U.S. Supreme Court holds that Trademarks Licenses cannot be deemed rescinded upon a rejection of an executory contract in Bankruptcy Court

June 26, 2019

Faced with the issue of the effect of a Debtor's (or trustee's) rejection of a contract under Section 365 of the Bankruptcy Code, in Mission Product Holdings, Inc. v. Tempnology, LLC, 597 U.S. ___ (2019), the United States Supreme Court settled a split among the circuits and held that a Debtor-licensor's rejection of a trademark licensing agreement does not deprive the licensee of its rights to use the trademark. . Since such breach does not constitute a rescission that would have the effect of unwinding the rejected contract as if it never existed, all rights previously granted under the contract that would survive a breach of contract under applicable non-bankruptcy law, remain in place. The court also reasoned that if a Trustee, or a Debtor-in-possession, can use rejection of the executory contract to rescind previously granted interests, then rejection would become functionally equivalent to granting the powers of an avoidance action.

In Tempnology, the Debtor was a sportwear manufacturing company, owner of trademarks (e.g., logos and labels) that granted Mission Product a non-exclusive trademark license agreement. The agreement was set to expire in July 2016, but in September 2015, Tempnology filed a petition for Chapter 11 and later requested the Bankruptcy Court to allow it to reject the licensing agreement and terminate Mission's rights under the license. Section 365 of the Bankruptcy Code provides that a debtor, subject to the court's approval, may assume or reject any executory contract to walk away from certain burdensome obligations. 11 U.S.C. § 365. The Bankruptcy Code identifies several categories of contracts under which a counterparty may retain some specified contract rights after rejection, including "intellectual property."

As Justice Sotomayor noted in her concurring opinion, Section 365(n)-which applies to patents, copyrights, and four other types of intellectual property, but not to trademarks, §101(35A)-alters the general rule on rejection of executory contracts in several respects. For example, a covered licensee that chooses to retain its rights post-rejection must make all of its royalty payments; the licensee has no right to deduct damages from its payments even if it otherwise could have done so under non-bankruptcy law. §365(n)(2)(C)(i). This provision and others in §365(n) mean that the covered intellectual property types are governed by different rules than trademark licenses.

The Court noted that the specific kinds of agreements under Section 365 were not exceptions to the rule but were added by Congress to correct judicial rulings in order to "reinforce or clarify the general rule that contractual rights survive rejection." Mission Product Holdings, Inc v. Tempnology, LLC, at 1664.

In sum, the Court held that Tempnology's rejection of an executory contract has the same consequence as a contract breach outside bankruptcy court: it gives Mission Product a claim for damages, while leaving intact the trademarks license that Mission Product has received under the contract.

Justice Sotomayor also noted two potentially significant features of the Supreme Court's holding . First, Sotomayor noted that the decision should not be interpreted to grant every trademark licensee the unfettered right to continue using licensed marks post rejection, because "[s]pecial terms in a licensing contract or state law could bear on that question in individual cases." Id., at 1666. Second, Justice Sotomayor stated that the Court's holdings sets forth that the "covered intellectual property types [in Section 365(n) of the Code] are governed by different rules that trademark licenses", and given that outcome, Congress should "tailor a [specific] provision for [post rejection] trademark licenses." Id., at 1667.

The importance of this ruling is that it will apply to all debtors that reject, under Section 365, any kind of executory contract or unexpired leases, not just trademark licenses because section 365 is the general provision, subject to certain exceptions and specifications, that guides contracts requiring execution of obligations after the filing of a bankruptcy petition. Debtors should be aware that the rejection of an executory contract cannot rescind what has already been conveyed, which could in turn lead the counterparty licensee the right to continue using the trademark license.

Goldman 2019 Summer Associate Jerry Negrón contributed in this article.

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