Jun
03

Are Trademark Licenses Subject to Rescission Under the Bankruptcy Code? No According to the U.S. Supreme Court

Intellectual property law is not an island all to itself but can show up as an issue in many other areas of the law: securities law, contract law, employment law, family law, estate planning law, successions law, bankruptcy law, social media law, tax law, etc.  Indeed, in the May 20, 2019 decision by the U.S. Supreme Court in Mission Product Holdings, Inc. v. Tempnology, LLC, three areas of the law were actually involved: intellectual property law, bankruptcy law and contract law.  The Court held that a trademark licensing agreement does not become rescinded (i.e. terminated) upon the debtor’s rejection of the agreement under Section 365 of the Bankruptcy Code (“Code”).

This article summarizes the case’s background and the High Court’s reasoning. It ends with a discussion of the practical aspects of the decision for trademark licensors who declare bankruptcy.  It is the first in a series of planned articles on cases where intellectual property issues have overlapped with at least one other area of the law.

Note: Our firm is available to collaborate with lawyers who do not practice intellectual property law on a day-to-day basis and may need guidance on intellectual property issues arising in their own cases.

  • Background

Tempnology had granted Mission a non-exclusive license to use Tempnology’s registered Coolcore trademarks in the U.S. and around the world and to serve as Temnology’s exclusive distributor for certain Coolcore products in the U.S. Tempnology filed a petition under Chapter 11 Bankruptcy in September 2015, or about nine months before the agreement was set to expire.

The filing of the “reorganization” petition created a bankruptcy estate consisting of all of Tempnology’s assets and rights for use in paying off creditors’ claims based on creditors’ superior rights and the value of the available assets/rights. Bankruptcy estates are administered by either a trustee or the debtor.  In this case, the debtor (the trademark licensor) administered the estate.

Executory contracts include provisions that confer value/rights on the debtor and are therefore a possible estate asset. Such contracts generally represent both an asset (i.e., the receipt of a benefit resulting from the counterparty’s future performance) and a liability (the debtor’s own obligation to perform).  The Code provides that a “trustee [or debtor] subject to the court’s approval may assume or reject any executory contract.”  Slip opinion at 2 quoting §365(a) of the Code.

Intellectual property licensing agreements are executory contracts. Regarding the trademark licensing agreement between Temptology and Mission, the obvious benefit for Tempnology was the receipt of royalty payments from the sales made by Mission. Tempnology’s liability was its agreement that mission could use its registered trademarks for a specified period of time.  As the licensor of a federal registered trademark, Tempnology also had another obligation imposed by trademark law which will be discussed in Part 3.

In determining how to handle executory contracts, debtors will decide whether the negotiated contract terms are still a good deal for the estate in going forward. If so, the debtor will likely want to assume the contract to continue benefitting from it as well as continuing to fulfill its own obligations.  If not, the debtor will want to reject the contract, repudiating any further performance of its duties. Slip opinion at 2.

What happens when the court approves rejection of an executory contract by the debtor? The rejection constitutes a breach of the contract by the debtor. Now the counterpart has a claim against the estate for damages resulting from the debtor’s nonperformance and this breach is deemed to occur immediately before the date of the filing of the bankruptcy claim. Slip opinion at 3 citing §365(g)(1).

What’s the practical effect a debtor’s rejection of an executory contract? The counterparty is now categorized as an unsecured creditor along with the debtor’s other unsecured creditors; these creditors often receive peanuts for their claims against the estate.

Under the instant case, Tempnology could stop performing under the rejected contract. Mission could assert a pre-petition claim in damages resulting from Tempnology’s non-performance.

Maybe with an eye towards trying get a licensing agreement with more favorable terms with another party, Tempnology then sought a declaratory judgment from the Bankruptcy Court that its rejection of the trademark licensing agreement also terminated the rights it had granted to Mission to use the Coolcore trademarks.  In essence, Tempnology was seeking rescission/revocation of the licensing agreement.

Numerous appeals ensued. The High Court granted certiorari because of a conflict between the First and Seventh Circuits over whether or not a debtor-licensor’s rejection of a trademark licensing contract deprives the licensee of its rights to use the trademark until the rejected contract expired.

  1. The High Court’s Reasoning
  • Allowing Rescission of a Trademark Licensing Agreement Is Inconsistent with the Code’s Stringent Limits Designed to Prohibit a Debtor from Getting Out of Its Obligations

In finding for Mission, the Court was careful to emphasize the Bankruptcy Code’s stringent limits on “debtor avoidance of obligation” actions, in particular the Code’s prohibition on a debtor’s fraudulent conveyance(s) to deplete the estate (and so cheat creditors) on the eve bankruptcy. Slip opinion at 11 citing §§544-553.  The power to reject an executory contract, on the other hand, has no strict limitation and can be exercised for any plausible economic reason.  Absent “strange” circumstances, the bankruptcy courts generally give much deference to the debtor’s “rejection” choice under the “business judgment” rule.  Slip opinion at 3. “If trustees or debtors could use rejection to rescind previous granted interests, then rejection would become functionally equivalent to avoidance” contrary to the Code’s clear intent and language to cabin avoidances. Slip opinion at 12.

  • Breach by a Debtor-Licensor (or Licensee-Debtor) Does not Revoke a License Outside of the Bankruptcy Context

The Court emphasized that under contract law outside the context of bankruptcy law, a breach of the licensing agreement by a licensor does not revoke the license or stop the licensee from doing what it allows – i.e., using the licensed intellectual property. Slip opinion at 10.  This of course does not mean that the licensee will be able to effectively continue using the licensed intellectual property.  For example, if the licensor is supposed to provide goods bearing the registered trademark to the licensee and stops doing so, then the licensee will be effectively prevented from using the licensed trademark.   However, the licensee will have recourse in a court of law to address the licensor’s breach – where state law will generally apply.

The Court further emphasized that a bankruptcy estate cannot possess anything more that the debtor itself did prior to the bankruptcy; the debtor is not entitled to augmented rights. Slip opinion at 11. The Code’s articulated rejection-as-breach rule in lieu of Tempnology’s proposed rejection-by-rescission-rule ensures that the same counterparty rights (Mission’s rights) survive rejection as they would survive al allegation of breach in a non-bankruptcy proceeding prevents a debtor in bankruptcy (Tempnology) from recapturing interests it had given up. Slip opinion at 11.

  • Tempnology’s Negative Inference Argument Lacks Merit

Tempnology also argued that certain provisions under § 365 of the Code actually articulate certain situations where a counterparty “may retain specified contract rights notwithstanding rejection [by the debtor]. As the argument went, the Code does not intend that a rejection of any type of executory contract not specifically identified in the Code means that such “unmentioned”  rejected contracts are actually rescinded contracts.

Interestingly, §365(n) of the Code applies specifically to patent and copyright licensing agreements but not trademark licensing agreements. Congress enacted this section in response to the Fourth Circuit’s decision in Lubrizol Enterprises v. Richmond Metal Finishers, 756 F.2d 1043, 1045-1048 (1985) wherein the court had held that the debtor’s rejection of the patent licensing agreement worked to revoke its grant of a patent license.   Section 365(n) corrected the perception that “Section 365 was ever intended to be a mechanism for stripping an innocent licensee[s] or rights.” Slip opinion at 14.   As Temptology’s argument went, absent a specific limitation within the Code stating that the rejection of a particular type of executory contract is to be construed only as a breach of the contract by the debtor, a debtor’s rejection means rescission or revocation of the contract.  Because the Code does not specifically address trademark licensing agreements, Temptology’s rejection licensing agreement must therefore a treated as a rescinded agreement wherein neither party has any further obligations. Slip opinion at 14. See also Justice Sotomayer’s concurring opinion, pg. 2 (also stating that under §365(n), “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 nonbankruptcy law [i.e. state contract law]. This provision . . .  means that the covered intellectual property types are covered by different rules than trademark licenses.”

The High Court gave short shrift to Tempnology’s round-about argument, noting that Congress has enacted specific provisions to the Code at different times over a period of fifty years more often than not to “correct a judicial ruling of just the type Tempnology urges.” Slip opinion at 13.  In other words, the legislative record shows that Congress has expressed its disapproval by amending § 365 whenever a court has terminated all contractual rights for executory contracts subject to a bankruptcy proceeding.  Tempnology was asking the Court to make a ruling contrary § 365’s long legislative history.

  • Unique Aspects of Trademark Licenses

The strongest argument Temptology offered in the commentator’s opinion as that trademark law imposes a duty on trademark licensor to exercise quality control over the goods and services sold under the terms of a license.  The public policy behind this requirement is that trademark law’s focus is the consumer.  The registered trademark owner (licensor) is in charge of ensuring that the quality/characteristics the consumer has come to associate with a good/service are consistently present.

What is the trademark licensor/debtor to do during a bankruptcy proceeding?  Temptology argued that “unless rejection of a trademark licensing agreement terminates the licensee’s rights to use the mark, the debtor will have to choose between expending scarce valuable resources on quality control and risking the loss of a valuable asset,” thereby impeding a [debtor’s] ability to reorganize inconsistent with a fundamental tenant of the Code.  Slip opinion at 15.

The High Court was unwilling to use the unique requirements of trademark licensing to adopt Temptology’s construction § 365 that will govern not just trademark licensing agreements but pretty nearly every executory contract.  In essence, Bankruptcy law is intended to balance the legitimate interests and expectation of the debtor’s counterparties which is inconsistent with granting debtors a right, through rejection of an executory contract, to escape all of its future contract obligations. Slip opinion at 15.

  1. Practical Considerations

Trademark Licensors should have a clearly articulated/implemented approach for monitoring the quality of all goods/services sold under its registered marks by a licensee from the get- go.  This approach should include maintaining records showing the monies spent on monitoring its licensees and the actual steps taken by the licensor.  Such information could sometime be invaluable to a bankruptcy trustee/debtor in allocating reasonable funds to continue overseeing a licensee’s goods/services until the licensing agreement terminates according to the agreement’s specified date.

THE FOREGOING IS NOT LEGAL ADVICE NOR SHOULD YOU CONSIDER IT AS SUCH. IT IS FOR INFORMATIONAL PURPOSES ONLY. YOU SHOULD CONSIDER CONSULTING WITH AN ATTORNEY IF YOU ARE CONTEMPLATING AN ACTION WHICH MAY HAVE LEGAL CONSEQUENCES.

 

© Troy & Schwartz, LLC 2019

Where Legal Meets Entrepreneurship™

Posted in Uncategorized on June 03,2019 11:06 AM