IN BRIEF
- A recent Supreme Court decision resolves a longstanding division among lower courts.
- The case held that when the licensor of a trademark files for bankruptcy, its “rejection” of the trademark license agreement does not terminate the licensee’s rights in the mark.
- The decision has the potential to simplify what has become an extraordinarily complex and confusing area of the law.
In Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), the U.S. Supreme Court answered what has been called the most important unresolved question in trademark licensing and resolved a decades-long division among the lower courts on a foundational question of bankruptcy law. Specifically, Mission held that when the licensor of a trademark files for bankruptcy, its “rejection” of the trademark license agreement under section 365 of the Bankruptcy Code does not terminate the licensee’s rights in the mark.
Mission is a critically important decision for trademark licensing, and practitioners in that area have welcomed it, because it makes clear that a licensee’s rights will not evaporate if the licensor files for bankruptcy and rejects the parties’ license agreement. That greater certainty will affect the negotiation and terms of trademark licenses because it makes trademark rights more valuable to the licensee (and, as a corollary, makes licenses more profitable for the licensor). It is also a highly significant decision for the bankruptcy bench and bar because it clarifies long-standing confusion regarding one of the Bankruptcy Code’s central concepts: the concept of rejection.
By way of background, section 365 of the Bankruptcy Code permits a trustee or debtor-in-possession in bankruptcy to “assume or reject any executory contract”—that is, any contract the debtor entered before bankruptcy in which each party still owes a duty of performance to the other. 11 U.S.C. §365(a). Briefly, section 365 permits the bankruptcy estate to assume an executory contract and perform the debtor’s future obligations under that contract if doing so will be profitable for the estate, and to reject the contract if performing would not be profitable. Mission, 139 S. Ct. at 1658. The Bankruptcy Code provides that rejection “constitutes a breach” of the rejected contract that is deemed to have occurred before bankruptcy, 11 U.S.C. §365(g), entitling the counterparty to a claim in the bankruptcy case (which will typically be paid at cents on the dollar) for damages stemming from the debtor’s failure to perform. However, courts have not always agreed on the precise consequences of rejection. Is rejection merely the equivalent of a breach of contract outside bankruptcy, or does it terminate all the counterparty’s rights? That was the core question in Mission.
The seeds for Mission were sown in 1985 when the Fourth Circuit addressed the same question in the context of a patent license. Lubrizol Enters. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Lubrizol held that the debtor-licensor’s rejection of the license agreement enabled the estate to take back the patent rights the debtor had granted to the licensee before bankruptcy and sell or license those rights to a third party. See id. at 1047-48. In response, Congress amended section 365 by adding a new provision governing rejection of licenses of “intellectual property,” which provided that licensees could choose either to treat such licenses as terminated or to retain their rights (and obligations) under the licenses. 11 U.S.C. §365(n). Congress defined “intellectual property” to include patents, copyrights, and trade secrets, id. §101(35A), but omitted trademarks, meaning that section 365(n), by its terms, does not apply to trademark licenses. After section 365(n) was enacted, courts divided over whether Lubrizol was still good law for trademark licenses. Some lower courts concluded that the omission of trademark licenses from section 365(n) meant that Congress had implicitly endorsed Lubrizol’s reasoning in the trademark licensing context. In 2012, however, the Seventh Circuit held to the contrary, reasoning that under section 365, rejection is simply a breach and, like a breach outside bankruptcy, cannot take away the licensee’s rights in the mark. See Sunbeam Prods., Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).
That was where matters stood when the Mission case originated. Tempnology had developed a patented technology for cooling fabric to be used in sportswear, towels, and the like, marketed under the COOLCORE trademark. In 2012, it licensed its patents and trademark to Mission, granting Mission the exclusive right to distribute certain COOLCORE products in the United States. In 2014, Tempnology filed a Chapter 11 petition and rejected the license agreement with Mission, contending that rejection terminated Mission’s right to use the trademark. Ultimately, the First Circuit agreed with Tempnology and split with the Seventh Circuit’s decision in Sunbeam, reasoning that allowing Mission to continue using the mark would be too burdensome for Tempnology and could impair its ability to reorganize. The Supreme Court granted Mission’s petition for certiorari to resolve the circuit split. Mission, 139 S. Ct. at 1658-60.
After rejecting Tempnology’s argument that the case was moot, see id. at 1660-61, the Court turned to the fundamental question presented: “What is the effect of a debtor’s . . . rejection of a contract under Section 365 of the Bankruptcy Code?” Id. at 1661. The Court’s answer was unequivocal: “Rejection of a contract—any contract—in bankruptcy operates not as a rescission but as a breach.” Id. Accordingly, rejection “leave[s] intact the rights the counterparty has received under the contract.” Id. “Both Section 365’s text and fundamental principles of bankruptcy law command [that] approach.” Id.
Beginning with the text, the Court observed that section 365 provides that rejection “‘constitutes a breach’” of the rejected contract. Id. Outside bankruptcy, one party’s breach of contract does not terminate the other party’s rights. The Court used the example of a contract in which a dealer leases a photocopier to a law firm and agrees to service the copier monthly. If the dealer stops servicing the machine, materially breaching the contract, the law firm may choose to terminate the contract, but the dealer cannot do so. “The contract gave the law firm continuing rights in the copier, which the dealer cannot unilaterally revoke.” Id. at 1662. Rejection in bankruptcy works the same way, for a trademark license as well as a photocopier lease: “The debtor can stop performing its remaining obligations under the agreement. But the debtor cannot rescind the license already conveyed. So the licensee can continue to do whatever the license authorizes.” Id. at 1662-63. That reading of section 365, the Court explained, “reflects a general bankruptcy rule: The estate cannot possess anything more than the debtor itself did outside bankruptcy,” at least absent a successful preference or fraudulent conveyance action by the trustee. Id. at 1663.
The Court found Tempnology’s contrary arguments unpersuasive. Tempnology had contended that because section 365(n) specifies that counterparties may retain their rights after rejection, one should draw the negative inference that “the ordinary consequence of rejection” is termination of those rights. Id. at 1663. After examining the history and context of section 365(n), however, the Court concluded that “no negative inference arises.” Id. at 1665. “Congress did nothing in adding Section 365(n) to alter the natural reading of Section 365(g)—that rejection and breach have the same results.” Id. Rather, section 365(g) could be read to “reinforce or clarify the general rule that contractual rights survive rejection.” Id. at 1664.
Finally, the Court dismissed Tempnology’s contention that if trademark licensees retained their rights after rejection, the debtor’s ability to reorganize would be impeded because the debtor would need to continue to exercise quality control over the goods bearing the mark or else risk losing the mark. See id. at 1665. As an initial matter, the Court noted that there was no support in the text of the Bankruptcy Code for a trademark-specific rule of rejection. Id. Moreover, Tempnology’s argument proved too much: The Code “aims to make reorganizations possible,” “[b]ut it does not permit anything and everything that might advance that goal.” Id.
The Mission decision has many significant aspects, three of which are noted here. First, as the Court expressly stated, its holding—that rejection has the same consequences as breach—is not limited to trademark licenses, but applies to all executory contracts. Mission thus has the potential to simplify what has become an extraordinarily complex and confused area of the law. Courts often conduct lengthy analyses of whether a particular contract is executory, at times seemingly doing so to avoid the draconian consequences that rejection would have if it terminated the counterparty’s rights. See, e.g., In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010) (holding that trademark license agreement was not executory, and licensor therefore could not reject it and terminate licensee’s right to use the mark); id. at 967-68 (Ambro, J., concurring) (noting the inequity of using rejection “to let a licensor take back trademark rights it bargained away”); see generally Michael T. Andrews, Executory Contracts in Bankruptcy: Understanding ‘Rejection,’ 59 U. Colo. L. Rev. 845 (1988). Once rejection is correctly understood as the bankruptcy analogue of breach, and not as a special power to terminate the other party’s rights under a contract, courts should no longer need to rely on the highly malleable test for executoriness to ensure a just result.
Second, Mission reaffirms that in deciding any question arising under the Bankruptcy Code, the Code’s language comes first, but Mission approaches that language contextually. As the Court observed, section 365’s statement that rejection “constitutes a breach” “does much of the work” in the Court’s analysis. Mission, 139 S. Ct. at 1661. That is not surprising. As Justice Kagan, who wrote the Court’s opinion, said in another context, “We’re all textualists now.” See The Scalia Lecture: A Dialogue with Justice Elena Kagan on the Reading of Statutes (Nov. 17, 2015). Significantly, however, the Court did not limit its inquiry to the text of section 365 considered in isolation, as it has at times in past bankruptcy cases. See, e.g., RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645-49 (2012). Rather, it also relied on the “fundamental principle[]” that the estate has no greater rights in property than the debtor had before bankruptcy—a principle reflected in the overarching structure of the Code and its various provisions governing the estate and its property—to confirm its interpretation. Mission, 139 S. Ct. at 1661; see id. at 1663. That willingness to grapple with the overall architecture of the Code—also reflected in the Court’s decision two years ago in Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017)—is a promising sign for the Court’s bankruptcy jurisprudence.
Finally, Mission once again confirms that to understand the workings of the Bankruptcy Code, one must start with the parties’ rights and obligations outside bankruptcy. To be sure, the Code can and sometimes does alter those rights and obligations, but the Court will not be quick to jump to the conclusion that Congress intended such an alteration unless the Code clearly indicates it. Likewise, the interpretation of the Code that best promotes reorganization will not always be the correct interpretation; the Code carefully balances the interests of different constituencies, and courts must respect the balance Congress struck. In short, as the Court has now held repeatedly in various contexts, the Bankruptcy Code gives debtors specific tools that can be used to maximize the value of the estate, but it does not grant either the debtor or the bankruptcy court any general power to alter the parties’ background entitlements in the service of reorganization or of an equitable resolution more broadly. See, e.g., Czyzewski, 137 S. Ct. 973 (when dismissing a Chapter 11 case, bankruptcy courts lack the power to order a distribution of estate assets that would violate the priority scheme applicable to a Chapter 11 plan). Although the Court’s view of the bankruptcy power as tied closely to the provisions of the Code may be more constrained than some bankruptcy practitioners would prefer, the Court has now made that view inescapably clear.