On May 20, 2019, the U.S. Supreme Court resolved a circuit split on the treatment of trademark licenses in bankruptcy. In an 8-1 decision, the Court held that a licensor's rejection of a trademark license in bankruptcy does not rescind the rights conveyed to the licensee. Rather, the licensee may continue to use the trademark if it wishes to do so, so long as it continues to comply with its own obligations under the license (such as payment of royalties) if that is what would be required to retain its rights after breach by the licensor in a non-bankruptcy environment.
The case, Mission Product Holdings, Inc. v. Tempnology, LLC,1 addresses the provision of the U.S. Bankruptcy Code allowing a debtor to "reject any executory contract"—a contract in which material performance is due on both sides.2 Section 365(g) of the Bankruptcy Code provides that a debtor's rejection of an executory contract "constitutes a breach of such contract." In Mission Product, the Supreme Court was asked to consider the meaning of these provisions in the context of a trademark licensing agreement. Specifically, the Court was asked to determine whether the debtor-licensor's rejection of that contract deprives the licensee of its rights to use the trademark.
Background
The case arises from a 2012 licensing agreement between Tempnology and Mission Product Holdings that gave Mission exclusive rights for United States distribution of Tempnology's clothing and accessories branded under the name "Coolcore." The agreement granted Mission a non-exclusive license to use the Coolcore trademarks, both in the U.S. and around the world. In 2015, Tempnology filed a petition for Chapter 11 bankruptcy and sought to reject the licensing agreement.
The U.S. Court of Appeals for the First Circuit sided with Tempnology, finding that rejection of the agreement rescinded the licensee's rights. The First Circuit reasoned that allowing the license to remain in effect would force the debtor to continue monitoring the trademark's use—exactly the type of burden from which the bankruptcy process is designed to free the debtor. In doing so, the First Circuit split with the Seventh Circuit, which has held that rejection of a trademark license does not terminate the licensee's rights to use the debtor's trademarks.3
The Supreme Court's Decision
In May 2019, the Supreme Court ruled that because rejection constitutes a breach, the result of rejection in bankruptcy must be the same as that of a breach outside of bankruptcy. Therefore, the debtor can stop performing its remaining obligations under the license agreement, but it "cannot rescind the license already conveyed." The licensee can continue to do whatever the license authorizes so long as the licensee's rights would survive the licensor's breach under applicable non-bankruptcy law.
The Court relied on the general bankruptcy principle that the debtor's estate cannot possess anything more than the debtor itself did outside bankruptcy. Therefore, if the not-yet debtor was subject to a counterparty's contractual right, so too is the trustee or debtor once the bankruptcy petition has been filed.
Tempnology's main argument to the contrary relied on provisions in the Bankruptcy Code that expressly identify certain types of contracts under which a counterparty may retain rights notwithstanding rejection. The absence of a specific carve-out for trademark licenses, Tempnology argued, gives rise to a negative inference with respect to such licenses. The Court rejected this view, concluding that the omission does not override "the main provisions governing rejection."
The Court also dismissed Tempnology's argument that the special features of trademark law make ongoing license rights particularly burdensome to the debtor-licensor, impeding the debtor's ability to reorganize. Acknowledging that a trademark licensor has a duty to monitor and exercise quality control over the goods and services sold under a license, the Court concluded that Section 365 of the Bankruptcy Code "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 observed: "The Code of course aims to make reorganizations possible. But it does not permit anything and everything that might advance that goal."
Takeaways
This decision has removed a key uncertainty faced by trademark licensees in the event of a licensor bankruptcy, thereby eliminating a significant risk for businesses that rely on the promotion of another company's trademarked products. The elimination of this risk of unilateral termination also enhances the negotiating leverage of trademark licensees in a licensor reorganization.
Trademark licensors, on the other hand, should be aware of this limitation when considering a reorganization and evaluating potential strategies. For some distressed trademark licensors, a bankruptcy filing may now be less attractive, as it cannot free them from having their trademarks used under the licenses that they have granted.
For more information about the U.S. Supreme Court's decision in Mission Product Holdings, Inc. v. Tempnology, LLC, please contact any member of the restructuring practice at Wilson Sonsini.
