U.S. Supreme Court rules rejection of trademark license in bankruptcy does not terminate license
The background of this dispute is relatively straightforward: Mission Product Holdings, Inc. (“Licensee”), entered into a contract with Tempnology, LLC (“Licensor”), which gave Licensee a license to use Licensor’s trademarks in connection with the distribution of certain clothing and accessories. Licensor subsequently filed for Chapter 11 bankruptcy and sought to reject its agreement with Licensee. Section 365 of the Bankruptcy Code enables a debtor to “reject any executory contract”— meaning a contract that neither party has finished performing and that the effect of such rejection “constitutes a breach of such contract.” The bankruptcy court approved Licensor’s rejection of the trademark license, which permitted that Licensor could stop performing under the contract; and Licensee could assert (for whatever it might be worth) an unsecured claim in the Licensor’s bankruptcy proceeding for damages resulting from Licensor’s nonperformance. Those are non-controversial results of a rejection that are found in virtually every bankruptcy case. However, the bankruptcy court also held that the rejection of the trademark license terminated Licensee’s rights to use Licensor’s trademarks. The Licensee appealed.
The Bankruptcy Appellate Panel reversed, relying on a 7th U.S. Circuit Court of Appeals holding that the language of Section 365(g) of the Bankruptcy Code provides that rejection of a license agreement “constitutes a breach” and that rejection does not terminate Licensee’s rights that would survive a breach of contract outside bankruptcy. The 1st U.S. Circuit Court of Appeals, however, rejected the Bankruptcy Appellate Panel’s interpretation and reinstated the underlying bankruptcy court’s decision by reasoning, in part, that certain special features of trademark law – the requirement of a trademark owner to monitor and exercise control over the goods associated with the trademark – counsel against allowing Licensee to retain rights to a mark after the licensing agreement’s rejection. The Supreme Court took up the case to resolve the split between the 1st Circuit and 7th Circuit.
The Supreme Court found that the language of Section 365 of the Bankruptcy Code and the fundamental principles of bankruptcy law require an interpretation that a rejection breaches a trademark license but does not rescind it. The Supreme Court reasoned that under bankruptcy law, a bankruptcy estate cannot possess anything more than the debtor itself did outside bankruptcy. Therefore, all the rights that would ordinarily survive a contract breach, including those conveyed under a trademark license, remain in place. The court found that while a debtor-licensor can stop performing its remaining obligations under a trademark agreement, the debtor-licensor cannot rescind the license already conveyed, so the licensee is free to do whatever the license authorizes. Notably, in a concurring opinion, Justice Sotamayor clarified that the Supreme Court’s ruling does not decide that every trademark licensee has the unfettered right to continue using licensed marks post-rejection; but rather the court decided only that rejection does not terminate rights of the licensee that would survive the licensor’s breach under applicable nonbankruptcy law. Therefore, the court left open the door for lower courts to interpret whether the licensee’s rights would survive a breach under applicable nonbankruptcy law and acknowledged that special terms in a licensing contract or state law could bear on that question in individual cases.
This ruling is important for franchisors/franchisees as trademarks are part of the lifeblood of the franchise relationship. If a franchisor experiences financial difficulty and files for Chapter 11 to rid itself of certain unprofitable franchisee agreements (which include use of trademarks), a franchisee now has the option to either assert damage claims as a result of the rejection of the license or to continue to use the trademarks through the end of the term of the franchise agreement. Since unsecured damage claims in bankruptcy are typically not worth very much, it is likely that continuing use of the trademarks would be more valuable to the franchisee. Alternatively, a financially distressed franchisor assessing the profitability of its various franchisees may now have less flexibility in a bankruptcy to rid itself of unprofitable franchises or renegotiate new agreements because existing franchisees now have the right to continue using the trademarks even after a franchisor’s rejection of the agreement.