The Restructuring Report

The United States Supreme Court issued its decision this spring in Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019). The Court took the case to resolve a split among the Circuit Courts on the treatment of trademark licenses under Section 365 of the Bankruptcy Code, specifically, what the rights of the trademark licensee are once the license has been rejected by the debtor in possession in a Chapter 11 case. While the decision resolves the important question as to the rights of the nonbankrupt licensee to continue to use a trademark under a rejected license, the opinion has potentially broader ramifications on the rights of contract parties when their executory contracts are rejected under Section 365 of the Code.

Case Background

The facts of the case are straightforward. Pre-bankruptcy, Tempnology licensed to Mission Products on a nonexclusive basis the right to use certain trademarks for manufacture and sale of athletic apparel in exchange for royalty payments. While the license was still in force, Tempnology filed for relief under Chapter 11 of the Bankruptcy Code and sought to reject the license agreement with the approval of the bankruptcy court. The court approved the rejection of the license agreement. After that, Tempnology sought a declaration from the bankruptcy court that the rejection terminated the rights it granted to Mission Products in the license agreement. Mission Products argued that the rejection instead only meant that Tempnology had breached the agreement, the license still was in existence, and it had the right to elect to continue to use the marks or elect to treat the contract as terminated. The bankruptcy court sided with the debtor—Tempnology—and appeals to higher courts ensued.

Supreme Court Decision

The Supreme Court began its analysis of the core issue by reviewing the Bankruptcy Code provisions affecting executory contracts including trademark licenses. Code Section 365 grants to the debtor in a Chapter 11 case the right to assume or reject an executory contract, subject to bankruptcy court approval of that decision. The Court noted that trademark license agreements are executory in nature and subject to Section 365 treatment. The court noted that Section 365(g) describes what rejection of an executory contract means: “Rejection ‘constitutes a breach of [an executory] contract’ deemed to occur ‘immediately before the date of the filing of the petition.’” Mission Prods. Holdings, Inc., 139 S. Ct. at 1658 (internal citations omitted).

The Court further reasoned that “breach” is not defined in the Bankruptcy Code and therefore has the same meaning as it has under contract law outside of bankruptcy. Generally, a non-breaching party may elect to treat the contract as terminated, or continue to perform and sue the breaching party for damages. The Court cited as an example a hypothetical lease of a photocopier to a law firm where the lessor breaches the lease. The Court noted that under contract law, the right to treat the contract as terminated belonged not to the breaching party but rather only to the non-breaching counterparty. As a result, the Court reasoned, Mission Products had the right to either (a) treat the trademark license agreement as terminated and cease its performance under the license or (b) elect to continue to perform under the agreement (including paying licensing fees) and assert a claim for any damages against the debtor for the breach.

The Court noted that this analysis followed naturally from a reading of the statute coupled with the common understanding of what flows from a breach of an executory contract outside of bankruptcy. In doing so, it rejected Tempnology’s arguments.

Tempnology’s chief argument was that rejection of the trademark license was tantamount to a termination of the agreement because other provisions of Section 365, such as Sections 365(h), (i) and (n) provided for just the kind of election by the counterparty the court noted existed outside of the Bankruptcy Code. Because Congress did not provide for an election for executory contracts that did not fall within those specific exceptions, that must mean there was no right to an election and the rejection had the effect of terminating the agreement. The court rejected this reasoning primarily because of the language and structure of 365’s provisions noted above: rejection means breach of the agreement, not that the contract was somehow zapped into oblivion, subject only to a claim for damages.

Finally, the court noted that its reading of the effect of rejection was consistent with the general notion that the estate of the debtor cannot possess anything more than what the debtor itself had rights to outside of bankruptcy and that it did not expand effectively the right to avoidance actions beyond what the Code provided. Id at 10-11.

Takeaways

Mission Products has some important implications. First, as noted in the concurring opinion of Justice Sotomayor, the holding does not mean that every trademark licensee has the unfettered right to continue using the marks under a rejected licensee agreement. For example, the licensee must pay for the use of the marks or follow the provisions of the license restricting geographic or other market scope of its rights to use the marks. Second, what the contract provides in this regard may be of paramount importance, so there is a particular emphasis on carefully drafting provision that address the rights of the parties if the contract is rejected in bankruptcy.

Third, it is unlikely that rejection followed by election to perform could burden the debtor beyond the need to accept that performance, but that is not entirely clear. Finally, the uncertainty around the effect of the rejection of an executory contract will undoubtedly lead to negotiations between the debtor and the counterparty as to what the rejection means, especially in the context where the hoped-for outcome is termination of the agreement.

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