United States: Supreme Court Holds That Bankrupt Trademark Licensors Cannot Terminate Licensee's Rights

Abstract

The Supreme Court recently held that if a bankrupt trademark licensor rejects a trademark licensing agreement during bankruptcy proceedings the licensee does not lose its right to continue using the licensed trademark post-rejection.

Background

Tempnology, LLC manufactured clothing and accessories designed to stay cool when used in exercise. It marketed those products under the brand name COOLCORE. In 2012, Tempnology granted Mission Product Holdings, Inc. (“Mission”) a non-exclusive license to use Tempnology’s COOLCORE trademarks in the United States and around the world, and an exclusive license to distribute certain COOLCORE products in the United States.  The licensing agreement expired in July 2016.

In September 2015, Tempnology filed for Chapter 11 bankruptcy.  Soon thereafter, Tempnology petitioned the Bankruptcy Court to “reject” its trademark licensing agreement with Mission, and the Bankruptcy Court obliged.  Both parties agreed that Tempnology’s rejection relieved Tempnology of its duty to perform under the agreement and permitted Mission to bring a damages claim against Tempnology for its nonperformance.  But Tempnology also believed that its rejection terminated any rights it had granted Mission to use the COOLCORE trademarks.

The Bankruptcy Court agreed with Tempnology, finding the licensing agreement was rescinded upon its rejection, but the Bankruptcy Appellate Panel reversed.  On appeal, the First Circuit reversed and reinstated the Bankruptcy Court’s original decision. The Supreme Court then agreed to hear the case on appeal.

The Mission Decision

Section § 365(a) of the Bankruptcy Code grants a debtor the ability to “assume or reject any executory contract” after the debtor enters bankruptcy, subject to the court’s approval.  An “assumed” contract obligates both parties to continue their performance.  A “rejected” contract relieves the debtor of its duties to perform and allows the counterparty to sue the estate for damages resulting from the debtor’s nonperformance.  Section 365(g) of the Bankruptcy Code explains that the rejection of an executory contract “constitutes a breach.”  Thus, any debtor who rejects a contract under § 365(a) has breached that contract under § 365(g). Mission argued that under normal contract rules a “breach” by a trademark licensor would not terminate a licensee’s rights.  Thus, it argued the result should be the same under the bankruptcy code.

The Supreme Court agreed that the term “breach” possessed the same definition in bankruptcy law as in contract law and thus, should not terminate Misson’s rights. The Court offered an explanatory hypothetical from contract law.  The Court described a contract leasing a photocopier and providing that the lessor would service the photocopier on a monthly basis.  Upon breach of that contract by the lessor, the lessee would not be required to return the photocopier.  Rather the lessee would have the option to either keep the photocopier and continue paying the lessor or return the photocopier to avoid future payment.  The Court analogized to its photocopier hypothetical in holding that the same result follows in bankruptcy law—in other words, a rejection is merely a breach and the consequences of rejection are merely that of a breach, which does not include contract termination.

The result is no different for trademark licensing agreements.  The Court explained that §§ 365(a) and (g) apply to “any executory contract,” which includes trademark licensing agreements.  And while a trademark license requires the licensor to monitor and exercise quality control over the licensee, potentially making a debtor’s reorganization more difficult by forcing the debtor to choose between expending scarce resources on quality control or potentially losing a valuable asset, the Court notes that this is simply one of the many burden’s intentionally built into the bankruptcy process.

The Court also addressed numerous exceptions in § 365 that enumerate specific categories of contracts where a counterparty may retain the contract rights notwithstanding rejection.  One of these exceptions—§ 365(n)—even carves out copyright and patent, but not trademark, licenses.  The Court rejected the negative inference that only these specific contracts survived rejection.  In doing so, the Court clarified that each exception was created in response to a judicial determination that a certain contract was terminated due rejection, thus, the Court determined, the exceptions did not alter the plain meaning of § 365.

Finally, the Court grounded its decision in policy, citing the general bankruptcy rule that “the estate cannot possess anything more than the debtor itself did outside of bankruptcy.”  The Court notes that a contrary holding—allowing termination upon rejection—would not only run afoul of this basic bankruptcy principle, but it would also undermine the exceptional cases where a bankruptcy trustee may legally undo pre-bankruptcy transfers, called “avoidance,” by making rejection the functional equivalent of avoidance.

Justice Sotomayor, agreeing with the Court in full, concurred to highlight two aspects of the Court’s decision. First, she noted that the decision does not decide that every trademark licensee may continue using licensed marks post-rejection because, for instance, the licensing agreement itself may include contrary provisions.  Second, given that § 365(n) enumerates specific provisions for the rejection of other intellectual property licenses, she noted that trademark licenses post-rejection are actually more expansive than other intellectual property licenses.

Justice Gorsuch dissented on the ground that the case was moot because the trademark license at issue expired nearly three years ago, but the Court rejected this argument because Mission asserted a damages claim based on its inability to use the COOLCORE marks post-rejection.

Strategy and Conclusion

Declaring for bankruptcy will not allow a debtor to prematurely terminate an ongoing trademark license.  As such, a decision to reject a trademark license may have little practical effect, only ridding a debtor of its obligation to provide services collateral to the trademark license itself.  To retain its valuable trademark rights and avoid naked licensing, the debtor will need to continue monitoring and policing the licensee, regardless of the rejection.

The Mission Product Holdings decision can be found here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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