U.S. Supreme Court Currently Considering Impact of Rejection of Trademark Licenses in Bankruptcy Cases

March 15, 2019

In 2018, the First Circuit in Mission Product Holdings, Inc. v. Tempnology, LLC, 879 F.3d 389 (1st Cir. 2018) (the Tempnology Decision) decided that trademark licensees lost their rights under a trademark license when the chapter 11 debtor-licensor rejected the trademark license between the parties. This decision by the First Circuit conflicted with another circuit court decision from the Seventh Circuit, leading the U.S. Supreme Court to resolve the conflict amongst the circuits regarding the rights of a licensee in a trademark that is rejected by a debtor-licensor in a bankruptcy case.

We have reviewed the Tempnology Decision and the legal memoranda submitted to the Supreme Court by Tempnology, the debtor-licensor and Mission Product Holdings, Inc., the non-debtor licensee. We have also listened to the oral argument of the Supreme Court’s hearing on February 20, 2019 to ascertain the Justices’ views and assess the most likely outcome. A brief summary of the Tempnology Decision, the arguments of the parties and the summary of the oral argument before the Supreme Court follow.

Background of Tempnology Decision

The debtor, Tempnology, LLC produced clothing that remained cool during exercise and marketed these products using the COOLCORE and DR COOL trademarks. In November 2012, Tempnology entered into a co-marketing and distribution agreement with Mission Product Holdings, Inc. in which it granted, among other things, a non-exclusive license to use Tempnology’s trademarks on products that Mission sold to its customers. Further, the agreement provided Mission an exclusive license to sell certain of Tempnology’s products bearing its trademarks in the United States.

In July 2014, disputes arose and Mission terminated the agreement “without cause,” which triggered a two year “wind down” period in which Mission was permitted to retain its distribution and trademark rights. Tempnology, in turn, terminated the agreement “with cause” and claimed that Mission’s hiring of Tempnology’s former CEO constituted “cause” for termination. An arbitration took place in which the arbitrator, in June 2015, found that Tempnology’s purported termination for “cause” was unwarranted, meaning that Mission could retain its distribution and trademark rights until July 1, 2016.

After the arbitrator’s ruling, Tempnology filed a Chapter 11 bankruptcy petition in the Bankruptcy Court for the District of New Hampshire. Immediately thereafter, Tempnology filed a motion to reject the agreement pursuant to section 365(a) of the Bankruptcy Code, which provides, in relevant part, that a trustee (or a debtor in possession in a Chapter 11 case) may reject executory contracts in which a debtor is a party. There was no dispute that the agreement was an executory contract which was capable of being rejected by the debtor.

Mission filed an objection to the rejection motion, arguing that section 365(n) of the Bankruptcy Code allowed Mission to retain, among other things, its intellectual property rights. Section 365(n) of the Bankruptcy Code provides protections to licensees of intellectual property when a debtor-licensor attempts to reject such licenses pertaining to intellectual property. In those instances, a non-debtor licensee, such as Mission in this case, could either (i) treat the license as terminated and pursue a claim for damages or (ii) retain its rights under the license.

In reaction to a Fourth Circuit decision, Lubrizol Enterprises, Inc. v. Richmond Metal Finishers Inc., 756 F.3d 1043 (4th Cir 1985), which allowed a debtor-licensor to reject a patent license and deprive such non-debtor licensee of all rights, section 365(n) was added to the Code, along with a definition of “intellectual property.” Interestingly, while trademarks are generally considered a form of intellectual property outside of bankruptcy, the definition of “intellectual property” under the Bankruptcy Code includes, among other things, patents and copyrights, but not trademarks. The legislative history in 1988 behind the intellectual property definition and section 365(n) reveals that Congress was solely reacting to the Lubrizol decision, and thus purposely left trademarks out of the intellectual property definition, thereby “postpon[ing] action on trademark licenses to allow the development of equitable treatment of this situation by bankruptcy courts.” S. Rep. No. 100-505, at 5.

After reviewing the relevant case law, the statutory text and legislative history, the bankruptcy court handling the Tempnology case determined that Mission did not have a right to retain its rights under the license after rejection by the debtor. In other words, Mission’s rights were limited to a claim in the bankruptcy estate. Mission appealed the Bankruptcy Court’s decision to the Bankruptcy Appellate Panel for the First Circuit (the BAP), which reversed the Bankruptcy Court’s decision, finding instead that a licensee of a transferee did not lose all rights under the license upon rejection by a debtor-licensor. In reaching its decision, the BAP relied on a Seventh Circuit decision in Sunbeam Products, Inc. v., Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012).

In Sunbeam, the Seventh Circuit held that rejection does not preclude the continued use of a trademark stating that “nothing about this process implies that any other rights of the other contracting party have been vaporized.” Sunbeam, 686 F.2d at 377. In other words, the Seventh Circuit determined that rejection constituted a contractual breach and not a termination and thus, whatever post-rejection rights Mission retained in the debtor’s trademark and logo were governed by the terms of the agreement and applicable nonbankruptcy law.

The debtor (Tempnology) appealed the BAP’s decision to the First Circuit, making it the third court in the Tempnology case to weigh in on this important legal issue. The First Circuit disagreed with the reasoning of the BAP (and consequently, the Seventh Circuit’s decision in Sunbeam), finding that rejection of the trademark license meant that Mission was limited to a claim for damages and that it retained no further rights in the trademark license after rejection. In support of its reasoning, the First Circuit determined that the exclusion of trademarks from the definition of “intellectual property” in the Bankruptcy Code means that the holders of trademark licenses are not able to retain the benefits of the trademark license, unlike the holders of patent and copyright licenses who were specifically provided for in the statute. The First Circuit also determined that allowing a licensee to retain the benefits of a trademark license could be construed to require a debtor-licensor to continue to comply with its obligations under the trademark, such as the obligation to monitor and exercise control over the quality of the goods sold to the public under the cover of the trademark.

The Supreme Court Petition and Oral Argument

Mission filed a petition for certiorari to the U.S. Supreme Court, which granted the petition, in order to resolve an important conflict amongst the circuits. In addition to the parties’ substantive briefs, numerous amicus curiae briefs by academics and trade associations such as the International Property Owners Association were filed in support of Mission’s interpretation of the law, and thus a more expansive protection to holders of trademark licenses. As noted, the Supreme Court heard oral argument from the parties on February 20, 2019.

While it is difficult to conclude how the Supreme Court will ultimately decide the dispute, certain remarks and questions from the participating Justices suggest that it is more likely than not that the Supreme Court will find that rejection of the trademark license should have permitted Mission to retain whatever rights that they may have under nonbankruptcy law. This was the Seventh’s Circuit’s view in Sunbeam.

Indeed, Justice Ginsburg challenged counsel to Tempnology during oral argument to explain why “the scholars in this field, the bankruptcy field, disagree with your interpretation and they say Lubrizol was wrong and Sunbeam was right.”

Justices Kagan and Breyer, in particular, seemed focused on the impact of a licensor’s breach of a trademark license outside of bankruptcy and the licensee’s rights to use a trademark under those circumstances. It would appear that these justices may be suggesting that if, outside of a bankruptcy case, a licensor’s breach under a trademark license means that that the licensee may retain the right to use a trademark, under such circumstances, licensees should be treated in the same manner, notwithstanding a debtor’s right to reject contracts under section 365 of the Bankruptcy Code.

Another important area that seemed to intrigue the justices, especially Justice Sotomayor, related to the impact of rejection on a licensor’s obligation to maintain quality control. Mission’s counsel argued that a licensee also has an interest in maintaining quality control and therefore that obligation may not be the licensor’s alone. The issue is important because there is a strong bankruptcy policy in favor of allowing debtors to reject contracts based on the need to avoid burdensome obligations. As such, if the Supreme Court were inclined to rule in favor of the non-debtor licensee in this matter and allow it to retain rights under a trademark license, even after rejection, the Supreme Court seemed concerned that such ruling could be construed to mean that future debtor-licensors might possibly be burdened with ongoing obligations to maintain quality control.

Of important note, Justices Gorsuch and Sotomayor raised the question as whether the case was “moot” because the rights of Mission, the licensee, to use the trademark expired in 2016 under the terms of the agreement and Mission was no longer ordering product under the agreement. Mission’s response was that the case was not moot because the debtor’s failure to provide product during the bankruptcy case after rejection led to damage claims that need to be addressed. A determination by the Supreme Court that the case is “moot” would mean that the petition would be dismissed as improvidently granted and parties to trademark licenses (as well as bankruptcy professionals and intellectual property professionals alike) will be left with the continuing debate regarding the impact of a debtor-licensor’s rejection of a trademark license.

A decision from the Supreme Court is expected in May 2019, and we will update you with a summary of this important decision at that time.

Rocco Cavaliere is a partner in the Bankruptcy and Corporate Restructuring Group at Tarter Krinsky & Drogin LLP. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

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