The Seventh Circuit Court of Appeals recently addressed in In re XMH Corp., 647 F. 3d 690 (7th Cir. 2011), whether or not trademark licenses are assignable in bankruptcy proceedings. In its ruling, the Court held that a trademark license may not be assigned by a licensee in a bankruptcy proceeding unless there is an express provision in the contract permitting assignment by the licensee.

XMH Corporation (formerly Hartmarx) (“XMH”), and a subsidiary, Simply Blue, filed for bankruptcy under Chapter 11 of the Bankruptcy Code. XMH asked permission of the Bankruptcy Court to sell assets of Simply Blue, which assets included an executory contract between Simply Blue and Western Glove Works (“Western Glove”). The contract with Western Glove was a two part contract which provided that Western Glove provide Simply Blue with a trademark license for a period of time, and once that time period elapses and the license expires, Simply Blue would provide Western Glove with certain support services with respect to the product using the trademark.

Western Glove objected to the assignment by Simply Blue of the contract, arguing that the contract was a trademark license and that, absent its permission, Simply Blue could not assign the contract to a third party.

The Seventh Circuit, in deciding whether the contract was assignable, recognized that Section 365(c)(1) of the Bankruptcy Code prohibits the assignment of an executory contract if “applicable law” authorizes the other party, in this case, Western Glove, to refuse to accept performance from an assignee, in this case, a third party purchaser, whether or not the contract itself prohibits assignment. The court found that “applicable law” means any laws other than bankruptcy law, and for the purposes of this matter, trademark law.

Citing a number of trademark cases, the Court noted that the default rule is that a licensee of a trademark license cannot assign the license unless the license expressly permits assignment. The Court’s reasoning was based on basic trademark policy. The Court explained that a trademark is a shorthand designation of a brand that consumers will use to associate with the particular product. If an unauthorized third party is granted the right to use the trademark (through the assignment of the license) without the owner’s permission, the owner will no longer be able to control the product or the use (or misuse) of the trademark.

Accordingly, because the contract between Simply Blue and Western Glove did not contain a provision expressly allowing assignment by the licensee, the Court barred the assignment absent the express consent of Western Glove.

Ultimately, the Court found that the first portion of the contract, the license portion, had expired, and only the second portion, the service portion, of the contract remained. Thus, because the trademark license was no longer in effect, the agreement was merely a service contract that was freely assignable by the Bankruptcy Court.

Notwithstanding the conclusion of the Court regarding the assignability of the contract, the Court’s holding is important to consider when drafting licenses and the effect such drafting can have during bankruptcy proceedings. To summarize, the Court held that absent an express provision in a trademark license, a licensee in bankruptcy does not have the right to assign the trademark license unless it has the express consent of the licensor.

As a practical matter, this holding emphasizes two important structure concepts. First, it is important how you designate your contract. A service contract, pursuant to this ruling, remains fully assignable in bankruptcy, despite language in the contract providing otherwise. However, a trademark license will not be assignable unless there is a provision in the license expressly permitting assignment. Second, to prevent any ambiguity regarding whether a court, bankruptcy or otherwise, would allow assignment of a trademark license, it is in the best interests of both licensees and licensors that the trademark license expressly address the assignability of the contract.