SCOTUS Rules Rejection of Trademark License in Bankruptcy Does Not Terminate Right to Use Mark

Decision is a Win for Trademark Licensees

In an 8-1 decision in Mission Products Holdings, Inc. v. Tempnology, LLC,[1] the US Supreme Court held that a rejection of a trademark license under the US Bankruptcy Code[2] by a debtor-licensor does not rescind the license or terminate the licensee’s right to continued use of the mark. [3] Such a rejection, instead, constitutes a breach and leaves the licensee with: (i) a pre-petition bankruptcy claim for the damages caused by the debtor’s breach; and (ii) its post-breach rights in the license the licensee would have under applicable non-bankruptcy contract law. This holding overrules the prior decision by the US Court of Appeals for the First Circuit,[4] resolves the short-lived split amongst the Court of Appeals on the issue and provides certainty to trademark licensees.

A more thorough description of the case background and discussions regarding the lower courts’ prior rulings as well as the formerly leading decisions on the trademark license rejection issue from the US Courts of Appeals for the Third and Seventh Circuits can be found in Arent Fox’s prior Alert summarizing the First Circuit’s decision.

The US Supreme Court’s Reasoning

Writing for the majority, Justice Kagan looked to the plain language of sections 365(a) and (g) of the Bankruptcy Code. Section 365(a) gives debtors the option, subject to court approval, to assume or reject any executory contracts. Section 365(g) provides that such rejection “constitutes a breach of [an executory] contract” that is deemed to occur “immediately before the date of the filing of the petition.” [5] Because the Bankruptcy Code does not define the term “breach,” Justice Kagan reasoned that the term carries the meaning applicable under relevant non-bankruptcy contract law. [6]

Therefore, the Supreme Court held that the same consequences that follow a licensor’s breach of a trademark license under non-bankruptcy law follow a breach caused by rejection in bankruptcy. [7] If, for example, a breach by a trademark licensor under applicable non-bankruptcy law would not rescind the license or cutoff the licensee’s right to use of the mark, then a debtor-licensor’s rejection of a trademark license also does not terminate the licensee’s right to use the mark.

No Negative Inferences

The Supreme Court’s plain language interpretation of sections 365(a) and (g) expressly counters the negative inference argument commonly raised by debtor-lessors seeking to terminate the rights of trademark licensees. Since the enactment of the Bankruptcy Code, Congress has periodically modified section 365(g)’s general rule that bankruptcy rejection constitutes a pre-petition breach of the contract. Section 365(n), for example, [8] provides that licensees of certain types of intellectual property licenses—excluding trademarks—may retain certain rights after rejection of the licenses. Debtor-licensors, including the debtor in Mission Products, have argued that Congress’ omission of trademarks from section 365(n) demonstrates its intent to exclude trademark licensees from the types of counter parties permitted to retain rights in licenses post-rejection.

In the majority decision, the Supreme Court notes that section 365(n) was specifically enacted by Congress to reverse the Fourth Circuit’s controversial decision in Lubrizol Enterprises v. Richmond Metal Finishers, [9] where the court found that a patent licensee’s rights terminated upon the debtor-lessor’s rejection of the patent license. Congress’ repudiation of Lubrizol by enacting section 365(n), Justice Kagan opined, does not show any intent from Congress to ratify Lubrizol’s approach for almost all other executory contracts and unexpired leases. [10] By adopting section 365(n), “Congress did nothing … to alter the natural reading of section 365(g)—that rejection and breach have the same result.”[11] Rather than change the general rule embodied by section 365(g), section 365(n) merely “sets out a remedial scheme embellishing on or tweaking the general rejection-as-breach rule[]” for intellectual property licenses governed by section 365(n).[12]

In her concurrence, Justice Sotomayor highlighted that the majority’s holding confirms that, in some respects, a trademark licensee’s post-rejection rights and remedies are more expansive as compared to those of other intellectual property licensees due to section 365(n)’s modification of the general rejection-as-breach rule. [13] She further noted that to the extent Congress saw fit to address the divergent treatment of trademark licensees and licensees covered by section 365(n), that Congress could do so with future legislation.

Practice Points To Consider

Mission Products solidifies the uncertainty that has surrounded the rejection of trademark licenses since Congress’ enactment of section 365(n). Before this decision, trademark licensors could attempt to control a licensee’s post-rejection rights by commencing its bankruptcy case in a friendly jurisdiction. [14] Now, regardless of which jurisdiction a debtor-licensor files for bankruptcy, a licensee’s post-rejection rights remain the same: the licensee retains whatever post-breach rights it held, if any, under applicable non-bankruptcy contract law.

While Mission Products is a confirmation for trademark licensees, not all is lost for licensors. As aptly highlighted by Justice Sotomayor in her concurrence, Mission Product’s majority decision “does not decide that every trademark licensee has the unfettered right to continue using licensed marks post-rejection.” [15] Where applicable non-bankruptcy contract law provides that a licensee’s right to continued use of the licensed mark does not survive the licensor’s breach, the debtor-licensor’s rejection of the trademark license will correspondingly cutoff the licensee’s rights.

As such, a licensor looking to terminate its licensee’s rights post-rejection is advised to structure a trademark license transaction so that the license does not survive the licensor’s breach. [16] Such license termination provisions, however, must be drafted so that they are not automatically triggered by the licensor’s insolvency, lest such provisions are deemed impermissible ipso facto clauses and stricken from the agreement.

On the contrary, a licensee is advised to ensure that its trademark license agreement does not contain language terminating its right to use the mark following a licensor’s breach. To the extent that a licensee is unsure whether non-bankruptcy contract law provides as such, the licensee should seek to modify its license agreement to make clear that its right to use the mark survives the licensor’s breach.

Furthermore, while Mission Products solely discusses the post-rejection rights of non-debtor parties in the context of trademark licenses, the Supreme Court did not necessarily limit its ruling to trademark license agreements. Indeed, the Court’s holding can be interpreted to be applied to any executory contract or unexpired lease, other than those that Congress has expressly excepted from the general rejection-as-breach rule, such as those provided for in sections 365(h), (i) and (n).

 

[1] Case No. 17-1657, ___ S.Ct. ___, 2019 WL 2166392 (U.S. May 20, 2019).

[2] Title 11 of the U.S. Code.  All references to a statutory section contained herein are made to the Bankruptcy Code.

[3] In the dissenting opinion, Justice Gorsuch opined that the Court should have declined to hear the Mission Products case because, in his view, there was no live case and controversy for the Court to redress. See id. at *10.

[4] In re Tempnology, LLC, 879 F.3d 389, 392 (1st Cir. 2018).  While not directly addressed by the Supreme Court, Mission Products also implicitly rejects the case-by-case approach endorsed by Judge Ambro in his concurrence in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010) as amended (June 24, 2010).  While not binding on lower courts in the Third Circuit, Judge Ambro’s concurrence has been relied on extensively by lower courts throughout this Circuit. See, e.g., In re Crumbs Bake Shop, Inc., 522 B.R. 766, 772 (Bankr. D.N.J. 2014) (sharing “Judge Ambro’s perspective that Congress intended the bankruptcy courts to exercise their equitable powers to decide, on a case by case basis, whether trademark licensees may retain the rights listed under § 365(n)”).  Following the Mission Products decision, bankruptcy courts in the Third Circuit no longer can employ their equitable powers to determine whether a trademark licensee can retain its rights on a case by case basis.

[5] Mission Products, 2019 WL 2166392 at *5.

[6] Through this reasoning, the Supreme Court has effectively affirmed the Seventh Circuit’s decision in Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).  The Supreme Court’s decision here follows the same reasoning employed by the Bankruptcy Appellate Panel for the First Circuit (the “BAP”) in its prior decision, In re Tempnology LLC, 559 B.R. 809, 822–23 (B.A.P. 1st Cir. 2016), which the First Circuit overruled.  The BAP, likewise, followed the Seventh Circuit’s reasoning in Sunbeam Products.

[7] Mission Products, 2019 WL 2166392 at *5.

[8] Congress further modified section 365(g)’s general rejection-as-breach rule for real property lessees (365(h)(1)) and counterparties to timeshare interest agreements (365(h)(2)) and real property sale contracts (365(i)).

[9] 756 F.2d 1043 (4th Cir. 1985).  Lubrizol is discussed in greater detail in Arent Fox’s prior Alert at footnote 8.

[10] Mission Products, 2019 WL 2166392 at *7.

[11] Id.

[12] Id. at *7 n. 2.  Likewise, the other provisions of section 365 described above in note 5 also merely embellish or tweak the general rule rejection-as-breach rule as to the types of agreements covered by those provisions.  See id.

[13] For example, while a trademark licensee’s post-rejection rights are governed by applicable non-bankruptcy contract law, a licensee governed by section 365(n) that chooses to retain its rights post-rejection “must make all of its royalty payments; the licensee has no right to deduct damages from its payments even if it otherwise could have done so under non-bankruptcy law.”  Id. at * 9.

[14] Filing in the First Circuit, for example, allowed a licensor to terminate its licensee’s post-breach rights through bankruptcy rejection.  See Tempnology, 879 F.3d at 392.  On the other hand, filing in the Seventh Circuit resulted in the same outcome endorsed by the Supreme Court in Mission Products (post-rejection rights are determined by applicable non-bankruptcy contract law) and filing in the Third Circuit left the decision of whether the lessee’s rights persisted post-rejection to be determined by the bankruptcy courts on a case-by-case basis.  See, e.g., Crumbs Bake Shop, 522 B.R. at 772 (following Exide Techs., 607 F.3d 957). 

[15] Id. at *9.

[16]For example, a licensor can condition the licensee’s use of the trademark on the licensor’s periodic quality-control review of products bearing the mark and, if the licensor fails to approve the quality of the product within a set timeframe, the licensee is not permitted to use the mark.  Where such a licensor stops conducting quality-control reviews post-rejection, the licensee would only be left with a claim against the debtor-licensor for breach.  See, e.g., Brief for American Intellectual Property Law Association as Amicus Curiae 20-25 (discussing contract terms which could result in limits to the trademark licensee’s post-rejection rights).

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