Tempting Fate: What Trademark Licensees Stand to Lose (or Win)
The Bankruptcy Code gives special protections to licensees of intellectual property when a debtor, as licensor, seeks to reject the license. However, the Bankruptcy Code does not include trademarks in its definition of “intellectual property.” So, are licensees of trademarks given any protection when debtors reject trademark licenses? If the Supreme Court grants a recent petition for writ of certiorari, we may get an answer.
In general, rejection of an executory contract is a breach of that contract. Pursuant to section 365(g), rejection releases the debtor from its unperformed obligations and “constitutes a breach of such contract . . . immediately before the date of the filing of the petition” for which the counterparty can file a proof of claim for damages arising from the breach, which claim is treated as a general unsecured claim. The special protections for intellectual property licensees are found in section 365(n), which Congress enacted following the Fourth Circuit’s opinion in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Lubrizol held that licensors’ rejection of intellectual property licenses deprives licensees of their rights to use intellectual property following rejection. As a result, Lubrizol spelled financial ruin for many licensees that had built their businesses on the use of a debtor’s intellectual property. To prevent such harsh consequences, section 365(n) authorizes licensees either to retain their rights under the license for the term of the license and any allowable renewals or to treat the license as terminated. However, the omission of trademarks from the Bankruptcy Code’s definition of “intellectual property” has generated much debate over the impact of rejection by a trademark licensor on the licensee.
On June 11, 2018, Mission Product Holdings, Inc. (“Mission”) filed a petition for writ of certiorari, which, if granted, may settle this issue. Mission had entered into a license agreement (the “License Agreement”) with Tempnology, LLC (the “debtor” or “Tempnology”). Among other things, the License Agreement granted Mission a non-exclusive license to use Tempnology’s intellectual property, defined in the License Agreement to include patents, trade secrets, designs, and copyrights. The License Agreement also granted Mission a non-exclusive license to use Tempnology’s trademarks on the Tempnology products that Mission distributed. Tempnology filed a Chapter 11 bankruptcy petition on September 1, 2015 and moved to reject the License Agreement. The bankruptcy court granted Tempnology’s rejection motion, but said that rejection was subject to Mission’s election to preserve its rights under section 365(n) without defining the scope of those rights. The parties disputed the effect of rejection on Mission’s non-exclusive trademark license and Tempnology sought a determination from the bankruptcy court that section 365(n) did not allow Mission to continue using Tempnology’s trademarks.
The bankruptcy court found that rejection terminated Mission’s right to use the trademarks and that section 365(n) did not apply because “the omission of trademarks from the definition of intellectual property under [the Bankruptcy Code] indicates that Congress did not intend for them to be treated the same as the six identified categories [of intellectual property].” Thus, the bankruptcy court embraced the negative inference drawn by the majority of bankruptcy courts, that the omission of trademarks from the definition of “intellectual property” means that section 365(n) did not overrule Lubrizol with respect to trademarks. The bankruptcy court rejected the equitable approach taken by other courts faced with construing § 365(n) as it pertains to trademarks. In particular, the bankruptcy court disagreed with the decision in In re Crumbs Bake Shop, Inc., 522 B.R. 766 (Bankr. D.N.J. 2014), in which the court said that the legislative history of section 365(n) indicated that Congress wanted courts to determine on a case-by-case basis whether trademark licensees retain the rights under 365(n).
On appeal, the Bankruptcy Appellate Panel (the “BAP”) agreed that section 365(n) did not protect trademark licensees, but disagreed that Mission’s rights were completely terminated upon rejection. Instead, the BAP concluded that under section 365(g), Mission had the rights that it would have under the License Agreement and applicable non-bankruptcy law if Tempnology had breached the License Agreement. The BAP adopted the Seventh Circuit’s decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012), in which the Seventh Circuit found that notwithstanding the omission of trademarks from the definition of “intellectual property,” a licensee’s right to use a trademark survives rejection. The BAP agreed with Sunbeam that because the licensor’s breach of a trademark license does not terminate the licensee’s right to use the trademark outside of bankruptcy, section 365(g) requires the same result.
The First Circuit affirmed the bankruptcy court, concluding that section 365(n) does not apply to trademarks and that the right to use a trademark does not survive rejection under section 365(g), though for a different reason. According to the First Circuit, to allow a licensee to continue using a trademark after rejection would undermine the “principal aim” of rejection—to relieve the estate of burdensome obligations that may impede reorganization—as well as the debtor’s fresh start. Because “effective licensing of a trademark requires that the trademark owner . . . monitor and exercise control over the quality of the goods sold to the public” under the trademark, there would be no point to rejecting a trademark license, as failure to monitor could result in the loss of the trademark. The First Circuit also opined that a debtor could not accurately perform a cost-benefit analysis to determine whether the value of the trademark is worth the cost of monitoring. In bankruptcy, “where the licensor and licensee are at odds over continuing to deal with each other, the burden will likely often be greater than normal.” Furthermore, the First Circuit reasoned, the burden imposed on a licensee by the loss of a trademark “will in most instances be less than the burden of having patent rights so converted [to a prepetition claim for damages].”
In its certiorari petition, Mission challenges the First Circuit’s reasoning that the use of trademarks after rejection would undermine the benefit of rejection. Because rejection merely releases debtors from their contractual obligations, and not from statutory obligations, Mission argues that the benefit of rejection cannot be undermined by the duty to monitor that is imposed under trademark law. Further, Mission argues, if a debtor “believes its trademarks are worth the cost of monitoring, it will presumably incur that cost to preserve the value of the asset; if it does not, it presumably will not incur those costs.” Mission does not respond directly to the First Circuit’s concerns regarding the difficulty of carrying out an accurate cost-benefit analysis in the bankruptcy context. However, Mission asserts that a licensee “who is confident that the licensor’s bankruptcy will not up-end its continued right to use licensed trademarks . . . will be more inclined to enter into an agreement that creates net efficiencies.” Though Mission’s argument is meant to persuade the Supreme Court that this issue should be settled, it also highlights the notion that this open question of law is a source of leverage for trademark licensors and licensees alike. Ironically, the uncertainty surrounding the effect of rejection on trademarks may enable debtors and licensees to realize better outcomes in bankruptcy than they would if the law were clear. Licensees can obtain assurances that their use of the trademark will not end upon rejection, and licensors can ensure that the benefit of the trademark outweighs the cost by obtaining cooperation from the licensee in complying with trademark law. Whether or not the Supreme Court resolves this circuit split, trademark licensors and licensees may be better off working together long before a bankruptcy filing to protect the rights and interests of both parties in a bankruptcy. In seeking an answer from the Supreme Court, Mission (and Tempnology) may be tempting fate for future debtors and trademark licensees.