September 10, 2019
On May 20, 2019, in Mission Product Holdings, Inc. v. Tempnology, LLC, the U.S. Supreme Court held that a debtor-licensor’s rejection of a trademark license agreement under section 365 of the Bankruptcy Code does not rescind the licensee rights that the contract previously granted.
In 2012, Tempnology entered into an agreement with Mission granting licenses to distribute clothing under the “Coolcore” brand name. Before the agreement expired in July 2016, Tempnology filed a petition for Chapter 11 bankruptcy. In its petition, Tempnology asked the Bankruptcy Court to allow it to reject the license agreement, and the court approved. Tempnology then requested a declaratory judgment ordering that its rejection of the license agreement also terminated Mission’s rights to use the “Coolcore” trademark. Tempnology argued that although certain provisions of section 365 of the Bankruptcy Code enable a counterparty to continue exercising various contractual rights after a rejection—including section 365(n), which applies to some types of intellectual property licenses—these terms do not cover trademark licenses. Thus, Tempnology asserted that its rejection of the agreement terminated the rights granted to Mission under the agreement. The Bankruptcy Court agreed.
The Bankruptcy Appellate Panel reversed, relying primarily on the Seventh Circuit’s decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, regarding the effects of rejection of trademark licensing agreements. The panel focused on section 365(g)’s statement that rejection of a contract “constitutes a breach.” The court held that such a breach does not extinguish contractual rights previously conferred on the nonbreaching party. On this basis, the panel held that Mission could continue to use the “Coolcore” trademark.
Subsequently, the Court of Appeals for the First Circuit rejected the panel’s holding and reinstated the Bankruptcy Court’s termination of Mission’s license. The First Circuit endorsed the court’s interpretation of section 365(n) and further relied on the principles of trademark law. Under these principles, the First Circuit reasoned that because Congress intended for rejection to “release the debtor’s estate from burdensome obligations,” and because allowing the licensee to retain rights to the trademark would burden the licensor with monitoring the licensee’s use of the trademark, the debtor-licensor should be released from its obligations. To resolve the split between the First and Seventh Circuits, the Supreme Court granted certiorari.
The Supreme Court considered the circuits’ differing interpretations of Section 365. Contrary to the view that rejection terminates the entire agreement along with all the rights it conferred, the Court held that rejection of a contract in bankruptcy is not a rescission, but a breach.
In its analysis, the Court first examined section 365(g) of the Code, which defines rejection as a breach. The Court concluded that the definition of “breach” under contract law must be applied in the case at hand. And, the Court concluded, principles of contract law provide that a breach does not terminate the contract. Thus, the licensor cannot revoke the license and the counterparty still retains its rights under the agreement so long as the licensee performs its obligations under the license agreement.
The Court held that this “rejection-as-breach rule” also preserves the general bankruptcy tenet that “the estate cannot possess anything more than the debtor itself did outside bankruptcy.” The Court clarified that if a rejection effectuated a rescission, the Code’s limitations on “avoidance” actions, which involve unwinding pre-bankruptcy transfers, would be frustrated.
The Court then responded to Tempnology’s arguments. First, Tempnology stated that the Code delineates several categories of contracts under which a counterparty retains its rights despite rejection. As a result, the debtor-licensor asserted its “negative inference” that contractual rights under all other categories, including trademarks, are not preserved. However, based on the legislative history of the Code, the Court observed that Congress enacted the exclusionary exceptions to reinforce and elaborate the general rule that contractual rights continue after rejection. As such, the Court rejected Tempnology’s argument for a “negative inference.”
Tempnology also contended that allowing a licensee to exercise its contractual rights after rejection would prevent a debtor-licensor’s ability to reorganize because it would have to either incur the costs of quality control over licensee’s goods or risk losing its trademark. The Court also rejected this argument reasoning that section 365 is not intended to relieve the debtor-licensor of all burdens applicable under the law.
Based on the considerations above, the Court reversed the judgment of the Court of Appeals. This ruling establishes that the rejection of a trademark license agreement during a bankruptcy proceeding is a breach, not a rescission, and that debtor-licensor’s rejection cannot terminate the licensee’s rights under the license.
For more information on this case, please contact Fitch Even partner Thomas F. Lebens, author of this alert.
Fitch Even associate Kerianne A. Strachan contributed to this alert.
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