We have written before about franchisors’ bankruptcies. This piece will examine one aspect of those events. We will first offer a brief overview for franchisees and then lay out more groundwork for attorneys who may be interested.
If you are a franchisee, you have an number of concerns, revolving around the rejection (or not) of your franchise agreement. Perhaps the most important effect on a franchisee is that the rejection of the franchise agreement may not actually end your agreement, but until very recently, it was thought to end your right to use the trademark. Obviously a critical and perhaps fatal blow to the business. However, a recent case may have opened the door to franchisees being able to continue to use a trademark even after a franchise agreement is rejected. It is not clear and we will keep you advised.
As to you lawyers, until recently, a franchisee’s ability to use a franchisor’s trademark would be terminated if the franchisor rejected the franchisee’s franchise agreement in bankruptcy court because of the previous application of Section 365(n) of the Bankruptcy Code. That section provides licensees of patents, copyrights and trade secrets with an option to continue to use the licensed intellectual property (and continue to pay a royalty) after the licensor rejects the license agreement in bankruptcy court. That section omits trademarks from the list of protected intellectual property and previous application of that section did not afford trademark licensees with the protection afforded to other intellectual property licensees. Thus, for trademark licensees, rejection by the licensor of a license agreement meant that the licensee lost the continued right to use the licensed trademark. However, a recent case (Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012)) held that the protections afforded to intellectual property licensees under 365(n) also applied to trademark licensees.
The future of 365(n) protection for trademark licensees is unclear at the moment. The Sunbeam case may be a one-time split from the previous application of Section 365(n) or it could be the first instance of broadening Section 365(n) protection so that trademark licensees are afforded the same protection as other intellectual property licensees.
Before discussing the potential impact of this recent decision, it may be helpful to provide a brief summary of the pre-Sunbeam landscape.
In 1985, before Section 365(n) had been enacted, the 4th Circuit ruled in Lubrizol Enterprises, Inc. v. Richmond Mutual Finishers, Inc., 756 F.2d 1043, that the affect of a licensor’s rejection of a patent license in bankruptcy court left the licensee without the right to use the licensed technology. Instead, the licensee would have a pre-petition unsecured claim for money damages. Most holders of pre-petition unsecured claims are ultimately paid pennies on the dollar for their damages. This ruling left licensee in a precarious position; no right to continue to use the licensed technology and no expectation to receive sufficient compensation for the loss of the licensed technology. That ruling was found be fundamentally unfair to the licensee. Accordingly, Congress enacted Section 365(n) of the Bankruptcy Code (11 U.S.C. §365(n)) in response to the Lubrizol decision.
As noted above, Section 365(n) specifically gives licensees of patents, copyrights and trade secrets whose license agreement was rejected in bankruptcy by the licensor the option of either (a) treating the license agreement as terminated and asserting pre-petition claims or (b) retaining the right to use the patents, copyrights and/or trade secrets and continuing to pay royalties for that continued use. Specifically omitted from Section 365(n) were trademarks. Congress determined that trademark licenses are different from other intellectual property licenses because the licensor has the obligation of ensuring that quality of the goods associated with the licensed trademark are maintained; an obligation that generally does not exist with the other forms of intellectual property licenses. The implication of Congress’ determination and the omission of trademarks from the list of protected intellectual property was that a trademark licensee would lose the right to continue to use the licensed trademark if the licensor rejected the license agreement.
The Sunbeam decision deviates from Section 365(n) in that the court held that rejection of a trademark license does not eliminate the licensee’s ability to continue to use the licensed trademark. The Sunbeam court indicated that Congress’ decision to not include trademark licenses in Section 365(n) is not a codification of the Lubrizol decision. Rather, it was a simple omission and that Section 365(n) protection should be afforded to trademark licensees as well. While Sunbeam was not a franchise case, application of its decision may allow a franchisee to continue to use a franchisor’s trademark even after its franchise agreement is rejected by its franchisor in bankruptcy court.
If a franchisee is allowed to continue to use the franchisor’s trademark after the franchise agreement is rejected, significant questions will arise as to how will the franchisor monitor quality of the goods associated with its trademark and if the franchisee continues to use the trademark, how (and how much) will the franchisee pay the franchisor for the continued right to use the trademark. We will update this blog if this question is analyzed by any court in the future.