The Supreme Court’s recent decision in Mission Product Holdings, Inc. v. Tempnology, LLC(2019) ruled on the effect of a rejection of trademark licenses in bankruptcy.
What happens when a trademark license is rejected as an executory contract, as is permitted by Chapter 11 of the Bankruptcy Code? Can the licensee continue using the trademark?
The Supreme Court resolved a Circuit split on that question, holding that the licensee may continue to use the license.
Counsel for parties involved with trademark licenses now need to take this decision into account when drafting these agreements. If one of the parties seeks bankruptcy protection, then the license terms will become important both in preserving the trademark (by providing for quality control and maintenance of trademark registrations) and regulating the parties’ continuing relationship.
On the licensor side, the license could provide, in the case of financial insolvency or bankruptcy, that the licensor would either have to commit in writing to continue the license (including quality control) or agree to assign the trademark. Provisions for maintenance of any trademark registrations could also be included.
On the licensee side, the license could provide, in the case of financial insolvency or bankruptcy, that the licensee would have to commit in writing to continuing to pay royalties and cooperate in quality control, or terminate the license.
Mission Product v. Tempnology
Chapter 11 of the Bankruptcy Code allows financially troubled companies to seek protection from their creditors, reorganize their debts, and then, hopefully, to continue their business. Among other things, the Bankruptcy Code allows the bankruptcy trustee to “reject” any of the debtor’s “executory contracts.” See 11 U.S.C. § 365.
Mission Product involves a typical trademark license where a trademark owner licenses its registered trademarks for use on products the licensee will manufacture and distribute. Tempnology, the licensor, filed for Chapter 11 when it experienced financial troubles. The trustee rejected the trademark license under Section 365(a) of the Code, which allows the trustee to reject the debtor’s “executory contracts,”i.e., contracts for which “performance remains due to some extent on both sides.”
The Supreme Court ruled that the licensee could continue using the license. It reasoned that the Bankruptcy Code provides that a rejection is treated as a breach of contract (which allows the other party to bring a claim for damages), but not, critically, as a rescission of the rejected contract, which would completely undo the contract. The Court found that Congress only intended that a rejection be treated as a breach, not a rescission, and so the contract itself remains, and the licensee may continue to use the license.
Mission Products argued that trademark licenses have a unique feature – the continued need to maintain quality control. Imposing such a quality-control requirement on the licensor would hamper a debtor-licensor’s ability to reorganize under Chapter 11.
The Court rejected Mission Products argument because that is a trademark-specific issue, while the applicable section of the Bankruptcy Code deals with all kinds of executory contracts. Using the unique legal quirks of trademark law to construe a general section that concerns all contracts “would allow the tail to wag the Doberman.” So, Mission Products’ license was treated the same as all executory contracts, and its license survived the rejection under the Bankruptcy Code.
Trademark Licenses – What’s So Special?
The Court acknowledged that its ruling might create special legal issues owing to the unique nature of trademark licenses, which require ongoing quality control efforts or else the trademark itself may be lost. What is so special about trademark licenses?
Trademarks are a unique form of intellectual property. Trademarks have no independent existence from a business – they are merely symbols of the company’s business reputation and goodwill. As the Supreme Court aptly put it over 100 years ago, a trademark is merely “a right appurtenant to an established business or trade in connection with which the mark is employed.” United Drug Co. v. Theodore Rectanus Co., 248 U.S. 90 (1918). Unlike a patent or copyright, for example, a trademark can never be separated from the underlying business and its reputation.
One corollary of this is that trademarks can only be licensed on condition that the licensor engages in quality control to ensure that the trademark is being used in conformance with its quality standards. A license without quality control is termed a “naked license” under trademark law. Trademark law considers a naked license to be an abandonment of the trademark, resulting in the loss of the mark.
Both the licensor and licensee have an interest in making sure trademark rights are maintained – the licensor to keep its valuable intellectual property, the licensee to keep the value of the property to which it has a license and for which it is paying royalties. Therefore, trademark licenses usually do contain provisions for quality control – the licensor is obligated to maintain quality control, and the licensee is obligated to cooperate.
Similarly, both the licensor and licensee have an interest in maintaining existing registrations for the licensed trademarks. While a federal registration is not required to maintain trademark rights, it does confer several important advantages. Registrations have to be maintained – renewals are due after the fifth year of registration, and then at ten-year intervals (from the original registration date). Since both the licensor and licensee have an interest in maintaining registrations for the licensed mark, licenses often provide for duties for one side (usually the licensor) to maintain the registration.
Provisions in Trademark Licenses to Deal with Bankruptcy
The Mission Product decision now creates a potential situation where the trademark may be put in jeopardy if the licensor or licensee enters bankruptcy, the license is rejected, and the license contains no provisions for quality control and maintenance of registrations.
This is where the terms of the license become critical. Justice Sotamayor made this very point in her concurrence in Mission Product. The effect of a trustee rejection on a license results from two different sources: the Bankruptcy Code itself, and the terms of the license. The Court only dealt with the first step, the effect of the Bankruptcy Code, concluding that a rejection does not rescind the contract and it remains in force.
But, if as the Court held, the contract remains in effect, then the license terms will still govern, and depending on the details, the end result might not be retention of the license by the licensee. For example, the terms might provide that, in case of a breach by the licensor (which, by statute, is what a bankruptcy trustee rejection constitutes), the licensee might lose its rights, or the licensee might have an option to terminate the license. Or, the terms might allow the license to continue, but impose duties on both parties to maintain the trademark rights. The critical point is that, even post-trustee rejection, the license terms are important in regulating the licensor-licensee relationship and the duties of both sides.
What is important, then, is that in drafting, if the parties want the license to continue after a trustee rejection, that the license contain contractual terms that ensure that the trademark rights are maintained and that both sides continue to reap its benefits. We suggest some terms below.
Terms to Govern Licensor Bankruptcy
One set of terms that should be incorporated deal with ensuring that the trademark rights are maintained:
- If the licensor becomes financially insolvent (or the trustee rejects the license), then the licensor should be required to provide a written commitment, within a given period of time (e.g., 60 days), to either continue maintaining quality control (including with other licensees, if any), or agree to assign the trademark (and any registrations) to the licensee.
- With respect to renewal of registrations, a license might provide that if the licensor cannot commit to doing so, the licensor would appoint the licensee as its agent to file renewals with the Trademark Office and fees incurred deducted from any royalties due.
Counsel should also consider other terms to regulate the licensor-licensee relationship in bankruptcy. In 1988, Congress added specific provisions to the Bankruptcy Code to deal with rejection of licenses of patents, copyrights, trade secrets and certain other forms of intellectual property, see 11 U.S.C. § 365(n), but not, notably, trademark licenses. These statutory provisions regulate the relationship between the bankrupt licensor and licensee after a rejection. For example, the licensee has the option to terminate the license, or if not, it must continue paying royalties, and may not deduct any damages from those payments (but rather must seek damages in the bankruptcy court as an unsecured creditor).
Justice Sotamayor’s concurrence notes that for trademark licenses, the specific, detailed statutory provisions in Section 365(n) would not apply, since these provisions do not encompass trademark licenses. The parties are therefore free to contract terms that are the same or more favorable to one side or the other. Still, the statute is a good checklist of the kind of issues that arise in licensor-licensee relationships post-rejection. Counsel involved in drafting trademark licenses should review Section 365(n) and consider whether to include terms that cover the same issues dealt with there.
Terms to Govern Licensee Bankruptcy
What if the licensee seeks bankruptcy protection, and then the trustee rejects the contract? Mission Product seems to lead to an odd result. As discussed, the key part of its reasoning is that a rejection is merely a breach, not a rescission, of the contract, and hence the contract and contractual rights remain. One trademark attorney has commented that under Mission Product’s reasoning, the licensee could continue using the trademark and avoid either cooperating in quality control efforts or paying royalties. This would create an untenable situation where not only is the licensed trademark in jeopardy (from lack of quality control and loss of federal registration), but the licensee may avoid paying royalties.
This situation can also be dealt with by terms in the license:
- If the licensee becomes financial insolvent (or the trustee rejects the license), then either the licensor has the option to terminate the license, or the licensee must provide a written commitment within a given period of time (e.g., 60 days) to continue to cooperate in quality control and pay royalties. The failure by the licensee to provide the written commitment (or the failure by the licensee to actually follow through with the quality-control and payment-of-royalties commitments) would be a breach that would terminate the license.
While details might vary in particular cases, what is important is that both sides commit to doing what is needed to maintain the trademark, even where financial difficulties or bankruptcy ensue, or otherwise terminate the licensing arrangement.
The Supreme Court’s Mission Product decision means that, even after a trademark license is rejected by a bankruptcy trustee, the licensor-licensee relationship continues. However, unlike for other forms of intellectual property, there are no statutory provisions to regulate this ongoing relationship. That gap now must be filled in with license terms.
A previous version of this post appeared in the New York Law Journal June 13, 2019