IP Law Daily, TOP STORY—Bankr. D.N.J.: Licensees can retain trademark rights despite bankrupt cupcake seller’s rejection of licenses, (Nov 4, 2014)

By Thomas Long, J.D.

Licensees of bankrupt baked goods retailer Crumbs Bake Shop, Inc. can continue to use the “Crumbs” trademark and sell products under the “Crumbs” brand for the remainder of their licenses’ terms, even though the retailer, acting as debtor-in-possession, had moved to reject the licenses following the court’s approval of sale of the business’s assets, the U.S. Bankruptcy Court for the District of New Jersey has decided (In re: Crumbs Bake Shop, Inc., October 31, 2014, Kaplan, M.). The licensees could elect, under 11 U.S.C. §365(n), to retain their rights under their respective licenses, notwithstanding the fact that “trademarks” were not explicitly included in the Bankruptcy Code definition of “intellectual property.” In addition, sale of the retailer’s assets pursuant to 11 U.S.C. §§363(b) and (f) did not trump or extinguish the rights of third-party licensees under §365(n). Royalties generated as a result of this use were payable to the retailer, because the agreements themselves had not been assumed, assigned, or rejected, and thus continued to be the retailer’s property.

Background. Crumbs Bake Shop, Inc. (“Crumbs”) specialized in the retail sales of cupcakes, baked goods, and beverages. Crumbs entered into licensing agreements with third parties allowing for the use of the “Crumbs” mark for the sale of products. To maximize licensing revenues, Crumbs entered into a representation agreement with Brand² Squared Licensing (“BSL”). BSL agreed to provide services to Crumbs, including the provision of brand licensing services related to license agreements. BSL procured licenses with several licensees for use of Crumbs’ trademark and trade secrets.

Due to financial difficulties, Crumbs ceased operations on July 7, 2014 and filed voluntary petitions for relief pursuant to Chapter 11 of the Bankruptcy Code. Since the petition date, Crumbs has managed the business as debtors-in-possession pursuant to §§1107 and 1108 of the Code.

On the petition date, Crumbs entered into a credit bid asset purchase agreement (“APA”) with Lemonis Fischer Acquisition Company, LLC (“LFAC”) for the sale of substantially all of Crumbs’ assets. A sale order was entered by the court and approved on August 27, 2014.

The next day, Crumbs filed a motion to reject certain executory contracts and unexpired leases, including the intellectual property licenses. BSL filed a response asserting that the licensees could elect, under §365(n), to retain their rights under their respective license agreements. BSL also sought entitlement to royalties in the even the licensees elected to continue using the licensed intellectual property.

Crumb subsequently withdrew its rejection motion only to the extent that it related to the license agreements. On October 1, 2014, the court entered an order authorizing the rejection of a number of executory contracts, unexpired leases, and licenses, but excluding those involving the intellectual property licensees. The parties now sought a determination of the effect of the sale order on their respective rights.

Protection of §365(n). Pursuant to 11 U.S.C. §365(n), the rights of an intellectual property licensee to use the licensed property cannot be unilaterally cut off as a result of the rejection of the license in the event of the licensor’s bankruptcy. When a debtor-licensor rejects an intellectual property license, the licensee is permitted to make an election under § 365(n). If the licensee chooses to retain its rights, the licensor is not bound by any continuing obligations under § 365(n).

The definition of “intellectual property” is found in §101(35A) of the Code. This definition lists trade secrets; inventions, processes, designs, or plants protected under title 35; patent applications; plant varieties; works of authorship protected under title 17; and mask works protected under chapter 9 of title 17, but it does not include trademarks. There was a split among authorities as to whether this omission indicated Congress’s intention that trademark licensees are not protected by §365(n), such that rejection of a license deprived the trademark licensee of the rights previously granted under the agreement.

The court disagreed with this position and held that reasoning by negative inference was improper in the context of the rejection of trademark licenses. According to the court, Congress intended the bankruptcy courts to exercise their equitable powers to decide, on a case by case basis, whether trademark licensees may retain the rights listed under §365(n). In this case, the court found that it would be inequitable to strip the licensees of their rights in the event of a rejection, as those rights had been bargained away by Crumbs.

LFAC argued that these equitable considerations should not come into play because Crumbs sold its assets to a bona fide purchaser. Some authorities have suggested that §365(n) rights of third parties should succumb to the interests of maximizing the bankruptcy estate in liquidation contexts. However, the court found no basis for such a distinction. Bankruptcy estates, whether reorganizing or liquidating, already benefit from the ability to assume or reject executory agreements. “There is no reason to augment such benefits at the expense of third parties and a licensing system which Congress sought to protect by means of preserving certain rights under § 365(n),” the court said.

LFAC argued that allowing the licensees to make an election under §365(n) to continue using the trademarks would place LFAC in a licensor-licensee arrangement that it never intended to assume. However, the court reasoned, LFAC came into this transaction with eyes open, after engaging in due diligence, and could adjust its purchase price to account for existing trademark license agreements.

Accordingly, the court held that trademark licensees to rejected intellectual property licenses fell under the protective scope of 11 U.S.C. §365(n).

Effect of asset sale. Next, the court held that a sale of a bankrupt debtors’ assets pursuant to 11 U.S.C. §§363(b) and (f) did not trump nor extinguish the rights of third-party licensees under § 365(n), in the absence of consent. The court rejected LFAC’s contention that sale of Crumbs’ assets pursuant to §§363(b) and (f) effectuated a free and clear conveyance of the licensees’ trademark rights to LFAC, such that §365(n) no longer applied.

LFAC contended that the licensees impliedly consented to the vitiation of their §365(n) rights by failing to object to the sale motion. However, in the court’s view, the licensees did not receive adequate notice. The court admitted that it had difficulty “following the definitional maze put in place under the APA.” It was unclear what was being sold and there was no clear discussion as to what rights were purported to be taken away as a result of the sale. The licensees had no apparent reason to believe that an objection was necessary to protect their rights under §365(n). The court suggested that the sale motion was drafted in a confusing manner with the intent of treating the license agreements as vitiated without raising the specter of §365(n) rights. Therefore, it would be inequitable to find that the licensees consented to the termination of their rights.

Royalties. Finally, the court held that Crumbs was the only party entitled to the collection of royalties generated as a result of Licensees’ use of licensed intellectual property. There was no question that the “Crumbs” trademark, among other intellectual property, was sold to LFAC. However, explicitly excluded from the sale were the license agreements between Crumbs and the trademark licensees, and the contract between Crumbs and BSL. The license agreements were not themselves sold, and they were not assumed or assigned, LFAC did not receive any rights under the agreements. Therefore, the rights as to the license agreements remained with Crumbs.

The case is No. 14-24287.

Attorneys: Michael D. Sirota (Cole, Schotz, Meisel, Forman & Leonard) for Crumbs Bake Shop, Inc. Mitchell Malzberg (Law Offices of Mitchell J. Malzberg, LLC) for Lemonis Fischer Acquisition Company, LLC. Douglas T. Tabachnik (Law Offices of Douglas T. Tabachnik, P.C.) for Brand^² Squared Licensing.

Companies: Crumbs Bake Shop, Inc.; Lemonis Fischer Acquisition Company, LLC; Brand² Squared Licensing

MainStory: TopStory Trademark NewJerseyNews