May 21, 2019 | William L. Hallam, Creditors’ Rights
In Mission Products Holdings, Inc. v. Tempnology, LLC, the United States Supreme Court resolved a split between the United States Courts of Appeal for the First and Seventh Circuits as to effect of rejection of a trademark license by the licensor under Section 365 of the Bankruptcy Code. In its May 20, 2019 decision, the Supreme Court sided with the Seventh Circuit and held that a licensee is not deprived of the right to continue to use the licensed trademark when the licensor rejects the license.
Tempnology, LLC had entered into a trademark license with Mission Products Holdings, Inc. under which Mission was permitted to market clothing using Tempnology’s “Coolcore” trademarks. Tempnology filed for Chapter 11 and rejected the license. Tempnology followed up on the rejection of the license by asking the Bankruptcy Court to confirm that Mission was prohibited from using the Coolcore trademark following rejection of the license. The Bankruptcy Court agreed with Tempnology. After an intervening appeal to the First Circuit Bankruptcy Appellate Panel, the United States Court of Appeals for the First Circuit agreed that rejection of the license by Tempnology prohibited any further use of Tempnology’s trademark by Mission. As the Seventh Circuit had concluded that rejection of a trademark license by the licensor did not terminate the licensee’s right to continue to use the licensed trademark, Tempnology petitioned the Supreme Court to resolve the Circuit split.
Tempnology argued that the First Circuit’s holding was supported by the language of Section 365 and by the Bankruptcy Code’s goal of facilitating reorganizations of distressed debtors. On the first point, Tempnology noted that several subsections of Section 365 expressly provide that licensees, lessees, and timeshare purchasers may continue to use and occupy the property that is the subject of the applicable license, lease, or timeshare agreement following rejection of the license, lease, or agreement by the licensor/lessor/seller. Those subsections include Section 365(n), which provides that a licensee of “intellectual property” may continue to use “intellectual property” after rejection of the license by the licensor. The Bankruptcy Code defines “intellectual property” to include patents, patent applications, and copyrights, but trademarks are not included within the definition. The omission of any provision from Section 365 expressly authorizing trademark licensees to continue to use trademarks following license rejection, Tempnology asserted, created a negative inference that no such use was permitted.
On the second point, Tempnology argued that trademark law requires trademark licensors to monitor use of their trademarks by licensees to insure appropriate quality control or risk losing their trademarks. Tempnology argued that allowing licensees to continue to use trademarks after rejection of their licenses would make it harder for trademark licensors to reorganize because they would have to use scarce resources to monitor the use of their trademarks or risk losing valuable trademarks.
The Court began its analysis of Section 365 by noting that it provides that rejection of any executory contract or lease by a Chapter 11 debtor or trustee “constitutes a breach” of the contract or lease. Because the Bankruptcy Code provides no specialized definition of “breach,” the Court said that the term “means in the Code what it means in contract law outside bankruptcy.” Under contract law, breach of a license by a licensor does not terminate the licensee’s right to use what it was licensed to use. The licensor “can stop performing its remaining obligations under the agreement,” but “cannot rescind the license already conveyed.” Allowing the licensor to breach the license and prohibit the licensee from using the trademark, the Court said, would be inconsistent with the “general bankruptcy rule” that the “[bankruptcy] estate cannot possess anything more than the debtor did outside bankruptcy.”
The Court rejected Tempnology’s argument that the absence of any provision in Section 365 authorizing a licensee to continue to use a trademark after rejection of a license following rejection by the licensor created a negative inference that such use was prohibited by saying that the argument “pays too little heed to the main provisions governing rejection and too much to subsidiary ones.” The main provision is that rejection constitutes a breach. The various subsections specifically permitting parties to continue to use property after rejection of their license, lease, or agreement by the licensor or lessee cited by Tempnology had each been enacted to respond “to a discrete problem—as often as not, correcting a judicial ruling of just the kind Tempnology urges.” Congress had enacted the provisions cited by Tempnology in support of its negative inference argument, the Court said, “as and when needed, to reinforce or clarify the general rule that contractual rights survive rejection.”
The Court rejected Tempnology’s argument that licensees under rejected trademark licensees needed to be prohibited from using the licensed trademarks to facilitate reorganizations by trademark licensors as “a mismatch for Tempnology’s reading of Section 365.” Tempnology argued that rejection of any contract or lease terminated the other party’s right to use the applicable property “unless the contract falls within an express statutory exception.” Since there was no statutory exception for trademark licenses, the Court said, “Tempnology is essentially arguing that distinctive features of trademarks should persuade us to adopt a construction of Section 365 that will govern not just trademark agreements, but pretty nearly every executory contract.” The Court said that doing that “would allow the tail to wag the Doberman.” The Court’s ruling is good news for trademark licensees. Had the Court agreed with the First Circuit’s interpretation of Section 365, the owner of, for example, a trademark for a nationally recognized chain of hotels, could have filed for bankruptcy, rejected its licenses with hundreds or thousands of hotels, and left the operators having to try to survive as generic hotels after having invested substantial sums in signage, stationary, linens, and other furnishings bearing the licensed trademark.