United States: The Supreme Court Clarifies A Trademark Licensee's Rights After Rejection In Bankruptcy

The Supreme Court’s recent decision in Mission Product Holdings, Inc., v. Tempnology, LLC 1 clarifies that a debtor-licensor’s rejection of a trademark license under § 365(a) 2 of the Bankruptcy Code is treated as a breach, and not as a rescission, of that license under § 365(g). 3 The Court held that if a licensee’s right to use the trademark would survive a breach outside of bankruptcy, that same right survives a rejection in bankruptcy. The clear import of Mission Product is that, absent a specific provision of the Bankruptcy Code to the contrary, a contract counterparty’s post-rejection rights will be governed by either the rejected contract itself or applicable non-bankruptcy law.

Background

In 2012, Tempnology, LLC (“Tempnology”) entered into a contract with Mission Product Holdings, Inc. (“Mission Product”) that granted Mission Product a worldwide license to certain “Coolcore” clothing products that stay cool when used during exercise. The license expired in 2016, but Tempnology filed for chapter 11 in 2015 and moved to reject the contract under § 365(a). The Bankruptcy Court granted Tempnology’s request, which allowed Tempnology to stop performing under the contract and gave Mission Product a pre-petition claim for damages related to Tempnology’s non-performance. 

Tempnology claimed that the effect of the rejection was to terminate the trademark license. Tempnology reasoned that, because several other provisions of § 365 address rights of contract counterparties in the event of rejection under § 365(a),4 the absence of such a provision in the case of trademark licensees means that trademark licenses, by negative inference, may be terminated upon rejection under § 365(a). The Bankruptcy Court accepted Tempnology’s argument, but the Bankruptcy Appellate Panel for the First Circuit (the “BAP”) reversed and relied on an opinion issued by the U.S. Court of Appeals for the Seventh Circuit (the “Seventh Circuit”) to hold that § 365(g) merely provides that a rejection “constitutes a breach” and does not terminate or extinguish the contract altogether.  

The U.S. Court of Appeals for the First Circuit (the “First Circuit”) reversed the BAP, endorsing the negative inference approach adopted by the Bankruptcy Court and concluding that trademarks are unique. The First Circuit noted that permitting a trademark licensee to keep the mark would require debtor-licensors to expend valuable estate resources maintaining it, which is contrary to the congressional purpose of freeing debtors from burdensome obligations. 

The Supreme Court granted certiorari to resolve a split between the First and Seventh Circuits.

The Supreme Court’s Decision

By a vote of 8-1, 5 the Court reversed the First Circuit.  The Court held that §§ 365(a) and (g) work in tandem to create a general rule that the “[r]ejection of a contract—any contract—in bankruptcy operates not as a rescission but as a breach.”6  In other words, the Court said that when contract rejection occurs, “the debtor and counterparty do not go back to their pre-contract positions. Instead, the counterparty retains the rights it has received under the agreement” in the same manner as if the debtor breached the contract prior to bankruptcy. 7  In respect of trademark licenses, licensees “can continue to do whatever the license authorizes” after breach, and specifically in the case of Mission Product, that includes the use of the mark as permitted in the original contract. 8 

The Court rejected Tempnology’s negative inference argument adopted by the First Circuit, concluding that the various provisions of § 365 purporting to give contract counterparties unique rights after rejection were actually enacted by Congress over several decades to correct judicial rulings that departed from the general rule created by §§ 365(a) and (g). 9 

Finally, the Court rejected the argument espoused by Tempnology and adopted by the First Circuit that trademarks are unique as a result of the expenditure of estate resources necessary to maintain the quality of a mark, which could hinder a debtor’s reorganization. The Court notably stated that while rejection allows debtors to escape their contractual obligations, the Bankruptcy Code does not allow them to escape all economic burdens of owning property. 10

Takeaways      

The Court’s straightforward, textualist application of §§ 365(a) and (g) provides helpful guidance for contract counterparties, including trademark licensees and other licensees of intellectual property not specifically governed by the rejection provisions of § 365. That is, unless otherwise provided for in the Bankruptcy Code, any contract rejection under § 365 will be treated as a breach, and a counterparty’s post-breach rights (including any right to possession or use post-breach) will be governed by the contract itself or applicable non-bankruptcy law. 

Beyond trademarks, however, the decision also highlights the need for debtors to consider the economic burden of preserving the value of their licensed, rented, or loaned property when rejecting an executory contract, and future debtors should be mindful of entering into prepetition contracts that have economic burdens attached to them in the event of rejection (or breach) in a future a bankruptcy case.

Footnotes

1 Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657, 2019 U.S. LEXIS 3544 (U.S. May 20, 2019).

2 Section 365(a) of the Bankruptcy Code provides that “the trustee, subject to the court’s approval, may assume or reject any executory contract or unexpired lease of the debtor.”  11 U.S.C. § 365(a).

3 As is relevant here, “the rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease . . . immediately before the date of the filing of the petition.”  11 U.S.C. § 365(g)(1).

4 For example, § 365(n) provides inter alia that a licensee of “intellectual property,” which does not include trademarks, see § 101(35A), may treat the rejection as a termination or may retain its rights through the duration of the contract.

5 Justice Gorsuch dissented, arguing that the Court should not reach the merits of the case because it is unclear whether there is an Article III “Case” or “Controvers[y]” because Mission Product’s license has expired.

6 Mission Product, 2019 U.S. LEXIS 3544 at *14.

7 Id. at *17.

8 Id. at *18.

9 Id. at *20-22.

10 Id. at *24-26

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

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