On October 31, 2014, the US Bankruptcy Court for the District of New Jersey in In re Crumbs Bake Shop, Inc. held that Section 365(n) of the Bankruptcy Code protected trademark licensees to rejected intellectual property licenses even though Congress failed to explicitly include trademarks within the definition of protected intellectual property (No. 14-24287, (Bankr. D.N.J. Oct. 31, 2014)). Additionally, the court held that:

Crumbs Bake Shop (collectively with the within debtors and the debtors-in-possession, the debtors) sold cupcakes, baked goods and beverages through retail stores, an online division, catering services and a wholesale distribution business. To maximize revenues, the debtors entered into license agreements with third parties allowing them to use the Crumbs trademark and trade secrets, and sell products under the Crumbs brand, including the five licensees at issue in this case (licensees). On July 11, 2014, the debtors filed a voluntary petition for Chapter 11 bankruptcy. On August 27, 2014, the Bankruptcy Court for the District of New Jersey entered a Sale Order approving the sale of substantially all of the debtors' assets, including its trademarks, to Lemonis Fischer Acquisition Company, LLC (LFAC), free and clear of liens, claims, encumbrances and interests. After debtors filed a motion to reject certain executory contracts, including the five license agreements at issue, the debtors, LFAC and the licensees sought a determination of the Sale Order's effect on their rights.

In concluding that Section 365(n) of the Bankruptcy Code protected the trademark licensees, the court found persuasive Judge Ambro’s concurring opinion in In re Exide Technologies that Congress intended the bankruptcy courts to exercise their equitable powers to decide on a case by case basis whether trademark licensees may retain rights under Section 365(n) (607 F.3d 957 (3d Cir. 2010)). The court determined that, in the event of rejection, it would be inequitable to strip the licensees of their rights as they had been bargained away by the debtors.

Additionally, outside of equitable considerations, the court cited the US Court of Appeals for the Seventh Circuit’s decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, which held that rejection of a trademark license is deemed a breach of contract giving rise to damages but does not extinguish the rights of the non-rejecting party (686 F.3d 372 (7th Cir. 2012)). For more information, see Legal Update, Trademark Licensee Retains Right to Use Trademark After Debtor Licensor Rejects License in Bankruptcy: Seventh Circuit.

The court rejected LFAC's argument that if the licensees were to elect to continue using the trademarks under Section 365(n), LFAC would be placed in a licensor-licensee arrangement that it never intended to assume, noting that LFAC or any other purchaser would have come into the transaction after engaging in due diligence and having the opportunity to adjust their purchase price to account for the existing license agreements. Notably, the court also rejected LFAC's argument that allowing the licensees the right to use the trademark would create quality control issues. The court found sufficient protection through market and anti-fraud forces including:

The court noted that, although not dispositive to its decision, the US House of Representatives recently passed a bill that would:

The court also held that a sale of the debtors’ assets under Sections 363(b) and (f) of the Bankruptcy Code, which allow a debtor-in-possession to make a sale of the debtor’s assets free and clear of any interest in property, does not override or extinguish the rights of third party licensees under Section 365(n) without their consent. In this case, the court determined that the licensees were not provided with adequate notice that they were at risk of losing their rights because the debtors' Sale Motion and supporting submissions, including the asset purchase agreement with LFAC, failed to state anything about the treatment of the licensees or the effect the sale would have on their rights.

Although subject to appeal, this decision and the Seventh Circuit's decision in Sunbeam last year highlight that protection of trademark licensees in the context of the debtor licensor's bankruptcy remains in flux. The Seventh Circuit and now courts in the Third Circuit have issued opinions favoring the rights of trademark licensees. However, trademark licensees continue to remain at substantial risk in a trademark licensor's bankruptcy without further guidance from Congress or the courts.

For more information on IP issues in bankruptcy generally, see Practice Note, IP Licenses and Bankruptcy.