When Can A Franchisee Continue to Operate if the Franchisor is in Bankruptcy?

When Can A Franchisee Continue

United States Court of Appeals for the Seventh Circuit, Decision of 9 July 2012, No. 11-3920, Sunbeam Products, Inc. v. Chicago AM. MFG. LLC, and United States Court of Appeals for the Eighth Circuit, Decision of 30 August 2012, No. 11-1850, In Re Interstate Bakeries Corp.

The U.S. Courts of Appeal for the Seventh and Eighth Circuits came to different conclusions in deciding the right of a trademark licensee to continue using the licensed mark after rejection or attempted rejection of the trademark license by a bankrupt licensor.

U.S. bankruptcy law allows a bankrupt licensor to reject an executory trademark license, i.e. where the parties have continuing, material obligations. Trademark licenses typically are considered executory due to the continuing obligations of the licensee to pay royalties and of the licensor to control the quality of the goods produced or services offered under the licensed mark.

Previously, courts followed a Fourth Circuit decision, Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. 756 F.2d 1043 (4th Circ. 1985), which held that after rejection, the former licensee would lose its right to use the mark and be left with only a damages claim.

Three years after the Lubrizol decision, Congress amended the bankruptcy Code to add Section 365(n) to protect the right of intellectual property licensees to continue using licensed copyrights and patents after rejection, but not trademarks.

In the Seventh Circuit's decision in Sunbeam Products, the court did not follow the Fourth Circuit's Lubrizol decision and found that the rejection of the agreement did not terminate the licensee's right to continue using the licensed mark, LAKEWOOD for ceiling fans.

The court determined that the rejection was a licensor breach, but that the breach should be treated as other breaches, with the licensee's rights not ending.

The decision did not address how and whether the licensor could continue to exert the quality control that is necessary to prevent abandonment of the licensed mark.

Shortly thereafter, the Eighth Circuit came to a contrary conclusion in In re Interstate Bakeries Corp. Even though the trademark license at issue, for use of the SUNBEAM BREAD and BUTTERNUT BREAD marks, was a prepaid, perpetual, exclusive license granted as part of the sale of the related business, the court agreed with the district court's determination that the license agreement was executory in light of the licensee's continuing standard of quality obligations. The court followed the Lubrizol rule and deemed the license terminated by the rejection of the license.

These decisions highlight the continuing risks of relying on a trademark license rather than ownership of a mark.

If a license must be used, a useful strategy is to structure the licensor-licensee relationship to maximize the likelihood that the license would be deemed fully performed (non-executory) and, thus, not subject to rejection.

In the context of a sale of a business, the closer the license grant is tied to the overall sale, the higher the likelihood that the overall arrangement will be deemed fully performed in material respects. In jurisdictions following In re Interstate Bakeries Corp., however, even that strategy does not assure the right to continue using a mark owned by a bankrupt licensor.

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