Exclusive Product Distribution Rights May Not Be Protected Under Section 365(n) of the Bankruptcy Code
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.
Background
The cast of characters is fairly simple. The Debtor-licensor, Tempnology LLC, was a company that “developed chemical-free cooling fabrics for use in consumer products under the brand name ‘Coolcore.’” The licensee, Mission Products Holdings, Inc., was a marketer and distributor of sports technologies. In November 2012, the parties entered into a “Co-Marketing and Distribution Agreement” for Mission’s sale and distribution of certain cooling material products developed by the Debtor. The Agreement provided Mission with the following rights, among others:
- Section 1. The Debtor granted Mission exclusive distribution rights within the United States and “first rights of notice and of refusal in certain other countries,” collectively defined in the Agreement as the “Exclusive Territory,” with respect to an assortment of the Debtor’s products identified in the Agreement and defined as “Cooling Accessories.” Additionally, the Debtor granted Mission “the non-exclusive right to sell the Cooling Accessories anywhere else in the world.”
- Sections 5/6. The Debtor agreed that in the Exclusive Territory, it would not license or sell certain specified Cooling Accessories, defined in the Agreement as “Exclusive Cooling Accessories,” to anyone other than Mission during the term of the Agreement.
- Section 15. The Debtor granted Mission a non-exclusive, perpetual license to “use, reproduce, modify, and create derivative work based on” certain of the Debtor’s patents, trade secrets, and copyrights relating to the Cooling Accessories and certain other products and inventions. Additionally, the Debtor granted Mission “a non-exclusive, non-transferable, limited license” to use the Debtor’s “Coolcore” trademark and logo for the time periods set forth in the Agreement.
The day following its bankruptcy filing, the Debtor filed a motion to reject the Agreement. Additionally, the Debtor filed a motion to sell substantially all of its assets “free and clear” pursuant to Section 363 of the Bankruptcy Code.
Mission objected to the rejection and sale motions, and provided notice of its election pursuant to Section 365(n) of the Bankruptcy Code. Mission argued that its election protected not only its non-exclusive, perpetual license of the Debtor’s patents, trade secrets, and copyrights, but also its exclusive product distribution rights granted under Sections 1, 5, and 6 of the Agreement and the limited trademark granted under Section 15. Mission also maintained that “any sale of the Debtor’s assets would be subject to, not free and clear of, Mission’s rights under the Agreement.” The Debtor disagreed, countering that the exclusive product distribution and trademark rights granted to Mission under the Agreement “did not survive rejection.”
The Bankruptcy Court for the District of New Hampshire sided with the Debtor, holding that Mission’s election under Section 365(n) only protected its rights as a non-exclusive licensee of the Debtor’s patents, trade secrets, and copyrights to the extent provided under the Agreement. The election provided no protectable interest in the exclusive distribution rights, nor did it protect Mission’s trademark rights. On this latter point, the bankruptcy court reasoned that, although trademarks fit within the general dictionary definition of “intellectual property,” the definition of this term under the Bankruptcy Code does not include trademarks or tradenames. Hence, “Mission [did] not retain rights to the Debtor’s trademarks and logos post-rejection.”
Mission appealed.
Discussion
The Bankruptcy Appellate Panel affirmed in part and reversed in part. The appellate panel affirmed the bankruptcy court’s ruling that the exclusive product distribution rights were not protected by Mission’s Section 365(n) election. Beginning its analysis with the principle that “the licensee’s…election applies only to its rights to intellectual property and not to any other rights that it might have received under the contract,” the appellate panel found that “[e]ven a cursory reading of the Agreement [made]…clear” that the grant to Mission of “the right to distribute certain of the Debtor’s products on an exclusive basis in a defined territory during a limited period” was independent of the “non-exclusive license to use some of the Debtor’s intellectual property in perpetuity.” “To conclude otherwise,” according to the appellate panel, “would allow the narrow exception of § 365(n) to upend the very purpose of § 365,” as “[a]ny executory contract could be made ‘rejection proof’ by inserting in it an intellectual property license no matter how remote or untethered….”
The appellate panel also agreed with the bankruptcy court’s conclusion that trademark rights are not protected under Section 365(n), reasoning that the Bankruptcy Code’s definition of “intellectual property” does not include trademarks or tradenames. The appellate panel, however, disagreed with the bankruptcy court regarding the effect of the Debtor’s rejection. Following the Seventh Circuit’s Sunbeam decision, the appellate panel held that the Debtor’s rejection did not “vaporize” Mission’s rights, instead finding that rejection only constituted a breach of the agreement. Thus, “[w]hatever post-rejection rights Mission retained in the Debtor’s trademark and logo are governed by the terms of the Agreement and applicable non-bankruptcy law.” Some courts, however, address this concern by looking to the main purpose of the agreement. See In re Golden Books Family Entertainment, Inc., 269 B.R. 300 (Bankr. D. Del. 2001); In re Matusalem, 158 B.R. 514 (Bankr. S.D. Fla. 1993).
Implications
The Tempnology decision is significant for at least two reasons. First, while Mission retained the (potentially valuable) right to “reproduce, modify, and create derivative work based on” the Debtor’s patents, trade secrets, and copyrights, the decision largely leaves unaddressed the practical implication that in many instances a license to intellectual property would be rendered worthless without the accompanying distribution rights. Second, the decision is the first appellate decision to adopt the Seventh Circuit’s approach articulated in Sunbeam, thereby widening the split of authority on this evolving issue. Aside from this approach, some courts have found that licensees are never entitled to use the debtor’s trademarks post-rejection, see, e.g., In re Old Carco LLC, 406 B.R. 180 (Bankr. S.D.N.Y. 2009), while at least one court has allowed trademark licensees to retain their Section 365(n) rights based on equitable considerations, see In re Crumbs Bake Shop, Inc., 522 B.R. 766 (Bankr. D.N.J. 2014). Recently, Mission filed an appeal in the Court of Appeals for the First Circuit, potentially providing an opportunity for another circuit-level court to weigh in.
