Exclusive Product Distribution Rights May Not Be Protected Under Section 365(n) of the Bankruptcy Code

January 11, 2017

Section 365(n) of the U.S. Bankruptcy Code affords special protection to a licensee of a right to “intellectual property,” notwithstanding the debtor-licensor’s rejection of the governing licensing agreement pursuant to Section 365(a) of the Bankruptcy Code. Basically, Section 365(n) allows a licensee to elect to retain most of its “intellectual property” rights under the agreement post-rejection, provided the licensee continues to pay royalties and waives its setoff rights and any administrative expense claims. While the debtor-licensor is generally freed of its affirmative obligations under the licensing agreement, it must allow the licensee to exercise its intellectual property rights free from interference. One issue that courts often grapple with in the event of an election is parsing through the bundle of rights granted to the licensee, separating those “intellectual property” rights entitled to special protection from those rights under the agreement subject to the ordinary rules of rejection.

In Mission Product Holdings, Inc. v. Tempnology LLC, n/k/a Old Cold, LLC, 559 B.R. 809 (1st Cir. B.A.P. 2016), the Bankruptcy Appellate Panel for the First Circuit held that the licensee’s Section 365(n) election protected its rights as a non-exclusive licensee of the Debtor’s patents, trade secrets, and copyrights to the extent granted under the agreement at issue, but did not protect the licensee’s exclusive distribution rights. Additionally, with respect to the trademark rights granted to the licensee under the agreement, the appellate panel followed the Seventh Circuit’s decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012), holding that while trademark rights are not entitled to special protection under Section 365(n), the effect of rejection does not necessarily “vaporize” these rights but instead constitutes a breach of the agreement by the Debtor. Thus, the licensee could continue using the Debtor’s trademark and logo to the extent permitted under applicable non-bankruptcy law upon a breach by the Debtor.

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