Supreme Court Resolves Longstanding Trademark Quandary
Yesterday the U.S. Supreme Court ruled that bankrupt trademark licensors cannot unilaterally rescind trademark license rights previously granted, resolving a longstanding split among the circuits and providing much needed certainty to intellectual property (IP) licensors and licensees. In fact, the International Trademark Association had dubbed this "the most significant unresolved legal issue in trademark licensing."
The Bankruptcy Code allows debtors in bankruptcy to elect to "reject" executory contracts, and thereby relieve the debtor's estate from otherwise burdensome obligations, essentially enabling the "fresh start" concept of bankruptcy. Counterparties to these agreements are entitled to treat such contracts as breached effective immediately prior to the filing of the bankruptcy, and to assert a claim for damages against the bankrupt estate. In addition, several provisions of Section 365 state that a counterparty to certain types of agreements may keep exercising contractual rights after the debtor's rejection.
Section 365(n) of the Bankruptcy Code explicitly provides licensees of intellectual property with the right to elect to continue to use the licensed IP following such a rejection. However, Section 365(n) intentionally omitted trademarks from the enumerated types of IP covered by the statute. This omission has resulted in differing interpretations by lower and appellate courts over the years, with some courts using what the Supreme Court described as a "negative inference" to conclude that 365(n) evidenced an intent that trademark licensees not be permitted to continue to use the licensed trademarks following a rejection of the underlying license, and ruling accordingly.
The possibility of this harsh result has led to a great deal of uncertainty and extraordinary efforts by trademark licensors and licensees in the pre-bankruptcy context, including in some cases establishing bankruptcy remote entities to hold and license trademarks, so that the "remote" licensor would not be swept into a bankruptcy of the operating company.
The decision yesterday of the Supreme Court in Mission Products v. Tempnology essentially adopts what had come to be known as the "Sunbeam Rule" after the seventh circuit's ruling in Sunbeam Products, Inc. v. Chicago Am. Mfg. Under the Sunbeam Rule, the focus is on Section 365(g), which simply states that the rejection of a contract "constitutes a breach," and the court then looks to the treatment of breached contracts outside of the bankruptcy context, noting that the breach of an agreement outside of bankruptcy does not eliminate rights the contract had already conferred on the non-breaching party. Accordingly, a rejection does not terminate either the licensee's rights to continue using the licensed mark, or its obligation to continue to comply with the license, which may include making any necessary royalty payments and maintaining quality control, which the licensor may continue to enforce. It should be noted that although the Mission Products decision arises in the unique context of trademark licenses and the omission of trademarks from Section 365(n), the holding applies equally to licensors and licensees under any executory contract not specifically otherwise addressed in Section 365.
While helpful in resolving the split among the courts and eliminating the most devastating consequence of a bankruptcy from the licensee's perspective, the Mission Products ruling leaves open many issues and presents as many opportunities that will no doubt be addressed with creative negotiation and drafting going forward. For example, what is the practical effect of the failure of the licensor to undertake any quality control or enforcement efforts post-bankruptcy? Should the parties negotiate a contingent liquidated post-bankruptcy royalty rate that anticipates reduced efforts from the licensor? How is a non-exclusive licensee to address infringements if the licensor refuses to act? Where the license bundles trademark and non-trademark IP (i.e., patents and copyrights), how are those rights coordinated in a post-bankruptcy context where the rules applicable to them differ?
Although a very significant issue has been resolved, it is clear that the intersection of IP and insolvency continues to be complicated terrain to navigate both pre- and post-bankruptcy.