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Article


A version of the following article first appeared in the New Jersey Lawyer Magazine
(February 2004, Federal Civil Practice Issue, at 52)

Lanham Act For Lenders:

Increasing Collateral Value By Obtaining
Related Intellectual Property Rights

By: Richard L. Ravin and Van V. Mejia

In the world of commercial finance, it is common for a lender to obtain a security interest in the accounts receivable and inventory of its borrower. Often overlooked, however, is the acquisition of important intellectual property rights that will permit the lender to realize the full value of its collateral upon foreclosure.

One of the more important protections provided by the Lanham Act 1 is the mark owner’s right to control the quality of goods which bear its mark.2 However, the sale or re-sale of genuine goods without the subsequent authorization of the trademark owner will generally not constitute trademark infringement under the Lanham Act.3 This genuine goods defense is normally applicable only after the authorized first sale of the good.4 Under the first sale (or exhaustion) doctrine, the trademark owner loses the right to further restrict or control the downstream sale or distribution of a genuine good upon that good’s first sale.5 The first sale defense is equally applicable in copyright cases.6

Warehouse Owner/Distributor as Borrower

Thus, where the borrower is the owner of a warehouse (or is a distributor), and its inventory comprises genuine goods owned by the borrower, but which bear the trademarks of various manufacturers, a foreclosing lender has the right to advertise and sell the inventory, using the trademark, without running afoul of the Lanham Act. In such a scenario, there has presumably been an authorized first sale to the warehouse owner or distributor. Additionally, the use of the trademark would be limited to merely describing what is being sold, and there could reasonably be no confusion as to source since the goods are genuine.

Manufacturer as Borrower

In the case of a manufacturer-borrower, however, the inventory will generally bear the marks of the borrower itself. If the inventory consists of finished goods, a foreclosing lender would be permitted to advertise and sell the goods bearing the trademark since the goods were presumably produced to the manufacturer’s own quality standards, and are thus genuine. In this scenario, because there has been no first sale of the goods in the traditional sense, the question arises whether a foreclosing lender may, nonetheless, assert a genuine goods defense.

A foreclosing lender could reasonably argue that, since the security agreement was entered into voluntarily, and since it calls for the transfer of the inventory upon the happening of certain events of default set forth in the security agreement, the foreclosure of the collateral constitutes a transfer of the goods in the same manner as a sale under the first sale doctrine. Accordingly, the lender would be able to assert the genuine goods defense. The lender would argue that the goods are genuine because they were produced pursuant to the manufacturer-borrower’s own quality control standards, bear a true mark, and there would be no confusion as to source if the lender advertised and sold the goods.

However, if the goods are unfinished but bear the trademark of the manufacturer-borrower, the borrower could reasonably argue the goods do not conform to the quality standards of its finished trademarked goods, and thus the sale of the unfinished goods by the foreclosing lender constitutes trademark infringement.7

In Fender Musical Instruments, Corp. v. Unlimited Music Center, Inc., for instance, the manufacturer-trademark owner had discarded several guitar bodies in a dumpster because they fell below its quality control standards.8 The guitar bodies were retrieved by a trespasser and sold to the defendants.9 The defendants in turn attempted to sell the guitar bodies as genuine.10 The District Court of Connecticut held, among other things, that the unauthorized sale of unfinished Fender guitar bodies violated the Lanham Act.

By selling these goods as 'genuine,' the use of the Fender trademark in correlation with these products is likely to confuse or deceive the public into believing that these were quality Fender guitars that were authorized for sale in this unfinished condition. Whether the defendants intended to infringe is not an issue.11

Private Label Manufacturer as Borrower

In the case of a private label manufacturer-borrower, however, its inventory will usually bear the trademarks of the borrower's customers, such as when an apparel company contracts with a private label manufacturer for the manufacture of merchandise bearing the apparel company’s trademark. In addition, it is also common for a private label manufacturer to produce goods bearing a trademark licensed to its customer by the owner of the trademark. This may be the case when an apparel company grants a license to a national retail chain for the manufacture and sale of the apparel company’s merchandise bearing the apparel company’s mark. That retailer, in turn, would contract with a private label manufacturer-borrower for the manufacture of the trademarked merchandise. In such circumstances, the license may require that the goods only be sold at the retailer’s stores. Or, the apparel company may grant a license to a third party for the manufacture or sale of goods bearing the trademark and restrict the channels of trade within which the product may be sold, such as limiting sales to certain types of distributors or purchasers, such as specialty boutiques. Moreover, it is likely such a license would be non-assignable and not sublicensable.

Infringement by Licensee

It has been held that use of a trademark outside the scope of the license agreement constitutes infringement, because such use is likely to confuse the public.12 Thus, if the lender were to foreclose on the inventory of its borrower, disregard the trademark license, and dispose of the collateral, it would run the risk of infringing the rights of the trademark owner.

It is important to note that trademark licenses are not security interests, and would not ordinarily be recorded as such. Thus, even where a lender's UCC-1 search reveals there are no filings against the inventory, federal trademark law may nonetheless restrict the manner in which the lender may dispose of its collateral if the goods are subject to a trademark license. A prudent lender should, therefore, determine as part of its due diligence, whether the goods in inventory are subject to any intellectual property licenses or restrictions.

SERVICE CONTRACTS, SERVICE MARKS, AND TRADE NAMES

When the borrower is a service business, its service contracts, service marks, and trade names are probably among its more valuable assets. If a lender has only taken a security interest in the service contracts (customer accounts), but not the service marks and trade names, the ability to foreclose on the collateral (contract rights) may be substantially impaired.

For instance, if the principal owners of a service company (as a borrower) are unscrupulous, they may set up a new corporation (NewCo), use confusingly similar service marks or trade names, or falsely designate the origin of the services, and then siphon-off customers (the collateral base). The unscrupulous principals may also use their own individual names (which may be well known to the customers), thereby creating the impression on customers that NewCo is the same old friendly service company, with a new location and a new address to remit payments. Some principals have even been known to send direct mail letters from NewCo to the customers of the borrower with the salutation: "Dear Valued Customer," further falsifying the origin of the services in violation of the Lanham Act.13 The principals may also resort to making such misrepresentations as: "We have changed our name," to further perpetuate the fraud and confusion.

If the lender does not have covenants from the individual principals to prevent the principals' use of infringing marks, the lender's collateral base can quickly evaporate. The Lanham Act, however, can provide an avenue for relief in addition to the obvious theories, such as fraud, tortious interference with contractual relations, and misappropriation of customer list (assuming it qualifies as a trade secret).

If the lender sought a preliminary injunction, the unscrupulous principals may defend that they have a right to compete, that restrictions on employment are disfavored, and that they never signed restrictive covenants. Under the Lanham Act, however, irreparable harm will usually be presumed for purposes of granting injunctive relief where the use of a trademark creates a likelihood of confusion in the mind of consumers regarding ownership or sponsorship of a product.14 Thus, at the preliminary injunction stage, the Lanham Act has a distinct advantage in that irreparable injury need not be proven directly, as with other theories. Once likelihood of confusion or false designation of origin is demonstrated as likely to succeed, a preliminary injunction will probably be granted.

Obviously, if a lender can obtain covenants not to compete, as well as non-use and non-disclosure agreements directly from the individual principals which prohibit solicitations of former and current customers and interference with the collateral, those agreements could be used to prevent the injurious conduct. From a customer relations or sales perspective, however, lenders are often reluctant to press for such agreements from officers, directors and/or owners.

GET A LICENSE IN ADDITION TO A SECURITY INTEREST

Whether the borrower is a manufacturer, distributor of goods, or service business, a lender can enhance its security interest by obtaining a license in the intellectual property related to the collateral. In the context of the above examples, the lender would want a license in the trademarks, service marks, trade names, and related goodwill for the purpose of exercising its rights as a secured creditor, such as disposing of the collateral, or as a levying judgment creditor. It should be noted, however, that if the borrower goes into bankruptcy, a license would be treated differently than a security interest by a bankruptcy court.15

In addition to a license, the lender should obtain a security interest in the borrower’s trademarks and goodwill and not just “intellectual property rights”, in general. From the borrower’s standpoint, however, it is important that the scope of the license in the trademark and goodwill be limited to disposing of the collateral upon foreclosure, and not be assignable or sub-licensable, especially to any competitor of the borrower. Similarly, the borrower will want to expressly limit the security interest in the trademark and goodwill related to the goods in inventory, and not grant a lien on the trademark or goodwill of the company generally.

DESCRIBING THE COLLATERAL

In drafting the license or the grant of the security interest in the intellectual property, it is important to carefully describe the collateral to be secured. Using general terms like "accounts receivable and inventory including all general intangibles related thereto" is risky if the lender intends to secure trademarks, copyrights, patents and trade secrets, related to the accounts receivables and inventory. If the inventory is copyrighted, patented or the subject of trade secrets, a similar analysis should be undertaken as described above in the trademark context.16

In In re Lady Madonna Industries, Inc., the district court, sitting as a bankruptcy appellate court, affirmed the holding of the bankruptcy court.17 Specifically, the district court held that the secured lender did not have a lien on the debtor-borrower's trademarks and trade name. The bankruptcy trustee had sold the debtor’s trademarks and trade name with all claims, liens, and encumbrances to attach to proceeds.18 The lender then sought to impress the proceeds with its security interest.19 The security agreement described the collateral as all "accounts receivable, contract rights, equipment, and farm products, and any instruments, documents, chattel paper and general intangibles relating thereto or arising therefrom."20 The lender argued that, since the value of the borrower's accounts receivables and contract rights were dependent on the value of the marks and goodwill, the trademarks were "related to" the accounts receivables and contract rights.21

The district court in Lady Madonna concluded, however, that the borrower's trademarks and trade names were not related to the borrower's accounts receivable because "they have no feature bearing on each other except when considered as parts of the total of all the debtor's assets. But here both the security agreements and the financing statements eschew claiming all assets as collateral."22 Thus, the bankruptcy court had held that the description of the collateral in the security agreement could not be construed to include the borrower's trademarks under the broad class of "general intangibles."23

If the collateral in Lady Madonna were inventory, rather than accounts receivable, it is likely that a different outcome would have resulted. By definition, trademarks are bound to the product and are necessarily related to the product. Therefore, general intangibles related to the inventory would include the trademarks and goodwill related to the inventory. Courts have also held that there are no rights in a trademark apart from the goodwill it has come to symbolize. A trademark and its goodwill are therefore inseparable.24 Thus, the sale or assignment of a trademark without its related goodwill (assignment of trademark in gross) is invalid.25

It should be noted that in Lady Madonna there was no dispute that trademarks and trade names were considered general intangibles.26 In In re SSE Int’l Corp., the Western District of Pennsylvania cited the existence of legal authority that intellectual property falls, per se, within the category of general intangibles.27 For this proposition, the SSE Int’l court cited In re Emergency Beacon Corp.,28 which stated that “patent rights, trade name, customer lists, books and records ... are general intangibles within the meaning of § 9-106 of the Uniform Commercial Code." Finally, the Comment to U.C.C. Section 9-102 states that general intangible is:

the residual category of personal property, including things in action, that is not included in other defined types of collateral. Examples are various categories of intellectual property and the right to payment of a loan of funds that is not evidenced by chattel paper or an instrument. As used in the definition of "general intangible," "things in action" includes rights that arise under a license of intellectual property, including the right to exploit the intellectual property without liability for infringement.29

LENDER'S STANDING TO SUE UNDER THE LANHAM ACT

When a lender brings a Lanham Act claim, standing becomes an issue. A lender may have Lanham Act standing if it has succeeded to the borrower’s rights in the borrower's trademark, service mark, or trade name, such as by operation of a security agreement. If a lender forecloses on a security interest in a trademark and related goodwill, the lender, under certain circumstances, may even have an infringement claim against the borrower, in addition to having the right to use the mark itself. Thus, if the lender has succeeded to all of the borrower's interest in the mark and related goodwill, the borrower would have no further rights in the mark. It should also be noted that the sale or assignment of a trademark without its accompanying goodwill (also known as an assignment in gross) is invalid.30 Thus, a security interest in a trademark in gross, would likewise be ineffective.

Even without the grant of any security interest in the trademark or goodwill of the borrower, the broad standing accorded by the Lanham Act may give a secured lender legal standing in a suit against an infringer of the marks (including the borrower or its principals) based on the lender’s substantial commercial interest or reasonable interest in the mark or trade name. In Thorn v. Reliance Van Company, Inc.,31 for example, the Third Circuit considered whether an individual investor (a non-competitor) had standing to maintain an action under Section 43 (a).32

The Thorn court held that the dispositive question under Section 43(a) is whether the plaintiff has a reasonable interest to protect against false advertising.33 The court held that the loss of the plaintiff-investor’s investment as a result of the defendant’s false advertising was “sufficiently direct” so as to grant her standing under the Lanham Act.34

The Thorn court’s holding is consistent with the Lanham Act's primary purpose to protect commercial interests.35 In fact, the Lanham Act states that its purpose is to:

regulate commerce within the control of Congress by making actionable the deceptive and misleading use of marks in such commerce ... to protect persons engaged in such commerce against unfair competition; to prevent fraud and deception in such commerce by the use of reproductions, copies, counterfeits, or colorable imitations of registered marks.36

Additionally, the district court in Estate of Elvis Presley v. Russen 37 commented that the Third Circuit has confirmed that Section 43 (a) “proscribes not only acts that would technically qualify as trademark infringement, but also unfair competitive practices involving actual or potential deception.”38

In Estate of Elvis Presley, a New Jersey District Court held that the estate of Elvis Presley had standing to sue under Section 43(a) because the estate had “shown that it has an economic interest in the protection of the rights it asserts, for it receives royalty or percentage payments from those who sell merchandise using the name, likeness and image of Elvis Presley.”39

Similarly, in PPX Enterprises, Inc. v. Audiofidelity Inc.,40 the Second Circuit held, among other things, that a New York corporation in the business of acquiring and licensing the performance rights of Jimi Hendrix had standing to sue under Section 43 (a) because it had “straight-forward commercial interests that could reasonably be affected by misleadingly packaged Jimi Hendrix recordings .... Because of their royalty interests, plaintiffs have a pecuniary stake in sales of Hendrix recordings that makes them genuine business competitors.”41

Both Estate of Elvis Presley and PPX Enterprises instruct that parties who succeed to intangible property of another have standing to sue under Section 43 (a) of the Lanham Act. It is important to note that, in both cases, the plaintiffs were making a Section 43 (a) claim not because their own use of the marks were being affected. Rather, they alleged that their licensees’ use of the names and likenesses at issue were being negatively affected by the use of a confusingly similar mark by the defendant, thus causing a potential reduction in royalty payments to the plaintiffs.

CONCLUSION

Disposition of a foreclosing lender's collateral inventory may be problematic if it has not obtained a security interest in the related intellectual property. Additionally, failure to obtain a security interest in intellectual property may create problems where the collateral is contract rights, such as in the case of a service business. Accordingly, when drafting garden-variety loan and security agreements, lenders can often increase their collateral value by obtaining security interests and licenses in the intellectual property related to their core collateral. Care must be taken, however, to accurately describe the intellectual property being hypothecated. Finally, even without the grant of a security interest, the Lanham Act’s liberal standing rules may permit a lender to pursue an infringement or false designation of origin claim against persons using the borrower's trademarks, service marks, and trade names.

ENDNOTES

1. 15 U.S.C.A. § 151, et seq.
2. See El Greco Leather Products Co., Inc. v. Shoe World, Inc., 806 F.2d 392, 395 (2nd Cir. 1986).
3. See Liz Claiborne, Inc. v. Mademoiselle Knitwear, Inc., 979 F. Supp. 224 (S.D.N.Y 1997); Polymer Tech. Corp. v. Mimran, 975 F.2d 58 (2nd Cir. 1992); Prestonettes, Inc. v. Coty, 264 U.S. 359, 368-69 (1924). The Lanham Act, 15 U.S.C.A. § 1051, et seq., contains provisions against infringement of registered and unregistered marks With respect to registered marks, Section 32(1) of Act states in pertinent part:

Any person who shall, without the consent of the registrant—

(a) use in commerce any reproduction, counterfeit, copy, or colorable imitation of a registered mark in connection with the sale, offering for sale, distribution, or advertising of any goods or services on or in connection with which such use is likely to cause confusion, or to cause mistake, or to deceive; or

(b) reproduce, counterfeit, copy, or colorably imitate a registered mark and apply such reproduction, counterfeit, copy, or colorable imitation to labels, signs, prints, packages, wrappers, receptacles or advertisements intended to be used in commerce upon or in connection with the sale, offering for sale, distribution, or advertising of goods or services on or in connection with which such use is likely to cause confusion, or to cause mistake, or to deceive;

shall be liable in a civil action by the registrant for the remedies hereinafter provided.

15 U.S.C.A. § 1114 (1) [§ 32 (1)].

Section 43(a) of the Act, false designation of origin provision, states in pertinent part:

 

(1) Any person who, on or in connection with any goods or services, or any container for goods, uses in commerce any word, term, name, symbol, or device, or any combination thereof, or any false designation of origin, false or misleading description of fact, or false or misleading representation of fact, which–

(A) is likely to cause confusion, or to cause mistake, or to deceive as to the affiliation, connection, or association of such person with another person, or as to the origin, sponsorship, or approval of his or her goods, services, or commercial activities by another person,

(B) in commercial advertising or promotion, misrepresents the nature, characteristics, qualities, or geographic origin of his or her or another person’s goods, services, or commercial activities,

shall be liable in a civil action by any person who believes that he or she is or is likely to be damaged by such act.

15 U.S.C.A. § 1125 (a) (1) (A) [§43(a)]

4. See Liz Claiborne, Inc., 979 F. Supp. at 230; Ryan v. Volpone Stamps Co., Inc., 107 F. Supp. 2d 36 (S.D.N.Y. 2000).
5. See Liz Claiborne, Inc., 979 F. Supp. at 230.
6. See 17 U.S.C. § 109 (a); Bourne v. Walt Disney Co., 68 F.3d 621, 631-33 (2nd Cir. 1995), cert. denied, 517 U.S. 1240 (1996); Sebastian Int’l, Inc. v. Consumer Contacts, Ltd., 847 F.2d 1093, 1096 (3rd Cir. 1988).
7. See Polymer Technology Corp., 37 F.3d at 78; El Greco Leather Products Co., 806 F.2d at 395; Fender Musical Instruments, Corp. v. Unlimited Music Center, Inc., 1995 WL 241990 (D. Conn. 1995).
8. See Id. at *2.
9. See Id.
10. See Id.
11. See Id. at *5.
12. E.G.L. Gem Lab, Ltd. v. Gem Quality Institute, Inc. 90 F. Supp. 2d 277, 293, n125 (S.D.N.Y. 2000), affirmed, 2001 WL 170455 (2nd Cir 2001); see also Baskin-Robbins Ice Cream Co. v. D & L Ice Cream Co., 576 F. Supp. 1055, 1060 (E.D.N.Y. 1983) (infringement upon termination of license).
13. See n. 1, above.
14. See Museum Boutique Intercontinental, Ltd. v. Picasso, 880 F. Supp. 153, 164 (S.D.N.Y. 1995); Church of Scientology Intern. v. Elmira Mission, 794 F.2d 38 (2nd Cir. 1986); Warner Lambert Co. v. McCrory’s, 718 F. Supp. 389, 393 (D.N.J. 1989).
15. The treatment of licenses as executory contracts under 11 U.S.C. § 365 (c) is beyond the scope of this article. It is also noted that “intellectual property” as used in 11 U.S.C. §365(n) and defined in 11 U.S.C. §101(35A) does not include trademarks.
16. The procedures for perfecting a security interest in intellectual property is beyond the scope of this article.
17. See In re Lady Madonna Industries, Inc., 99 B.R. 536 (S.D.N.Y. 1989)
18. See Id. at 538.
19. See Id.
20. See Id. at 538 (emphasis added).
21. See Id. at 540.
22. See Id. at 541 (citing language from bankruptcy court's decision and order).
23. See Id. at 539.
24. See Marshak v. Green, 746 F.2d 927 (2nd Cir. 1984).
25. E&J Gallo Winery v. Gallo Cattle Co., 967 F.2d 1280, 1289 (9th Cir. 1992); 15 U.S.C. § 1060.
26. See In re Lady Madonna Industries, Inc., 99 B.R. at 539.
27. See In re SSE Int’l Corp., 198 B.R. 667, 670 (Banker. W.D. Pa. 1996).
28. 23 U.C.C. Rep. Serv. 766 (S.D.N.Y. 1977).
29. U.C.C. § 9-102, Comment 5d (1999).
30. See n. 24 and 25, above.
31. See Thorn v. Reliance Van Company, Inc., 736 F.2d 929 (3rd Cir. 1984)
32. See Id. at 931.
33. See Id. at 933.
34. See Id.
35. See generally Sandoz v. Pharmaceuticals Corp. v. Richardson-Vicks, Inc., 902 F.2d 222, 230 (3rd Cir. 1990); Serbin v. Ziebart Int’l Co., 11 F.3d 1163, 1175 (3rd Cir. 1993); Granite State Ins. Co. v. Aamco Transmissions, Inc., 57 F.3d 316, 321 (3rd Cir. 1995.); Conte Bros. Automotive, Inc. v. Quaker State-Slick 50, Inc., 165 F.3d 221, 229 (3rd Cir. 1998); Joint Stock Society v. UDV North America, Inc., 266 F.3d 164, 180 (3rd Cir. 2001); Loy v. Armstrong World Industries, Inc., 838 F. Supp. 991, 994 (E.D. Pa. 1993.)
36. 15 U.S.C.A. § 1127.
37. See Estate of Elvis Presley v. Russen, 513 F. Supp. 1339, 1350-51 (D.N.J. 1981)
38. See Id. (citing SK & F, Co. v. Premo Pharmaceutical Laboratories, Inc., 625 F.2d 1055, 1065 (3rd Cir. 1980)).
39. See Id. at 1350-51.
40. See PPX Enterprises, Inc. v. Audiofidelity Inc., 746 F.2d 120 (2nd Cir. 1984)
41. See Id. at 125.

Richard L. Ravin is a member of Hartman & Winnicki, P.C., and head of the firm’s Internet and intellectual property law group. He is Vice Chair of the New York State Bar Association’s Intellectual Property Section, and past (founding) co-chair of the Internet Law Committee of the section.
Van V. Mejia practices law in New York City and was an associate with the firm’s Internet and intellectual property law group. He earned his J. D. in 2000 from Seton Hall Law School, and his LL.M. (Banking, Corporate, and Finance Law) in 2003 from Fordham Law School. The authors wish to thank Michael Chakansky past Chair of the Intellectual Property Law Section for his contribution to the article. Copyright 2003, Richard L. Ravin and Van V. Mejia.

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