On May 20, 2019, in Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. ---, 139 S. Ct. 1652 (2019), the Supreme Court resolved a split among the circuits, holding that a licensor's rejection of a trademark license in bankruptcy constitutes a prepetition breach, but does not terminate the license. Focusing on the language of the Bankruptcy Code and the common law of contracts, the decision reversed a decision of the First Circuit that had held that the licensor's rejection terminated all the licensee's rights, thereby helping to eliminate continuing confusion in the lower courts about the effect of contract rejection and placing the treatment of trademarks on a similar footing to the treatment of other intellectual property under Section 365.
The Facts
Tempnology, LLC ("Tempnology," or the "Debtor-Licensor") manufactured clothing and accessories under the brand name "Coolcore." In 2012, it granted Mission Product Holdings, Inc. ("Mission" or the "Licensee") an exclusive license to distribute Coolcore products in the United States and a nonexclusive license to use the Coolcore trademarks worldwide. Three years later, Tempnology filed for bankruptcy, where it sought to reject the license agreement under Section 365(a) of the Bankruptcy Code. After the Bankruptcy Court approved the rejection, Tempnology sought and obtained a declaration from the Bankruptcy Court that rejection terminated Mission's right to use the trademarks.
The First Circuit ultimately upheld the Bankruptcy Court's conclusion. It noted that Section 365 contained provisions that expressly preserved the rights of lessees, real estate vendees and non-trademark intellectual property licensees in similar circumstances. The negative inference from these provisions, it held, was that trademark licensees enjoy no such protection. This result, it reasoned, was consistent with the purpose of contract rejection. If a licensee could continue using a trademark post-rejection, the licensor would need to continue monitoring the marks and, thus, be deprived of at least some of the benefit of rejection.
The Opinion
After concluding that the expiration of the license during the appellate process did not moot the appeal, Justice Elena Kagan, writing for an 8-1 majority, turned to the substantive effect of a debtor-licensor's rejection of a license under Section 365 of the Bankruptcy Code. Adopting the approach taken by the Seventh Circuit, she focused on the language of the Bankruptcy Code and the common law of contracts.1Section 365(a) of the Bankruptcy Code authorizes a trustee or a debtor in possession, with court approval, to "assume or reject any executory contract." Section 365(g), in turn, specifies that "rejection of an executory contract . . . constitutes a breach of such contract." Because the Bankruptcy Code did not define the term "breach," the Supreme Court looked to non-bankruptcy contract law to assess its meaning. Under generic contract law, a breach grants the non-breaching party the choice either to continue performance and seek damages or to stop further performance. In either case, the election belongs to the non-breaching party; the breaching party had no ability to rescind the contract based on its own violation.
Returning to bankruptcy law, the Supreme Court explained that a debtor's estate "cannot possess anything more that the debtor itself did outside bankruptcy." 139 S. Ct. at 1663. Accordingly, because the Bankruptcy Code specifies that the debtor-licensor's rejection of a license was a "breach," that rejection could not terminate the license. Instead, rejection allowed the licensee to elect whether to retain its rights in the license or treat the contract as terminated. To treat rejection as rescission or termination would allow the debtor unilaterally to strip the licensee of its rights — a power the debtor did not possess outside of bankruptcy. Such a construction would also effectively create a new form of avoidance action, under Section 365 rather than Article 5 of the Bankruptcy Code, that was not subject to the same requirements and limitations as the claims expressly created by that Article.
The Supreme Court also refused to find a negative inference from other provisions of Section 365 that permitted rejection to be construed as rescinding or terminating the contract. Section 365(n) provides that a non-debtor licensee of intellectual property — not including trademarks — whose license is rejected may elect to "retain its rights" or "treat such contract as terminated." See 11 U.S.C. § 365(n)(1)(A),(B). Other subsections grant lessees and real estate purchasers a similar election. See id. §§ 365(h) (rejection by debtor-lessor) and (i) (rejection by debtor seller of real property or timeshare). Tempnology argued that the necessary implication of these provisions was that such an election was not available where other types of contracts were rejected, but the Court disagreed. The plain language of Section 365(g) required rejection to be treated as a breach regardless of the subject matter of the relevant contract; the asserted "negative inference" therefore could not support granting rejection any different or greater effect. In addition, the Court found no negative inference was warranted. The provisions of Section 365 had evolved over half a century to address specific situations and court decisions. The resulting "mash-up" of provisions, the Court held, did not suggest an intent to vary the effect of rejection on specific types of contracts but, if anything, reinforced the "general rule that contractual rights survive rejection." 139 S. Ct. at 1664. The Court also rejected the contention that unique features of trademark law required a different result. The language of Sections 365(a) and (g) was phrased generally, without reference to the policies of trademark. To allow trademark principles to control their interpretation would "allow the tail to wag the Doberman." Id. at 1665.
Justice Sotomayor joined the majority opinion in full but concurred separately to stress two points. First, she noted the majority decision did not hold that every trademark licensee necessarily has the right to continue using licensed marks post-rejection, and that the specific terms of a license could impact the effect of rejection under applicable non-bankruptcy law. Second, the Supreme Court's holding confirms that trademark licensees' post-rejection rights and remedies are different than other types of intellectual property rights (such as copyrights and patents) under Section 365(n), which leaves open a path for Congress to legislate comparable rights for trademark licenses if it so chooses. Justice Gorsuch dissented on the ground that the appeal should have been dismissed as moot.
Looking Ahead
The Supreme Court's decision clarifies the impact of a debtor-licensor's rejection of a license. By adopting the Seventh Circuit's approach, the Court has confirmed that rejection of a licensing agreement does not "vaporize" a licensee's rights under that agreement, but instead gives the debtor's counterparty the right to choose whether to retain its rights or terminate the contract. Under this decision, a debtor-licensor will need to continue monitoring its trademarks under rejected licenses. But if a debtor is unable to do so because of its financial condition, the licensee may see the value of the marks decline. On the other hand, licensors, particularly economically distressed licensors, may find the Supreme Court's ruling useful, as licensees may be more willing to bargain with them because certain of the licensee's rights can survive rejection.
Importantly, the Court's ruling does not appear to be limited to rejection of licenses or trademark agreements. The Court premised its reasoning on general contract principles and, in fact, explicitly rejected an argument that trademark policy should control the outcome of the case. Future decisions will consider whether the holding has rendered Sections 365(h), (i) and (n) superfluous, or whether non-trademark intellectual property licensees, lessees and real estate vendees retain some different or additional rights upon rejection. Similarly, as the concurrence suggests, courts will no doubt consider how individual contract provisions change the impact of contract rejection.
Footnotes
1 See Sunbeam Prods., Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).
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