interpretation because the language of Section 365(c)(1) is clear and unambiguous (“the

trustee 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 it

does 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 re

Sunterra 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 even

though the licensor had consented to the assignment in the license agreement and the debtor did

not propose assigning the license to a third party, but rather intended to assume the agreement as

debtor in possession.101 The basis for the court’s reasoning is that the assignment provision of

the agreement did not address assumption, and since assignment and assumption are two distinct

events, consent is required for both.102 Although this result was “quite unreasonable,” it did not

reach the level of absurdity required for the court to consult legislative history.103




96
   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) of
this section, notwithstanding a provision in an executory contract…of the debtor, or in applicable
law, that prohibits, restricts, or conditions the assignment of such contract…, the trustee may
assign such contract…”
99
    David H. Kennedy, Bankruptcy Issues in Intellectual Property Transactions, Practising Law
Inst., Handling Intellectual Property Issues in Bankruptcy in Business Transactions 2009, 956
PLI 151, 191 (2009).
100
    Sunterra Corp., 361 F.3d 257.
101
    Id. at 263.
102
    Id. at 271-72.
103
    Id. at 268.

                                                  16
B.      THE ACTUAL TEST
        The First104 and Second105 Circuits follow the actual test, which examines “whether the

executory contract at hand, in actuality, can be assumed when applying the applicable federal

law.”106 Thus, in these Circuits, the assignment of a license is only relevant if the debtor wishes

to actually assign the agreement.107

        Courts following the actual test explain that following the hypothetical test would cause a

debtor to “lose its option to assume the contract, even though it never intended to assign the

contract.”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 someone

other than the debtor . . . with whom it originally contracted.’”109 In other words, the actual test

acts to protect a nondebtor from “being forced to accept service from or render service to entities

other 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 proponents

argue that reading the statute as conjunctive, rather than disjunctive, is “more harmonious” with

bankruptcy policy.112 Citing canons of statutory interpretation, at least some courts are unwilling

to foray into an area that is reserved for the legislative branch.113


104
    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 License
Agreements 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
In summary, under the hypothetical test, a debtor could not assume an agreement if the

nondebtor 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 intend

to assign, because the nondebtor would not actually be forced to accept performance from a party

other than debtor.114

       The debate between the hypothetical and actual tests was presented to the Supreme Court

in 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 of

combining martial arts with boxing, resulting in the pop culture fitness phenomenon known as

Tae Bo®.115 Blanks and his wife own the Tae Bo® trademark, among others, through their

company 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, a

disagreement arose over the parties’ obligations under the agreement.118 In 2001, the parties

settled their differences via settlement agreement which confirmed BG Star’s ownership in the

Tae Bo® trademark. In 2002, the parties entered in to a license agreement outlining how the

trademark 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 breaching

the agreement.120       BG Star arbitrated its claim against N.C.P. and won a $2.1 million


114
    Sunterra Corp., 361 F.3d at 263.
115
    What is Tae Bo – Billy Blanks, http://www.billyblanks.com/category/meet+billy/what-is-tae-
bo.do (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
judgment.121 N.C.P., unable to pay the judgment, filed for Chapter 11 protection.122 In its

disclosure statement, N.C.P. claimed ownership of the Tae Bo® brand, which the Blanks, on

behalf of BG Star, disputed.123 BG Star moved for an order compelling the rejection of the

license 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 the

bankruptcy court’s order and concluded that BG Star had only granted N.C.P. a non-exclusive

license giving N.C.P. the right to assign a non-exclusive license.125 The district court held that

under trademark law, “trademarks are personal and non-assignable without the consent of the

licensor” 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 Appeals

affirmed without oral argument.127         N.C.P. petitioned the Supreme Court for a writ of

certiorari.128 In denying certiorari, the Supreme Court issued a statement acknowledging the

importance of resolving the dispute between the hypothetical and actual test, but reserving the

decision for a more appropriate case.129

       Justice Kennedy joined by Justice Breyer, appeared to suggest a preference for the actual

test, 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 about
whether N.C.P. could assign the non-exclusive trademark license agreement as opposed to
assigning the actual trademarks (“NCP does not have the consent of the Blanks to license to third
parties at this time and therefore cannot assume the trademarks under Section 365(c)(1)”). Id. at
238 (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
[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 own

challenges: “[i]t may be argued, for instance, that the actual test aligns with § 365(c) with sound

bankruptcy policy only at the cost of departing from at least one interpretation of the plain text of

the law.”131

                                     V.      GOING FORWARD
       The treatment of trademark licenses in bankruptcy proceedings is not of little

consequence. In 2008, despite the recent economic downtown, royalty payments for brand

licenses alone topped $5.7 billion.132 Twenty-one years ago when the IPBPA was enacted, the

global marketplace looked very different than it does today. The Internet as we know it today

was just beginning to take shape, and certainly most did not imagine that it would become the

global e-commerce133 resource that it is today. Although there does not appear to be a perfect

solution, there are several options worth investigating further to address the treatment of

trademark licenses in bankruptcy proceedings.

       First, as a matter of which “applicable law” applies in the case of a true assignment to a

third party, the courts could review trademark license agreements as personal service contracts

since the identity of the licensee is a material element of the license agreement. It is a


130
    Id. It appears that the Supreme Court may also have confused the license agreement and the
actual trademark since the Court’s statement refers to “resell” and “sold.” Rights under a license
agreement 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 Owners
Look        to    Position      Themselves       for   the      Future,     June     2,      2009,
http://www.reuters.com/article/pressRelease/idUS151856+02-Jun-2009+BW20090602.                 See
supra n. 14 (discussing the different types of trademark licenses).
133
    Nguyen, supra note 14, at 1302.

                                                 20
foundational principle of trademark law that the trademark owner has the exclusive choice in

deciding whom to allow to represent its image, brand, and good will. It would be inequitable to

deny 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 should

conduct the “extensive study” that is described in the IPBPA legislative history and determine

how trademarks should be handled in light of the results. The study should include soliciting

information 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 Trademark

Office, 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 and

how trademark law views a lack of quality control, and the effect on the licensor’s rights. The

panel should also seek information from licensees to determine whether simply amending

Section 365(n) to include trademarks, trade names, and services marks would address licensee

concerns. The result of the study would provide a basis to determine a workable solution for

both 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 be

maintained.134 This should provide a workable resolution for licensees when a licensor files for

bankruptcy. Additionally, amendment of Section 365(n) should include a section dealing with

debtor 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 licensor

to continue to monitor quality from the time of filing the bankruptcy petition until any transition



134
      Saunders, supra note 43, at 58.

                                                 21
period expires, without need to seek relief from stay to do so. This resolution would address

quality control issues when a licensee rejects a license agreement.

          In the alternative, the Code could provide for the appointment of a trademark

ombudsman, similar to the consumer privacy (Section 332) and patient care ombudsman

(Section 333) may be an appropriate solution. The trademark ombudsman would monitor the

quality of products produced by the licensee and report to the court whether the quality meets

appropriate quality standards. The trademark ombudsman would be a disinterested third party

knowledgeable or expert in trademark law that would be appointed by the court in cases

involving trademark licenses. The cost of the trademark ombudsman could be subsidized by a

nominal fee increase for the filing of trademark applications.

          The hypothetical test versus actual test debate does not appear to have an easy resolution

absent revision to the code or interpretation from the Supreme Court. The Supreme Court is

reluctant to address this important issue because of the specialized and sometimes complicated

application of trademark law in the bankruptcy context.135

          A true assumption and assignment situation presents problems. Presumably, prior to

entering into a licensing arrangement with a licensee, the licensor investigates the licensee’s

creditworthiness and general suitability. If the licensee is allowed to assign the agreement to a

third party without the licensor’s consent, the licensee is denying the licensor the ability to

perform its due diligence as to suitability, this potentially materially increasing the licensor’s

risk. Thus, under contract principles, the assignment of the agreement should be prohibited.136

The actual test, employing a case-by-case analysis to determine whether there is proposed

performance by a third party, appears to be the least problematic and aligns with bankruptcy

135
      N.C.P. Mktg., 556 U.S. at __, 129 S. Ct. at 1578.
136
      Restatement (2d) of Contracts § 317(2)(a).

                                                  22
policy. In a pure assumption situation, absent any legitimate quality control or adequate

protection concerns, it would be inequitable to allow a licensor to use the licensee’s bankruptcy

as a “second bite at the apple” to get out of the agreement.

       Finally, the courts can analyze the treatment of trademark licenses under equitable

principles, balancing licensor and licensee concerns to reach a fair result. Although Congress

explicitly encouraged the bankruptcy courts to determine equitable principles for handling

trademark licenses,137 few have elected to do so.138 Courts have cited the plain, unambiguous

language of the Code as the reason they need not consult legislative history.139    However, if

following the plain meaning of the statute would lead to absurd results or a result “demonstrably

at odds with the intent of the drafters” the courts should consult legislative history and other

methods of statutory interpretation to reach the correct result.140 As one group of commentators

point out, canons of statutory construction in bankruptcy court decisions “do not necessarily

compel consistent conclusions.”141

                                               CONCLUSION

       The “parallel universe” created by forcing trademark law and bankruptcy law to mesh

together creates numerous nuanced issues and little consistency in application. It is clear that

Congress needs to undertake an extensive study to deal with each of these trademark issues in the

context of the bankruptcy proceeding to ensure that licensors maintain their reputation with the

consuming public and associated goodwill, while protecting licensees who depend on a

licensor’s trademarks for the survival of its business. Until these issues are investigated more

137
    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, supra
note 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
fully, there will continue to be a disconnect between the two universes rather than a manageable,

if not more harmonious co-existence.




                                               24

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Treatment Of Trademark Licenses In Bankruptcy Proceedings

  • 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 law school: legislators cannot draft laws that are neatly and cleanly applicable to every possible situation. This being so, it is logical to assume that legislators cannot ensure that all laws are harmonious with all other laws.1 One such example exists within the Bankruptcy Code2 as it pertains to treatment of trademark licenses in bankruptcy proceedings. As one commentator summarized “for better or worse, filtering…trademark law through the procedures and processes of the bankruptcy system can result in the creation of a parallel universe: the surroundings are familiar, 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 law compared to bankruptcy law. Part III outlines the two tests, the hypothetical test and the actual test, that the Courts have applied to the issue of assignment under section 365(c)(1) and benefits and drawbacks to each of the tests. Part IV reviews the most current reaction to the use of the hypothetical test found in the Supreme Court’s denial of certiorari in N.C.P. Marketing v. BG 1 See Bass, et al., BAPCPA in the Courts: How Judicial Interpretation of the New Provisions Affects 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 applied to specific facts, it is not always clear what the words plainly mean or what the drafters intended or the legislators enacted. In fact, the justices haven’t even always agreed on when the text is ambiguous 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, 78 AMER. 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 Law Inst., Understanding the Intellectual Property License 2009, 985 PLI 657, 657 (2009). 1
  • 2. Star Productions, Inc. Finally, Part V offers suggestions for handling trademark licenses in bankruptcy. II. TRADEMARK LAW VERSUS BANKRUPTCY LAW A. IN THIS CORNER, TRADEMARK LAW . . . Intellectual Property is comprised of copyrights, patents, and trademarks. Each of these individual components is codified in its own section of the United States Code4 and each has its own function and purpose. The Copyright and Patent Acts, respectively, seek to encourage invention and artistic creation to foster the proliferation of the arts and sciences and ensure those individuals profit from their efforts.5 Trademarks, conversely, are not for the purpose of encouraging arts and sciences, but rather are to prevent confusion among consumers by identifying 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 as copyrights and patents.7 Thus, the purpose of trademark law “is to prevent consumer confusion and protect the value of identifying symbols, not to encourage invention by providing a period of exclusive rights.”8 In addition to preventing consumer confusion, trademark owners use trademarks to “preserve the value of their business name and products.”9 A trademark “includes any word, name, symbol, or device, or combination thereof … to identify and distinguish…goods and services…from those manufactured or sold by others and to 4 Copyright Act, 17 U.S.C. § 101, et seq. (West 2009); Patent Act, 35 U.S.C. § 101, et seq. (West 2009), 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. indicate the source of goods.”10 Trademarks are symbols of good will and the trademark and good will cannot be separated.11 Good will is a somewhat abstract concept that generally refers to public confidence in a product and name recognition in the trademark and of the trademark owner as the source of quality goods.12 It is well settled that trademarks and their associated good will are property rights.13 Trademark owners can broaden the coverage and use of their trademarks by licensing their trademarks to third parties.14 A trademark license allows a licensee to use the trademark for particular goods or services within a geographic area.15 The trademark licensee pays the trademark owner royalty fees for the privilege of manufacturing and marketing products bearing the trademark. The Lanham Act permits a trademark owner to license trademarks where the trademark “is or may be used legitimately by related companies.”16 Section 1127 of the Lanham Act defines “related company” as “any person whose use of a mark is controlled by the owner of the mark regarding the nature and quality of goods or services on or in connection with which the mark is used.”17 Thus, the Lanham Act requires the trademark owner, as licensor, has “the affirmative duty of policing in a reasonable manner the activities of his licensees” to ensure that 10 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 the extent that an attempted transfer of a trademark is void without a transfer of the good will associated with the trademark”); J. Thomas McCarthy, MCCARTHY ON TRADEMARKS AND UNFAIR 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 the aforementioned types of licensing. 16 15 U.S.C. § 1055. 17 15 U.S.C. § 1127. 3
  • 4. the public is not being misled or exposed to deceptive uses of the trademark.18 In addition, a trademark owner has an interest in monitoring the quality of goods bearing its trademark to ensure that the associated good will maintains a high value.19 Thus, in order to have a valid trademark license, the licensor must grant permission to the licensee to use its trademarks and must obligate the licensor to maintain quality standards and control.20 B. . . . AND IN THIS CORNER, BANKRUPTCY LAW. The purpose of bankruptcy is to provide a “fresh start” for a debtor and as it pertains to businesses, attempts to reorganize businesses rather than liquidate in order to save jobs.21 For creditors 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 Subcommittee on Patents, Copyrights, and Trademarks introduced the Intellectual Property Bankruptcy Protection Act (IPBPA).23 In his introduction of the IPBPA, Senator DeConcini expressed concern over the bankruptcy court’s ability to decide that reselling intellectual property rights 18 Dawn Donut Co. v. Hart’s Food Stores, Inc., 267 F.2d 358, 367 (1959). Quality control and inspection provisions need not be expressly set forth within the license agreement to comply with the 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 on good will”). 20 In re The Travelot Co., Inc., 286 B.R. at 455 (Bankr. S.D. Ga. 2002) (citing Bunn-O-Matic Corp. 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. could yield greater royalties than honoring an existing license.24 Further, Senator DeConcini cited the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.25 as demonstrating the need for the IPBPA. Lubrizol involved a debtor licensor seeking to reject a technology license agreement. The technology at issue was the principal asset of the debtor, and thus the source of money that would allow the debtor to emerge from bankruptcy. Rejection of the license agreement would strip the licensee of its rights to the agreement. The Court noted that the outcome of the case could have a “chilling effect” on parties entering into these types of agreements.26 Senator DeConcini stated that “[t]he Lubrizol ruling occurred because Congress never considered this issue, because no courts had considered it before the Bankruptcy Reform of 1978 and because it requires the application in bankruptcy cases of the very specialized area of intellectual property law.”27 The proposed IPBPA legislation included a definition of intellectual property, which included trademarks, trade names, and service marks, and allowed for expansion in to “other products of intellectual or creative effort now or hereafter protected by applicable nonbankruptcy law.”28 The proposed legislation also included a provision applicable to trademarks, trade names, and service mark licensees to “continue in concert the quality assurance procedures of the 24 S. 1626 at S11654. See also S. Rep. No. 100-505 at *2 (1988), reprinted in 1988 U.S.C.A.A.N. 3200, 3201 (acknowledging that it “will nearly always be arguably beneficial to the bankruptcy estate and any exercise of business judgment” to reject the license agreement); In re Blackstone Potato Chip Co., Inc., 109 B.R. 557, 560 (Bankr. D. R.I. 1990); Nguyen, supra note 14, at 1268 (stating that “the property value of some trademarks is significantly greater than that of the trademark owner’s physical assets”); Jason B. Binford, Supreme Court Passes on Assumption 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 a debtor’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. licensor.”29 Despite the stated purpose of “keep[ing] secure the rights of intellectual property licensors and licensees…,” the only provision of the proposed legislation dealing with debtor licensees required them only to maintain the confidentiality of information under the subject agreement.30 In 1988, President Ronald Regan signed a significantly modified version of the IPBPA into 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 1988 U.S.C.A.A.N. 3200, 3200 (stating that the purpose of the amendment to Section 365 is “to make clear that the rights of an intellectual property licensee to use the licensed property cannot be unilaterally cut off as a result of the rejection of the license… in the event of the licensor’s bankruptcy”) (emphasis added); see also S. Rep. No. 100-505, *4 (1988), reprinted in 1988 U.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 in possession operates its business and performs many functions that would fall to the trustee under other 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 assign a contract because Section 1107 “does not provide in words or substance that ‘trustee’ means or includes ‘debtor in possession’”). 6
  • 7. The language of the IPBPA parallels the language of 365(h)(1) pertaining to the treatment of real property leases.33 Congress noted a similarity between intellectual property licenses and real estate 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 another source.”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 and can elect to retain rights under the agreement.36 If the licensee elects to retain its rights under the license agreement, the licensee is obligated to continue to pay royalties,37 waives any right to a set-off,38 and waives the right to a claim under Section 503(b).39 Congress 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 by accident. 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 was 33 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. 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 executory contract is a contract “on which performance remains due to some extent on both sides.”42 Intellectual property licenses have consistently been held to be executory contracts due to the ongoing nature of customary obligations such as the payment of royalties and maintenance of intellectual property.43 Under Section 365(a), subject to court approval, a debtor can assume or reject an executory contract.44 Although the court is required to approve the assumption or rejection of the agreement,45 the court is deferential to the choice of the debtor as long as the choice meets sound business judgment.46 Under the business judgment standard, rejection of an executory contract (in this case, a trademark license) is appropriate if rejection of the agreement would benefit the estate47 and if it is not “so manifestly unreasonable that it could not be based on sound 41 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 where trademark licenses found to be executory contracts); Darren W. Saunders, Should the Bankruptcy Code 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 Intellectual Property Rights and Bankruptcy, Practising Law Inst., Handling Intellectual Property Issues in Bankruptcy in Business Transactions 2009, 956 PLI 127, 141 (2009) (noting that it is difficult to challenge 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 judgment in determining whether to approve rejection of contract). 47 Id. 8
  • 9. business judgment, but only on bad faith, or whim or caprice.”48 If a debtor elects to reject a contract, the nondebtor is left only with a claim for damages for breach of contract as of the date of the filing of the bankruptcy petition.49 Upon rejection of a trademark license agreement by a debtor licensor, the licensee must stop use of the trademark.50 The licensor’s rejection of a trademark license acts to restore the licensor’s right to use the trademark for the goods and services and/or geographic location previously designated to the licensee.51 Exclusion from 365(a), that is, when a trademark license agreement may not be assumed or 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 the nondebtor from accepting performance from an entity other than debtor and if the nondebtor does not consent to the assumption of the agreement.53 48 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 since trademarks do not fall under Section 365(n), Lubrizol controls and thus trademark use must cease). 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. C. TRADEMARK AND BANKRUPTCY CONVERGE When trademark law and bankruptcy law converge, there are several sub-issues that are key to analyzing the treatment of trademark licenses. First, under 365(c) what is “applicable law” 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 the case of a debtor licensor versus a debtor licensee? I. “APPLICABLE LAW” As it pertains to trademarks, “applicable law” under Section 365(c) has been generally split into two categories: analysis as a personal service contract or analysis under the Lanham Act.54 A. PERSONAL SERVICE CONTRACT A personal service contract involves contracting for the unique services of a particular person; services that could not “equally be performed by another.”55 For example, contracting with a famous singer to perform a concert would be considered a personal services contract. At common law, personal service contracts are not assignable without consent.56 Thus, the singer could not assign her duties to perform under the contract because her services are unique to her and are a material aspect of the contract.57 54 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); 3-365 COLLIER 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. Some courts have used personal service contract analysis in the context of assignment in bankruptcy to determine whether the rights and obligations under the license constitute personal services, which involve “the exercise of special knowledge, judgment, taste, skill, or ability” that would not be assignable without the consent of the licensor.58 Analysis of a trademark license as a personal service contract has unpredictable results.59 Generally, however, the theory is that if the license is treated as a personal service contract, the identity of the licensee is a material element of the license, and thus the license would not be assignable absent licensor consent.60 At least one commentator argues that applying the personal services contract analysis to trademark licenses 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 only restriction 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.63 Courts have thus cited the Lanham Act’s requirement for licensors to control the use of their trademarks as the basis for determining that trademark licenses cannot be assigned without the consent of the licensor.64 One commentator notes that it would be more accurate for courts to 58 In re Rooster, 100 B.R. 228, 232 (E.D. Pa. 1989). Some have argued that since corporations delegate 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 individuals within 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. cite trademark common law where it is generally accepted that a trademark licensee cannot sublicense (a situation analogous to assigning a license to a third party) without the consent of the licensor.65 II. LICENSOR-DEBTOR VERSUS LICENSEE-DEBTOR A debtor licensor can put the licensee in a precarious position by rejecting the license agreement, thus preventing the licensee from utilizing the trademarks66 as was the case in Lubrizol.67 Clearly, the debtor licensor holds a strong bargaining position with the threat of rejection looming for the licensee.68 If the debtor licensor opts to reject the license the licensee is required to cease use of the trademarks immediately, although some courts will allow a transition period, which may be as short as thirty days.69 A licensee that can show that rejection of the license agreement would be devastating to its business, while only providing a small benefit to the debtor licensor may convince the court to deny the request to reject the agreement.70 Since the 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 required to perform its obligations under the license agreement, absent a court order to do so, until the agreement is assumed or rejected.72 Since the automatic stay constrains the licensor’s ability to enforce the agreement, quality control standards may be left unsupervised.73 This can subject 65 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. the licensor to claims of abandonment for failure to control the quality of products bearing its trademarks and potentially cause damage to the licensor’s reputation.74 The licensor can seek relief from stay for “cause” under Section 362(d)(1) to terminate the license for lack of adequate protection under Section 361.75 Arguably, there is no adequate protection available when a licensor’s reputation is at stake.76 In practice, however, it appears that a court is unlikely to grant relief from stay for cause unless the licensor timely demonstrates that quality control is a real concern.77 III. EXCLUSIVITY VERSUS NON-EXCLUSIVITY Whether an intellectual property license agreement is exclusive can make a difference in whether the license will be assumable in a bankruptcy proceeding. For example, under applicable copyright law, an exclusive license acts as a transfer of the copyright since the licensee 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 are considered to be personal to the licensee.80 74 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 service marks…[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 Catapult Entm’t, Inc., 165 F.3d 747, 750 (1999) (internal citations omitted) (non-exclusive patent); In re CFLC, Inc., 89 F.3d 673, 679 (9th Cir. 1996) (internal citations omitted) (non-exclusive patent). 13
  • 14. In the trademark context, only a few courts have addressed the non-exclusive versus exclusive issue. The most recent cases held a non-exclusive license is personal to the assignee and not assignable to a third party.81 As such, a “a licensor need not accept performance from or render performance to an entity other than the licensee.”82 If an exclusive license is treated as a transfer of rights, then the license is not an executory contract and is thus does not fall under the ambit 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 of the trademark versus bankruptcy issue. The manner in which trademark licenses are treated in bankruptcy proceedings could have a devastating effect on the parties to the agreement.84 As one commentator points out, “when a party is suddenly forced to stop use of a trademark that has become associated with a product and develop a new commercial identity, there will be an obvious 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, subject to the exceptions found in Section 365(c). Confusion arises depending on how the court interprets Section 365(c)(1)’s “assume or assign” language. Courts interpreting the statute’s based on its disjunctive, plain meaning follow the “hypothetical test,” while courts interpreting the 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 any executory contract”) (emphasis added). 84 In re Centura Software Corp., 281 B.R. 660, 674 n. 26 (internal citations omitted) (“rejection of a trademark license can potentially destroy licensee’s business”); Saunders, supra note 42, at 58. See supra Part II(C)(ii). 85 Saunders, supra note 43, at 58. 14
  • 15. A. THE HYPOTHETICAL TEST The Third,86 Fourth,87 and Ninth88 Circuits follow the hypothetical test.89 Following statutory language, the hypothetical test “examin[es] whether, hypothetically, without looking to the individual facts of the case, any executory contracts could be assumed under applicable federal law.”90 Applying the plain meaning of the statute, assumption and assignment are two separate events, each requiring the nondebtor’s consent, before the agreement can be assigned.91 Courts applying the hypothetical test hold that Section 365(c)(1) prohibits the debtor from assuming the trademark license without licensor consent, even if the debtor does not intend to assign the license to a third party, but rather intends to continue using the license.92 The hypothetical test prevents “the debtor from assuming an executory contract where the licensor would 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 the nondebtor’s consent outside of bankruptcy, then the debtor cannot assume the agreement within the bankruptcy.94 It does not matter if the debtor wants to perform under the agreement, rather than actually assign the license to a third party.95 86 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 software license agreement even though the debtor did not intend to assign the agreement and the licensor had consented to an assignment). 88 Catapult Entm’t, 165 F.3d 747 (refusing assignment of a non-exclusive patent license and acknowledging 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 the hypothetical 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. Courts following the hypothetical test explain that they are adhering to settled rules of statutory interpretation because the language of Section 365(c)(1) is clear and unambiguous (“the trustee 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 it does 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 re Sunterra 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 even though the licensor had consented to the assignment in the license agreement and the debtor did not propose assigning the license to a third party, but rather intended to assume the agreement as debtor in possession.101 The basis for the court’s reasoning is that the assignment provision of the agreement did not address assumption, and since assignment and assumption are two distinct events, consent is required for both.102 Although this result was “quite unreasonable,” it did not reach the level of absurdity required for the court to consult legislative history.103 96 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) of this section, notwithstanding a provision in an executory contract…of the debtor, or in applicable law, that prohibits, restricts, or conditions the assignment of such contract…, the trustee may assign such contract…” 99 David H. Kennedy, Bankruptcy Issues in Intellectual Property Transactions, Practising Law Inst., Handling Intellectual Property Issues in Bankruptcy in Business Transactions 2009, 956 PLI 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. B. THE ACTUAL TEST The First104 and Second105 Circuits follow the actual test, which examines “whether the executory contract at hand, in actuality, can be assumed when applying the applicable federal law.”106 Thus, in these Circuits, the assignment of a license is only relevant if the debtor wishes to actually assign the agreement.107 Courts following the actual test explain that following the hypothetical test would cause a debtor to “lose its option to assume the contract, even though it never intended to assign the contract.”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 someone other than the debtor . . . with whom it originally contracted.’”109 In other words, the actual test acts to protect a nondebtor from “being forced to accept service from or render service to entities other 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 proponents argue that reading the statute as conjunctive, rather than disjunctive, is “more harmonious” with bankruptcy policy.112 Citing canons of statutory interpretation, at least some courts are unwilling to foray into an area that is reserved for the legislative branch.113 104 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 License Agreements 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. In summary, under the hypothetical test, a debtor could not assume an agreement if the nondebtor 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 intend to assign, because the nondebtor would not actually be forced to accept performance from a party other than debtor.114 The debate between the hypothetical and actual tests was presented to the Supreme Court in 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 of combining martial arts with boxing, resulting in the pop culture fitness phenomenon known as Tae Bo®.115 Blanks and his wife own the Tae Bo® trademark, among others, through their company 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, a disagreement arose over the parties’ obligations under the agreement.118 In 2001, the parties settled their differences via settlement agreement which confirmed BG Star’s ownership in the Tae Bo® trademark. In 2002, the parties entered in to a license agreement outlining how the trademark 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 breaching the agreement.120 BG Star arbitrated its claim against N.C.P. and won a $2.1 million 114 Sunterra Corp., 361 F.3d at 263. 115 What is Tae Bo – Billy Blanks, http://www.billyblanks.com/category/meet+billy/what-is-tae- bo.do (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. judgment.121 N.C.P., unable to pay the judgment, filed for Chapter 11 protection.122 In its disclosure statement, N.C.P. claimed ownership of the Tae Bo® brand, which the Blanks, on behalf of BG Star, disputed.123 BG Star moved for an order compelling the rejection of the license 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 the bankruptcy court’s order and concluded that BG Star had only granted N.C.P. a non-exclusive license giving N.C.P. the right to assign a non-exclusive license.125 The district court held that under trademark law, “trademarks are personal and non-assignable without the consent of the licensor” 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 Appeals affirmed without oral argument.127 N.C.P. petitioned the Supreme Court for a writ of certiorari.128 In denying certiorari, the Supreme Court issued a statement acknowledging the importance of resolving the dispute between the hypothetical and actual test, but reserving the decision for a more appropriate case.129 Justice Kennedy joined by Justice Breyer, appeared to suggest a preference for the actual test, 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 about whether N.C.P. could assign the non-exclusive trademark license agreement as opposed to assigning the actual trademarks (“NCP does not have the consent of the Blanks to license to third parties at this time and therefore cannot assume the trademarks under Section 365(c)(1)”). Id. at 238 (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. [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 own challenges: “[i]t may be argued, for instance, that the actual test aligns with § 365(c) with sound bankruptcy policy only at the cost of departing from at least one interpretation of the plain text of the law.”131 V. GOING FORWARD The treatment of trademark licenses in bankruptcy proceedings is not of little consequence. In 2008, despite the recent economic downtown, royalty payments for brand licenses alone topped $5.7 billion.132 Twenty-one years ago when the IPBPA was enacted, the global marketplace looked very different than it does today. The Internet as we know it today was just beginning to take shape, and certainly most did not imagine that it would become the global e-commerce133 resource that it is today. Although there does not appear to be a perfect solution, there are several options worth investigating further to address the treatment of trademark licenses in bankruptcy proceedings. First, as a matter of which “applicable law” applies in the case of a true assignment to a third party, the courts could review trademark license agreements as personal service contracts since the identity of the licensee is a material element of the license agreement. It is a 130 Id. It appears that the Supreme Court may also have confused the license agreement and the actual trademark since the Court’s statement refers to “resell” and “sold.” Rights under a license agreement 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 Owners Look to Position Themselves for the Future, June 2, 2009, http://www.reuters.com/article/pressRelease/idUS151856+02-Jun-2009+BW20090602. See supra n. 14 (discussing the different types of trademark licenses). 133 Nguyen, supra note 14, at 1302. 20
  • 21. foundational principle of trademark law that the trademark owner has the exclusive choice in deciding whom to allow to represent its image, brand, and good will. It would be inequitable to deny 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 should conduct the “extensive study” that is described in the IPBPA legislative history and determine how trademarks should be handled in light of the results. The study should include soliciting information 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 Trademark Office, 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 and how trademark law views a lack of quality control, and the effect on the licensor’s rights. The panel should also seek information from licensees to determine whether simply amending Section 365(n) to include trademarks, trade names, and services marks would address licensee concerns. The result of the study would provide a basis to determine a workable solution for both 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 be maintained.134 This should provide a workable resolution for licensees when a licensor files for bankruptcy. Additionally, amendment of Section 365(n) should include a section dealing with debtor 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 licensor to continue to monitor quality from the time of filing the bankruptcy petition until any transition 134 Saunders, supra note 43, at 58. 21
  • 22. period expires, without need to seek relief from stay to do so. This resolution would address quality control issues when a licensee rejects a license agreement. In the alternative, the Code could provide for the appointment of a trademark ombudsman, similar to the consumer privacy (Section 332) and patient care ombudsman (Section 333) may be an appropriate solution. The trademark ombudsman would monitor the quality of products produced by the licensee and report to the court whether the quality meets appropriate quality standards. The trademark ombudsman would be a disinterested third party knowledgeable or expert in trademark law that would be appointed by the court in cases involving trademark licenses. The cost of the trademark ombudsman could be subsidized by a nominal fee increase for the filing of trademark applications. The hypothetical test versus actual test debate does not appear to have an easy resolution absent revision to the code or interpretation from the Supreme Court. The Supreme Court is reluctant to address this important issue because of the specialized and sometimes complicated application of trademark law in the bankruptcy context.135 A true assumption and assignment situation presents problems. Presumably, prior to entering into a licensing arrangement with a licensee, the licensor investigates the licensee’s creditworthiness and general suitability. If the licensee is allowed to assign the agreement to a third party without the licensor’s consent, the licensee is denying the licensor the ability to perform its due diligence as to suitability, this potentially materially increasing the licensor’s risk. Thus, under contract principles, the assignment of the agreement should be prohibited.136 The actual test, employing a case-by-case analysis to determine whether there is proposed performance by a third party, appears to be the least problematic and aligns with bankruptcy 135 N.C.P. Mktg., 556 U.S. at __, 129 S. Ct. at 1578. 136 Restatement (2d) of Contracts § 317(2)(a). 22
  • 23. policy. In a pure assumption situation, absent any legitimate quality control or adequate protection concerns, it would be inequitable to allow a licensor to use the licensee’s bankruptcy as a “second bite at the apple” to get out of the agreement. Finally, the courts can analyze the treatment of trademark licenses under equitable principles, balancing licensor and licensee concerns to reach a fair result. Although Congress explicitly encouraged the bankruptcy courts to determine equitable principles for handling trademark licenses,137 few have elected to do so.138 Courts have cited the plain, unambiguous language of the Code as the reason they need not consult legislative history.139 However, if following the plain meaning of the statute would lead to absurd results or a result “demonstrably at odds with the intent of the drafters” the courts should consult legislative history and other methods of statutory interpretation to reach the correct result.140 As one group of commentators point out, canons of statutory construction in bankruptcy court decisions “do not necessarily compel consistent conclusions.”141 CONCLUSION The “parallel universe” created by forcing trademark law and bankruptcy law to mesh together creates numerous nuanced issues and little consistency in application. It is clear that Congress needs to undertake an extensive study to deal with each of these trademark issues in the context of the bankruptcy proceeding to ensure that licensors maintain their reputation with the consuming public and associated goodwill, while protecting licensees who depend on a licensor’s trademarks for the survival of its business. Until these issues are investigated more 137 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, supra note 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. fully, there will continue to be a disconnect between the two universes rather than a manageable, if not more harmonious co-existence. 24