bankruptcy – Forward Thinking Advocate

Cool Tech Hot Mess: Tempnology — An Update

The First Circuit Court of Appeals recently issued another opinion (the court’s third) in the long running saga of Tempnology LLC (now known as Old Cold, LLC). The opinion, Mission Product Holdings, Inc. v. Schleicher & Stebbins Hotels, does not blaze any new legal trails. Rather, it upholds the entry of an order granting a secured creditor relief from stay to foreclose on certain collateral.

Read only for its holding — the decision is unremarkable. But when read as part of the long history of litigation rooted in a deal described by the Supreme Court with some understatement as “a licensing agreement gone wrong” — the value of the decision emerges. Indeed, as noted in my post earlier this year, Cool Tech — Hot Mess: Tempnology a Year After SCOTUS Argument, litigation over fallout from the deal has lasted years longer than the deal itself. If such outcomes can be avoided, then this blog’s objective of advocating for forward thinking deal-making will be met.

The Debtor, the Lender and the Licensee

The litigation relates to disputes involving the following three parties:

(i) Tempnology — the Debtor which manufactured “Coolcore” branded clothing and accessories designed to stay cool when used in exercise;

(ii) Schleicher & Stebbins Hotels — the Debtor’s secured lender, which also purchased the Debtor’s assets at a bankruptcy auction conducted under Section 363 of the Bankruptcy Code; and

(iii) Mission Product Holdings, Inc. –the Debtor’s trademark licensee, which bid for the Debtor’s assets at the auction but lost out to the secured lender.

Prior First Circuit Decisions

The First Circuit’s prior opinions were both issued in January 2018. In the first decision, the First Circuit rejected the licensee’s attempt to unwind the sale and have its own bid recognized as the winner. The First Circuit ruled that the sale had already closed and the lender had been deemed “a good faith purchaser” entitled to protection under section Bankruptcy Code 363(m) from having the sale unwound.

In the second decision, the First Circuit held that the Debtor’s rejection of the applicable trademark license agreement left the licensee with only a pre-petition damages claim and no further rights to the licensed rights. The licensee appealed that decision to the United States Supreme Court, which reversed in an opinion issued in May 2019 — holding that a debtor-licensor’s rejection of a trademark license did not deprive a licensee of rights provided for in the license.

Relief from Stay Litigation

As noted in the prior post, the Supreme Court decision did not bring an end to issues pending in the bankruptcy case. Specifically, proceedings continued concerning the rights of the secured lender to relief from the automatic stay with respect to certain remaining collateral in the estate excluded from the sale.

On that issue, in the fall of 2018, the Bankruptcy Court held that the Supreme Court review of the license issues did not preclude the Bankruptcy Court from granting relief from stay to the secured lender. The licensee opposed the relief then appealed the order to the Bankruptcy Appellate Panel (BAP) which affirmed in a decision issued June 18, 2019. The licensee appealed that decision to the First Circuit in July 2019.

First Circuit’s October 2020 Opinion

In its decision issued this week, the First Circuit affirmed the order granting the secured lender relief from stay.

The First Circuit began by confirming that the licensee’s appeal was not moot and that the Court possessed jurisdiction to decide the appeal. The Court then reviewed the merits of the licensee’s argument on an abuse of discretion standard. On three fundamental points raised by the licensee, the First Circuit left little doubt about its ruling. Specifically, the Court:

- - characterized as “poppycock” the licensee’s principal argument that the secured lender waived its liens, either implicitly or explicitly, by virtue of its participation in the bidding process;

- - concluded that there was “no question” that the lender held valid liens in excess of the value of the debtor’s remaining assets and that the lender thus satisfied its burden of proof needed to prevail on a motion for relief from stay; and

- - rejected the licensee’s contention that the Bankruptcy Court abused its discretion by refusing to grant discovery and a full evidentiary hearing before granting relief from stay — on this point the First Circuit determined there “clearly” was no such abuse and that the licensee’s contention that the secured lender “waived its liens made no sense for a slew of reasons.”

Looking Ahead

Although the First Circuit’s opinion should bring to a close the dispute over the relief from stay issue, the bankruptcy case remains open. The licensee previously filed an amended proof of claim and an administrative expense motion seeking damages for both the pre-bankruptcy and post-bankruptcy period.

Last year, the parties agreed to defer any action on the damage claims pending the First Circuit’s decision on the challenge to the relief from stay order. With the First Circuit ruling now issued, the parties will need to evaluate whether to exercise rights previously reserved against each other.

While that plays out to an inevitable conclusion at some point, others entering into business agreements of any type should keep the Tempnology situation in mind when crafting an appropriate agreement at the outset of a deal as well as strategically overcoming obstacles that arise.

Supreme Court Set to Tackle Key IP/Insolvency Issue

In the fall of 2018, the United States Supreme Court agreed to review the January 2018 decision of the First Circuit Court of Appeals in Mission Product Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC). In Tempnology, the First Circuit ruled that a trademark owner that files for bankruptcy can deprive a nondebtor licensee from any rights to use trademarks of the owner licensed to the licensee.

Although the First Circuit’s opinion cites with approval the Fourth Circuit’s 1985 decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. as supporting the stripping away of a licensee’s rights, more recent authority from the Seventh Circuit in 2012 in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC cut the other way and provided protection to a trademark licensee.

Last Friday, the Supreme Court set February 20, 2019 as the date for oral argument in the Tempnology case. Within the past month, no fewer than six briefs have been filed by various neutral parties urging the Court to reverse the First Circuit and protect the rights of a trademark licensee upon rejection by a debtor licensor. Briefs have been filed by the Intellectual Property Owners Association, American Intellectual Property Law Association, International Trademark Association and New York Intellectual Property Law Association. In addition to those organizations, the United States of America also weighed in with a brief as did a group of several law professors. Copies of all the briefs and other documents pending before the Supreme Court are available here.

An example of the practical issue before the Supreme Court is evident in an opinion issued by the United States Bankruptcy Court for the District of Connecticut in May, 2018. In In re SIMA International Inc., a chapter 7 trustee sought to reject a debtor licensor’s trademark license on the grounds that rejection would benefit creditors by yielding a higher sale price for the trademarks if no continued rights existed for the licensee. Not surprisingly, the licensee argued that it should have continued rights to the trademarks it had previously licensed. In ruling for the licensee, the Bankruptcy Court in Connecticut (which is located in the Second Circuit and not bound by opinions from the First Circuit) rejected the First Circuit’s Tempnology decision. The SIMA decision cited with approval the Seventh Circuit’s Sunbeam decision that rejection did not “abrogate” the licensee’s right to use the trademarks or somehow make the license agreement “disappear.”

In sum, in agreeing to review the Tempnology case, the Supreme Court is poised to deliver much needed clarity to all parties with an interest in trademarks in distressed situations including licensors, licensees, buyers, creditors and others. In addition to resolving the particular dispute that has divided the lower courts, the Supreme Court decision may also shed light on what role equity can or should play in the context of interpreting plain statutory language concerning intellectual property issues in insolvency matters.

Trade Creditor Strategies

I was pleased to join Adrienne Walker from Mintz and Lindsay Zahradka Milne from Bernstein Shur on a business panel yesterday hosted by Massachusetts Continuing Legal Education. Our focus was on strategies for trade creditors to obtain (and keep) payment in light of issues arising in recent financial meltdowns including Sports Authority, Toys R Us, Sears, Papa Gino’s and many other distressed companies.

We covered a lot of territory in a short amount of time with thoughtful insights and commentary from the audience. Topics included maximizing lien rights, obtaining critical vendor status, risks associated with post-petition administrative claim recoveries, the value of reclamation claims, recent consignment issues, and minimizing preference exposure.

My focus was on lien issues which included the practicality of obtaining and perfecting a security interest under Article 9 of the Uniform Commercial Code. The discussion also covered various non Article 9 liens including judgment liens, state statutory liens (including mechanics liens) and federal statutory liens (including the Perishable Agriculture Commodities Act).

My top takeaways for trade creditors from the session:

Be Proactive: Trade creditors who actively monitor and manage receivables are best positioned to avoid the pain of a customer’s financial distress. Understand the reality that a customer’s filing could completely extinguish all amounts owed and could also result in the forced return of certain funds paid to the creditor before filing as a “preference.” Avoid putting off dealing with the unpleasantness of a customer issue; rather make it a priority to protect your right to payment.

Explore Lien Rights Early: Creditors often explore lien rights only after experiencing non-payment. A better strategy is to consider the possibility of lien rights at the outset of a business relationship. Establishing lien rights requires strict compliance with detailed statutory elements such as those created by Article 9 of the UCC or other statutes. If lien rights are important, take the time to ensure that the lien is properly created and not subject to attack.

Understand Consignment: Some trade vendors believe that shipping goods to a customer “on consignment” can insulate the vendor from any financial issues of the customer. However, the law of consignment is highly complex drawing from both the common law and operative provisions of the Uniform Commercial Code enacted by the states. If you intend to be protected by a consignment relationship, it is imperative that the relationship withstand judicial scrutiny. Two decisions (available here) issued on November 26 2018 in the Sports Authority case drill down into these issues and provide a sense of the complexities that can arise.

Treat DIPs with Care: “DIP” stands for “debtor in possession” — the term used to describe a company that has filed for chapter 11 relief. Conventional wisdom teaches that supplying a company in chapter 11 (a DIP) offers some protection to a creditor as claims arising from amounts due post-petition constitute “administrative expense claims” and not just mere “general unsecured claims” (the term given to amounts due for obligations arising pre-petition). In Toys R Us, however, vendors holding millions of dollars in “admin” claims faced the prospect of no payment whatsoever given the retailer’s cessation of restructuring efforts and implementation of a liquidation. Although a settlement was reached which provided some payment to holders of admin claims, the recovery was nowhere near 100 percent. In short, before supplying any company operating in chapter 11, be careful to understand the dynamics of the case and the practical ability to compel payment.

Understand Preference Risk: A trade creditor that receives payment in the 90 day period before a customer’s bankruptcy filing is at risk of having that payment examined and potentially challenged as an “avoidable preference.” There are several defenses available to a trade creditor to defend against such an action. The best defenses rest on good facts. Thus, it is imperative that a creditor obtaining payment from a financially distressed firm do so with an eye towards strengthening available defenses in case of a later challenge. Our session highlighted several recent decisions impacting the ordinary course of business defense, subsequent new value defense and other theories. The time to think about such issues is well before a preference lawsuit is filed.

In sum, the opportunity to collaborate with Adrienne and Lindsay was terrific. The conference also included an excellent presentation on non-judicial options for restructuring and sales as well as an insightful judicial forum.

Filing Urges Supreme Court To Decline Review of Case Involving Trademark Rights After License Rejection

Although there has been much attention on the Supreme Court this week, a filing made earlier today will draw little popular notice. Yet, the filing could have significant impact on whether the Court decides to accept a case this term which would impact the rights of trademark licensors and trademark licensees.

The filing was made by Tempnology, LLC in opposition to a petition for a writ of certiorari filed by Mission Products Holdings, Inc. in June 2018. Mission filed the petition to seek Supreme Court review of a January, 2018 opinion from the United States Court of Appeals for the First Circuit. In that decision, the First Circuit determined that Mission, a licensee, retained no rights to continue to use trademarks previously licensed from Tempnology upon the rejection of the license agreement by Tempnology in its chapter 11 proceeding. See here for a copy of the petition for writ of certiorari along with a brief in support filed this summer by The International Trademark Association and another brief in support from a group of law professors.

The litigation over the trademark rights has been brewing for quite some time. I wrote about the First Circuit decision in January 2018 as a LinkedIn article here and wrote about the Bankruptcy Appellate Panel opinion which proceeded that for the American Bankruptcy Institute Journal here (co-authored with Andrew Hellman). For the past three years, I have included discussion of the issues in chapters contributed to the Norton Annual Survey of Bankruptcy Law (2018 edition due out soon, 2017 edition, and 2016 edition).

In seeking Supreme Court review of the First Circuit decision, Mission emphasized the existence of a circuit split with the Seventh Circuit’s reasoning in Sunbeam Products Inc. v. Chicago American Manufacturing LLC, which held that although rejection constitutes a breach of contract, rejection does not terminate a trademark license or strip the nondebtor licensee of its post-breach rights under applicable nonbankruptcy law. The First Circuit’s 2-1 decision specifically rejected the Seventh Circuit’s reasoning in Sunbeam.

Today’s filing acknowledges the existence of the circuit split but urges the Court to deny review on three fundamental grounds:

“First, the Petition overstates the depth and duration of the circuit split by attempting to recast the issue as implicating all types of intellectual property rights including patents. That way, according to the Petition, a 1985 Fourth Circuit decision on patent rights, Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), gets swept into the calculus. But not only is Lubrizol a patent case, the issues it raised were squarely addressed by Congress and put to bed in 1988 by the enactment of 11 U.S.C. § 365(n)(1).”

“That brings us to the second, perhaps more fundamental, reason that the Court should deny the Petition: Congressional intent. In passing section 365(n)(1) to address issues raised by the decision in Lubrizol, Congress expressly considered the impact of rejection under the then-new statute on other intellectual property rights such as patents, but deliberately chose not to include trademarks at that time, given the disparate and complex issues involving trademarks. Instead, the legislative history reflects that Congress intended to leave issues involving trademarks for further development and evolution in the courts. At the Court of Appeals level, that exploration has only just begun. In the three decades since the enactment of section 365(n)(1), this issue has only arisen a handful of times and only twice at the Court of Appeals. Until the issues are further fleshed out by other Courts of Appeals, it would be premature for the United States Supreme Court to step in and terminate the judicial developments that Congress envisioned.”

“Third, even assuming a single split of circuit authority warrants the attention of this Court, the present case is not the proper vehicle for the Court to resolve these complex issues. This case is a particularly poor choice for the Supreme Court to forestall either bankruptcy court evolution of the law or appropriate legislative action to try to create new standards, because key points such as the burdens on the debtor of the continued policing of the trademark, the debtor’s balancing of those costs versus any benefits derived from that effort, and the impact of a “stranding” of the trademark were the mark to become “abandoned,” were not litigated on a developed evidentiary record below. If the Court were to take up this abstract question on such a thin evidentiary record, that would likely lead either to new standards based largely on speculation, or a further remand for fleshing out the evidence. Far better to await further development of the issues involving trademark licenses in courts as Congress expressly intended or to allow Congress to address the issue as it also contemplated.”

If the Supreme Court declines review of the First Circuit decision, then confusion will continue to reign about trademark rights in the event of license rejection by a debtor licensor. Although greater clarity might come someday through Congressional action or a future case finding its way to the Supreme Court neither of those paths seem likely at the moment. Well drafted license agreements tailored to the needs of the parties and monitored carefully can help save parties years of litigation given the current legal uncertainty.

A Cautionary Tale For Sublicensees

Law 360 recently published the following analysis I contributed concerning ongoing patent infringement litigation involving four patents licensed by Sirius. Any party currently sublicensing technology or thinking of doing so should understand the issues that Sirius has confronted in litigation brought by the master licensor of the patents at stake.

In a venue not that far away — just south of New Jersey — Sirius Radio has been defending itself against a patent infringement suit that deserves the attention of any party that has ever sublicensed rights or is thinking of doing so. Sirius fully paid for an irrevocable sublicense of certain patents. Moreover, Sirius has been using the technology for approximately 20 years. Yet, it has been accused of infringement by the master licensor that granted rights to the sublicensor that licensed to Sirius. The nuance to the story is that the sublicensor commenced bankruptcy, which resulted in a rejection of the license between the master licensor and sublicensor. That development led to the master licensor contending that Sirius’ rights under its sublicense were forfeited as a result of that rejection.

On March 29, 2018, U.S. Magistrate Judge Sherry Fallon issued a decision in the litigation that is sure to be welcome news to any sublicensee.[1] Specifically, the decision recommends dismissal of the suit. The decision alone does not put the matter to rest, however. Rather, the decision takes the form of a report and recommendation to the U.S. District Court for the District of Delaware, which will have to determine whether to adopt the report and dismiss the case or reject the report and let the litigation continue. No matter the determination of the district court, an appeal to the U.S. Court of Appeals for the Third Circuit could of course follow. In other words, this litigation is sure to have at least one sequel beyond Magistrate Judge Fallon’s recent determination.

The Delaware Litigation

The facts are relatively straightforward. Plaintiff Fraunhofer-Gesellschaft Zur Förderung der angewandten Forschung e.V. developed patented multicarrier modulation technology (the “MCM IP”) to four patents for use in satellite radio broadcasting. Thereafter, Fraunhofer licensed the MCM IP to WorldSpace International Network Inc. (the “MCM license”).

WorkSpace in turn granted a sublicense, on an irrevocable basis, to a firm that later merged to become Sirius Satellite Radio, and which used the sublicensed technology to develop its own technology.

WorldSpace subsequently commenced a Chapter 11 proceeding under the U.S. Bankruptcy Code. During the course of those proceedings, the bankruptcy court approved a settlement agreement under which Sirius paid WorldSpace funds in full satisfaction of all sums owed under the sublicense agreement.

Eventually, the Chapter 11 proceeding was converted to a Chapter 7 liquidation proceeding, in which the trustee did not move to assume the MCM license for the benefit of the estate, resulting in automatic rejection of the MCM license.

Approximately three years later, Fraunhofer notified Sirius of its position that Sirius was infringing. Fraunhofer alleged that the rejection of the MCM license in the WorldSpace bankruptcy proceeding operated to deny Sirius any continuing rights under its sublicense.

As noted above, the magistrate judge disagreed, concluding that the rejection of the MCM license in bankruptcy did not impact the continuation of the irrevocable sublicense previously granted to Sirius by WorldSpace. To support this conclusion, the magistrate judge relied on a Seventh Circuit opinion[2] holding that “[w]here a sub-licensee has lived up to the terms of the license it is inequitable that his license should be revoked because the main licensee has failed to do the same, especially where the sub-licensee has made extensive investments on the strengths of his license.”

The magistrate judge rejected Fraunhofer’s arguments, which were based on decisions issued in the context of nonresidential real property that when a lease is deemed rejected pursuant to Section 365(d)(4) of the Bankruptcy Code, subleases associated with the property must also be deemed rejected because the rights of the sublessee are extinguished when the rights of a debtor are extinguished with respect to the property.[3]

Implications

Although the determination of the magistrate judge should be welcome news for any sublicensee, no such party should believe that the decision paves a clear path forward. As noted, the decision will be reviewed by the district court and then will be subject to the normal opportunities for appeal. Fraunhofer instituted suit against Sirius in February 2017, and oral argument on the motion to dismiss was heard in August 2017, with the magistrate judge’s determination issued in late March 2018. No matter the ultimate outcome of this particular litigation, Sirius has experienced the burden of more than a year of litigation expense and uncertainty with the guarantee of more to follow.

Thus, although sublicensees should keep an eye open for future developments in this case, sublicensees should also consider obtaining contractual certainty at the time of entering into a sublicense agreement. Specifically, a sublicensee should consider obtaining the affirmative consent of the master licensor that the sublicenee’s rights under the sublicense shall continue despite the rejection of the master license agreement in bankruptcy or in the event of any termination of the master license. This same approach should also be used by subleases of real property leases to avoid the draconian result imposed by the case law relied on by Fraunhofer noted above.

Moreover, a sublicensee whose licensor commences bankruptcy should pay close attention to the proceedings and take appropriate action to preserve its rights and position itself to guard against similar attacks. In the case of Sirius, for example, the opportunity should have existed in the WorldSpace bankruptcy proceeding to explore potentially acquiring the MCM license from the bankruptcy trustee rather than just allowing that license to be rejected in the proceeding. In short, sublicensees should anticipate the exact scenario that Sirius confronts and then craft binding contractual provisions to address as well as monitor legal proceedings affecting the validity of the rights granted by the sublicensor. Both of those steps should provide more control and certainty at a cheaper cost than defending litigation from a master licensor lodging an infringement attack.

Notes

[1] Fraunhofer-Gesellschaft Zur Förderung Der Angewandten Forschung E.V., Plaintiff, v. Sirius XM Radio Inc. (Civil Action No. 17-184-JFB-SRF).

[2] Rhone Poulenc Agro SA v. DeKalb Genetics Corp., 284 F.3d 1323, 1332 n.7 (Fed. Cir. 2002)

[3] In Chatlos Systems Inc. v. Kaplan, 147 B.R. 96, 100 (D. Del. 1992), aff’d sub nom In re TIE Commc’ns Inc., 998 F.2d 1005 (3d Cir. 1993).