Does a trademark licensee retain any rights under a licensing agreement following the debtor-licensor’s “rejection” of the agreement under Section 365 of the Bankruptcy Code?
In this case, the Supreme Court will decide whether a debtor-licensor’s “rejection” of a trademark licensing agreement terminates the licensee’s rights under the agreement. Mission Product Holdings Inc. argues against termination, claiming that no such termination would occur from a breach of contract outside of the bankruptcy context, and that, in any case, there is a statutory exception that protects a licensee’s rights to use intellectual property post-rejection. Tempnology, LLC counters that rejection limits the licensee to the sole remedy of seeking monetary damages, and that the statutory exception for intellectual property does not contemplate trademarks as intellectual property. The outcome of this case will clarify the effect of rejection on contractual rights and whether trademarks are distinguishable from other types of intellectual property under Section 365 of the Bankruptcy Code.
Questions as Framed for the Court by the Parties
Whether, under Section 365 of the Bankruptcy Code, a debtor-licensor’s “rejection” of a license agreement—which “constitutes a breach of such contract,” 11 U.S.C. § 365(g)—terminates rights of the licensee that would survive the licensor’s breach under applicable non-bankruptcy law.
Respondent Tempnology, LLC (“Tempnology”) designs and manufactures accessories—such as towels, socks, and headbands—that remain cool while a user exercises. In connection with these products, Tempnology owns a significant amount of intellectual property. On November 21, 2012, Tempnology entered into an executory contract (the “agreement”) with Petitioner Mission Product Holdings Inc. (“Mission”), which provided Mission with three distinct rights relating to distribution and intellectual property.
First, Tempnology granted Mission both exclusive and nonexclusive distribution rights to Tempnology’s “Cooling Accessories.” Second, the agreement provided Mission with a nonexclusive, irrevocable license to Tempnology’s intellectual property, apart from Tempnology’s trademarks. Third, Tempnology granted Mission a limited license to Tempnology’s trademark and logo for the sole purpose of using the trademark and logo in conjunction with Mission’s other rights under the agreement. According to the agreement, Mission could not use Tempnology’s trademark or logo in any way that hurt Tempnology, and Mission had to comply with trademark guidelines. Tempnology retained the right to “review and approve” of most uses of its trademark or logo.
On June 30, 2014, Mission exercised its right to end this agreement without cause, which began a “Wind-Down Period” of two years during which the companies planned to end the agreement. On July 22, 2014, however, Tempnology sought to terminate the agreement for cause, claiming that Mission violated an employment restriction in the agreement. The case went before an arbitrator who determined that the wind-down period would continue until July 1, 2016, at which time Mission would give up its distribution and trademark rights but would retain its other intellectual property rights permanently.
Unfortunately, in both 2013 and 2014, Tempnology suffered multi-million-dollar net operating losses. On September 1, 2015, Tempnology filed a petition for bankruptcy and moved to reject the agreement with Mission under Section 365(a) of the Bankruptcy Code (the “Code”). Mission opposed this rejection motion, asserting that Mission was entitled to keep its intellectual property licenses and distribution rights under Section 365(n). The bankruptcy court granted Tempnology’s motion to reject the agreement, but held that Mission retained some rights from the agreement under Section 365(n). After a hearing to determine these rights, the bankruptcy court ruled that Section 365(n) protected only Mission’s intellectual property rights, and therefore Mission would have to relinquish its distribution rights and trademark license.
Mission appealed this decision to the Bankruptcy Appellate Panel for the First Circuit (“BAP”), which affirmed the bankruptcy court’s ruling that Mission’s exclusive distribution rights had been extinguished. The BAP, however, reversed the bankruptcy court’s ruling that Mission had relinquished its trademark rights. Instead, following the Seventh Circuit, the BAP held that because a licensor’s breach of a trademark agreement outside of bankruptcy law does not always terminate the licensee’s rights, and because Section 365(g) treats a rejection of an agreement as a breach of contract, this type of rejection may not terminate Mission’s trademark license.
On appeal, the First Circuit affirmed the bankruptcy court’s decision that Mission’s exclusive distribution rights and trademark license were not preserved under Section 365(n). But the First Circuit disagreed with the BAP and the Seventh Circuit, instead holding that Mission did not retain its trademark rights after the agreement’s rejection. The First Circuit reasoned that because trademark owners—such as Tempnology—have the obligation to maintain the quality of the goods sold under their trademark, allowing Mission to continue using these trademarks would put Tempnology in the unfair position of having to continue maintaining the trademark or lose the trademark altogether.
EFFECT OF REJECTION ON CONTRACTUAL RIGHTS
Mission points out that, under the plain text of Section 365(g) of the Code, rejection of an executory contract constitutes a breach of that contract. While acknowledging that such rejection releases the bankruptcy estate from future performance, Mission argues that rejection does not eliminate every contractual obligation or the non-breaching party’s contractual rights. Because Section 365(g) treats the contractual breach as occurring prior to the petition for bankruptcy, Mission claims that a breach arising from rejection is no different than a contractual breach outside of the bankruptcy context. Mission therefore concludes that rejection does not alter the parties’ “non-bankruptcy rights.” Mission accordingly argues that, because a licensor’s breach in a non-bankruptcy setting does not eliminate a licensee’s entitlement to use licensed intellectual property, Mission’s right to use Tempnology’s intellectual property here is not affected by Tempnology’s rejection of the parties’ license agreement.
Mission furthermore posits that rejection is not equivalent to the power of avoidance, which, according to Mission, is the only means by which a bankruptcy estate can completely unwind a contract. Mission states that avoidance is available in only limited circumstances under the Code, such as with fraudulent conveyances under Section 548 and preferences under Section 547(b). Mission argues that a rejection under Section 365(g) is not an avoidance because the plain text of Section 365 speaks only to future performance and is silent on asset ownership. It would go against “basic principles of statutory construction,” claims Mission, to view Section 365 as containing an “implied avoiding power.”
In response, Tempnology argues that rejection of an executory contract renders the entire contract unenforceable, leaving the counterparty with only a pre-bankruptcy petition claim for damages. Tempnology states that a rejection is not piecemeal—no contractual provisions survive rejection. It is improper to equate rejection with the general concept of contractual breach outside the bankruptcy setting, Tempnology claims, because rejection is a power unique to bankruptcy that is only available to a bankrupt party. Tempnology therefore concludes that rejection does change the other party’s “non-bankruptcy” rights by converting them into a claim for monetary damages. This claim for monetary damages, Tempnology contends, is the only right available to the counterparty unless there is an express statutory exception. Tempnology argues that Section 101(5) of the Code defines “claim” so broadly that it covers “any conceivable” contractual damages, even damages that are “unmatured” or difficult to quantify. This broad definition, Tempnology maintains, indicates that monetary damages are the sole remedy for rejection.
Tempnology also contends that Mission mischaracterizes rejection as avoidance. Unlike avoidance, which, according to Tempnology, completely eliminates all contractual rights, rejection simply converts those rights into a claim for damages. In other words, Tempnology explains, avoidance “unwinds” a contract by restoring the parties to the status quo that existed prior to the contract. Because rejection leaves the counterparty with a claim for damages, Tempnology asserts, rejection cannot undo a contract in the way that avoidance does. Furthermore, Tempnology continues, avoidance and rejection have different purposes: avoidance enables a bankruptcy estate to recuperate certain transfers while rejection allows an estate to relieve the debtor from detrimental obligations.
A STATUTORY EXCEPTION FOR TRADEMARK LICENSES?
Mission claims that the Code’s Section 365(n) safe harbor, which specifically protects a licensee’s rights to use intellectual property post-rejection, can include licenses to use trademarks. Although Mission concedes that “intellectual property,” as defined in Section 101(35A), does not expressly mention trademarks, Mission contends that this omission does not mean that trademark licensees find no protection under Section 365(n). According to Mission, the legislative history behind Section 365(n) merely indicates that Congress was unsure of whether to include trademark licenses within the Section 365(n) safe harbor. The purpose of a safe harbor provision, Mission continues, is to address a specific ambiguity in the law; a safe harbor is not meant to “rewrite the entire statute.” Mission thus argues that it would be inappropriate to draw the “negative inference” that a trademark licensee’s rights terminate with rejection. If this were the case, Mission claims, then a trademark licensor’s rejection of a license agreement would be tantamount to avoidance. Endowing rejection with this avoidance power, Mission states, is simply too far a leap.
Tempnology counters that a contractual right survives rejection only if there is an express statutory exception to the general rule of Sections 365(a) and 365(g) that rejection terminates all contractual rights. While acknowledging that Congress has created more statutory exceptions over time, Tempnology argues that these exceptions have always been narrowly tailored. Moreover, Tempnology states that Congress has enacted these exceptions by creating new subsections to Section 365—not by altering the general rule. Tempnology asserts that this method of legislative action reinforces the general rule that rejection renders a contract unenforceable. Furthermore, Tempnology argues that the Section 365(n) exception for intellectual property is not applicable to trademark licenses. According to Tempnology, the legislative history indicates that that Congress intentionally excluded trademark licenses from protection under Section 365(n). Tempnology thus concludes that there is no exception for trademark licenses. Moreover, Tempnology contends, it is not the Court’s place to recognize new exceptions absent congressional approval. Doing so, Tempnology states, would upset the “carefully balanced” scheme of Section 365.
TRADEMARK LICENSOR OBLIGATIONS
Mission argues that a trademark licensor’s obligation to protect its trademarks is independent of any contractual obligations arising from a trademark licensing agreement. Rather, Mission contends that a licensor’s obligation to protect its trademarks, such as by monitoring the quality of goods that a licensee sells using the trademark arises from trademark law. Mission accordingly claims that a licensor owes no quality control “performance obligation” to any licensee, unless a licensing agreement itself makes such an obligation contractual. Mission therefore concludes that a bankrupt licensor’s rejection of a trademark licensing agreement does not actually change the licensor’s obligations to protect its trademarks. If that is the case, Mission continues, then it should not matter whether a licensee’s trademark rights survive rejection: regardless, the licensor still has the obligation to “preserve the value of its mark.” Mission points out that a licensor undertakes this obligation for its own benefit, and that this obligation is not made compulsory were a licensee’s rights survive rejection. In any event, Mission claims, a licensor’s quality control monitoring obligation does not represent a significant hardship; trademark licensees are equally incentivized to protect the value of licensed trademarks.
In response, Tempnology claims that allowing a trademark licensee’s rights to survive rejection undermines the purposes of the Code. Tempnology asserts that the “basic purpose” of reorganizing under Chapter 11 is to rehabilitate the distressed company, and that terminating burdensome contracts facilitates this rehabilitation. If a trademark licensee’s rights survive rejection, Tempnology continues, then the licensor would have greater difficulty repositioning itself in the marketplace. Furthermore, Tempnology states that a bankruptcy estate cannot simply reject any contract automatically; a bankruptcy court must approve the rejection. Tempnology argues that this backstop prevents rejections that would cause “undue hardship” to counterparties. In any case, Tempnology contends, the Lanham Act, codified at 15 U.S.C. §§ 1051 et seq., makes it impossible to carve out property interests from trademarks. Tempnology claims that this principle of “unified ownership” means that a trademark can only have one owner. Furthermore, Tempnology argues that its licensing agreement with Mission explicitly stated that the license did not constitute a transfer of a property interest. Tempnology also posits that a trademark owner may license a mark only if the licensor maintains quality control over goods sold using the licensed trademark. Absent this quality control obligation, Tempnology maintains, there is no license.
EFFECT ON TRADEMARK LICENSORS AND LICENSEES
The International Trademark Association (“INTA”), in support of Mission, notes that trademark owners have the right to license out the use of their trademarks to licensees and that these licenses help promote the licensor’s business and increase profits. INTA further asserts that if the Court accepts the First Circuit’s ruling that a rejected contract discontinues a licensee’s trademark license, uncertainty will arise for both trademark licensors and licensees, who will not know whether the trademark license will survive a licensor’s potential bankruptcy. This uncertainty, INTA argues, will dissuade future parties from entering into trademark licensing agreements, particularly due to the increased financial risks of these agreements under the First Circuit’s ruling. Moreover, INTA contends that licensors will have to decrease the prices of their trademark licenses to account for the licensee’s future potential loss of rights due to the licensor’s bankruptcy. Similarly, INTA emphasizes that a licensee’s loss of a trademark can devastate the licensee’s business—to protect itself, a licensee whose license could be lost through bankruptcy may not invest in, and thus fully profit from, this trademark license. Finally, the Intellectual Property Owners Association (“IPO”) posits that the substantial costs in negotiating and contracting around a potential bankruptcy license termination—especially for licensees whose only recourse for a rejected license agreement due to bankruptcy is a pre-petition damages suit, which often awards only minimal damages.
Tempnology counters that the Seventh Circuit’s rule that Mission and its amici advocate for could seriously hinder trademark licensors from reorganizing their companies to attempt to survive bankruptcy. Tempnology notes that trademark owners in bankruptcy often rely on rejecting trademark licenses and repossessing these licenses to maintain the value of their trademarks. Therefore, Tempnology argues that without the ability to repossess these trademarks, these bankrupt companies may be unable to reorganize and restructure their finances. Furthermore, Tempnology contends that this rule will be especially burdensome to hotel and restaurant franchisors who will be unable to redesign their brands if they are unable to reject trademark licenses. Additionally, Tempnology agrees with the First Circuit that applying the Seventh Circuit’s rule will place trademark owners in the unfair and difficult position of having to maintain the quality of their trademarks through bankruptcy or risk losing their trademarks altogether.
EFFECT ON CONSUMERS, CONTRACT PARTIES, AND FUTURE BANKRUPT COMPANIES
In support of Mission, the INTA asserts that any fear that the quality of a trademark will decrease when the licensor enters bankruptcy and no longer is obligated to maintain the trademark’s quality is unfounded, because the licensee will have the incentive to maintain consumer quality in order to continue profiting from the trademark. Additionally, the United States, in support of Mission, argues that the First Circuit’s interpretation of licenses granted in executory contracts could apply not just to trademark licenses, but to executory contracts in general. Therefore, the United States contends that the First Circuit’s ruling could have far-reaching, negative consequences for contract parties, because the First Circuit interpreted the statutory language in Section 365 to mean that a contracting party can reject a contract and in doing so, repossess property and extinguish another contracting party’s rights.
Tempnology, on the other hand, focuses on the possible effects that the adoption of the Seventh Circuit’s rule could have on companies entering bankruptcy in the future. To maintain the rehabilitative effect of bankruptcy law, Tempnology argues, it is essential that the bankrupt company’s future obligations to a party be consolidated into one claim—which the First Circuit’s ruling allows them to be. Otherwise, Tempnology asserts, these obligations linger and have the potential to hurt the bankrupt party in the future.Tempnology further contends that leaving a failing contract in effect during bankruptcy would likely hinder a bankrupt company’s ability to pay wages and “attract new capital,” which is essential for the recovery of a bankrupt business.
- Timothy J. McKeon, Supreme Court to Decide Whether Debtors can Terminate a Licensee’s Rights to Trademarks Under License Agreements, Mondaq (Jan. 31, 2019).
- Lewis R. Clayton & Eric Alan Stone, Circuit Split on Trademark License Issue Heads to Supreme Court, New York Law Journal (Jan. 8, 2019).
- Supreme Court Watch: Mission Product v. Tempnology, JD Supra (Nov. 2, 2018).
- Barbara Leonard, High Court Takes Up Circuit Split Over IP in Bankruptcy, Courthouse News Service (Oct. 29, 2018).