Various debt-burdened retailers are looking to their intellectual property assets as a source of untapped value for refinancing transactions. While it remains to be seen which strategies will be most successful, IP assets will play a key role in future retail restructurings. As the value of brick-and-mortar “hard” assets stores becomes tapped out, a retailer’s brands, licenses, and associated IP rights may present reliable sources of value.
J. Crew: A Bellwether
Companies and investors alike are keeping an eye on recent high-profile IP-driven refinancing transactions, most particularly by J. Crew, whose restructuring and corresponding IP transfers are the subject of pending litigation. See Eaton Vance Mgmt. v. Wilmington Sav. Fund, No. 654397/2017 (N.Y. Sup. Ct. complaint filed June 22, 2017). In December 2016, the clothing company assigned rights in certain of its trademarks — including its quintessential J.CREW mark — to an unrestricted subsidiary, effectively eliminating an upcoming maturity. The transferred marks were subsequently pledged by the unrestricted sub to back new notes issued as part of a restructuring transaction.
The J. Crew operating companies then entered royalty-bearing license agreements in favor of the unrestricted sub, which provided for use by the restricted sub of the trademarks it had initially owned and pledged, though transferred as part of this restructuring. Certain term loan holders under the original term loan sued the company, alleging that the company’s asset transfer violates their term loan agreement, under which the transferred trademarks were pledged.
The parties’ dispute turns in part on the valuation of the transferred trademarks, with the lenders asserting that their value exceeds the cap permitted by, and J. Crew arguing that its actions were expressly contemplated by, the term loan agreement. Regardless of the outcome, the takeaway is clear: IP assets reflect a source of value for retailers to enhance the lending value from inventory, accounts receivables, and FF&E. As such, lenders and borrowers alike would benefit from paying close attention to all operative provisions in loan documents, understanding what investment baskets exist and what types of transactions and transfers are governed by restrictive covenants.
Using Unencumbered Assets
Unencumbered IP assets can offer a great source of new value. Pledging unencumbered IP assets as collateral for new debt can enable a company to secure financing on more favorable terms, which in turn can potentially reduce a company’s overall debt load, and/or permit refinancing of debt with upcoming maturities.
As J. Crew highlights, however, undertaking transactions that result in the decollaterization of IP assets is not without potential pitfalls. Retailers and their counsel will want to evaluate the likelihood that such transactions might trigger litigation, and consider potential costs and publicity associated therewith. To limit dispute, retailers and lenders could identify a prescribed IP asset valuation method in their loan documents, and otherwise implement protocols to address anticipated sources of disagreement between the parties.
Strategic Advance Trademark Filings
Aligning a retailer’s trademark portfolio with its current — and a potential acquiror’s foreseeable — business plans offers another avenue for maximizing IP asset value. Trademark registrations cover specific goods and/or services. As trademark applications are typically filed in advance of product development, it’s not uncommon for there to be divergence between a retailer’s product line at market, and its trademark registrations intended to cover that line.
While pivoting from brick-and-mortar to e-commerce, or adopting differentiated product or service lines, could be a viable solution for addressing a company’s suffering sales, exercising these options may be foreclosed if one or more third parties own similar trademarks within previously unchartered expanded areas. By anticipating fields of growth, and making strategic advanced trademark filings, retailers facing insolvency could significantly increase the value of their brand positioning in the eyes of potential acquirors.
Although wisdom would typically dictate to avoid non-critical expenses in the face of financial uncertainty, from a cost-benefit analysis, allocating limited resources toward trademark protection in advance of insolvency — and even securing additional debt to do so — may support otherwise unavailable opportunities and unlock significant value.
Licensing As a Value
A retailer can also derive value through outbound licensing (which efforts would also benefit from a robust trademark registration portfolio as discussed above). Be aware, however, that trademark law requires licensors to maintain control over the quality of goods and/or services offered by a licensee under the licensor’s mark(s).
Although the protocols for exercising such quality control may differ, the absence of such control could lead to a licensor’s loss of rights in the licensed mark(s). Retailers should keep this requirement in mind when considering the viability of a licensing program, and assess whether they have sufficient resources to dedicate toward exercising quality control over one or more domestic or foreign licensees. Retailers should also ensure that any license agreements include quality control standards, and impose such standards in practice.
The value paradigm with regard to a retailer’s IP assets in the bankruptcy context will vary significantly, depending on whether the retailer’s IP rights are predominantly owned or licensed, and if owned, whether they are licensed out. Section 365(n) of the Bankruptcy Code protects non-debtor licensees of “intellectual property” from losing their rights in the event of rejection in bankruptcy by the debtor-licensor.
While § 365(n) does not, by its terms, apply to trademark licenses because trademarks are excluded from the Bankruptcy Code’s definition of “intellectual property” under § 101(35A), certain courts (including within the U.S. Courts of Appeal for the First, Third, Seventh and Eighth Circuits) have been trending toward extending varying degrees of protection to trademark licensees under § 365(n), while other courts (including within the Second and Fourth Circuits) have held fast to a doctrinal interpretation of the Code’s statutory exclusion of trademarks, thereby offering no protection to non-debtor trademark licensees. A retailer contemplating bankruptcy that licenses out its trademarks should thus be aware of the extent to which courts in its jurisdiction have limited a debtor licensor’s ability to terminate a trademark license via rejection, or have alternatively protected the rights of trademark licensees. For example, a retailer may have licensed out its brand marks when its core business was store-based. As part of the transformation to an e-commerce platform, the retailer may want to regain control over how its products are sold outside of its stores (especially if those stores are closed).
The same goal could exist with a buyer of a debtor’s assets under § 363 of the Bankruptcy Code looking to tap into a new e-commence market. This flexibility can be impacted by how § 365(n) is interpreted. In any event, the transitional state of the law on this issue might offer debtor licensors leverage for renegotiation of more favorable license terms in advance of a contemplated rejection.
The Bankruptcy Code also limits the ability of debtor trademark licensees to assume, or assume and assign, a trademark license in bankruptcy. Section 365(c)(1) provides that the debtor/trustee may not assume or assign any executory contract if applicable law prohibits the assignment of a contract without the other party’s permission. Because the non-debtor owner of a trademark has an interest in the identity of the party to whom the trademark is licensed in order to maintain the goodwill, quality, and value of its products and the licensed trademark, non-exclusive trademark licenses are considered personal and non-assignable under applicable federal trademark law.
Accordingly, unlike other types of agreements that a debtor-licensee can monetize by assignment to a third party in connection with a sale, a debtor-licensee cannot unilaterally assign its rights under a trademark license. Moreover, circuits remain divided over whether a non-exclusive trademark license may be assumed by a debtor-in-possession, even without assignment to a third party. Retailers who are trademark licensees should therefore think carefully about the potential implications of filing for bankruptcy on their ability to continue using key trademarks and brand names.
Adam C. Rogoff, a member of The Bankruptcy Strategist’s Board of Editors, and Erica D. Klein are partners at Kramer Levin Naftalis & Frankel. Marsha Sukach is an associate.