No Special Loopholes for Trademark Rights: A Breach is a Breach Under Section 365 of the Bankruptcy Code

By: Emily E. Clark

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff Member

            In Mission Products Holdings, Inc. v. Tempnology, LLC the United States Supreme Court held that a debtor’s rejection of an executory contract under Section 365 of title 11 of the United States Code (the “Bankruptcy Code”) has the same effect as a breach of that contract outside bankruptcy.  Consequently, rejection of a license does not lead to the termination of a right previously granted, including the right of a licensee to continue using a trademark.[1]  The debtor/licensor, Tempnology, LLC,  manufactured clothing and accessories designed to stay cool during exercise.[2]  Tempnology marketed the products under a brand name “Coolcore,” using trademarks to distinguish this particular athletic gear from other ordinary workout gear on the market.[3]  In 2012, Tempnology entered into a contract with the petitioner, Mission Product Holdings, Inc. (“Mission”), pursuant to which Tempnology granted Mission an exclusive license to distribute certain Coolcore products and a non-exclusive license to use Coolcore trademarks.[4]

            Before the agreement expired, Tempnology filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of New Hampshire.  Soon afterward, the bankruptcy court had to decide whether a rejection of the executory contract between Tempnology and Mission deprives Mission of its rights to use the trademark licensed to them under the contract.  The bankruptcy court allowed Tempnology to reject the executory licensing agreement with Mission.[5]  Consequently, Mission lost the previously granted rights to use the Coolcore trademark.  This case followed the appeals process through the Bankruptcy Appellate Panel, the First Circuit, and it was finally heard by the United States Supreme Court.  The Supreme Court held that the rejection of an executory contract constitutes a breach of such contract, and that there is no exception for trademark rights.[6]  Under this rationale, Mission would have retained the right to use the trademark, even if rejection of the contract was allowed.  This decision also settled a circuit split between the First and Fourth Circuit, and the Seventh Circuit.

            The Court of Appeals for the Fourth Circuit, when faced with a similar issue regarding the intellectual property rights to patents following the rejection of a contract under bankruptcy law, held that a debtor’s rejection of an executory contract worked to re­voke its grant of a patent license.[7]  Congress then amended Bankruptcy Code Section 365(n) to effectively reverse the Fourth Circuit’s holding and ensure the continuation of intellectual property licenses after rejection of executory contracts in chapter 11 bankruptcy cases.[8]  However, Section 101(35A) of the Bankruptcy Code’s definition of  “intellectual property” only includes trade secrets, patents, patent applications, plant varieties, copyrights and mask works for semiconductor chip products and, therefore, trademarks are not considered intellectual property under this definition.[9]

            In 2012, the Seventh Circuit, addressing a situation factually similar to the situation addressed in Mission, rejected the Fourth Circuit’s reasoning and held that nothing about rejection implies that any rights of the other contracting party have been “vaporized.”[10]  The Seventh Circuit explained that, outside of bankruptcy, a licensor’s breach does not terminate a licensee’s right to use intellectual property, and that “[w]hat § 365(g) does [in] classifying rejection as a breach is establish that in bankruptcy, as outside of it, the other party’s rights remain in place.”[11]

            Here, the Bankruptcy Appellate Panel followed the Seventh Circuit rationale, and held that Mission’s rights to the Coolcore trademark did not seize to exist upon Tempnology’s rejection of the contract.[12]  However, following the Bankruptcy Appellate Panel decision, the First Circuit rejected this line of reasoning and adopted the Fourth Circuit rationale holding that Mission’s rights to the Coolcore trademark were revoked upon rejection of the contract.[13]

            On review, the Supreme Court upheld the rationale used in the Seventh Circuit, and the Bankruptcy Appellate Panel, that a debtor’s rejection of an executory contract giving rights to a trademark under Section 365 of the Bankruptcy Code has the same effect as a breach of that contract outside bankruptcy.[14]  Thus, the rejection does not grant any special rights to debtors that are not awarded in a breach of contract situation outside of bankruptcy.

            In her concurrence, Justice Sotomayor stated that the Court did not “decide that every trademark licensee has the unfettered right to continue using licensed marks postrejection."[15]  It is, therefore, unclear if “trademark licensees are required to continue making royalty payments with no right to deduct damages from their payments even if they otherwise could have done so under nonbankruptcy law – or if such a deduction is indeed available to a trademark licensee electing to retain its rights to use a mark.”[16]  Further, debtors/licensors now need to consider that while the Bankruptcy Code favors reorganization, “it does not permit anything and everything that might advance that goal.”[17]  As a result of the integration of nonbankruptcy law needed to determine the scope of the non-debtor party’s rights in trademark licensing contracts, there is now a degree of uncertainty in the planning and strategy of many potential Chapter 11 bankruptcy cases involving intellectual property.[18]  The debtor/licensor may have to choose between expending scarce resources on quality control and reputation of their trademark on the one hand, or risking the loss of a valuable asset, in this case their trademark, on the other.[19]  Although Tempnology argued that either choice would impede a debtor’s ability to reorganize,[20] the Supreme Court made clear that a breach is a breach, and there are no special provisions when looking to bankruptcy law, or elsewhere.