Yesterday, in an 8-1 decision, the US Supreme Court held in Mission Product Holdings, Inc. v. Tempnology, LLC1 that under Section 365 of the Bankruptcy Code, a debtor-licensor’s rejection of a trademark license agreement does not terminate the rights of the licensee to continue using the trademark where those rights would otherwise survive the licensor’s breach of the agreement under non-bankruptcy law.2 The Tempnology decision resolves the most significant unanswered question regarding the treatment of trademark licenses in bankruptcy.
As Justice Elena Kagan described in the Court’s opinion, Tempnology manufactured athletic apparel designed to stay cool when a person exercises. Tempnology entered a licensing agreement under which it gave Mission Product Holdings an exclusive license to distribute some of its products in the United States, and a non-exclusive license to use Tempnology’s COOLCORE trademark in the United States and around the world.
However, before the licensing agreement expired, Tempnology filed a Chapter 11 bankruptcy case and sought to reject the licensing agreement under Section 365(a) of the Bankruptcy Code, which generally permits a trustee or debtor-in-possession, “subject to the court’s approval, [to] assume or reject any executory contract.3 As the Court explained, an executory contract is one where “performance remains due to some extent on both sides.”4 Ordinarily, a debtor will want to assume an executory contract and continue performing if it perceives the contract to be a good deal going forward; conversely, the debtor will want to reject such a contract, and thus relieve itself of the obligation to continue performing, if it believes the contract is not beneficial to it. Courts generally evaluate the debtor’s decision to assume or reject an executory contract under the “business judgment” rule. When a debtor rejects an executory contract, under Section 365(g)(1), its counterparty is generally left with a pre-petition damages claim for breach of contract.5
If the rejected contract is one under which the debtor is the licensor of certain types of intellectual property, Section 365(n)(1) of the Bankruptcy Code gives the licensee the option to “retain its rights . . . to such intellectual property” for the duration of the contract and any period for which the licensee may extend the contract as a matter of right under applicable nonbankruptcy law.6 However, the Bankruptcy Code’s definition of “intellectual property” does not include trademarks.7 Accordingly, Tempnology argued that neither Section 365(n)(1) nor any other provision of the Bankruptcy Code permitted Mission to continue using the trademarks, and, to the contrary, argued that the rejection terminated Mission’s right to continue using the marks.
The US Court of Appeals for the First Circuit agreed with Tempnology, holding that the rejection terminated Mission’s right to continue using the marks. The First Circuit considered its decision to be consistent with the policy of relieving a debtor from burdensome obligations, which would have included the ongoing obligation under trademark law to monitor and exercise quality control over goods associated with the trademarks, in order to ensure the marks’ continued validity. The First Circuit’s decision was contrary to a prior decision by the Seventh Circuit Court of Appeals,8 which focused on the legal principle that rejection of an executory contract constitutes a breach of the contract, but does not extinguish the counterparty’s rights.
The Court reversed the First Circuit and, as noted, held that Tempnology’s rejection of the license agreement did not terminate Mission’s rights under nonbankruptcy law to continue using the trademarks. The Court’s holding was based principally on “Section 365’s text and fundamental principles of bankruptcy law” that treat the debtor’s rejection of any executory contract as a breach — and not a rescission or termination — of the contract. The Court explained that the effects of the breach are substantially the same as under nonbankruptcy contract law, under which a party’s breach of contract does not give it the unilateral right to revoke or rescind its counterparty’s rights under the contract. Thus, Mission could continue to do whatever the license authorizes, including use of the COOLCORE trademark.
The Court explained that its holding is consistent with the general rule that a debtor’s bankruptcy estate has no greater rights than the debtor held outside of bankruptcy. On the other hand, the Court observed that treating the rejection as a rescission or termination of the contract would be “functionally equivalent” to an “avoidance” action (such as a fraudulent transfer claim) that permits pre-bankruptcy transfers to be unwound and which are governed by separate and discrete provisions of the Bankruptcy Code.
The Court also found support for its holding in the legislative history of Section 365(n), which reflects that whenever Congress has been faced with discrete situations (usually a judicial ruling) where rejection has been treated as a termination of the non-debtor’s contractual rights, Congress has expressed its disapproval. Accordingly, the fact that Section 365(n) does not expressly cover trademark licenses does not create a negative inference that Congress intended to treat a rejection of a trademark license as a termination of the non-debtor licensee’s rights under the license. Rather, the rejection continues to be treated as a breach of the contract, consistent with the general rule in Section 365(g)(1).
Finally, the Court rejected Tempnology’s argument that a trademark licensor’s obligation to monitor and exercise quality control over goods and services sold under a license merit a different result. As the Court explained, such a view has no support in the text of Section 365, which does not give a property owner “an exemption from all the burdens that generally applicable law” imposes on it.
The Tempnology decision resolves a significant question regarding the treatment of trademark licenses in bankruptcy. But as Justice Sonia Sotomayor explained in her concurring opinion, the Tempnology decision does not necessarily give a non-debtor trademark licensee the “unfettered right” to continue using a licensed trademark post-rejection. Rather, that right is still governed by applicable nonbankruptcy law, and special terms in the licensing agreement or under state law may affect the right to continue using the mark in certain cases. In addition, the Court only addressed trademark rights and did not address Mission’s exclusive distribution rights under the licensing agreement.
We also note that the Tempnology holding addressed a non-exclusive license. Nothing in the decision suggests that a debtor-licensor would have any greater right to extinguish an exclusive licensee’s right to use the licensed trademark. However, the decision, as a result of the underlying license being non-exclusive, does not address whether a debtor-licensor’s rejection of an exclusive license may allow a debtor-licensor to license additional parties (thereby defeating the exclusivity), potentially leaving the licensee with only a pre-petition claim for the debtor-licensor’s breach of the exclusivity provisions or whether the exclusive licensee instead would be permitted to seek injunctive relief to enforce such exclusivity provisions if that relief otherwise would have been available to it outside of bankruptcy under applicable nonbankruptcy law.
Separately, the Tempnology decision implicitly resolves the issue as to whether, in the event of the rejection of a general equipment lease where the debtor is the lessor, the non-debtor lessee is obligated to return the leased equipment to the bankruptcy estate or is instead entitled to retain the equipment notwithstanding such rejection. The prior concern among market participants and bankruptcy practitioners was that the non-debtor lessee could be compelled to return the leased equipment in the event of such a rejection.9 Both the holding of the Court’s decision — that “under Section 365, a debtor’s rejection of an executory contract in bankruptcy has the same effect as a breach outside of bankruptcy” — and the example the Court used, a law firm’s copier lease,10 in reasoning to its holding — would seem to leave that concern behind. In such a situation, the decision whether to retain or return the equipment in the event of such a rejection would belong to the non-debtor lessee; the debtor lessor, through rejection, cannot compel the return of the equipment.11
1Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17-1657, 587 U.S. ___ (2019). Justice Gorsuch dissented and would have dismissed the petition for writ of certiorari as improvidently granted. In his view, the case appeared to have become moot because the license agreement had expired by its own terms.
7“The term ‘intellectual property’ means — (A) trade secret; (B) invention, process, design, or plant protected under title 35; (C) patent application; (D) plant variety; (E) work of authorship protected under title 17; or mask work protected under chapter 9 of title 17; to the extent protected by applicable nonbankruptcy law.” 11 U.S.C. § 101(35A).
10Tempnology, No. 17-1657, at 10 (saying that the law firm lessee has the option as to how to respond to rejection of the lease and “assuming the law firm wants to keep using the copier, the dealer cannot take it back”).
11Tempnology does not address the payment or other obligations that the non-debtor equipment lessee would have following its decision to retain the equipment notwithstanding the rejection, e.g., would those rights and obligations be the same as the non-breaching lessee would have outside of bankruptcy, would the lessee be entitled to reduce any of its payment obligations under the breached lease by its damages, such as the cost of any replacement servicing agreement, etc.? These and related issues, as and when they arise, will be resolved by subsequent case law.