Actual or hypothetical: determining the proper test for trademark licensee rights in bankruptcy.

Author:Steele, Laura D.

INTRODUCTION PART I A. Trademark Law vs. Bankruptcy Law: Competing Interests 1. Trademark Law Purpose a. Trademark Licensing b. Licensor Control 2. Bankruptcy Law Purpose a. Overview of Chapter 11 Bankruptcy b. The Roles of the Debtor-in-Possession and the Chapter 11 Trustee i. Statutory Controls over Executory Contracts ii. Assumption of an Executory Contract iii. Objection to Assumption of an Executory Contract by Non-Debtor B. The Conflict between Trademark Law and Bankruptcy Law 1. Trademarks Are Not Intellectual Property 2. Rights of a Trademark Debtor-Licensee PART II A. In re N.C.P. Marketing Group 1. The Genesis of TAE BO B. Assumption of the License 1. The In re N.C.P. Marketing Group Court's Interpretation of Bankruptcy Code [section] 365(c)(1) a. The Hypothetical Test b. The Actual Test c. Applicable Federal Law 2. Critique of In re N.C.P. Marketing Group C. Questions Remain: N.C.P. Marketing Group v. BG Star Productions PART III A. Conjunction Junction, What Is Your Function: Explaining the Circuit Split 1. The Hypothetical Test a. The Ninth Circuit: In re Catapult Entertainment b. The Third Circuit: In re West Electronics c. The Fourth Circuit: In re Sunterra Corp 2. The Actual Test: The First Circuit B. An Alternative: In re Footstar CONCLUSION INTRODUCTION

Across the country, storefront window displays have become frames for large neon posters that scream: "Going out of business!"; entrances have been adorned with large yellow banners proclaiming in bold letters: "Everything Must Go!" In a matter of weeks, store shelves that were once fully stocked become victims of savage bargain hunters. Eventually, the stores are stripped clean until only the bolted down shelves remain. It is a scene that has unfolded uniformly at myriad retail locations of Sharper Image, Bombay Co., Linens 'n Things, and Circuit City. (1) Today, these stores have become empty shells, serving only as blighted reminders of hard economic times. (2) Yet, even as bargain hunters have snatched up every ionic air cleanser, incense holder, pillow sham, and cell phone charger from these bankrupt retailers, the most valuable asset remains--the store's brand. (3)

Investors know that while a company may be bankrupt in the sense of its hard assets, significant value remains in the brand itself. (4) For example, The Sharper Image, which filed for Chapter 11 bankruptcy protection in 2008, is no longer a retail company with stores and retail associates. Instead, The Sharper Image has reincarnated itself as a "global lifestyle brand licensor." (5) So while a customer can no longer walk into a Sharper Image store and try out the "deluxe shiatsu foot massager," a customer in search of the "Sharper Image experience" can still buy Sharper Image licensed merchandise at Macy's, Best Buy, or OfficeMax. (6) Thus, The Sharper Image has reorganized itself from a failed capital-based business, to a more sustainable royalty-driven business that exploits the value of its brand, and its trademark in particular. (7)

Although THE SHARPER IMAGE trademark has found a happy ending in life after bankruptcy, that is not always the case for trademark licensees. Rather, for licensees, the intersection of trademark law and bankruptcy law has largely been a train wreck: The courts are divided over debtor-licensee rights, and Congress has neglected the problem. (8)

As trademark rights become an increasingly valuable asset (9) in Chapter 11 reorganizations, (10) it is critical for Congress and the courts to clarify how trademarks will be treated in bankruptcy. Resolution is particularly important for trademark licensees seeking to revive their businesses through reorganization. Recent cases demonstrate that Chapter 11 reorganization may not be a viable option for businesses that depend on licensing. Rather, most courts will allow a licensor to strip the bankrupt licensee of its rights, therefore stifling any chance of a licensee's successful reorganization.

This Comment urges that a trademark licensee should not be stripped of its licensing rights simply because the licensee enters bankruptcy. Instead, where a licensee intends only to continue using an existing license under the terms of the existing agreement with the licensor, the licensee's use of that license should be uninterrupted during reorganization. This recommendation, contrary to the position of trademark licensors, will not invade the province of trademark owners to control their marks.

To support this recommendation, this Comment examines the statutory frameworks of both trademark law and bankruptcy law, legislative history of the Bankruptcy Code, and cases that illuminate the current circuit split over the rights of a trademark licensee in bankruptcy. Building on these elements, this Comment outlines an analytical approach that strikes a balance between the need for business reorganization and the duty of a trademark licensor to exercise control over its mark.

Accordingly, this Comment proceeds in three parts. Part I provides a brief overview of the purposes of trademark law and bankruptcy law and also explains why these areas of law conflict. Part II introduces In re N.C.P. Marketing Group to explain the two analytical frameworks--the "hypothetical test" and the "actual test"--used by the courts to determine the rights of a trademark licensee in bankruptcy. (11) Part III explains how federal circuit courts have employed these differing approaches--including one court that has attempted an end run around the issue. Finally, this Comment concludes that courts should adopt the actual test to balance the interests of both trademark licensors and debtor-licensees.


  1. Trademark Law vs. Bankruptcy Law: Competing Interests

    Trademark law and bankruptcy law are both concerned with the "use" of assets. (12) For example, trademarks are given protection for their use in commerce. (13) And in bankruptcy, assets are used to pay creditors and as leverage for the debtor's "fresh start." (14) Yet, unlike physical assets, a trademark is not valuable in and of itself. Rather, the value of a trademark depends on the underlying business it symbolizes. This interdependent relationship creates competing interests between the trademark licensor and the debtor-licensee: On one hand, the trademark licensor will seek to protect its mark from any loss of control and ultimate harm to its business by snatching back the license. on the other hand, a debtor-licensee whose business depends on the license will seek to use the license as leverage to keep its business going. Yet, if the licensor strips the licensee of the right to use the mark, the licensor will virtually ensure the failure of the licensee's bankruptcy reorganization.

    Courts that permit a licensor to strip a licensee of its right to use a mark favor the protectionist principles of trademark licensing while entirely frustrating the purpose of bankruptcy reorganization. Instead, Congress and the courts must balance the rights of a trademark owner to protect its mark, and the ability of a business to reorganize.

    This Part will first briefly explain the unique purposes of trademark law and bankruptcy law. Second, this Part will explain the existing conflict between these two areas of law.

    1. Trademark Law Purpose

      A trademark is defined under the Lanham Act as a word, phrase, logo, or symbol used in commerce to signify a source, to distinguish the source from competitors, and to prevent confusion in the marketplace. (15) Accordingly, a trademark owner is given the right to protect its mark against infringement and dilution through blurring and tarnishment. (16) The Lanham Act also allows the trademark owner to benefit from the goodwill associated with the mark by selling, assigning, or licensing the trademark to a third party. (17)

      a. Trademark Licensing

      Modern trademark law has recognized and legitimized the practice of trademark licensing. (18) Trademark licensing permits the use of a trademark on goods that may not "emanate directly from the trademark owner," (19) but rather come from a selected third party--the licensee. The policy behind the legitimization of trademark licensing, as endorsed by Congress, is to expand the national and global value of trademarks in the marketplace. When a licensing agreement is successful, the mark becomes more widely known by consumers, increasing the mark's corresponding goodwill, and ultimately making the brand more valuable for the mark's owner. Trademark licensing has proliferated to such an extent that an entire business models have become dependent on licensing agreements with trademark owners. However, because the goodwill behind a mark is a volatile commodity based on consumer perception, a trademark owner must continue to exercise control over the use of its mark in commerce. (20)

      b. Licensor Control

      A trademark owner who licenses its mark has the duty to ensure a licensee upholds the quality of a given product. (21) A licensor who fails to oversee the quality of its licensee's products may not only tarnish the mark, but may also lead a court to find the licensor has abandoned the mark. (22) Courts are concerned with control of licensees because of what a mark embodies: it is a guard against consumer confusion and deceit. (23) The courts reason that without oversight a mark connotes nothing and is without value in the marketplace. (24)

      In recent years, while courts have begun to ease this control requirement, courts still require that a licensor be able to demonstrate due diligence in supervising the use of its mark by licensees. (25) Accordingly, a licensor's duty of control necessarily creates strict limits on a licensee's use of a mark. For example, a licensee must have the express permission of a licensor to sub-license a mark. (26) This restrictive use is required "[b]ecause the owner of the trademark has an interest in the party to whom the trademark is assigned so that it can maintain the good will...

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