White & Case Technology Newsflash
On May 20, 2019, the Supreme Court held in Mission Products Holdings, Inc. v. Tempnology, LLC that a debtor-licensor's rejection of a trademark license agreement does not "deprive the licensee of its rights to use the trademark."1 This holding resolves a longstanding circuit split in the Federal Courts of Appeal about the effects of bankruptcy on trademark licenses.
Tempnology manufactured athletic apparel and accessories under the brand-name "Coolcore." In 2012, Tempnology granted Mission Products a non-exclusive license until 2016 to use Coolcore trademarks in the United States and internationally, but Tempnology filed for bankruptcy in 2015, prior to the expiration of the license agreement. The Bankruptcy Court permitted Tempnology to reject its agreement with Mission Products under 11 U.S.C. § 365(a).2
Section 365(a) of the Bankruptcy Code provides that a debtor or trustee may, subject to court approval, assume or reject any "executory contract"— a contract in which some performance remains due on both sides. As a result, a debtor or trustee will decide whether the executory contract is worth maintaining, i.e., whether it is a net asset or net liability to the estate. While the exercise of this power is subject to court approval, the decision to assume or reject a contract is granted broad deference. If an executory contract is rejected, § 365(g) provides that the rejection constitutes a "breach" by the debtor, and the counterparty may sue and seek damages from the estate.
While the Bankruptcy Code specifically protects certain types of intellectual property rights upon contract rejection (including patents, trade secrets and copyrights), the Bankruptcy Code's (the "Code") definition of "intellectual property" does not include trademarks.3 Per § 365(n), a licensee of intellectual property whose agreement has been rejected may elect to retain its rights in the intellectual property, so long as it makes royalty payments for the duration of the contract.4
Section 365(n) was added to the Code to counter the Fourth Circuit decision Lubrizol Enterprises., Inc. v. Richmond Metal Finishers, Inc. (1985), which held that rejection of a patent license by a debtor-licensor rescinded the licensee's rights in the patent.5 In this case, as in many others, the Bankruptcy Court reasoned by negative inference that the omission of trademarks from § 365(n) means that the Lubrizol rule was not superseded by statute as applied to trademarks. Thus, Tempnology's rejection of the contract constituted a rescission of Mission Products' right to use the Coolcore trademark.6
The Bankruptcy Appellate Panel reversed, relying on the Seventh Circuit decision Sunbeam Products v. Chicago American Manufacturing, LLC (2012).7 In Sunbeam, Judge Easterbrook held that rejection of a trademark license constitutes a breach of the contract, and, both in and out of the bankruptcy context, "a licensor's breach does not terminate a licensee's right to use intellectual property."8
The Court of Appeals for the First Circuit rejected this interpretation, instead relying upon Lubrizol and distinguishing trademarks from other forms of IP in the bankruptcy context.9 Trademarks require a continued obligation on the part of a licensor to monitor the quality of goods associated with the licensed trademark, placing a burden on the debtor's estate that the First Circuit believed Congress intended to avoid by creating the option for the licensor to reject the contract.10
After granting certiorari to resolve this split between the First and Seventh Circuits, the Supreme Court, in an opinion delivered by Justice Kagan, held that Tempnology could not rescind in bankruptcy the trademark license it had previously granted.11 Specifically, the Court held that "[r]ejection of a contract—any contract—in bankruptcy operates not as a rescission, but as a breach."12 Because "breach" is not a "specialized bankruptcy term," the traditional rule that the injured party "retains the rights it has received under the agreement" holds.13 The Court rejected Tempnology's argument that there was a negative implication created by various sections of the Code. Tempnology had reasoned that because §§ 365(h) and 365(n) identify specific categories of contracts where the counterparty retains its contractual rights despite a debtor's rejection (respectively, real-property leases and intellectual property, excluding trademarks), a debtor's rejection of any other contracts terminates the rights of the counterparty.14
In response to this argument, the Court analyzed the legislative history of § 365 and found that the various provisions identified by Tempnology "emerged at a different time" and "responded to a discrete problem—as often as not, correcting a judicial ruling of just the kind Tempnology urges."15 Accordingly, "Congress enacted the provisions, as and when needed, to reinforce or clarify the general rule that contractual rights survive rejection."16 The Court held that § 365(n)'s failure to expressly include trademark licenses does not lead to the negative inference that Congress intended to treat a debtor's rejection of a trademark license as a termination of the licensee's rights.17
One point on which the Court was silent is whether, in the case of an exclusive trademark license, the license's exclusivity would also survive a rejection. In the case of other categories of intellectual property protected by § 365(n), the statute expressly states that exclusivity survives rejection. One might argue that the obligation to refrain from granting further rights to other licensees is an obligation of the licensor, which the licensor could abandon upon rejection, subject only to pre-petition claims for damages, and consequently, only the express provisions of § 365(n) enable such exclusivity to survive.
On the other hand, the majority's reasoning, as articulated by Justice Kagan, indicates that the Court may hold the opposite view and that exclusivity for trademark licensees should also survive rejection. The Court noted that under § 365(g), the bankruptcy estate "cannot possess anything more than the debtor itself did outside bankruptcy."18 Thus, a debtor's rights should not expand by virtue of the filing of a bankruptcy petition. Consequently, a future court might hold that if a licensor did not have the right to grant further trademark licenses prior to bankruptcy, bankruptcy would not expand such a licensor's rights.
The Tempnology decision has clear implications for trademark licensees who have to measure the counterparty risks of the licensors of their trademarks. Tempnology may not eliminate the risks that arise out of a trademark licensor's bankruptcy, but it reduces them considerably. A trademark licensor in bankruptcy can no longer cut off a licensee's rights of a licensee to continue using the trademarks. Moreover, a licensor's estate may now be less likely to reject a trademark license agreement, because such a rejection would likely only serve to impair the value of the trademarks, as quality control protections may fall away in the wake of such rejection.
Tempnology may also have implications for companies seeking to restructure in advance of a potential bankruptcy reorganization. A bankruptcy of an entity holding trademark assets will not necessarily jeopardize intra-company licenses of those trademarks to other parts of an enterprise. On the other hand, a holding company's ability to maintain and enforce such trademarks may still be jeopardized by a bankruptcy, as well as the losing of the ownership value of the trademarks themselves. Moreover, as discussed above, the exclusivity of such intra-company licenses still remains uncertain.
Although Tempnology does not resolve all of the unanswered questions of intellectual property licenses in bankruptcy, it answered a key question and may signal the direction for other rulings through its strongly worded view that entering bankruptcy should not contract or expand the rights of a licensor. It is worth considering whether the Court will eventually apply this same view to licensees who enter bankruptcy, where there also remains some uncertainty under the current law. Going forward, practitioners will need to give the entire decision careful consideration when restructuring companies where trademark and other intellectual property licenses between entities are material to operations.
1 587 U. S. ____, 1 (2019).
2In re Tempnology, LLC, 541 B.R. 1, 7 (Bankr. D.N.H. 2015).
3 See 11 U.S.C. § 101(35A).
4 11 U.S.C. § 365(n).
5 756 F.2d 1043, 1048 (4th Cir. 1985).
6In re Tempnology, LLC, 541 B.R. at 7–8.
7In re Tempnology LLC, 559 B.R. 809, 819–22 (B.A.P. 1st Cir. 2016) (citing Sunbeam Prods. v. Chi. Am. Man., LLC, F.3d 372 (7th Cir. 2012)).
8 Sunbeam, F.3d at 376–77 (citing §365(g)).
9In re Tempnology, LLC, 879 F. 3d 389, 394–95 (1st Cir. 2018).
10 Id. at 402–403.
11 Justice Kagan was joined in her decision by Chief Justice Roberts, and Justices Thomas, Ginsburg, Breyer, Alito, Sotomayor (who authored a concurrence), and Kavanaugh. Justice Gorsuch dissented on grounds the case was moot.
12Mission Prod. Holdings, Inc. v. Tempnology, LLC, 587 U. S. ____, at 8.
13Id. at 8, 10.
14Id. at 12.
15Id. at 13.
17Id. at 14.
18Id. at 11.