The U.S. Supreme Court has ruled that bankrupt trademark licensors cannot use federal bankruptcy law to rescind the rights of their trademark licensees to continue use of duly licensed trademarks. The decision settles a long-simmering circuit split on a question that the International Trademark Association has labelled “the most significant unresolved legal issue in trademark licensing.”

The case arose out of a 2012 license and product distribution agreement granted by Respondent Tempnology, LLC to Mission Product Holdings Inc. to use Tempnology’s COOLCARE trademarks in connection with its sales of Tempnology’s cooling fabric for athletic apparel. The agreement was set to expire in July 2016. When Tempnology filed for bankruptcy in 2015, it sought to use that declaration as the basis to rescind the license under §365 of the Bankruptcy Code (11 U.S.C. §365). In response, Mission Product argued that Tempnology’s rejection of the license merely opened up Tempnology to a breach of contract claim rather than nullify Mission Product’s rights to continue to use Tempnology’s trademarks or Mission Product’s obligations to pay royalties for the duration of the agreement.

§365 of the Bankruptcy Code gives a debtor the option, subject to court approval, to assume or reject any executory contract. §365(g) provides that rejection “constitutes a breach” of an executory contract, but fails to provide a definition of “breach.” The breach is, however, interpreted as occurring immediately before the date of the petition.

The bankruptcy court rejected Mission Product’s arguments, finding that Tempnology’s rejection amounted to a rescission of the trademark license, thereby preventing Mission Product from using the marks through the conclusion of the agreement’s term. The Bankruptcy Appellate Panel reversed, explaining that the language of §365(g) plainly states that rejection constitutes “a breach,” and concluded instead that rejection does not terminate rights that would survive a breach of contract outside bankruptcy. The First Circuit then reinstated the bankruptcy court’s decision by holding that a licensee cannot continue to use a debtor-licensor’s marks if the debtor-licensor is released from the burden of exercising quality control over the licensee’s use.

The Supreme Court reversed. Writing for the Court in an 8-1 decision, Justice Kagan clarified that while rejection eliminates the debtor-licensor’s obligation to perform under the license agreement, rendering the licensor liable for breach of contract, it cannot retract rights previously granted to a licensee. Rather, a bankruptcy debtor’s rejection of an executory (i.e., ongoing and not yet completed) contract under §365 of the Bankruptcy Code has the same effect as a breach of that contract outside bankruptcy, namely, “[a]ll the rights that would ordinarily survive a contract breach, including [the trademark licenses] conveyed here, remain in place.” The “rejection-as-breach” rule reflects the general bankruptcy rule that an estate cannot possess anything more than the debtor itself did outside of bankruptcy. The rejection-as-rescission rule, on the other hand, would have circumvented the Code’s stringent limits on “avoidance” actions. “Section 365 does not grant the debtor an exemption from all the burdens that generally applicable law—whether involving contracts or trademarks—imposes on property owners,” the Court said.

Notably, the Court rejected Tempnology’s arguments that rejection of a trademark licensing agreement must terminate the licensee’s rights to use the mark, because the debtor must otherwise exercise quality control over the goods and services offered under the license (expending their scarce resources during a bankruptcy proceeding) or risk losing their rights in the marks through naked licensing. Because the position Tempnology advocated would govern nearly every executory contract, and not just trademark agreements, the Court observed, “[h]owever serious Tempnology’s trademark related concerns, that would allow the tail to wag the Doberman.”

Justice Sotomayor filed a concurring opinion, emphasizing that this decision is limited to trademark licenses that would survive breaches under applicable non-bankruptcy law, which is a fact-dependent inquiry. She also noted that this decision does not provide trademark licensees with the same protections explicitly afforded other types of intellectual property licensees by the bankruptcy statute.

Justice Gorsuch dissented, contending that this case was moot because the license at issue had expired after the bankruptcy court’s initial decision.

Comment

Monday’s decision reiterates that the bankruptcy laws are intended to shield debtors in certain ways, but these laws cannot be used as a sword to axe duly negotiated contracts, even when those contracts are executory. Trademark licensees should breathe a sigh of relief knowing that their licenses, if properly drafted, will not disappear in the event their licensor goes belly up. But the Court’s decision did not address how lack of quality control in such situations may impact the validity of licensed trademarks.

The case is Mission Product Holdings Inc. v. Tempnology, LLC, No. 17-1657(U.S. Supreme Court, Opinion, May 20, 2019)