On Monday, the U.S. Supreme Court finally resolved a trademark law issue that had remained unsettled for years: whether a bankrupt trademark owner may revoke a trademark licensee’s rights to a licensed trademark by “rejecting” the license agreement under a specific provision of the Bankruptcy Code. The Court, in an 8-1 decision, held that the Code provided a bankrupt trademark owner with no such right, and thus a trademark licensee maintains its right to continue using the trademark per the terms of the license. This holding is important because it provides more certainty in the operation of trademark licenses. Absent specific contract provisions to the contrary, trademark licensees need not worry about losing important trademark rights when the licensor declares bankruptcy. At the same time, a bankrupt trademark owner undergoing Chapter 11 reorganization is not free to unilaterally terminate a trademark license in hopes of entering into a better licensing deal upon emergence from bankruptcy.
Tempnology owned patents and trademarks related to a specialized fabric used to make clothing and accessories that help keep users cool during exercise. Tempnology entered into an agreement with Mission Product Holdings that, among other rights, granted to Mission a non-exclusive license to use Tempnology’s COOLCORE® trademark and logo in the sale and distribution of this specialized athletic gear.
Before the term of the license expired, Tempnology filed a voluntary petition for Chapter 11 bankruptcy and moved, pursuant to Section 365(a) of the Bankruptcy Code, to reject the license agreement with Mission. Section 365(a) provides that a debtor, such as Tempnology, may “reject any executory contract” if the debtor determines that such contract would not be beneficial to the business. After rejecting the license with Mission, Tempnology sought to license the trademarks to another entity on more beneficial terms. Mission objected, relying on § 365(n) of the Bankruptcy Code, which provides an exception to § 365(a) and allows an intellectual property licensee to choose either “treating the license as terminated” and seeking damages or, instead, retaining the intellectual property rights under the license.
Bankruptcy and Appeals Court Decisions
The Bankruptcy Court in the First Circuit sided with Tempnology, reasoning that although § 365(n) specifically calls out patents, trade secrets, and copyrights as “intellectual property,” it does not reference trademarks. As such, the court reasoned, § 365(n) could not save Mission’s rights under the trademark license. The court’s analysis also focused on a trademark owner’s ongoing obligation to maintain quality control over its licensed products, explaining that a licensor/debtor in bankruptcy should not be burdened by the duty of quality control, thus potentially subjecting the licensed marks to abandonment and a resulting decrease in the value of the marks, all of which would be detrimental to the licensor/debtor’s estate and contrary to the purpose of bankruptcy law.
On appeal, the Bankruptcy Appellate Panel concluded differently, holding that the licensee’s right to use a licensor/debtor’s trademarks is not extinguished when a debtor-licensor rejects the license agreement. The panel relied on the Court of Appeals for the Seventh Circuit, which had decided a similar question, and explained that the licensor/debtor is merely relieved of its quality control obligation, not that the license is terminated. The court reasoned that because Bankruptcy Code § 365(g) treats rejection as a breach of contract, and because a licensor’s breach of a trademark agreement outside the bankruptcy context would not necessarily terminate the licensee’s rights, a rejection likewise should not eliminate the licensee’s rights. On further appeal, the Court of Appeals for the First Circuit disagreed and, relying on the fact that “trademarks” are not covered by the intellectual property definition in § 365(n), concluded that Congress must have meant that the § 365(n) exemption should not apply to trademarks.
The First Circuit rejected the Seventh Circuit’s reasoning and held that because the Bankruptcy Code’s rejection provision is designed to permit the debtor to walk away from burdensome obligations, allowing a licensee to continue using a trademark would necessarily impose oversight obligations that, if not fulfilled by the debtor, could result in abandonment of the trademarks and harm to the estate. The First Circuit thus adopted – in contrast to the Seventh Circuit – a categorical approach in which the right to use a trademark under a license agreement is terminated if the debtor-licensor rejects the license agreement.
The Supreme Court’s Analysis
The issue presented to the Court was whether, under § 365 of the Bankruptcy Code, a licensor/debtor’s “rejection” of a license agreement ‒ which “constitutes a breach of such contract” under § 365(g) – terminates the rights of the licensee given that, in a non-bankruptcy context, a contract breach by one party would not automatically terminate the other party’s rights under the contract.
Writing for the majority, Justice Kagan began by reviewing the Bankruptcy Code and clarified that under the Code, a “rejection constitutes a breach.” A “breach,” however, is not a defined or specialized bankruptcy term, and thus it “means in the Code what it means in contract law outside bankruptcy.” In a non-bankruptcy context, the breaching party has no right to take back its licensed rights as a result of its breach. Rather, the licensee has the right to decide whether it wants to walk away from the contract based on the licensor’s breach or, instead, continue performing its obligations under the license (e.g., paying royalties), notwithstanding the breach by the licensor. Continued operation of the license is not the breaching licensor’s choice; it is the licensee’s choice. The Court saw no material difference in the trademark license context. The bankrupt trademark owner’s “breach” (i.e., its “rejection” of the license agreement under § 365(a)) does not permit the trademark owner to rescind the license already conveyed. As such, the licensee may continue to do whatever the license agreement permits it to do.
With respect to the argument that permitting the trademark licensee to continue to operate under the license would impose obligations on the licensor/debtor’s estate that would be inconsistent with the purposes of the Bankruptcy Code, Justice Kagan noted that while the Code is, of course, intended to help facilitate reorganizations by the debtor, it “does not permit anything and everything that would advance that goal.” Thus, the fact that a licensor/debtor may need to invest resources to maintain its trademarks (by, for example, overseeing the use of the marks by the licensee and monitoring quality control) does not serve as a rational basis for permitting the debtor/licensor to reject the license and take back the license rights. The Code does not relieve the debtor/licensor “from all the burdens the generally applicable law – whether involving contracts or trademarks – imposes upon property owners.” The debtor/licensor will need to make economic decisions about preserving the estate’s value. One of those decisions will be whether to invest the resources needed to maintain trademarks. That such choices will need to be made and that they may have economic impact is not a justification for treating trademark licenses differently from other contracts “breached” through rejection in bankruptcy.
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The Mission Product decision provides important clarity to trademark licensees caught in a situation where the trademark licensor seeks bankruptcy protection. While the decision arguably means that the debtor/licensor may be “burdened” by the requirement to monitor the use of its licensed marks, that obligation is not actually very far removed from its other obligations vis-à-vis the estate in the bankruptcy context, namely to maximize the value of the estate.