In Landmark Decision, Supreme Court Rules Trademark Licensees Retain Rights Even After Rejection by Licensor in Bankruptcy

May 24, 2019 Advisory

The issue of what it really means for a trademark licensee when a debtor-licensor “rejects” its trademark license is crucially important.  Does the licensee lose their rights to continue to use the trademark, or not? In Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657, slip op. (May 23, 2019). the Supreme Court resolved a circuit split over whether Section 365 of the Bankruptcy Code treats a debtor-licensor’s rejection of a trademark licensing agreement as a breach or a unilateral revocation of the agreement. Many considered this the most significant unresolved legal issue in trademark licensing, because it determines whether a bankrupt licensor of a trademark can prevent a licensee from continuing to use the licensed mark. The Supreme Court held, in an 8-1 decision, that a trademark licensor in bankruptcy cannot prevent a licensee from continuing to operate under the license.

The U.S. Bankruptcy Code provides that a licensor in bankruptcy (or its bankruptcy trustee) has the option of either “assuming” or “rejecting” executory contracts, which generally include intellectual property license agreements.  Recognizing that the prospect of a licensee losing its rights to licensed intellectual property could be a harsh result, the Bankruptcy Code also builds in some protections for licensees. Specifically, Section 365(n), which was added by Congress in 1988, allows a licensee to elect to retain its rights to the licensed intellectual property, if the debtor or trustee rejects a license. Significantly, however, when the licensee protecting Section 365(n) was added, Congress used a narrow limiting definition of “intellectual property,” which did not include trademark rights. Therefore, the protections of Section 365(n) do not apply to trademark licensees.

Against this backdrop, the Supreme Court in Mission Products addressed the specific legal issue of whether a licensor’s rejection of a trademark license agreement under Section 365 had the effect of rescinding the rights previously granted by contract and held that it did not. Rather, rejection has the same effect as a breach of that contract outside of bankruptcy. While the ruling should be welcome relief to trademark licensees, it will invariably impact how parties approach negotiations for the exchange of trademark rights, in addition to changing how debtor-licensors approach rejection of these agreements in bankruptcy.

The facts of the case are simple. Petitioner Mission entered into a contract with Tempnology that gave Mission non-exclusive rights to use Tempnology’s “Coolcore” trademarks in connection with a line of athletic wear. Prior to the end of the license term, Tempnology filed for Chapter 11 bankruptcy. In the bankruptcy proceeding, Tempnology rejected its contract with Mission and sought declaratory judgment from the Bankruptcy court to preclude Mission from further use of the Coolcore marks.

Rejection of Executory Contracts in Bankruptcy: Section 365

Debtors in Chapter 11 routinely rely on Section 365 to reject executory contracts that are no longer advantageous. If a debtor decides performance is not an optimal use of its resources, the Code allows a debtor to reject those future obligations and places a non-breaching party’s damages claim in line with the debtor’s other general unsecured creditors. In a common example, a debtor committed to supply a product under a requirements contract at a below-market rate could reject the contract and sell its remaining product to a different buyer at a greater profit. However, unlike rejection of a contract for goods, where Section 365 frees the debtor of its obligations to subsequently deliver goods to its counterparty, a debtor-licensor of trademarks may also need to somehow to claw-back the continued use rights already given to the licensee at the outset of the agreement to truly maximize the value of their licenses. 

In Mission Products, Tempnology attempted to do just that. Not only did Tempnology assert that its rejection of Mission’s license agreement ended Tempnology’s future obligations as licensor, but also that the rejection cut short Mission’s rights to use the Coolcore marks for the remainder of the license term. The bankruptcy court agreed, as did the First Circuit. Under the First Circuit’s holding, a rejection of a trademark license agreement under Section 365 terminates the agreement and rescinds a licensee’s continuing-use rights. This holding stands in stark contrast to the law in the Seventh Circuit, which, consistent with the plain language of Section 365, treats a rejection as a breach. Applying contractual common law breach principles, the Seventh Circuit maintains that a rejection under Section 365 permits the non-debtor licensee to continue exercising its rights to the marks for the duration of the agreement in addition to a claim for damages.

Relying on a Negative Inference

Tempnology’s principal argument focused not on the general provision of Section 365, under which the licensing agreement at issue falls, but instead on subsidiary provisions or so-called “exceptions.” Among these subsidiary provisions rests Section 365(n), which permits licensees of certain types of intellectual property (not including trademarks) to continue to exercise those rights after rejection subject to certain conditions. Tempnology argued, and the First Circuit agreed, that the existence of Section 365(n) and similar provisions creates a negative inference that Section 365’s general rule must not permit counterparties from maintaining continuing rights lest “the exceptions swallow the rule.” Tempnology further asserted that had Congress intended trademark rights to survive rejection of an agreement, trademarks would have been expressly included in the definition of “intellectual property” as used in Section 365(n).

Justice Kagan, writing for the majority, rejected the negative inference argument, finding nothing in the Code to suggest that a rejection of a contract is anything other than a breach as defined by general terms of contract law. Justice Kagan also delved into the historical context of the Code “exceptions” from which Tempnology draws its negative inference, explaining that “each responded to a discrete problem—as often as not, correcting a judicial ruling of just the kind Tempnology urges.”

One such Congressional response is evident from the legislative history of Section 365(n). Following the Fourth Circuit’s decision in Lubrizol Enterprises v. Richmond Metal Finishers, 756 F.2d 1043 (1985), which held that a debtor’s rejection of an executory contract revoked a grant of a patent license, Congress enacted Section 365(n) to provide special protections for licensees of certain types of intellectual property (as defined in the 11 U.S.C. § 101(35A)), which included patents and trade secrets but not trademarks.

Notwithstanding Congress’s omission of trademarks from this provision, Justice Kagan stated that “Congress’ repudiation of Lubrizol for patent licenses does not show any intent to ratify that decision’s approach for almost all others” (emphasis in original). As Justice Sotomayor points out in a concurring opinion, Congress’s omission of trademarks from Section 365(n) does not evince a desire to limit rights of trademark licensees, but to the contrary, permits more expansive rights than those possessed by licensees of other types of intellectual property who are subject to the somewhat stricter requirements of Section 365(n).

Unique Features of Trademark Law in the Context of Rejection

Tempnology also urged the Court to consider unique features of a trademark licensor’s obligations that undermine the utility of rejection in the absence of a full revocation of the licensee’s rights. The inability to cast aside less lucrative licensing parties for other suitors not only hampers a debtor-licensor’s efforts to maximize the bankruptcy estate but also submits the debtor-licensor to the continued burden of monitoring the licensee’s use of the mark after rejection. This requires the licensor to unnecessarily expend resources on policing efforts, which may in turn impede its ability as a debtor to successfully reorganize its debt.

The Court dismissed this argument as well, noting that, this time Tempnology would “allow the rule to swallow the exception” vis-a-vis subverting a general principle under Section 365 to accommodate unique features of trademark law. While the Court acknowledged that the debtor is given certain powers in bankruptcy to increase the overall value of the estate, these powers are finite and governed by the language of the Code. Indeed, “[t]he estate cannot possess anything more than the debtor itself did outside bankruptcy,” and as such, a licensor of a trademark cannot rescind a contract where its only remedy is breach, irrespective of special obligations or considerations inherent in the grant of a trademark license.

Conclusion

For trademark licensees, the holding in Mission Products provides some comfort that their license rights cannot be stripped away in the event the licensor files for bankruptcy. In the wake of the Court’s decision, licensees can be assured that rejection under Section 365 will not in itself disturb a licensee’s right to continued use of licensed marks for the duration of an agreement and consistent with its terms. However, as Justice Sotomayor rightly points out in concurrence, the holding does not prevent licensors from negotiating termination rights in the event of a future bankruptcy. In such cases, contract law principles, rather than the operation of Section 365 will determine the parties’ respective rights to terminate a license following a licensor’s petition for bankruptcy.

As such, the Mission Products decision may usher a change in how parties approach negotiations for the licensing of trademarks. Licensors may seek to enter into licenses with shorter terms or that contain contingencies to facilitate termination of an agreement in the event of bankruptcy. Moreover, debtor-licensors may hesitate to reject even suboptimal license arrangements, given that a rejection will nevertheless leave the debtor with at least some continuing obligations to monitor a mark’s usage. In interpreting Section 365 narrowly, the Court places the expectations of contracting parties ahead of the immediate needs of the debtor, and arguably at the expense of other creditors who would benefit from a better-funded estate. Unable to extract the greatest value from a license, these restrictions on the debtor, may work to benefit one particular creditor at the expense of all others and ultimately change the way that contracting parties approach negotiations long before a bankruptcy petition is ever filed.