May 23, 2019Client Alert

Rejection of a Trademark License Agreement under the Bankruptcy Code does not Result in Rescission of the License

On May 20, 2019, an 8-1 majority of the United States Supreme Court held that a bankruptcy debtor’s rejection of a trademark license agreement does not constitute a rescission of the license under the Bankruptcy Code. This resolved a split among federal circuit courts previously addressing the issue. Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657 (May 20, 2019). As a result, the Court clarified that a trademark licensee may continue using trademarks licensed under such agreements even if the debtor rejected the contract under the Bankruptcy Code, provided the licensee could do so outside of bankruptcy (for example, because the licensee continues performing its obligations under the contract).

The case involved debtor-licensor Tempnology, LLC, a manufacturer or clothing marketed under the COOLCORE trademark. Tempnology in 2012 entered into a trademark license agreement with Mission Product Holdings, Inc., granting Mission Product Holdings an exclusive license to distribute various COOLCORE-brand products in the U.S., as well as a non-exclusive license to use the COOLCORE trademark internationally.

After entering Chapter 11 bankruptcy proceedings in 2015, however, Tempnology invoked § 365(a) of the Bankruptcy Code and obtained permission to “reject” the licensing agreement. Tempnology then successfully sought a declaratory judgment before the Bankruptcy Court, ordering that rejection of the contract resulted in rescission of the trademark license given to Mission Product Holdings.

As background, under § 365(a), a debtor, subject to court approval, may reject any “executory contract.”  § 365(a). “A contract is executory if performance remains due to some extent on both sides.”  Mission Product Holdings, slip op. at 2. Under § 365(g), “the rejection of an executory contract [ ] constitutes a breach of such contract.”  § 365(g). Consequently, a debtor-licensor’s rejection of a trademark licensing agreement under the Bankruptcy Code creates for the counterparty-licensee a claim for damages against the bankruptcy estate for the debtor-licensor’s non-performance of the contract. A circuit split existed concerning whether, after such a rejection, the counterparty-licensee also retained its rights to use the trademark under the rejected licensing agreement.

The issue before the Supreme Court was “whether the debtor-licensor’s rejection of a [trademark licensing agreement] deprives the licensee of its rights to use the trademark.”  Mission Product Holdings, slip op. at 1. Tempnology argued in the affirmative, citing another Bankruptcy Code provision, § 365(n), which specifies that when a debtor-licensor rejects a patent license agreement, the licensee may continue using the patent, consistent with the licensee’s continued compliance. Because neither § 365(n) nor any other Bankruptcy Code provision specified such a rule for trademark license agreements, Tempnology reasoned that the general rule of § 365(a) results in rescission of a trademark license when a debtor-licensor rejects a trademark license agreement under § 365(a). Tempnology also argued that certain differences between typical contracts and trademark license agreements supported its position, notably a trademark licensor’s duty to monitor and exercise quality control over a licensee’s use of the mark. Accordingly, Tempnology reasoned, allowing a licensee to continue using a mark after rejection of the agreement by the debtor-licensor would impede “Congress’s principal aim in providing for rejection . . . to release the debtor’s estate from burdensome obligations.”  Mission Product Holdings, slip op. at 5 (quoting 1st Circuit opinion).

Under trademark law, a trademark licensor has a duty to monitor and “exercise quality control over the goods and services sold” under a license. Mission Product Holdings, slip op. at 14-15. If the licensor fails to undertake such quality control efforts, “the mark will naturally decline in value and may eventually become altogether invalid.”  Mission Product Holdings, slip op. at 15 (citing 3 J. McCarthy, Trademarks and Unfair Competition § 18:48, pp. 18-120, 18-133 (5th ed. 2018)). Tempnology argued that if rejection of a trademark license fails to terminate the licensee’s rights to use the mark, then the debtor is presented with a choice between (1) expending limited resources on quality control, or (2) risk losing its trademark assets. Both choices, Tempnology argued, would undermine a fundamental purpose of the Bankruptcy Code to allow companies to reorganize.

The Court found the existence of this eventuality unpersuasive, noting that § 365 does not “relieve the debtor of the need . . . to make economic decisions about preserving the estate’s value – such as whether to invest the resources needed to maintain the trademark.”  Mission Product Holdings, slip op. at 16. Ultimately, the Supreme Court disagreed with Tempnology’s position, reversed the First Circuit and held that a rejection of a contract under the Bankruptcy Code “has the same consequence as a contract breach outside bankruptcy:  It gives the counterparty a claim for damages, while leaving intact the rights the counterparty has received under the contract.”  Mission Product Holdings, slip op. at 8. In short, “[r]ejection of a contract – any contract – in bankruptcy operates not as a rescission but as a breach.” Id. The Court based its decision on the broad language of § 365(a), which applies to “any executory contract[s],” necessarily including trademark licensing agreements. Id., slip op. at 10 (emphasis added). Furthermore, such a holding comported with (1) the “general bankruptcy rule” that an “estate cannot possess anything more than the debtor itself did outside bankruptcy,” and (2) the Bankruptcy Code’s “stringent limits on ‘avoidance’ actions” in which bankruptcy trustees may unwind pre-bankruptcy transfers. Id., slip op. at 9. The Court rejected the negative inference relied upon by the First Circuit – that the Bankruptcy Code specified an exhaustive list of particular types of contracts, including patent license agreements, in which a counterparty retains certain post-rejection rights. The Court noted that the provisions cited by Tempnology were enacted by Congress to overrule specific judicial rulings holding that rejection under § 365 terminated all contractual rights (precisely the type of ruling Tempnology sought), and such provisions also clarified certain details about the post-rejection relationship. Therefore, the Court noted its interpretation did not render § 365(n) redundant with § 365(g).

In light of Mission Product Holdings, trademark licensees may continue using trademarks licensed under contracts rejected under the Bankruptcy Code to the same extent they could if the licensor breached the license agreement outside of bankruptcy. Licensees also retain the ability to sue the bankruptcy estate for non-performance of the contract, but § 365(g) puts such licensees in the position of unsecured creditors who may be unlikely to recover full, if any, damages. Correspondingly, because a debtor-licensor’s rejection of a trademark licensing agreement under the Bankruptcy Code does not rescind the license, debtor-licensors wishing to keep their trademark rights must be mindful of their duty to monitor and exercise quality control over their licensee’s use of the trademark.

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