The Supreme Court recently limited the ability of debtors to use contract rejection in bankruptcy to shed unwanted trademark licensees. But the Court acknowledged that the result could change if the trademark licensing agreement had different termination rights. Going forward, parties entering into trademark licensing agreements will need to consider this decision carefully as they negotiate termination rights in the event of a bankruptcy by the licensor.
In Mission Product Holdings, Inc. v. Tempnology, LLC nka OLD Cold LLC, 2019 WL 2166392, No. 17-1657 Slip Op. (U.S. May 20, 2019), the Supreme Court held that rejection of an executory contract involving a trademark license does not deprive the licensee of the right to use the trademark, resolving a longstanding question of how trademark licensing agreements are treated in bankruptcy.
Tempnology and Mission entered into a licensing agreement that allowed Mission to use Tempnology’s trademarks. Later, Tempnology filed for bankruptcy and moved to reject the agreement under section 365 of the Bankruptcy Code. The bankruptcy court granted the motion. Tempnology then sought a declaratory judgment that the rejection terminated Mission’s rights to use the trademarks. The Bankruptcy Court ruled in favor of Tempnology. On appeal, the Bankruptcy Appellate Panel (“BAP”) reversed the bankruptcy court’s judgment, but the First Circuit reversed the BAP and reinstated the bankruptcy court’s judgment.
The question of what happens to a trademark licensing agreement after rejection in bankruptcy has been brewing for many years. Thirty-four years ago, in Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985), the Fourth Circuit held that rejection of a patent licensing agreement terminated the licensee’s right to use the patent. In response, Congress amended the Bankruptcy Code to add section 365(n). Section 365(n) of the Bankruptcy Code specifies that rejection of an executory contract granting rights in intellectual property does not terminate the licensee’s rights. The legislative history of this section indicates that Congress specifically intended for it to overrule Lubrizol.
However, the definition of “intellectual property” in section 101(35A) does not include trademarks. Tempnology argued that this omission, coupled with other provisions that specifically state that certain contract counterparties retain rights after rejection, created a negative inference that Congress intended for trademark licensees to lose their rights after rejection.
The Court rejected this argument. The Court instead adopted the logic of the Seventh Circuit in Sunbeam Products Inc. v. Chicago American Manufacturing LLC, 686 F.3d 372 (7th Cir. 2012), which held that a trademark licensee did not lose its rights because rejection of a contract in bankruptcy was a merely a breach and did not rescind or vaporize the contract. Section 365(g) of the Bankruptcy Code provides that rejection “constitutes a breach.” “Breach” in this context has its ordinary contract law meaning and does not have any bankruptcy-specific meaning. Because a breach of a trademark licensing agreement outside bankruptcy would not, as a matter of law, result in a termination of the licensee’s rights to use the trademark, a breach within a bankruptcy should be no different.
This interpretation is consistent with the fundamental principle that a debtor’s interests in property are not expanded in bankruptcy beyond what those interests were outside bankruptcy. Outside of bankruptcy, a debtor would not be able to use its own breach to unilaterally terminate a licensee’s ability to use the debtor’s trademark, so it follows that a debtor in bankruptcy cannot do so either. To allow the debtor to do so would grant it greater contractual rights than it had prebankruptcy at the expense of its licensee.
The Court further noted that allowing the debtor to claw back trademark rights would be akin to the exercise of an avoidance power. However, the Bankruptcy Code sets very stringent limits on the exercise of avoidance powers. These powers can only be exercised in exceptional cases and only in the discrete ways laid out in chapter 5 of the Bankruptcy Code. Allowing rejection to claw back valuable interests in property “would subvert everything the Code does to keep avoidances cabined.” Mission Slip Op. at 12.
The Court also rejected the First Circuit and Tempnology’s argument that terminating a trademark licensee’s rights promotes the objectives of the Bankruptcy Code. The fundamental principle of the Bankruptcy Code, Tempnology argued, is to promote the debtor’s ability to reorganize. This goal is served, in part, by the ability of the debtor to reject burdensome executory contracts. Allowing a licensee to retain its rights to use a trademark after rejection would undermine this goal because trademarks, unlike other types of intellectual property, require affirmative action from the owner to police the quality of the products produced under the trademark. Otherwise, the trademark owner risks a decline in value of the trademark. Forcing a debtor to expend resources in this way would undermine the goals of the Bankruptcy Code by continuing the burdens of the contract after rejection and impeding the debtor’s efforts to reorganize.
As the Court pointed out, however, bankruptcy is not all about the debtor. The Bankruptcy Code was designed to strike a balance between competing interests. While debtors are able to shed burdensome obligations through rejection, section 365 of the Bankruptcy Code does not grant a broad “exemption from all the burdens of generally applicable law.” Mission Slip Op. at 16. It is not, in other words, a get out jail free card.
Prior to this decision, trademark licensors (outside of the Seventh Circuit) had a lot of leverage over their licensees in bankruptcy. If the debtor rejected the contract, the licensee could potentially lose their entire business. A debtor could thus extract significant concessions from the licensee under threat of rejection.
Now, debtors will have to think more carefully about whether any benefit can be achieved by rejecting trademark licensing agreements. Further, this decision almost certainly will eliminate a debtor’s ability to capture the upside of a license that has greater value than it did when it was issued to the licensee. If the licensee’s rights terminated, the debtor would be free to re-market the trademark license at a higher rate. Now, debtors will have to live with the licenses they have, even if those rates are below the current market.
This decision, however, only addresses the impact of the Bankruptcy Code on licensing agreements. Critically, as the Court acknowledged, the terms of a licensing agreement can change the outcome of any future case, notwithstanding the Mission decision. Thus, in consultation with counsel, future licensors may seek to include language that would terminate the licensee’s rights upon occurrence of a “triggering event,” such as covenant defaults in loan agreements, commencement of insolvency proceedings, the filing of a motion to reject in bankruptcy, or failure to assume or seek assumption before confirmation of a plan in a chapter 11 case.1 Licensees, on the other hand, should work with counsel to amplify their protections and be on the lookout for attempts to slip terms like this into their trademark licensing agreements.