Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC , 686 F.3d 372 ( 2012 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 11-3920
S UNBEAM P RODUCTS, INC.,doing business as
Jarden Consumer Solutions,
Plaintiff-Appellant,
v.
C HICAGO A MERICAN M ANUFACTURING, LLC,
Defendant-Appellee.
Appeal from the United States Bankruptcy Court
for the Northern District of Illinois, Eastern Division.
No. 09 A 341—Pamela S. Hollis, Judge.
A RGUED M AY 22, 2012—D ECIDED JULY 9, 2012
Before E ASTERBROOK, Chief Judge, and W ILLIAMS and
T INDER, Circuit Judges.
E ASTERBROOK, Chief Judge. Lakewood Engineering &
Manufacturing Co. made and sold a variety of con-
sumer products, which were covered by its patents and
trademarks. In 2008, losing money on every box fan,
Lakewood contracted their manufacture to Chicago
2 No. 11-3920
American Manufacturing (CAM). The contract au-
thorized CAM to practice Lakewood’s patents and
put its trademarks on the completed fans. Lakewood
was to take orders from retailers such as Sears, Walmart,
and Ace Hardware; CAM would ship directly to
these customers on Lakewood’s instructions. Because
Lakewood was in financial distress, CAM was reluctant
to invest the money necessary to gear up for produc-
tion—and to make about 1.2 million fans that
Lakewood estimated it would require during the 2009
cooling season—without assured payment. Lakewood
provided that assurance by authorizing CAM to sell
the 2009 run of box fans for its own account if Lakewood
did not purchase them.
In February 2009, three months into the contract, several
of Lakewood’s creditors filed an involuntary bankruptcy
petition against it. The court appointed a trustee, who
decided to sell Lakewood’s business. Sunbeam Products,
doing business as Jarden Consumer Solutions, bought
the assets, including Lakewood’s patents and trade-
marks. Jarden did not want the Lakewood-branded fans
CAM had in inventory, nor did it want CAM to sell
those fans in competition with Jarden’s products.
Lakewood’s trustee rejected the executory portion of
the CAM contract under 11 U.S.C. §365(a). When CAM
continued to make and sell Lakewood-branded fans,
Jarden filed this adversary action. It will receive 75% of
any recovery and the trustee the other 25% for the
benefit of Lakewood’s creditors.
The bankruptcy judge held a trial. After determining
that the Lakewood–CAM contract is ambiguous, the
No. 11-3920 3
judge relied on extrinsic evidence to conclude that CAM
was entitled to make as many fans as Lakewood estimated
it would need for the entire 2009 selling season and
sell them bearing Lakewood’s marks. In re Lakewood
Engineering & Manufacturing Co., 459 B.R. 306, 333–38
(Bankr. N.D. Ill. 2011). Jarden contends in this court—
following certification by the district court of a direct
appeal under 28 U.S.C. §158(d)(2)(A)—that CAM had to
stop making and selling fans once Lakewood stopped
having requirements for them. The bankruptcy court
did not err in reading the contract as it did, but the
effect of the trustee’s rejection remains to be determined.
Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.,
756 F.2d 1043 (4th Cir. 1985), holds that, when an
intellectual-property license is rejected in bankruptcy,
the licensee loses the ability to use any licensed copy-
rights, trademarks, and patents. Three years after
Lubrizol, Congress added §365(n) to the Bankruptcy
Code. It allows licensees to continue using the intel-
lectual property after rejection, provided they meet cer-
tain conditions. The bankruptcy judge held that §365(n)
allowed CAM to practice Lakewood’s patents when
making box fans for the 2009 season. That ruling is no
longer contested. But “intellectual property” is a defined
term in the Bankruptcy Code: 11 U.S.C. §101(35A)
provides that “intellectual property” includes patents,
copyrights, and trade secrets. It does not mention trade-
marks. Some bankruptcy judges have inferred from the
omission that Congress codified Lubrizol with respect to
trademarks, but an omission is just an omission. The
limited definition in §101(35A) means that §365(n) does
4 No. 11-3920
not affect trademarks one way or the other. According to
the Senate committee report on the bill that included
§365(n), the omission was designed to allow more
time for study, not to approve Lubrizol. See S. Rep.
No. 100–505, 100th Cong., 2d Sess. 5 (1988). See also In re
Exide Technologies, 607 F.3d 957, 966–67 (3d Cir. 2010)
(Ambro, J., concurring) (concluding that §365(n) neither
codifies nor disapproves Lubrizol as applied to trade-
marks). The subject seems to have fallen off the legisla-
tive agenda, but this does not change the effect of what
Congress did in 1988.
The bankruptcy judge in this case agreed with
Judge Ambro that §365(n) and §101(35A) leave open
the question whether rejection of an intellectual-
property license ends the licensee’s right to use trade-
marks. Without deciding whether a contract’s rejec-
tion under §365(a) ends the licensee’s right to use the
trademarks, the judge stated that she would allow
CAM, which invested substantial resources in making
Lakewood-branded box fans, to continue using the
Lakewood marks “on equitable grounds”. 459 B.R. at 345;
see also id. at 343–46. This led to the entry of judgment
in CAM’s favor, and Jarden has appealed.
What the Bankruptcy Code provides, a judge cannot
override by declaring that enforcement would be “in-
equitable.” See, e.g., Toibb v. Radloff, 501 U.S. 157, 162
(1991); In re Kmart Corp., 359 F.3d 866, 871 (7th Cir. 2004);
In re Sinclair, 870 F.2d 1340 (7th Cir. 1989). There
are hundreds of bankruptcy judges, who have many
different ideas about what is equitable in any given
No. 11-3920 5
situation. Some may think that equity favors licensees’
reliance interests; others may believe that equity favors
the creditors, who can realize more of their claims if the
debtor can terminate IP licenses. Rights depend, how-
ever, on what the Code provides rather than on notions
of equity. Recently the Supreme Court emphasized
that arguments based on views about the purposes
behind the Code, and wise public policy, cannot be used
to supersede the Code’s provisions. It remarked: “The
Bankruptcy Code standardizes an expansive (and some-
times unruly) area of law, and it is our obligation to
interpret the Code clearly and predictably using well
established principles of statutory construction.” RadLAX
Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065,
2073 (2012).
Although the bankruptcy judge’s ground of decision
is untenable, that does not necessarily require reversal.
We need to determine whether Lubrizol correctly under-
stood §365(g), which specifies the consequences of a
rejection under §365(a). No other court of appeals has
agreed with Lubrizol—or for that matter disagreed with
it. Exide, the only other appellate case in which the
subject came up, was resolved on the ground that the
contract was not executory and therefore could not be
rejected. (Lubrizol has been cited in other appellate opin-
ions, none of which concerns the effect of rejection on
intellectual-property licenses.) Judge Ambro, who filed a
concurring opinion in Exide, concluded that, had the
contract been eligible for rejection under §365(a), the
licensee could have continued using the trademarks.
607 F.3d at 964–68. Like Judge Ambro, we too think
Lubrizol mistaken.
6 No. 11-3920
Here is the full text of §365(g):
Except as provided in subsections (h)(2) and (i)(2)
of this section, the rejection of an executory con-
tract or unexpired lease of the debtor constitutes
a breach of such contract or lease—
(1) if such contract or lease has not been as-
sumed under this section or under a plan
confirmed under chapter 9, 11, 12, or 13 of
this title, immediately before the date of the
filing of the petition; or
(2) if such contract or lease has been assumed
under this section or under a plan confirmed
under chapter 9, 11, 12, or 13 of this title—
(A) if before such rejection the case has
not been converted under section 1112,
1208, or 1307 of this title, at the time of
such rejection; or
(B) if before such rejection the case has
been converted under section 1112, 1208,
or 1307 of this title—
(i) immediately before the date of such
conversion, if such contract or lease
was assumed before such conver-
sion; or
(ii) at the time of such rejection, if such
contract or lease was assumed after
such conversion.
Most of these words don’t affect our situation. Subsec-
tions (h)(2) and (i)(2) are irrelevant, and paragraph (1) tells
No. 11-3920 7
us that the rejection takes effect immediately before
the petition’s filing. For our purpose, therefore, all that
matters is the opening proposition: that rejection “con-
stitutes a breach of such contract”.
Outside of bankruptcy, a licensor’s breach does not
terminate a licensee’s right to use intellectual property.
Lakewood had two principal obligations under its
contract with CAM: to provide CAM with motors and
cord sets (CAM was to build the rest of the fan) and to
pay for the completed fans that CAM drop-shipped to
retailers. Suppose that, before the bankruptcy began,
Lakewood had broken its promise by failing to provide
the motors. CAM might have elected to treat that breach
as ending its own obligations, see Uniform Commercial
Code §2–711(1), but it also could have covered in the
market by purchasing motors and billed Lakewood for
the extra cost. UCC §2–712. CAM had bargained for
the security of being able to sell Lakewood-branded fans
for its own account if Lakewood defaulted; outside of
bankruptcy, Lakewood could not have ended CAM’s
right to sell the box fans by failing to perform its own
duties, any more than a borrower could end the
lender’s right to collect just by declaring that the debt
will not be paid.
What §365(g) does by classifying rejection as breach
is establish that in bankruptcy, as outside of it, the other
party’s rights remain in place. After rejecting a contract,
a debtor is not subject to an order of specific perfor-
mance. See NLRB v. Bildisco & Bildisco, 465 U.S. 513, 531
(1984); Midway Motor Lodge of Elk Grove v. Innkeepers’
8 No. 11-3920
Telemanagement & Equipment Corp., 54 F.3d 406, 407 (7th
Cir. 1995). The debtor’s unfulfilled obligations are con-
verted to damages; when a debtor does not assume
the contract before rejecting it, these damages are
treated as a pre-petition obligation, which may be
written down in common with other debts of the same
class. But nothing about this process implies that any
rights of the other contracting party have been vaporized.
Consider how rejection works for leases. A lessee that
enters bankruptcy may reject the lease and pay damages
for abandoning the premises, but rejection does not
abrogate the lease (which would absolve the debtor of
the need to pay damages). Similarly a lessor that enters
bankruptcy could not, by rejecting the lease, end
the tenant’s right to possession and thus re-acquire pre-
mises that might be rented out for a higher price. The
bankrupt lessor might substitute damages for an obliga-
tion to make repairs, but not rescind the lease altogether.
Bankruptcy law does provide means for eliminating
rights under some contracts. For example, contracts that
entitle creditors to preferential transfers (that is, to pay-
ments exceeding the value of goods and services
provided to the debtor) can be avoided under 11 U.S.C.
§547, and recent payments can be recouped. A trustee
has several avoiding powers. See 11 U.S.C. §§ 544–51.
But Lakewood’s trustee has never contended that
Lakewood’s contract with CAM is subject to rescission.
The trustee used §365(a) rather than any of the avoiding
powers—and rejection is not “the functional equivalent
of a rescission, rendering void the contract and re-
quiring that the parties be put back in the positions they
No. 11-3920 9
occupied before the contract was formed.” Thompkins v.
Lil’ Joe Records, Inc., 476 F.3d 1294, 1306 (11th Cir. 2007).
It “merely frees the estate from the obligation to per-
form” and “has absolutely no effect upon the contract’s
continued existence”. Ibid. (internal citations omitted).
Scholars uniformly criticize Lubrizol, concluding that
it confuses rejection with the use of an avoiding power.
See, e.g., Douglas G. Baird, Elements of Bankruptcy 130–40
& n.10 (4th ed. 2006); Michael T. Andrew, Executory
Contracts in Bankruptcy: Understanding “Rejection”, 59 U.
Colo. L. Rev. 845, 916–19 (1988); Jay Lawrence Westbrook,
The Commission’s Recommendations Concerning the Treat-
ment of Bankruptcy Contracts, 5 Am. Bankr. Inst. L. Rev.
463, 470–72 (1997). Lubrizol itself devoted scant attention
to the question whether rejection cancels a contract,
worrying instead about the right way to identify ex-
ecutory contracts to which the rejection power applies.
Lubrizol does not persuade us. This opinion, which
creates a conflict among the circuits, was circulated to
all active judges under Circuit Rule 40(e). No judge
favored a hearing en banc. Because the trustee’s rejection
of Lakewood’s contract with CAM did not abrogate
CAM’s contractual rights, this adversary proceeding
properly ended with a judgment in CAM’s favor.
A FFIRMED
7-9-12