What Happens to a Trademark License in Bankruptcy?

December 28, 2018
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U.S. Supreme Court to Consider What Happens to a Trademark License in Bankruptcy

The U.S. Supreme Court recently added another intellectual property case to its docket. The issue in Mission Product Holdings Inc. v. Tempnology, LLC is what happens to the rights of a trademark licensee when a bankruptcy debtor rejects a license agreement during Chapter 11 proceedings.

What Happens to a Trademark License in Bankruptcy?

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Intellectual Property Under Bankruptcy Law

In most cases, when a business files for protection under Chapter 11 of the Bankruptcy Code, the trustee or the debtor-in-possession may secure court approval to “reject” any executory contract of the debtor. Under Section 365(g)(1) of U.S. bankruptcy code, the other party to the contract can pursue a damages claim for breach, but may not compel further performance.

Intellectual property is treated differently. Pursuant to 11 U.S.C. § 365(n)(1), when the rejected contract is one “under which the debtor is a licensor of a right to intellectual property,” the licensee may elect to “retain its rights . . . to such intellectual property,” thereby continuing the debtor’s duty to license the intellectual property. “Intellectual property” is defined in the Bankruptcy Act to include patents and copyrights, but not trademarks.

Because it is not directly addressed in the Bankruptcy Code, the circuit courts are split on whether the rejection of a trademark licensing agreement terminates a licensee’s rights.  In 1985, the Fourth Circuit held in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. that a debtor-licensor’s rejection of a licensing agreement involving a metal-coating process extinguished the licensee’s right to continue practicing the IP covering that process. In response to the court’s controversial ruling, Congress enacted 11 U.S.C. § 365(n)(1). However, that statute addressed patent rights, but failed to address trademark rights.

In 2012, the Seventh Circuit held in Sunbeam Products, Inc. v. Chicago Manufacturing, LLC that the rejection of a trademark license does not strip the licensee of its right to use the trademark. The appeals court reasoned that under §365(g), rejection is simply ‘“a breach”’ of the rejected contract, and “in bankruptcy, as outside of it,” following a breach, “the other party’s rights remain in place.”

Facts of Mission Product Holdings Inc. v. Tempnology, LLC

On November 21, 2012, Mission Product Holdings Inc. (Mission) and Tempnology, LLC (Tempnology) executed a Co-Marketing and Distribution Agreement (the “Agreement”). The Agreement granted Mission a non-exclusive, worldwide, perpetual license to use for any purpose (including manufacture and sale) all of Tempnology’s products, inventions, and designs and all of Tempnology’s intellectual property rights (other than trademarks and domain names) with respect to those products, inventions, and designs. Agreement §15(b), App. 120a-121a.

The Agreement granted Mission a non-exclusive, worldwide (except for certain countries in East Asia) license to use Tempnology’s trademarks on the Tempnology products Mission distributed  for the term of the Agreement. The license also granted Mission the exclusive right to sell certain patented and trademarked products in the United States.

On June 30, 2014, Mission exercised its right to terminate the Agreement without cause, triggering the Agreement’s wind-down period. The next month, Tempnology purported to terminate the Agreement for cause and stopped performing under the Agreement. In June 2015, an arbitrator ruled that Tempnology’s purported termination for cause was improper. Before a second phase of arbitration could address Mission’s claim that Tempnology had breached the Agreement by failing to perform, Tempnology filed a voluntary petition for Chapter 11 bankruptcy, halting the arbitration proceedings.

The bankruptcy court ruled that Mission retained its non-exclusive, license to use Tempnology’s patents post-rejection, but held that rejection of the Agreement terminated Mission’s trademark and exclusive-distribution rights.

The Bankruptcy Appellate Panel for the First Circuit (BAP) affirmed that the trademark license did not survive. However, it concluded that “rejection of the Agreement did not vaporize Mission’s trademark rights under the Agreement.” Relying on Sunbeam, it held that the rejection was a breach of contract, but did not terminate licensee’s rights.

A divided panel of the First Circuit disagreed. It held that Mission’s right to use Debtor’s trademarks did not survive rejection of the Agreement. The majority reasoned that it was not “possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark,” explaining that Tempnology would be required to “monitor and exercise control over the quality of the goods” produced by Mission to protect the “continued validity” of its trademarks.

Issues Before the Supreme Court

In its appeal to the U.S. Supreme Court, Mission argued that the First Circuit’s decision not only deepened the circuit split, but is clearly erroneous.  According to Mission, the First Circuit’s ruling “contravenes the text and purpose of the Bankruptcy Code, as well as the weight of authority among courts and scholars regarding the meaning of rejection.” As the petition for certiorari argues:

Rejection of an executory contract is merely a breach. It enables the debtor to decline to perform its future obligations under a contract if the cost of doing so outweighs the contract’s benefit to the estate. And it allows the estate to pay the resulting damages pro rata (typically in cents on the dollar) along with other claims that arose before the bankruptcy filing. But it does not enable the debtor to take back rights already granted to a licensee so that the debtor can cut a better deal for those rights.

The Supreme Court granted the petition on October 26, 2018. The justices have agreed to consider whether “rejection” of a trademark license agreement terminates rights of the licensee.

The Court has yet to schedule oral arguments in Mission Product Holdings Inc. v. Tempnology, LLC. Nevertheless, a decision is expected by the end of the term in June. We will follow the progress of this case and report on updates.

If you have any questions, please contact us

If you have any questions or if you would like to discuss the matter further, please contact me, David A. Einhorn, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.