For decades, trademark licensees were left in the limbo when their licensors filed for bankruptcy. If a debtor-licensor exercises its statutory right to reject a licensing agreement, a luxury brand product could potentially turn into a trademark-infringing knockoff overnight. ((See Ronit J. Berkovich, From Gucci to Knock-off: How Bankruptcy Leaves Trademark Licensees at Risk, Weil Bankr. Blog (Jul. 17, 2018), https://business-finance-restructuring.weil.com/assumption-and-rejection/from-gucci-to-knock-off-how-bankruptcy-leaves-trademark-licensees-at-risk/.)) This issue is at the center of a circuit split regarding the question of whether a debtor-licensor’s rejection of an executory trademark licensing agreement terminates the licensee’s right to use the licensed trademarks.
When a company files for a Chapter 11 bankruptcy protection, all of the assets of the company become part of the bankruptcy estate. ((See 11 U.S.C. § 541; Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652, 1658 (2019).)) If those assets include intellectual property licensed to licensees, the trustee or debtor may choose to “assume or reject any executory contract” under 11 U.S.C. § 365(a). A contract is executory if “performance remains due to some extent on both sides.” ((NLRB v. Bildisco & Bildisco, 465 U. S. 513, 522, n. 6 (1984).)) Thus, a licensing agreement is an executory contract because the licensor provides continuing services in exchange for ongoing fees from the licensee. Circuits split on the consequences to a licensing agreement if the debtor-licensor chooses to reject it.
Courts have adopted two approaches: the “rejection-as-rescission” approach adopted by the First and Fourth Circuits, and the “rejection-as-breach” approach adopted by the Seventh Circuit. ((Melanie J. Howard et al., Supreme Court to Decide Fate of Trademark Licenses in Bankruptcy, Loeb & Loeb (Dec. 2018), https://www.loeb.com/en/insights/publications/2018/12/mission-product-holdings-inc-v-tempnology-llc.)) Under the rejection-as-rescission approach, the rejection acts as a rescission of the agreement and the licensee would no longer own any post-rejection rights to the trademark. However, licensees are entitled to assert a claim for damages. Using this approach, the Fourth Circuit held in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985) that a licensee of a rejected trademark license cannot continue using the trademark because the rejection equates to a license termination or rescission. Similarly, the Second Circuit also ruled in favor of the debtor in Licensing by Paolo, Inc. v. Sinatra, 126 F.3d 380 (2d Cir. 1997). The most recent ruling adopting the rejection-as-rescission approach came from the First Circuit in In re Tempnology, LLC, 879 F.3d 389 (1st Cir. 2018). The Court reasoned that allowing the licensee to continue to use the trademark would require the debtor to monitor the product for quality assurance, which is too burdensome a task. ((Berkovich, supra note 1.)) This would essentially force the debtor to “choose between performing executory obligations arising from the continuance of the license or risking the permanent loss of its trademarks.” ((In re Tempnology, 879 F.3d at 403.))
Under the rejection-as-breach approach, however, the rejection acts as a breach of contract by the licensor and the licensee retains the post-rejection rights to the license. The Seventh Circuit is a champion of such an approach. In a 2012 case called Sunbeam Prods., Inc. v. Chicago American Mfg., the court ruled that license rejection constitutes only a contractual breach and has no effect on its continued existence. ((686 F. 3d 372, 377 (7th Cir. 2012).)) A rejection only converts a “debtor’s unfulfilled obligations” to a pre-petition damages claim but does not terminate the contract. ((Id.)) As a result, the licensee could choose to either continue to use the trademarks or not. ((Tempnology,139 S. Ct. at 1662.)) However, in either case, it could sue for damages against the debtor. ((Jason B. Binford, The Supreme Court Decision Mission Product Holdings, Inc. v. Tempnology, LLC Has Broad Implications for Licenses and Other Agreements in Bankruptcy: Analysis, Mfg. Indus. Advisor Blog (May 22, 2019), https://www.foley.com/en/insights/publications/2019/05/supreme-court-decision-mission-products-analysis.))
Although Congress afforded licensees of “intellectual property” some protections in the event of a license rejection through Section 365(n) of the Bankruptcy Code, it omitted trademarks from the definition of intellectual property. ((Berkovich, supra note 1.)) Section 101(35A) of the Bankruptcy Code defines “intellectual property” to include trade secrets, patents, patent applications, and copyrights, but it leaves out trademarks and any statutory protections for trademark licensees. ((Howard et al., supra note 4.)) The Seventh Circuit responded to this by invoking the legislative history behind Congress’ enactment of Section 365(n). ((Sunbeam, 686 F. 3d at 375.)) A Senate committee report on the bill revealed that Congress did not intend to leave trademarks unprotected, but only allowed themselves “more time for study.” ((Id.))
In Tempnology, apparel company Mission and athletics textile company Tempnology entered into a licensing agreement in 2012, which allowed Mission to use Tempnology’s trademarks on its products. ((Howard et al., supra note 4. )) Tempnology filed for bankruptcy in 2015 and rejected the agreement pursuant to Section 365(a) of the Bankruptcy Code in an attempt to terminate Mission’s right to the licensed trademarks. The bankruptcy court held that termination of the licensing agreement revoked Mission’s right to use the trademarks. ((In re Tempnology, LLC, 541 B.R. 1 (Bankr. D.N.H. 2015). )) The Bankruptcy Appellate Panel reversed, ((In re Tempnology, LLC, 559 B.R. 809 (B.A.P. 1st Cir. 2016).)) and the First Circuit reinstated the bankruptcy court’s decision. ((In re Tempnology, 879 F.3d 389.))
Following the First Circuit’s decision, the licensee filed a petition for writ of certiorari with the Supreme Court of the United States in June 2018. It rebutted the argument that monitoring is too burdensome for the licensor by pointing out the history of courts relaxing the licensor’s obligations in trademark licensing agreements. ((Berkovich, supra note 1.)) For example, the Southern District of New York held that a licensor’s monitoring requirements could be met through reliance on the integrity of the licensee. ((Syntex Labs., Inc. v. Norwich Pharmacal Co., 315 F. Supp. 45, 56 (S.D.N.Y. 1970).))
The IP community filed amicus briefs in support of licensees. The International Trademark Association urged the court to adopt the rejection-as-breach approach because “it enhances the value of trademark licenses and promotes the stability of the trademark system.” ((Brief of the International Trademark Association as Amicus Curiae Supporting Petitioner at 6, Mission Prod. Holdings v. Tempnology, 139 S. Ct. 1652 (2019) (No. 17-1657).)) Several law professors also submitted a brief to support licensees and criticized the First Circuit’s holding because it “will allow debtor-licensors to unwind a variety of settled transfers of property rights” by rejecting trademark licenses. ((Brief of Law Professors as Amici Curiae Supporting Petitioner at 2, Mission Prod. Holdings v. Tempnology, 139 S.Ct. 1652 (2019) (No. 17-1657).)) The Supreme Court granted certiorari in October 2018 and heard oral argument in February 2019.
On May 20, 2019, the Supreme Court settled this longstanding debate surrounding the fate of trademark licensees in bankruptcy. In an 8-1 opinion penned by Justice Kegan, the Court firmly adopted the rejection-as-breach approach and held that “the rejection of an executory contract constitutes a breach of such contract,” which is deemed to have occurred immediately before the bankruptcy filing. ((Tempnology, 139 S. Ct. at 1658.)) By relying mainly on the unambiguous language of Section 365(g) of the Bankruptcy Code, this decision effectively allows licensees to retain their rights to the trademark post-rejection. In its reasoning, the court draws parallel between bankruptcy and non-bankruptcy laws by claiming that “[o]utside bankruptcy, the breach of an agreement does not eliminate rights the contract had already conferred on the non-breaching party…neither could a rejection of an agreement in bankruptcy have that effect.” ((Id. at 1659.)) The court further rejected the view that omission of trademark from Section 365(n) of the Bankruptcy Code deprives trademark licensees of protections afforded to licensees of other intellectual property. ((Tempnology, 139 S. Ct. at 1664-65.)) Instead, it held that the clear language of the general provision in Section 365(g) governs. ((Ronit J. Berkovich & Justin R. Pitcher, Supreme Court Sides with Trademark Licensees in Rejection Dispute, Weil Bankr. Blog (Mar. 21, 2019), https://business-finance-restructuring.weil.com/assumption-and-rejection/supreme-court-sides-with-trademark-licensees-in-rejection-dispute/.))
This decision is a big win for licensees. On the one hand, although licensees could still assert a claim for damages under the rejection-as-rescission approach, they could usually receive only cents on the dollar in the bankruptcy context. ((Howard et al., supra note 4.)) This is because, contrary to regularly contract damages, the licensees only have an unsecured claim for damages that is discharged at the end of bankruptcy. On the other hand, the rejection-as-breach approach preserves the licensees’ rights post-rejection and can help them maintain the full revenue stream obtained from the licensed trademarks. ((Id.)) However, there is a caveat for the licensees. Since the licensor is required to monitor the quality of the trademarked products in order to maintain its trademark rights, ((John C. Paul et al., Loss of Trademark Rights from Naked Licensing, LES Insights (Jan. 17, 2011), https://www.finnegan.com/en/insights/loss-of-trademark-rights-from-naked-licensing.html.)) a trademark could still be put in jeopardy of abandonment if the licensor fails to follow through with this continuing obligation. ((In Mission Product Ruling, Supreme Court Clarifies Longstanding Circuit Split on Effects of Bankruptcy on Trademark Licenses, IPWatchdog (May 20, 2019), https://www.ipwatchdog.com/2019/05/20/mission-product-ruling-supreme-court-clarifies-longstanding-circuit-split-effects-bankruptcy-trademark-licenses/id=109440/.))
Justice Sotomayor concurred by highlighting “two potentially significant features” of the holding. ((Tempnology, 139 S. Ct. at 1666.)) She advocated for a case-by-case inquiry to determine whether the licensee’s rights would survive a breach under applicable non-bankruptcy law. ((Id.)) This will likely introduce some uncertainty into the planning of potential Chapter 11 cases. ((Binford, supra note 10.)) In addition, citing Section 365(n) of the Bankruptcy Code, Justice Sotomayor suggested that the court should distinguish post-rejection effects for trademark licensee from licensees of other types of intellectual property. ((Tempnology, 139 S. Ct. at 1666-67.))
The Supreme Court made it clear that this ruling applied broadly to every type of agreement rejected by a debtor under Section 365 of the Bankruptcy Code, not only to trademark licensing. ((Id. at 1661.)) Thus, this decision would not only negatively impact the value of debtor’s estate but also give non-debtors a negotiating leverage over their counterparts. However, bankruptcy law does provide means for eliminating rights under some contracts, such as those that entitle creditors to preferential transfers. ((Sunbeam, 686 F. 3d at 377.)) Therefore, despite this setback on rejection rights for debtors, creative debtor’s counsel could still make use of the many powerful bankruptcy tools available to them.