Case on 'Coolcore' Marks Settles a 34 Year Debate Regarding Bankruptcy and IP Law

In Mission Product, petitioner and apparel company Mission Product Holdings, Inc. (Mission), and respondent, a textiles company, Tempnology, LLC (Tempnology), had entered into a contract whereby Mission would distribute certain Tempnology products meant to keep the wearer comfortable while exercising. As part of the agreement, Tempnology granted Mission a non-exclusive license to use its trademarks, including the aptly named “COOLCORE” mark, on certain products that would be distributed by Mission (the products included towels, headbands, socks, etc.). Three years after entering into the agreement, Tempnology filed for bankruptcy and sought to reject its agreement with Mission pursuant to Section 365(a), which allows a debtor to assume or reject any executory contract of the debtor. Prior case law established that a contract is executory if “performance remains due to some extent on both sides.” NLRB v. Bildisco & Bildisco, 465 U. S. 513, 522, n. 6 (1984).

Mission initially sought to protect its rights to the licensed marks by invoking Section 365(n) of the Bankruptcy Code, which allows a non-debtor licensee to retain its rights under a rejected license agreement if it continues to make royalty payments and waives certain setoff and other rights. Tempnology noted, however, that Section 365(n) does not apply to trademark licenses. Section 365(n) applies to licenses of “intellectual property,” and “intellectual property” is defined in Section 101(35A) of the Bankruptcy Code to include patents, copyrights, trade secrets and certain other rights, but not trademarks. It is the omission of trademarks that has led many commentators over the years to conclude that trademark licensees have no protection in the event of a licensor's bankruptcy.

In fact, the omission of trademarks from Section 365(n) helped to persuade the Bankruptcy Court for the District of New Hampshire to side with Tempnology. In doing so, the bankruptcy court adopted the Fourth Circuit's position in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 765 F.2d 1043 (4^th Cir. 1985), which held that a non-debtor licensee under a patent license was not authorized to continue practicing the patents after the license agreement was rejected. Put another way, the bankruptcy court endorsed the Fourth Circuit's position that a rejection rescinds the contract, treating the granted license as though it never existed.

In support of Tempnology's stance, it should be pointed out that it was the Lubrizol decision that led Congress to adopt Section 365(n) in the first place. That is, Section 365(n) was intended to reverse — and take some of the sting out of — Lubrizol's impact on licensing agreements. While 365(n) provided some clarity (and a degree of protection) for licensees of patents and other enumerated intellectual property, the omission of trademarks from the definition of “intellectual property” left the door open for subsequent debtor-licensors to continue to invoke Lubrizol to extinguish previously granted licenses.

Mission appealed the New Hampshire bankruptcy court's decision to the Bankruptcy Appellate Panel for the First Circuit. The appeals panel disagreed with the bankruptcy court, and in the process rejected the Fourth Circuit's reliance on Lubrizol. Instead, the panel endorsed the Seventh Circuit's position in Sunbeam Prods, Inc. v. Chicago Mfg., LLC, 686 F. 3d 372, 376–377 (CA7 2012), holding that Tempnology's rejection of the agreement amounted to a breach of contract and not a termination. More specifically, the review panel reasoned that Tempnology's rejection of the agreement, “did not vaporize Mission's trademark rights under the Agreement” and “whatever post-rejection rights Mission retained in the Debtor's trademark and logo [were] governed by the terms of the Agreement and applicable non-bankruptcy law.” To reach this conclusion, the review panel focused less on 365(n), instead relying heavily on 365(g), which states that the rejection of a contract “constitutes a breach.” As the panel explained (relying on Sunbeam), the breach of an agreement outside bankruptcy does not eliminate the rights the contract had already granted to the non-breaching party.

This time it was Tempnology's turn to appeal, and the Court of Appeals for the First Circuit rejected the position endorsed by the review panel and the Seventh Circuit. The First Circuit, instead, reinstated the position taken by the New Hampshire bankruptcy court and the Fourth Circuit. In short, the First Circuit decided that Tempnology's rejection of the agreement terminated the trademark license granted to Mission. The First Circuit again relied on 365(n) but emphasized that trademark licenses should be treated differently because special features of trademark law weighed against allowing a licensee to retain rights to a mark after the agreement granting the rights had been extinguished. That is, the rationale was that, as the Supreme Court later described it, “the trademark owner's '[f]ailure to monitor and exercise [quality] control' over goods associated with a trademark 'jeopardiz[es] the continued validity of [its] own trademark rights.'”

While the First Circuit seemed to be endorsing the Fourth Circuit's approach, it did little to settle the split created between the Fourth and Seventh Circuits, reflected in the Lubrizol and Sunbeam decisions, respectively. Mission petitioned the U.S. Supreme Court to finally settle matters.

In its petition, Mission asked the Supreme Court to answer “[w]hether, under §365 of the Bankruptcy Code, a debtor-licensor's 'rejection' of a license agreement — which 'constitutes a breach of such contract under 11 U.S.C. §365(g)' terminates rights of the licensee that would survive the licensor's breach under applicable non-bankruptcy law.”

Mission emphasized that the First Circuit's position “contravenes the text and purpose of the Bankruptcy Code” and “reinstates much of the confusion Lubrizol caused.” Mission argued that the dispute highlighted a split of authority among the circuits which necessitated the Supreme Court's review.

In its response, Tempnology declared the Fourth Circuit's reasoning as proper and correct and also focused on why trademarks should be treated differently from the other intellectual property rights addressed by Section 365(n). Tempnology stated: “[T]he First Circuit properly recognized that trademarks are different from other intellectual property rights, and that the Bankruptcy Code's strong policy of permitting a debtor to free itself of ongoing obligations under a contract as embodied in section 365(a) and the right to reject such obligations applies to the burden of policing trademarks — something to which the Seventh Circuit had given shorter shrift.”

In ruling for Mission, the Supreme Court reversed the lower court's decision and remanded the case back to the First Circuit. Justice Kagan wrote for the majority, stating that: “The question is whether the [debtor-licensor's] rejection of a contract deprives the licensee of its rights to use the trademark. We hold it does not.” Justice Kagan went on to explain that, consistent with applicable non-bankruptcy law, “a rejection breaches the contract but does not rescind it. And that means all the rights that would ordinarily survive a contract breach, including those conveyed here, remain in place.”

Part of the Supreme Court's reasoning centered on Tempnology's (and presumably many commentators') selective application of Section 365 with respect to trademarks. The Court pointed out that the policy-based argument regarding Section 365 is trademark specific — that is, licenses of trademarks impose a burden on the debtor-licensor because, in order to maintain the trademarks, the debtor-licensor must monitor and exercise quality control over goods associated with the trademarks and such burden is inconsistent with the principles of bankruptcy law. But the Court noted that, as a statutory matter, this argument necessarily requires a construction of Section 365(g) that is not specific to trademarks and, rather, governs all executory contracts. In particular, Section 365(g) states that rejection of an executory contract “constitutes a breach”; and, under applicable non-bankruptcy law, breach by a party does not allow that same party to rescind the agreement. In expressing skepticism about use of a trademark law principle to construe general Bankruptcy Code language, Justice Kagan said that interpreting the whole of Section 365 for all executory contracts in a way that makes sense for just trademarks, “would allow the tail to wag the Doberman.”

Justice Kagan's opinion also commented on the metes and bounds of Section 365 more generally. She suggested that Section 365 is not a cure-all or free pass, stating, “Section 365 provides a debtor like Tempnology with a powerful tool: Through rejection, the debtor can escape all of its future contract obligations, without having to pay much of anything in return …. But in allowing rejection of those contractual duties, Section 365 does not grant the debtor an exemption from all the burdens that generally applicable law — whether involving contracts or trademarks — imposes on property owners,” including the obligation to monitor and exercise quality control.

What Does the Mission Product Ruling Mean for Trademarks?

Justice Sotomayor, in her concurring opinion, emphasized that the Court's ruling does not necessarily mean trademark licenses are automatically preserved whenever an agreement granting such licenses is rejected. Rather, “the baseline inquiry remains whether the licensee's rights would survive a breach under applicable non-bankruptcy law.” She noted that special terms in the license agreement or applicable state law could affect the outcome.

Therefore, the Supreme Court has not granted trademarks the protections of Section 365(n). Instead, it has simply said that trademark licenses should be treated like other executory contracts and that rejection in bankruptcy should have the same effect as breach under general contracts law.

What Does the Mission Product Case Mean for Other Intellectual Property Rights ?

It remains to be seen if licensees of patents and other intellectual property rights will seek to invoke Mission Product for their licenses, rather than rely on Section 365(n) (which requires, among other things, that the licensee waive certain setoff and other rights as a condition to retaining their licenses under Section 365(n)). Since Congress instituted 356(n) as a direct response to the Lubrizol decision, courts may be reluctant to ignore the “bargain” reflected in Section 365(n) and, if so, the status quo would remain unchanged. But the logic of Mission Product suggests that licensees may have the right to retain licenses without having to rely on Section 365(n).

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Charles A. Cartagena-Ortiz is an associate in the Technology Transactions Group in Morrison & Foerster's San Francisco office.