On July 9, 2012, in Sunbeam Products, Inc. v. Chicago American Manufacturing LLC, Case No. 11-3920 (7th Cir. July 9, 2012), the United States Court of Appeals for the Seventh Circuit (the "Seventh Circuit") issued an opinion (the "Opinion") affirming the order of the Bankruptcy Court in the Lakewood Engineering & Manufacturing Co. ("Lakewood") bankruptcy case. Specifically, the Seventh Circuit held that, when an intellectual-property license is rejected in bankruptcy, the licensee does not lose the ability to use any licensed trademarks. The Opinion creates a circuit split with the United States Court of Appeals for the Fourth Circuit (the "Fourth Circuit"), which previously ruled, in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), that, post-rejection, the licensee loses the ability to use any licensed copyrights, trademarks and patents. The full text of the Opinion can be found here.

Background Facts

Lakewood made and sold a variety of consumer products, which were covered by its patents and trademarks. In 2008, as it was losing money on its box fan products, Lakewood contracted their manufacture to Chicago American Manufacturing ("CAM").  The contract authorized CAM to use Lakewood's trademarks on the completed fans. Because Lakewood was in financial distress, CAM was reluctant to invest its resources to gear up for the production of the approximately 1.2 million fans that Lakewood estimated it would require during 2009. Accordingly, the contract further authorized CAM to sell the 2009 inventory of box fans for its own account if Lakewood did not purchase them. Three months into the contract, several of Lakewood's creditors commenced involuntary bankruptcy proceedings against it. In bankruptcy, the court-appointed chapter 7 trustee sold Lakewood's business – including its patents and trademarks – to Sunbeam Products ("Sunbeam"). Upon its acquisition of Lakewood's assets, Sunbeam did not want the Lakewood-branded fans that CAM had in inventory, nor did it want to sell those fans in competition with Sunbeam's products. The trustee subsequently rejected Lakewood's contract with CAM pursuant to Bankruptcy Code section 365(a). When CAM continued to make and sell Lakewood-branded fans post rejection of the contract, the trustee filed an adversary proceeding against CAM claiming that CAM, in its capacity as the manufacturer of the box fans, infringed on Lakewood's patents and trademarks by continuing to manufacture and sell box fans post-rejection of the underlying contract between Lakewood and CAM.

The Bankruptcy Court Ruling

After presiding over the trial, the Bankruptcy Court held that, notwithstanding the trustee's rejection of the contract, CAM was entitled to sell its remaining inventory of fans with the Lakewood patents and trademarks. In re Lakewood Engineering & Manufacturing Co., 459 B.R. 306, 333-38 (Bankr. N.D. Ill. 2011). The Bankruptcy Court reasoned that CAM, which invested substantial resources in making Lakewood-branded box fans, could continue using the Lakewood marks on equitable grounds.  Id. at 343-46.  Accordingly, the Bankruptcy Court entered a judgment in CAM's favor. Sunbeam subsequently appealed whether CAM could continue to use the Lakewood trademarks. The judgment was certified for direct appeal to the Seventh Circuit.

The Seventh Circuit's Analysis and Holding

In the Opinion, the Seventh Circuit focuses on the effect of the rejection of the underlying contract and whether the licensee, CAM, is entitled to continue to use the Lakewood trademarks. In so doing, it analyzes the only other court of appeals case that squarely addresses the issue, Lubrizol. Opinion at 4. In Lubrizol, the Fourth Circuit held that, when an intellectual property license is rejected in bankruptcy, the licensee loses the ability to use any licensed copyrights, trademarks and patents. Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Three years after the Lubrizol decision, Congress added section 365(n) to the Bankruptcy Code – which allows licensees to continue using the "intellectual property" after rejection, provided they meet certain conditions. Notably, "intellectual property" is a defined term in the Bankruptcy Code and includes patents, copyrights and trade secrets. 11 U.S.C. §101(35A). The definition, however, does not include trademarks. As the Sunbeam court recognized, some bankruptcy courts have held that by omitting trademarks from the definition of "intellectual property," Congress codified Lubrizol with respect to trademarks. Opinion at 3. However, because "an omission is just an omission,"  the Sunbeam court believed it had to determine whether or not to follow Lubrizol as it relates to the issue of whether the rejection of a license terminates the licensee's right to use the trademarks associated with that license. Id. 

In no uncertain words, the Seventh Circuit's ruling in Sunbeam characterizes the Lubrizol opinion as "mistaken," concluding that it confuses rejection with the use of an avoiding power. Opinion at 5-9. The court's analysis hinged on the distinction between "rejection" in bankruptcy and termination of a contract. Section 365(g) of the Bankruptcy Code provides that rejection of a contract "constitutes a breach of such contract." Opinion at 7. Therefore, just as a licensor's breach does not terminate a licensee's right to use intellectual property outside of bankruptcy, the rejection of a license in bankruptcy does not terminate a licensee's right to use intellectual property. Id. Nothing about the rejection "process implies that any rights of the other contracting party have been vaporized." Opinion at 8. Accordingly, the Seventh Circuit ruled that, "because the trustee's rejection of Lakewood's contract with CAM did not abrogate CAM's contractual rights, the adversary proceeding properly ended with a judgment in CAM's favor." Opinion at 9.

As a result of the Opinion, the federal courts of appeals are now in disagreement over the effect of rejection of a contract granting a trademark license, and the next court to consider this issue may very well be the United States Supreme Court.   

This article was prepared by Mark A. Platt (mplatt@fulbright.com or 214 855 7172) and Ryan E. Manns (rmanns@fulbright.com or 214 855 8304) from Fulbright's Bankruptcy and Insolvency Practice Group.

Fulbright's Bankruptcy and Insolvency Practice represents secured and unsecured creditors (both official and ad hoc), bondholders, asset purchasers, equity sponsors, debtors, trustees and other parties involved in financial restructuring transactions and cases, both in and out of court. For further information or questions regarding Fulbright's Bankruptcy and Insolvency Practice Group, please contact Louis R. Strubeck, Jr. (lstrubeck@fulbright.com, 214 855 8040 in Dallas or 212 318 3159 in New York) global chair of the practice.