United States: First Circuit Holds Rejection Of Trademark License Leaves Licensee With Only A Claim For Pre-Petition Damages – No Right To Continued Use Of Trademarks; Court Upholds Termination Of Exclusive Distribution Rights

The Bottom Line

The First Circuit in Mission Product Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), 879 F.3d 389 (1st Cir. 2018), recently held that the Debtor's rejection of a trademark license left the licensee with only a pre-petition damages claim in lieu of any obligation by the Debtor to further perform under the trademark license or the grant of exclusive distribution rights.  The case is notable because (i) it excludes distribution rights from the protections of Section 365(n) of the Bankruptcy Code and (ii) it declines to follow certain cases (including in the First Circuit) that included trademark rights as protected intellectual property rights post-rejection.

What Happened?

The Debtor made specialized products (including towels, socks, headbands, and other accessories) designed to remain at low temperatures even when used during exercise, which it marketed under the "Coolcore" and "Dr. Cool" brands.  A significant intellectual property portfolio supported the Debtor's products.  This portfolio consisted of two issued patents, four pending patents, research studies, and a multitude of registered and pending trademarks.  On November 21, 2012, Mission Product Holdings, Inc. ("Mission") and the Debtor executed a Co-Marketing and Distribution Agreement (the "Agreement"), which granted three categories of rights: (i) the Debtor granted Mission distribution rights to certain of its manufactured products within the United States – some of the covered categories of goods were exclusive distribution and others were nonexclusive; (ii) the Debtor granted Mission a nonexclusive irrevocable license to the Debtor's intellectual property which expressly excluded any rights to the Debtor's trademarks; and (iii) finally, with respect to trademarks, the Debtor granted Mission a "nonexclusive, non-transferable, limited license" for the term of the Agreement "to use [Debtor's] trademark and logo (as well as any other Marks licensed hereunder) for the limited purpose of performing its obligations hereunder, exercising its rights and promoting the purposes of this Agreement."  879 F.3d at 392–93.

The Debtor-licensor sought to reject seventeen contracts pursuant to Section 365(a) of the Bankruptcy Code, including the Agreement with Mission, the licensee.  The licensee objected to the rejection, arguing that Section 365(n) allowed it to retain both its trademark license and its exclusive distribution rights.

By way of background, Section 365(n) of the Bankruptcy Code limits a debtor's ability to terminate intellectual property licenses and deprives the non-debtor licensee of certain ongoing benefits of the use of the licensed intellectual property.  Specifically, Section 365(n) provides that, despite contract rejection, a licensee may elect to "retain its rights (including a right to enforce any exclusivity provision of such contract . . . ) under such contract and under any agreement supplementary to such contract, to such intellectual property (including any embodiment of such intellectual property to the extent protected by applicable nonbankruptcy law)."  11 U.S.C. § 365(n)(1)(B) (emphasis added).

In the case at issue, the bankruptcy court granted the Debtor's motion to reject, subject to the licensee's election to preserve its rights under Section 365(n).  The Debtor subsequently moved for a determination of the applicability and scope of the licensee's continued usage rights under Section 365(n).  The bankruptcy court found that Section 365(n) only protects "intellectual property" rights and that the licensee's exclusive distribution rights could not be characterized as such.  In addition, trademarks are not included in the list of protected intellectual properties set forth in Section 101(35A) and thus, the court found they are not subject to the exceptions for the effect of rejection under Section 365(n).  The licensee appealed to the Bankruptcy Appellate Panel for the First Circuit (the "BAP").  The BAP affirmed with respect to the exclusive distribution rights but reversed the bankruptcy court's ruling as to the continued use of the trademark license.  The BAP followed the Seventh Circuit's ruling in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 272 (7th Cir. 2012), holding that because Section 365(g) deems the effect of rejection to be a breach of contract, and a licensor's breach of a trademark agreement outside of bankruptcy does not necessarily terminate the licensee's rights, then rejection under Section 365(g) similarly does not necessarily eliminate the right to ongoing use of the trademarks.  The Debtor appealed.

Looking first to the statutory language, the First Circuit found that the reference to "any exclusivity provision of such contract" in Section 365(n)(1)(B) is limited to exclusivity provisions related to intellectual property and does not extend to exclusive distribution rights.  "The Agreement and record are clear that Debtor can use its intellectual property to make and sell products other than those for which the Agreement grants Mission exclusive distribution rights. The only thing that is exclusive is the right to sell certain products, not the right to practice, for example, the patent that is used to make those products. An exclusive right to sell a product is not equivalent to an exclusive right to exploit the product's underlying intellectual property."  879 F.3d at 398.  The Court found that its interpretation was supported by legislative history, noting that Section 365(n) was enacted to ensure that the rights of an intellectual property licensee to use the licensed property cannot be unilaterally cut off.  Therefore, there was no post-rejection right to continue any exclusive distribution.

Turning next to whether the licensee retained the right to use the trademark license post-rejection, the First Circuit initially observed that trademark licenses are not included in the definition of  "intellectual property" set forth in Section 101(35A) of the Bankruptcy Code and, thus, would seem ineligible for protection under Section 365(n).  See 11 U.S.C. § 101(35A).  However, again looking to legislative history, the Court noted that Congress "'postpone[d]' action on trademark licenses to allow the development of equitable treatment of this situation by bankruptcy courts."  879 F.3d at 401.  The only circuit to squarely address this issue is the Seventh Circuit in Sunbeam and there, the Seventh Circuit did not rely on equitable considerations but looked to the meaning of rejection.  The Seventh Circuit found that "while rejection converts a debtor's duty to perform into liability for pre-petition damages, it leaves in place the counterparty's right to continue using a trademark licensed to it under the rejected agreement."  Id. at 402.  The First Circuit disagreed with this approach, finding that the result—allowing a licensee to retain use of a debtor's trademarks thereby forcing the debtor to choose between performing executory obligations arising from continuance of the license or risking the permanent loss of its trademarks—would be inconsistent with Section 365(a), which would otherwise allow a debtor to free itself of burdensome obligations.  Accordingly, the First Circuit held that the licensee's right to use the trademark did not survive rejection of the agreement. 

In a dissent, Judge Torruella disagreed "with the majority's bright-line rule" that Section 365(n) leaves a licensee without any post-rejection rights to use a debtor's trademark and logo.  Instead, Judge Torruella advocated the approach used in Sunbeam and stated that the effect of rejection on a trademark license should be guided by the terms of the agreement and non-bankruptcy law to determine the appropriate equitable remedy.

Why This Case Is Interesting

The Seventh Circuit's approach in Sunbeam, which permitted a trademark licensee to retain rights post-rejection, has been an exception to both the plain reading of the Bankruptcy Code and the majority of cases interpreting the issue.  The First Circuit's decision furthers a divide among circuit courts on whether to grant protection to trademarks despite the language of the Bankruptcy Code.  For certain distressed businesses, including retailers with popular private label products, trademarks can be a valuable right. The ability of the debtor versus the non-debtor licensee to control the use of that trademark can affect the overall restructuring.  This latest decision adds to the uncertainty (depending upon where a case is filed) on the treatment of this potentially valuable property right.

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