May 28, 2019
Authored by: John Bush and Jacob Johnson
Trademark licensors and licensees, as well as their stakeholders (including lenders), should heed the U.S. Supreme Court’s decision in Mission Product Holdings, Inc. v. Tempnology, LLC n/k/a Old Cold, LLC, No. 17-1657. The Justices resolved a long-standing question arising from the intersection of bankruptcy and trademark law: whether a debtor/licensor’s rejection of a trademark license terminates the licensee’s right to use a trademark after rejection. In an 8-1 decision, the Justices answered: “no,” rejection simply creates a breach, but not rescission. If the license or applicable law grant continuing rights to the licensee upon a breach by the licensor, rejection under the Bankruptcy Code does not alter or terminate such continuing rights.
Section 365(a) of the Bankruptcy Code (11 U.S.C. § 365) is the starting point of the analysis (but critically, not the ending point as discussed below). Section 365(a) permits debtors in bankruptcy to “assume or reject any executory contract or unexpired lease.” A contract is executory if performance remains due to some extent on both sides. One such executory contract is an agreement where one party licenses a trademark to a licensee in return for ongoing royalty payments.
With some exceptions not relevant here, a debtor has wide latitude to assume or reject executory contracts – if rejection benefits the debtor, the bankruptcy court will approve that decision, even if the non-debtor counterparty suffers harm (or great harm) from rejection and future nonperformance by the debtor. Likewise, if the debtor chooses to assume a contract and partake of its future benefits and burdens, the non-debtor counterparty has limited ability to stop it. So long as the debtor timely cures its prior defaults, compensates the counterparty for its prior losses due to the debtor’s default(s), and provides adequate assurance of future performance, the non-debtor counterparty remains stuck to the deal after the debtor assumes.
Mission Product settles a long disputed area of Section 365(a) – what effect does rejection have, in the case of a contract (or here, a license) where the non-debtor counterparty has post-breach rights under the contract or applicable law? Mission Product holds that rejection under Section 365(a) simply creates a breach governed by Section 365(g). Section 365(g) provides that the breach is deemed to occur immediately before the bankruptcy case was filed. This makes the claim for breach a pre-petition claim, recovering pennies on the dollar. Thus, nothing in Section 365(a) or Section 365(g) terminates the non-debtor licensee’s rights: rejection still leaves it to non-bankruptcy law (particularly, contract law) to resolve the practical ramifications of the breach.
Justice Sonia Sotomayor (concurring) and Justice Neil Gorsuch (dissenting) penned separate opinions in Mission Product. Justice Sotomayor emphasized the narrowness of the Supreme Court’s holding, pointing out that writ of certiorari was granted simply to determine whether rejection “terminates rights of the licensee that would survive the licensor’s breach under applicable nonbankruptcy law.” Accordingly, “the Court [did] not decide that every trademark licensee has the unfettered right to continue using licensed marks post rejection.” Rather, she maintained that the license’s contractual terms and governing law remain key. Meanwhile, in dissent, Justice Gorsuch criticized the Court’s exercising jurisdiction over the dispute (he did not address the merits).
Going forward, Mission Product necessitates greater attention to the license terms, particularly termination, remedies, and renewal provisions. Per the Supreme Court’s decision, rejecting a trademark license will be treated as a breach of the license by the licensor. Typically, contracts neutrally permit the “non-breaching party” to elect to terminate the contract. So, all other things being equal and without revisiting this approach in light of the holding, licensees would retain any contractual or other legal rights to continue using the trademark during the term of these license agreements, even though the licensor may prefer to terminate the license and use it or re-license it to someone else for greater value.
Even if a trademark license is rejected, enterprise value lenders to the licensor will be exposed to more risk, as they will essentially fall lower in priority than licensees (who will have the right to use the trademark for the remaining term of the license if the license or applicable law provides such remedy to the licensee). On the flip side, for the same reason, lenders to the licensee will be exposed to less risk during the remaining term of the license. Accordingly, lenders should carefully monitor their borrowers’ license agreements, particularly, the termination and renewal terms. Thus, Mission Product will likely lead to more negotiation of termination and renewal provisions as licensors and their stakeholders push to incorporate contractual certainty.
In sum, Mission Product potentially provides a higher level of certainty for licensors, licensees, lenders, and other interested parties. Achieving that certainty will depend on whether the contracting parties (and their counsel) pay closer attention to bankruptcy scenarios when drafting agreements.
Editor’s Post-Script: For more BCLP thoughts on a variety of other IP matters in bankruptcy, please see our review of the American Bankruptcy Institute’s proposed revisions to the Bankruptcy Code, located here.