Stephen B. Selbst
Partner, Herrick Feinstein
The U.S. Supreme Court resolved a split among circuit courts over the status of a trademark license after the bankruptcy licensor of the trademark rejects the license. Stephen Selbst provides the history behind the ruling and explains the 8 to 1 decision written by Judge Elena Kagan.

In Mission Products Holdings v. Tempnology, the Supreme Court held that when a bankrupt licensor of a trademark rejects a trademark license, the licensee does not lose the ability to use the trademark.1 In an eight to one decision written by Justice Elena Kagan, the court held that rejection of a trademark license under Section 365 of the Bankruptcy Code is a breach of the contract, but does not revoke or terminate the license. The court’s decision resolves a split among the circuit courts on this issue; the Seventh Circuit had held that rejection of a trademark license does not terminate the licensee’s rights to use the license, but the First Circuit had ruled to the contrary.

This is an important decision, with implications for the bankruptcy bar and for lenders. Intellectual property is an increasingly important asset class for businesses and for the lenders that finance them. This ruling ends the uncertainty about the status of trademark licenses in bankruptcy.

Odd History of IP in Bankruptcy

The treatment of intellectual property licenses in bankruptcy has an odd history. In Lubrizol Enterprises v. Richmond Metal Finishers, the Fourth Circuit held that a debtor had the right to reject a non-exclusive patent license, and upon rejection, the licensee lost the right to use that intellectual property.2 As Justice Kagan noted in Mission Products, Lubrizol led to the enactment of Section 365(n) of the Bankruptcy Code, which provides that where a licensor of intellectual property rejects a license, the licensee has the option of treating the license as terminated or continuing to use the license in accordance with its terms. But the definition of “intellectual property” in the Bankruptcy Code does not include trademarks, trademark trade names or service marks.3 Since section 365(n) was added to the Bankruptcy Code, courts have struggled to determine the proper treatment of trademark licenses in bankruptcy. The Seventh Circuit had ruled in Sunbeam Products v. Chicago Am. Mfg. that rejection of a trademark license does not permit the licensor to terminate the licensee’s rights in the use of the trademark,4 but the First Circuit had held to the contrary in In re Tempnology, creating a split in the circuit courts.5

Lower Court History

Tempnology manufactured exercise clothing designed to stay cool while in use and had developed a trademark called “Coolcore.” Tempnology granted Mission Products a non-exclusive license to sell its Coolcore line of clothing and use the related trademark in the U.S.

Under Section 365(a) of the Bankruptcy Code, a debtor may assume or reject an executory contract. Although the term “executory contract” is not defined in the Bankruptcy Code, the most common formulation is that an executory contract is one where material performance is still due from each party.6 Section 365(g) of the Bankruptcy Code provides that “the rejection of any executory contract […] constitutes a breach of such contract,” which gives the non-debtor party a claim for damages against the debtor’s estate. In Tempnology, the debtor also believed that there was another consequence to the rejection of its license: the rejection terminated the right of Mission Products to use the Coolcore trademark.

In the bankruptcy court, Tempnology argued that although Section 365(n) provides that a licensee of intellectual property may continue to use the licensed property, trademarks were not included in the definition of intellectual property. Thus, it argued, Congress must have intended to exclude trademarks from such protection, and that without such protection, the licensee’s right to use the licensed trademarks must cease.

The bankruptcy court agreed,7 but the First Circuit’s Bankruptcy Appellate Panel reversed,8 relying on the Seventh Circuit’s decision in Sunbeam Products. The BAP reasoned that rejection of an executory contract, outside of bankruptcy, does not permit the breaching party to divest the non-breaching party of its rights, and it does not “terminate the contract” or “vaporize” the non-breaching party’s rights.9 The First Circuit reversed, reinstating the bankruptcy court’s decision. The First Circuit decision rested on the absence of trademark licenses in the Bankruptcy Code’s definition of intellectual property. The First Circuit agreed with Tempnology that a trademark licensor has a duty to protect and police the use of licensed trademarks, which it would have no incentive to do if it had rejected the license. It also reasoned that the Congressional bankruptcy policy behind allowing debtors to reject executory contracts was to free them from burdensome obligations, which it said would be frustrated if licensors were required to continue to monitor licensees.

Supreme Court Opinion

Justice Kagan’s opinion begins with an analysis of Section 365, noting that under Section 365(g), rejection of an executory contract “constitutes a breach.” She then observes that “breach” is not defined in the Bankruptcy Code nor given a specialized meaning in bankruptcy practice, leading her to conclude that breach has the same meaning that it has outside bankruptcy law. Thus, non-bankruptcy law is the proper place to examine the consequences of a breach of an executory contract. Justice Kagan used the example of a lease of a photocopier to illustrate the consequences of a material breach; if the lessor defaults, the user would have the right to sue for breach of the lease or terminate the agreement. But she emphasized that the decision whether to sue for damages or terminate the agreement rested with the non-breaching party.

From that analysis, she held that because breach, as used in Section 365(g), had the same meaning as a breach outside bankruptcy, the debtor who rejects the agreement should not have the right to terminate the licensee’s rights. Instead, the licensee has rights under the agreement that survive the breach, and in the case of a rejection, the licensee’s rights to continue to use the licensed rights survive: “The debtor can stop performing its remaining obligations under the agreement. But the debtor cannot rescind the license already conveyed. So, the licensee can continue to do whatever the license authorizes.”10 She also emphasized that, with limited exceptions, a debtor does not possess more rights than it held outside bankruptcy. She noted that there are “exceptional cases” in which a debtor can recover property from a third party using the avoidance provisions of Sections 544-553 of the Bankruptcy Code. But she noted that those provisions were intended to protect the estate from depletion, and that the debtor or trustee could invoke those powers in “narrow circumstances,” whereas contract rejections are commonplace and can be exercised in the debtor’s business judgment. Allowing debtors or trustees to use contract rejection as clawback tools would constitute an effective – and impermissible – end run around the limitations placed on the avoidance powers.

Tempnology’s primary argument was that because Congress had not included trademark licenses in Section 365(n), trademark licensees had no equivalent rights, and that licensors were free to terminate the right of use if they rejected a trademark license. Justice Kagan responded to that argument in several ways. First, she examined the history of intellectual property rights in bankruptcy. Rather than agreeing with Tempnology’s position, she found Congress had enacted a series of discrete fixes to intellectual property problems in the Bankruptcy Code each time a significant problem arose. She quoted a scholar who had written, “What the legislative record [reflects] is that whenever Congress has been confronted with the consequences of the [view that rejection terminates all contractual rights], it has expressed its disapproval.”11

Justice Kagan noted that Section 365(n) had been enacted to reverse the Lubrizol decision, observing that Lubrizol had ruled the same way as the First Circuit in Tempnology, that rejection of an executory contract terminated the licensee’s right of use. But she observed that following Lubrizol, “Congress sprang into action, drafting Section 365(n)” to ensure the continuation of certain intellectual property licensees’ rights. While she acknowledged that trademark licenses were not covered by 365(n), “Congress’s repudiation of Lubrizol for patent contracts does not show any intent to ratify that decision’s approach for almost all others. Which is to say that no negative inference arises.”12

Mission Products resolves the issue of the right of a trademark licensee to continue to use the licensed marks if a trademark license is rejected in the licensor’s bankruptcy case. As the conflicting circuit court opinions showed, the confusion arose principally from Congress’s decision not to include trademark licenses as intellectual property when it enacted Section 365(n) to address the Lubrizol decision. The decision is sound for several reasons; as Justice Kagan noted, with rare exceptions, debtors do not have greater rights than they had prior to seeking bankruptcy relief.

Allowing a trademark licensor to terminate the licensee’s use would have created a situation where trademark licenses were treated differently than other kinds of executory contracts, including intellectual property licenses covered by Section 365(n). For trademark licensees (and their lenders), the ruling means that licensees can continue to rely on and use licensed trademarks, even if the licensor seeks to reject the license in bankruptcy. That holding makes trademark licenses better collateral for underwriting loans. •