As background, Section 365 of the Bankruptcy Code permits a debtor to “assume or reject any executory contract” and provides that rejection “constitutes a breach of such contract” (a contract is “executory” if there is some continuing performance due by both sides). In 1985, the Fourth Circuit held that a debtor-licensor’s rejection of a technology license terminated the licensee’s right to use the technology.  In response to that decision, Congress enacted Section 365(n) of the Bankruptcy Code, which permits a licensee to retain its rights to “intellectual property” under a rejected license agreement. Intellectual property was defined in Section 365(n) to include patents and copyrights but not trademarks. The legislative history reveals that Congress believed the issue with regard to trademarks required “more extensive study” which was postponed.
After the enactment of Section 365(n), a split developed in the courts as to the effect of rejection on trademark licenses. As a result of the uncertainty surrounding the continued rights of a trademark licensee after a licensor’s bankruptcy, some parties had to take expensive and complex steps – such as forming a bankruptcy-remote entity to hold the trademarks – to ensure that the licensee will not lose its rights before the end of the term of the license.
At issue in Mission Product was a clothing license that allowed use of the marks DR. COOL and COOLCORE on athletic towels, socks, and headbands designed to stay cool during exercise. Tempnology (the licensor) filed for bankruptcy and immediately moved to reject the license under §365. The bankruptcy court granted the debtor’s motion to reject the license “subject to [the licensee’s] . . . election to preserve its rights under 11 U.S.C. § 365(n).” When the debtor moved for a determination of the licensee’s rights under Section 365(n), the bankruptcy court concluded that Section 365(n) did not apply to trademarks, and thus the licensee did not have the right to continue to use the licensed marks.
A divided First Circuit agreed. The majority reasoned that to achieve the goal of Section 365 (which is “releas[ing] the debtor’s estate from burdensome obligations that can impede a successful reorganization”), a debtor should not be burdened with monitoring a licensee’s use and exercising quality control. The Supreme Court granted certiorari and rendered its decision on May 20, 2019.
Justice Kagan delivered the 8-1 opinion of the Court; Justice Gorsuch dissented, believing the issue was moot.
The Court began by pointing out that in a non-bankruptcy context, if one party breaches an agreement, that does not terminate the other party’s rights under that agreement. The Court concluded that there is nothing special about either bankruptcy proceedings or trademarks that would change this rule. “Rejection of a contract – any contract – in bankruptcy operates not as a rescission but as a breach.” The statute itself provides that rejection is a breach, and “breach” means in the Bankruptcy Code what it means in general contract law.
The Court rejected the argument that by specifically calling out copyrights and patents in §365(n), “Congress showed that it wanted the counterparties in all other contracts to lose their rights.” Interpreting §365(n) this way would contradict the “rejection constitutes a breach” language of §365(g). In a sense, the Court found that §365(n) was unnecessary.
The Court pointed out that its holding is consistent with the general bankruptcy rule that “the estate cannot possess anything more than the debtor itself did outside bankruptcy.” So if the debtor was constrained by the licensee’s rights before bankruptcy, it remains so constrained after bankruptcy. Further, the Court reasoned that allowing rejection of equal rescission would undermine the limits on a trustee’s “avoidance” powers – the unwinding of a pre-bankruptcy transfer to deplete the estate.
Tempnology also argued that the unique obligation under trademark law for licensors to monitor the quality of a licensee’s goods means that the mark will decline in value and potentially become invalid if the licensee continues to use it without the licensor’s exercising such quality control. So the debtor would be forced to choose between “expending scarce resources on quality control and risking the loss of a valuable asset,” which would impede the debtor’s ability to reorganize.
The Court rejected this argument primarily because the special considerations of trademark owners cannot overcome the language of the statute. The Court pointed out that §365 provided Tempnology with a “powerful tool” – to reject an executory contract and be relieved of all future obligations. But the tool of rejection does then exempt them from all applicable legal obligations, whether relating to contracts or to trademarks. This is a significant ruling in that it resolved a very long-standing split in the courts, and it provides certainty to what was previously an uncertain situation. No longer do parties need to contemplate forming a bankruptcy-remote entity or imposing burdensome financial disclosure obligations on the licensor in order to provide a licensee some comfort. Thus, overall transactional costs surrounding trademark licenses are reduced, and trademark licenses are more valuable without a potential cloud hanging over them. A ruling that had gone the other way would have made permanent all the uncertainty surrounding trademark licenses.
 Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985).
The opinions expressed are those of the authors on the date noted above and do not necessarily reflect the views of Fish & Richardson P.C., any other of its lawyers, its clients, or any of its or their respective affiliates. This post is for general information purposes only and is not intended to be and should not be taken as legal advice. No attorney-client relationship is formed.
Jenifer deWolf Paine is Of Counsel in Fish & Richardson’s New York office. Jenifer is a highly experienced intellectual property attorney serving as business and legal advisor to clients in a wide variety of industries on all aspects of trademark, brand protection, copyright, rights of privacy and publicity matters, intellectual property...