The Supreme Court this week resolved a long-standing open issue regarding the treatment of trademark license rights in bankruptcy proceedings. The Court ruled in favor of Mission Products, a licensee under a trademark license agreement that had been rejected in the chapter 11 case of Tempnology, the debtor-licensor, determining that the rejection constituted a breach of the agreement but did not rescind it.  The decision means that a holder of rights under a trademark license will retain such rights even if its underlying license agreement is rejected in bankruptcy.

Tempnology was a sportsware manufacturing company. Prior to filing for chapter 11, it had entered into a distribution agreement with Mission Products, and granted Mission Products a license to use its trademarks.

Section 365(a) of the Bankruptcy Code allows a debtor to assume executory contracts (i.e., contracts for which material obligations remain unperformed on both sides) which are favorable, and to reject executory contracts which are burdensome or detrimental, in order to maximize the value of its bankruptcy estate for the benefit of its creditors.  Section 365(g) states that the rejection of a contract “constitutes a breach of such contract,” and provides the non-debtor counterparty with a claim against the bankruptcy estate for damages arising from such breach.  Following the commencement of its bankruptcy case, Tempnology chose to reject the distribution agreement, which meant that Tempnology no longer had to perform any its obligations.  A dispute arose, however, over Mission Products’ ongoing right to use Tempnology’s trademarks following the rejection.

Tempnology based its arguments primarily on Section 365(n), a provision added to the Bankruptcy Code by Congress in order to negate the effects of Lubrizol Enterprises v. Richmond Metal Finishers, a judicial decision regarding patent rights.  In Lubrizol, the Fourth Circuit Court of Appeals ruled that a debtor’s rejection of a patent license agreement terminated the licensee’s rights to use the patent.  In response, Congress specified in Section 365(n) that a licensee under a contract granting the right to use “intellectual property” could elect to retain its rights under such contract and continue to use such rights for the duration of the contract.  The definition of “intellectual property” inserted into the Bankruptcy Code did not, however, include trademarks.  Tempnology contended that the failure of Congress to include trademarks within the scope of intellectual property protected by Section 365(n) created a negative inference, and that trademark rights cannot be retained by a licensee under a rejected trademark license agreement.

The Court rejected Tempnology’s arguments. The Court emphasized that rejection of a contract in bankruptcy under Section 365 operates as a breach of the contract and not as a rescission, and that the non-debtor counterparty’s rights do not “vaporize.”  Moreover, the Court found no negative inference from the failure of Congress to include trademarks in Section 365(n).

The key to the Court’s decision is its determination that contract rejection does not permit rights granted under a trademark license agreement to be rescinded. The Court makes clear that the language in Section 365(g) that rejection “constitutes a breach” is intended to allow the debtor to cease performing under a burdensome contract, but does not allow the debtor to rescind the rights previously conveyed under such contract.  The Court observed that outside of bankruptcy, the breach of a trademark license agreement would not permit the licensor to terminate the licensee’s rights.  Allowing trademark license rights to be terminated in bankruptcy, through contract rejection, would therefore violate a basic rule of bankruptcy law by giving debtor-licensors greater rights in bankruptcy than they could possess outside of it.  The Court also noted that allowing contract rejection to terminate a licensee’s rights would effectively allow a debtor to avoid a conveyance of property (i.e., the license rights) while circumventing the Bankruptcy Code’s detailed and narrow provisions for unwinding pre-bankruptcy transfers.

The Court similarly found no merit in Tempnology’s arguments regarding Section 365(n). Tempnology contended that the specific protections to retain rights provided under Section 365(n) to holders of patent and other intellectual property licensees meant that no such protection exists for trademark licensees.  The Court held, however, that accepting Tempnology’s logic would require a reading of Section 365(g) that would be “essentially opposite” to its language that rejection “constitutes a breach.”  Moreover, it ignored that Section 365(n) was an amendment to the Bankruptcy Code designed to undo a specific judicial decision (Lubrizol), and that its legislative history expressly stated that no inferences should be drawn from its failure to include trademarks within its scope.

Many of the Supreme Court’s recent bankruptcy law rulings have not been models of clarity.  The Mission Products decision is a welcome departure from that trend.