05 Aug 2019 in Newsletter
U.S. Supreme Court Decision in Mission Product Resolves Issues Surrounding Trademark Agreements Rejected in Bankruptcy
In Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657 (S.Ct. May 20, 2019), the U.S. Supreme Court issued a ruling that will have broad implications for licenses and other agreements in bankruptcy. The Court held that agreements rejected by a debtor in bankruptcy are not terminated. Instead, the non-debtor party retains whatever rights it would have under applicable non-bankruptcy law following a breach of agreement. Specifically, the issue at hand was whether a debtor-licensor’s rejection of a contract deprives the licensee of its rights to use the trademark. The Supreme Court held that, in bankruptcy proceedings, rejection of a trademark license does not terminate the agreement, and that all rights that would ordinarily survive a contract breach remain in place.
The parties involved in this case are Mission Products, an online apparel company, and Tempnology, a manufacturer of clothing and accessories designed to stay cool when used in exercise. The parties entered into an agreement that granted Mission the exclusive right to use Tempnology’s COOLCORE trademarks on Tempnology products distributed by Mission in the United States, as well as a non-exclusive license to use the COOLCORE trademarks around the world.
The agreement was set to expire in July 2016, but in September 2015, Tempnology filed for Chapter 11 bankruptcy. During the bankruptcy proceedings, Tempnology asked the Bankruptcy Court to allow it to “reject” the licensing agreement under 11 U.S.C. § 365(a). Section 365(a) of the Bankruptcy Code provides that a “trustee [or debtor], subject to the court’s approval, may assume or reject any executory contract.” § 365 (a). A rejection of an executory contract constitutes a breach of the contract that is deemed to occur immediately before the date of filing the bankruptcy petition, under § 365(g). The non-breaching party then has a claim against the estate for damages resulting from non-performance, but the claim is unlikely to ever be paid in full and usually only cents on the dollar.
Here, the Bankruptcy Court approved Tempnology’s rejection of the licensing agreement with Mission. The parties agreed that the rejection meant that Tempnology could stop performing under the contract and that Mission could assert a claim for damages in the bankruptcy proceeding. However, the dispute arose between the parties regarding whether Tempnology’s rejection also terminated the rights it had granted to Mission under the agreement to use the COOLCORE trademarks.
Tempnology argued that rejection of a trademark license should result in termination of the license. Tempnology partially based their position on the argument that trademark licenses are unique in that they impose an ongoing duty on the licensor to monitor and exercise quality control over the trademarks. As a general principle, a trademark owner’s failure to exercise quality control over goods associated with the mark puts the validity of the mark owner’s rights in jeopardy. This ongoing duty requires the licensor’s time and resources, and therefore will not release the debtor’s estate from burdensome obligations, which is the principle aim of Congress in providing for rejection of contracts in bankruptcy.
Under § 365(n), if the debtor-licensor rejects the agreement, the licensee can continue to use the property (typically, a patent), so long as it makes whatever payments the contract demands. In further support of its position that rejection of a trademark license should also terminate the license, Tempnology relied on a negative inference of the language of § 365(n). While Section 365 specifically addresses how rejection affects many other types of contracts, it does not address trademark licenses. Further, § 101(35A), which provides definitions for the Bankruptcy Code, defines intellectual property to include trade secrets, patents, patent applications, plant varieties, copyrights and mask works for semiconductor chip products—but leaves out trademarks. In support of its position that the license should be terminated, Tempnology argued that the exclusion of trademarks from these sections of the Bankruptcy Code means that the ordinary consequence of rejection of this type of contract should be treated differently, i.e. that trademark licenses should be an exception to the general rule of the statute.
The Bankruptcy Court agreed with Tempnology’s position, holding that the debtor’s rejection of a trademark license must extinguish the rights that the agreement had conferred on the trademark licensee. On appeal, the Bankruptcy Appellate Panel reversed, holding that rejection of a contract converts a debtor’s unfulfilled obligations to a pre-bankruptcy-petition damages claim, but it does not terminate the contract or vaporize the counterparty’s rights. Next, the Court of Appeals for the First Circuit rejected the Panel’s view and reinstated the Bankruptcy Court decision terminating Mission’s license.
Mission then petitioned the U.S. Supreme Court to resolve the split between the lower courts. The Supreme Court granted certiorari and reversed the First Circuit’s ruling, holding that rejection of a trademark license under Section 365 of the Bankruptcy Code does not terminate the licensee’s right to continue using the licensed mark. Justice Kagan authored the 8-1 decision, stating: “A rejection breaches a contract but does not rescind it. And that means all the rights that would ordinarily survive a contract breach … remain in place.” The Court reasoned that under § 365(g), rejection of a contract constitutes breach of a contract. Therefore, the same consequences for breach of a contract follow in bankruptcy. As Kagan summarizes, “The debtor can stop performing its remaining obligations under the agreement. But the debtor cannot rescind the license already conveyed. So the licensee can continue to do whatever the license authorizes.”
In practice and going forward, it will be especially important for trademark licenses to explicitly set out mechanisms to account for this decision. Specifically, trademark licensors should attempt to preserve some form of control that complies with bankruptcy and contract law, and also addresses a licensees’ post-rejection activities. Furthermore, licensor companies contemplating Chapter 11 bankruptcy must take into consideration rights that will be retained by licensees for rejected agreements. Whether Congress will take any action in light of this ruling remains to be seen. For now, the impact of rejection of trademark licenses in bankruptcy proceedings is resolved.