In 8-1 decision resolving circuit court split, U.S. Supreme Court holds that bankrupt company’s rejection of executory contract containing trademark license constitutes breach of contract, not its rescission or termination, and licensee retains its rights under the license.
Respondent Tempnology, a manufacturer of clothing and accessories, entered into a Co-Marketing and Distribution Agreement in 2012 with petitioner Mission Product Holdings, granting Mission Products a nonexclusive license to use Tempnology’s trademarks in the U.S. and internationally. The term of the agreement was through 2016. But Tempnology filed for Chapter 11 bankruptcy in 2015 and rejected the contract pursuant to Section 365(a) of the U.S. Bankruptcy Code. Under Section 365, a “trustee [or debtor], subject to the court’s approval, may assume or reject any executory contract. According to Section 365(g), “the rejection of an executory contract  constitutes a breach of such contract.” Tempnology subsequently sought, and the bankruptcy court granted, a declaratory judgement terminating Mission’s trademark rights.
Mission argued that Tempnology’s rejection did terminate its rights under the agreement. Tempnology countered, and the bankruptcy court agreed, that a negative inference should be drawn from Section 365(n) of the Bankruptcy Code. This provision identifies licenses of certain types of intellectual property — but does not include trademarks — in which a counterparty licensee may retain specified rights despite the license’s rejection in bankruptcy. The bankruptcy court concluded that this exclusion of trademarks from protection under Section 365(n) meant that Mission’s licensed rights to the trademarks terminated upon Tempnology’s rejection.
On appeal, the bankruptcy appellate panel reversed, holding that Tempnology’s rejection of the agreement “did not vaporize Mission’s trademark rights under the agreement.” Following the Seventh Circuit’s 2012 decision in Sunbeam Prods, Inc. v. Chicago Mfg., LLC, Tempnology’s rejection did not terminate Mission’s rights in the licensed trademarks because the Bankruptcy Code defines rejection as a contract breach, which “does not eliminate rights conferred on the non-breaching party.”
The First Circuit, however, rejected the appellate panel’s decision and the Seventh Circuit’s view, affirming the bankruptcy court’s holding and effectively terminating Mission’s license. The court of appeals instead followed the reasoning of the Fourth Circuit’s 1985 decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., which held that a debtor’s rejection of a technology license equated to termination of the licensee’s patent rights. The circuit court also endorsed the bankruptcy court’s negative inference from the exclusion of trademarks from Section 365(n). In addition, the First Circuit concluded that a trademark licensor’s continuing duty to “monitor and exercise control over” the use of its trademark, implied by the rejection-as-breach approach of the Seventh Circuit and the bankruptcy appellate panel, would frustrate “Congress’s principal aim in providing for rejection”: namely, to “release the debtor’s estate from burdensome obligations.”
The U.S. Supreme Court granted certiorari to resolve the question at the heart of the split between the First and Seventh Circuits, namely: “Whether, under Section 365 of the Bankruptcy Code, a debtor-licensor’s ‘rejection’ of a license agreement — which ‘constitutes a breach of such contract’ — terminates rights of the licensee that would survive the licensor’s breach under applicable non-bankruptcy law.” The Court reversed the First Circuit’s holding, agreeing with the approach of the bankruptcy appellate panel and the Seventh Circuit.
Writing for the Court, Justice Elena Kagan stated that “[r]ejection of a contract — any contract — a in bankruptcy operates not as a rescission but as a breach.” Justice Kagan explained that “both Section 365’s text and fundamental principles of bankruptcy law command the … rejection-as-breach approach.” Justice Kagen emphasized that Section 365 also reflects a general bankruptcy rule that “[t]he estate cannot possess anything more than the debtor itself did outside bankruptcy,” and that the rejection-as-breach rule ensures that “[a] debtor’s property does not shrink by happenstance of bankruptcy, but it does not expand, either.”
The Court also detailed why it disfavored the First Circuit’s rejection-as-rescission approach. The First Circuit’s characterization of the effect of rejection would “circumvent the Code’s stringent limits on ‘avoidance’ actions — the exceptional cases in which trustees (or debtors) may indeed unwind pre-bankruptcy transfers that undermine the bankruptcy process.” As Justice Kagan explained: “If trustees (or debtors) could use rejection to rescind previously granted interests then rejection would become functionally equivalent to avoidance.”
Tempnology’s principal counterargument rested on the negative inference drawn from Section 365(n) of the Bankruptcy Code, which the First Circuit endorsed. In response, Justice Kagan cited the legislative history of the portions of Section 365 on which Tempnology relied, and explained that Congress created each one — like Section 365(n) — to address a “discrete problem” such as “correcting a judicial ruling.” “Congress enacted the provisions, as and when needed, to reinforce or clarify the general rule that contractual rights survive rejection,” Justice Kagin wrote. The omission of trademark from Section 365(n) does not support Tempnology’s position.
The Court also rejected Tempnology’s argument that trademark licenses should be treated differently from other contracts under Section 365, because applying a rejection-as-termination rule to trademark licenses better supports debtor reorganization in bankruptcy. The Court disagreed, explaining that, while Section 365 is a “powerful tool” providing debtors with the ability to reject contracts and escape future obligations without paying “much of anything in return,” that section does not grant them “an exemption from all the burdens that generally applicable law — whether involving contracts or trademarks — imposes on property owners.”
Justice Gorsuch penned the lone dissent, writing that mootness should have precluded the Court’s review. “After the bankruptcy court ruled, the license agreement expired by its own terms, so nothing we might say here could restore Mission’s ability to use Tempnology’s trademarks,” wrote Justice Gorsuch. The majority, however, found that the case was not moot, reasoning that the Court could only dismiss a case for mootness if “it is impossible for a court to grant any effectual relief whatever,” assuming the petitioner prevails. In this case, Mission presented a claim for money damages arising from its inability to use Tempnology’s trademarks between the time the agreement was rejected and the agreement’s stipulated expiration date. “If there is any chance of money changing hands [to compensate for damages], Mission’s suit remains live,” ruled the majority.