SCOTUS: Debtor’s Rejection of Trademark Licensing Agreement Does Not Terminate Counterparty’s Rights Under Contract

By Karl Johnson posted 13 days ago

Karl Johnson, Briggs and Morgan, P.A.
Alexander J. Beeby, Larkin Hoffman DalyLindgren Ltd

 Contributing Editor: Karl Johnson, Briggs and Morgan, P.A.

In Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S.Ct. 1652 (2019), the Supreme Court held that a debtor-licensor’s rejection of a trademark licensing agreement did not terminate a licensee’s rights under the executory contract to use the trademark. The Court further held that a case is not moot if there is a claim for monetary relief even if recovery is unlikely.

The debtor manufactured exercise clothing designed to stay cool and marketed its products under a brand name with logos and labels, i.e., trademarks. It also entered into agreements to license its trademarks to other manufacturers and distributors. After the debtor filed a voluntary petition under chapter 11, it also rejected the licensing agreements. As a result, the debtor could stop performing under the licensing agreements and the licensees could assert a pre-petition claim for damages resulting from the debtor’s breach of the licensing agreement. The debtor also sought and obtained a declaratory judgment that the rejection of the contract terminated the licensee’s rights to use the trademarks. Because 365(h), (i), and (n)  specifically allow for the non-debtor counterparty to continue to exercise rights under a rejected contract for real property and some kinds of intellectual property, the debtor argued that the non-debtor counterparty’s rights are terminated unless the Code provides otherwise. The bankruptcy court agreed.

The BAP reversed, relying heavily on a Seventh Circuit decision that analyzed the statement in 365(g) that the rejection of an executory contract “constitutes a breach” and the case law that a breach under non-bankruptcy law normally does not terminate a counterparty’s rights. The First Circuit, however, reversed the BAP’s decision, endorsed the negative inference relied on by the bankruptcy court, and also pointed to laws that state that a trademark owner’s failure to monitor and control the use of the trademark jeopardizes the validity of the trademark. The First Circuit reasoned that the debtor would be forced to continue the very obligations that it sought to reject.

The Supreme Court first analyzed the language of the Code to determine that rejection means breach. Because “breach” is not defined by the Code, it means what it would mean outside of bankruptcy. Because a licensor’s breach outside of bankruptcy would not normally terminate the licensee’s rights to use a trademark, the same is true in bankruptcy. The Supreme Court further reasoned that its decision reflects the general rule that the bankruptcy estate does not have greater interests in property than the debtor did outside of bankruptcy. Finally, the Supreme Court reasoned that if rejection of a contract resulted in rescission or termination, then rejection of contracts would become the functional equivalent of an avoidance action and the strict limitations on avoidance would conflict with the broad discretion allowed for rejection of contracts.

In addressing the debtor’s arguments, the Supreme Court reviewed the history of  sections 365(h), (i), and (n) and noted that each of the subsections was a legislative response to a judicial ruling that rejection of a specific kind of executory contract should be treated as a rescission or termination. The Supreme Court reasoned that “whenever Congress has been confronted with the consequences of the [view that rejection terminates all contractual rights], it has expressed its disapproval.”

The Supreme Court also rejected the argument that failure to monitor the use of the trademarks would diminish their value. First, the Court noted the debtor’s overall argument was that “rejection=rescission” should be the default; this is antithetical to an argument based on a distinctive feature of trademark law. Second, the Court held that even if there were not an internal contradiction in the argument, the consequence of failing to monitor use of the trademarks would not overcome the clear directives of §§ 365(a) and (g).

Justice Sotomayor wrote a separate concurrence mainly to clarify that the court’s holding is limited to the facts of this case, pointing out that the general rule mandated by the Court is that whether a licensee continues to have rights under a rejected trademark license depends on applicable nonbankruptcy law.

Justice Gorsuch dissented based on his view that a party typically does not have a legally viable claim for money damages based on the other party’s choice to resort to civil courts, and the appeal was therefore moot.