Supreme Court Holds Trademark Licensees Can Continue Using Marks after Termination by Bankrupt Licensors, but Leaves Goodwill Exposed

The Supreme Court’s May 20 decision in Mission Product Holdings, Inc. v. Tempnology, LLC resolved a dispute among the circuits and may have had some trademark licensees breathing a sigh of relief – no longer will a debtor-in-possession-licensor’s rejection of a license agreement terminate all rights of the licensee to use the licensed mark. But this result may not be as favorable for all trademark licensees as it might seem.

Section 365(a) of the Bankruptcy Code permits a debtor to reject any executory contract (a contract neither party has finished performing), and Section 365(g) dictates that such a rejection constitutes a breach of that contract. Section 365(n) provides that for licenses of “intellectual property,” the non-debtor licensee can continue to use the property so long as it makes any required payments under the license. So, what was the issue? Trademarks are conspicuously absent from the definition of “intellectual property” in section 101 (35A) of the Bankruptcy Code, whereas other types of IP, including trade secrets, patents, and copyrights, are expressly addressed. Prior to the Supreme Court weighing in, the circuits were split as to the impact of this conspicuous absence. On one side, the Seventh Circuit treated rejection of a trademark license in bankruptcy like a breach of contract outside of bankruptcy, allowing the licensee to retain any rights received under the contract along with a damages claim for the breach. On the other side, the First Circuit treated rejection as a contract rescission terminating all of the licensee’s rights.

Siding with the Seventh Circuit reasoning, Justice Kagan wrote for the 8-1 majority (Justice Gorsuch dissenting on a procedural ground, Justice Sotomayer concurring), holding that a debtor’s rejection of an executory contract (including but not limited to a granted trademark license) is treated the same as a breach outside of bankruptcy, and does not rescind continuing rights previously granted. As for the concern that a trademark licensor’s duty to monitor and exercise quality control would require the debtor to expend resources on quality control or risk invalidity of the trademark, the Court noted that Congress had struck a balance among multiple competing interests in enacting the Code, and did not intend to permit “anything and everything” to advance reorganizations. Furthermore, because the Court’s decision will impact not just trademark agreements, but “pretty nearly every executory contract,” the Court declined to make a ruling based on trademark-related concerns that would “allow the tail to wag the Doberman.”

In a concurring opinion, Justice Sotomayer highlighted two potentially significant features of the holding. First, the decision does not give every trademark licensee “the unfettered right” to continue using licensed marks post-rejection (because special terms in a license or state law could bear on that question in individual cases). Second, the ruling clarifies that trademark licenses are treated differently post-rejection than licenses to the types of intellectual property specifically listed in Section 365(n). For example, a trademark licensee is not statutorily obligated to make all of its royalty payments, nor is it expressly prohibited from deducting damages from its royalty payments.

The Court’s decision leaves unaddressed the potential problem of how a debtor-licensor’s rejection of a trademark license agreement, which unburdens it of the duty to exercise quality control or to police the marketplace for infringement, results in an arguably naked license that undermines goodwill in the mark. For example, absent special terms or circumstances, a licensor simply rejecting a license granted to a poor-quality licensee no longer prevents ongoing use of the licensed mark by the rejected licensee, to the detriment of all other licensees. Look for a new body of trademark/bankruptcy law to develop around this decision, particularly in the context of franchises. Will courts infer that the debtor-licensor still maintains some level of quality control, even if not contractually or legally bound? Will trademark licensors and licensees begin inserting special terms in their license agreements in an attempt to avoid unintended consequences if a licensor bankruptcy arises? Meanwhile, debtor-licensors should carefully consider whether rejecting a trademark license risks diminishing one of its most valuable assets, as preserving or enhancing the value of its mark is typically a motivation for a debtor-licensor rejecting a trademark license (in the hope of making a better deal). Additionally, look for brand owners to call upon Congress to amend the Bankruptcy code to balance the rights of trademark licensees and licensors and to avoid the risk of undermining the value of their marks.