dictionary macro with focus on BankruptcyOral argument before the Supreme Court was held on February 20 in the much-watched and even more intensely discussed trademark dispute Mission Product Holdings, Inc. v. Tempnology, LLC.[i] The case presents the difficult and multifaceted question: Does bankruptcy law insulate the right of a trademark licensee to continue using the licensed mark despite the bankrupt trademark licensor’s decision to “reject” the remaining term of the trademark license?

It may come as a surprise to some that trademark rights, under the Bankruptcy Code, are not categorized as “intellectual property.” [ii] Patents, copyrights and trade secrets are included; Congress, by design, omitted trademarks from the category, recognizing that trademarks are very different from the other types of IP.

Therefore, the enactment of Bankruptcy Code § 365(n) in 1988, which protects licensees of rights in the statutorily defined types of IP from termination when the licensor files for bankruptcy protection, left that question open for further judicial analysis and resolution in the case of ongoing trademark licenses when the licensor goes bankrupt. The Mission Products case may – or may not – provide that answer.

Debtors in bankruptcy reorganization are generally allowed to “reject” executory contracts – that is, to be freed from any ongoing obligations to render performance otherwise owed to the counterparty under an ongoing license agreement.[iii] The objective is to enhance the debtor’s prospects to achieve a successful reorganization of its financial and business affairs. But recognizing the particular hardships that such rejection can impose on certain types of non-bankrupt counterparties, bankruptcy law imposes limitations on the right of rejection for certain types of agreements. These “special cases” include non-bankrupt lease tenants, purchasers of timeshares, parties to collective bargaining agreements, and, of particular interest here, licensees of intellectual property rights.[iv] Given the constitutional purpose under the patent and copyright laws to encourage and reward intellectual innovation, and the integral role of commercial licensing in those domains, §365(n) provides explicit protection for licensees of such IP rights against debtor licensor rejection of executory licenses.[v]

Trademarks, on the other hand, do not fundamentally reward innovation, but rather serve to assure the public that the products and services marketed under an established brand will provide the quality, performance and advantages that have become associated with that brand.  This imposes on the trademark owner the obligation to monitor and police the activities of trademark licensees to ensure that the public’s expectations are fulfilled.  A license agreement that omits the duty to police is known as a “naked license” If the trademark owner abdicates its duty to police, the mark itself may become unenforceable. But if the licensee continues to use the mark notwithstanding the bankrupt trademark owner/licensor’s rejection of the license, a continuing obligation by the debtor licensor to police may interfere with the reorganization plan, or may simply not be doable. Or, if bankruptcy law both allows continued trademark use by the licensee following rejection, while extinguishing any duty of the bankrupt licensor to continue policing that use, then by definition, a naked license has been created.

On the other hand, the success of the non-bankrupt licensee’s business may be dependent on the continuing viability of the trademark license. Allowing the debtor licensor to cancel that license, presumably to negotiate more advantageous arrangements to exploit the brand in its reorganization, is a harsh and arguably inequitable outcome. The debtor licensor’s rejection is deemed to be a breach of the license, entitling the licensee to pre-bankruptcy damages, but that remedy may not provide adequate relief.

The Mission Products case invites the Supreme Court to solve this conundrum, but on a factual record that is less than ideal (more on that later). Tempnology owns patents and related IP for manufacturing stay-cool fabrics for sportswear. It licensed the patents as well as the associated trademark to Mission Products, a sports apparel retailer. The agreement included a right of termination for convenience, with a two-year wind-down period. Mission Products exercised its right to terminate the agreement. About 15 months later, Tempnology filed for bankruptcy reorganization and rejected the trademark license portion of the agreement.

The First Circuit ruled that the rejection of the trademark license by Tempnology was effective and terminated Mission Products’ right to use the licensed marks. Mission Products sought Supreme Court review, arguing that the First Circuit’s decision is in error and is at odds with the contrary result reached in the Seventh Circuit in Sunbeam Products v. Chicago Manufacturing LLC.[vi] In Sunbeam, the Seventh Circuit decided that rejection of the trademark license does terminate any further performance obligations of the debtor-licensor (including the obligation to police use of the mark) but does not terminate the licensee’s continuing right to use the licensed mark under the terms of the license.

At oral argument, the questioning by the justices did not provide any clear indication of the direction the Court is likely to take. Justice Samuel Alito seemed to be sympathetic to the position of the non-bankrupt trademark licensee, analogizing the termination of the right to use the licensed mark to a bankrupt landlord trying to terminate a tenancy under the right of contract rejection (a result specifically not allowed under § 365 (h)). But Justice Stephen Breyer seemed to tilt in the opposite direction with a different “housing” analogy, imagining a landlord renting an igloo with an obligation to provide constant air conditioning. If the bankrupt landlord can no longer keep the igloo cold, the igloo will disappear; similarly, when a bankrupt trademark owner cannot police the licensed mark, the mark itself may become unenforceable.

How the Court will decide the issue is not the only question; equally in doubt is whether the Court will choose to make a dispositive ruling in this case. Mission Products itself had elected to terminate its agreement with Tempnology before the bankruptcy was filed, and by the time the trademark license was rejected, there were only a few months of permitted trademark use remaining under the two-year wind-down period. So, the record before the Court does not present in a practical sense the dilemma between the bankrupt debtor’s right to be free of continuing policing obligations, and the prejudice to the licensee created by terminating further use of the mark following rejection. Tempnology has argued that, even if the decision below is doubtful, this is not the right case for the Court to decide what the International Trademark Association has described as “the most significant unresolved legal issue in trademark licensing.” Justice Neil Gorsuch alluded to these circumstances at oral argument, expressing some concern whether the case may be moot.

But multiple filers of amici briefs, joined by the U.S. Solicitor General, have urged the Court to settle the issue now, in favor of allowing trademark licensees to continue use notwithstanding bankruptcy rejection. We – along with tens of thousands of trademark owners and licensees – will be watching, and we will report the outcome here.

[i] Mission Products Holdings, Inc. v. Tempnology, LLC, case no. 17-1657 before the United States Supreme Court.
[ii] 11 U.S.C. § 101(35A).
[iii] 11 U.S.C. § 365(a).
[iv] See 11 U.S.C. § 365(h) and (n), and § 1113.
[v] § 365(n) was a direct congressional reaction to the holding in Lubrizol Enter., Inc. v. Chicago Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), which upheld a debtor patent licensor’s right to reject an executory patent license and terminate the licensee’s right to continue practicing the patent.
[vi] Sunbeam Products v. Chicago Manufacturing, 686 F.3d 372 (7th Cir. 2012).