Supreme Court Issues Major Ruling on the Ongoing Viability of Trademark Licenses by Bankrupt Entities

By: Daniel C. DeCarlo

For years, the courts and companies alike have struggled with what to do with license agreements when the trademark licensor files for bankruptcy, specifically Chapter 11, where the bankrupt entity seeks to reorganize its debt and continue operating. A fundamental tool of such bankruptcies is that the debtor is permitted to "reject" contracts entered into prior to the bankruptcy. These "rejections" can free up the debtor from burdensome agreements and are often a key tool to the success of a bankruptcy.

But the courts have long struggled with how to handle trademark license agreements which, while of course contractual, have some unique characteristics due to the nature of trademarks. At issue in Mission Product Holding v. Tempnology, LLC 587 U.S. ___(May 20, 2019) No. 17-1657, was whether a licensee whose license agreement was "rejected" by the bankrupt debtor licensor was permitted to continue using the trademark that was the subject of the license. The debtor/licensor wanted the licensee to cease ongoing usage of the mark and cited to the bankruptcy law's tool of rejection as the basis for doing so. However, the U.S. Supreme Court rejected the proposition that the licensee had to cease usage. The Court’s reasoning was specific to the contours of the bankruptcy laws and most certainly will lead to some impactful consequences as it relates to trademark licenses.

Essentially, the Supreme Court held that a "rejection" of a contract (which a debtor is permitted to do) serves as a breach of contract by the debtor, but not a "rescission" of a contract. The breach by the debtor is deemed to have occurred prior to the filing of the bankruptcy, which means that the party who seeks to enforce the contract will be a creditor of the bankrupt entity, just like any other pre-petition creditor, which may likely mean that the other party to the contract will not see any value from the breach because the debt will be washed away in the bankruptcy. In other words, while the debtor is deemed in breach, because of the bankruptcy laws, there is usually no financial consequence to the debtor. But since the "rejection" is not a rescission under the bankruptcy laws, the debtor does not have the right to retract the rights granted to the licensee, and so the debtor cannot compel the licensee to cease use of the mark. Said another way, the licensee, even in the face of a rejection of the license agreement, continues to enjoy the benefits of the rights conveyed on the licensee. The rights granted to the licensee do not get washed away in the bankruptcy. "But the debtor cannot rescind the license already conveyed. So, the licensee can continue to do whatever the license authorizes". Id. at 10.

Why does this case matter so much?

This decision will have significant implications on many trademark licensees and trademark owners. A fundamental tenet of trademark law is that trademarks are not "rights in gross," meaning trademarks are intangible property rights. A trademark's value is derived exclusively from its ability to have consumers recognize the mark with a particular source of goods or services. The trademark standing alone, without good will, is worthless.

Consider, before Steve Jobs envisioned APPLE, the word APPLE in the context of computers meant nothing. Its value as a trademark has grown as the value of the source of the goods and services signified by APPLE has grown. A corollary to this concept is that a trademark owner must exercise quality control over its licensees, because if the licensor does not exercise that quality control, "the mark will naturally decline in value and may eventually become altogether invalid." Id. at 15.

From these twin concepts, two major implications flow from this ruling:

  1. Bankrupt debtors seeking to maintain their trademark rights, and who have license agreements, must continue to honor those agreement and exercise quality control even through the bankruptcy process if the trademark holder wishes to maintain those trademark rights. This necessarily means that resources which may be limited (after all, the entity was in poor enough financial status to file for bankruptcy) will have to be devoted in some regard to maintaining trademark rights and quality control with licensees. Because if the debtor chooses not to so exercise those quality control obligations, the trademark rights will eventually be deemed abandoned under the trademark laws. This also means that, for example, if the debtor had issued an exclusive license prior to the bankruptcy, the bankruptcy wouldn't permit the bankrupt entity to rescind that right and license those trademark rights to another licensee post-bankruptcy in violation of the prior exclusive license. While rejection of a contract is permitted, such a rejection "cannot rescind rights that the contract previously granted. Here, that construction of [the bankruptcy law] means that the debtor-licensor's rejection cannot revoke the trademark license." Id. at 17. This puts the debtor in the position of making a choice: either abandon the trademark as an asset, or devote resources to maintain the trademark rights.
  2. If an entity is being accused of trademark infringement of an entity that previously filed for bankruptcy, care should be taken to examine what took place in the bankruptcy with regard to the debtor's trademark rights. Perhaps, as noted above, the debtor did not maintain its trademark rights through the bankruptcy, meaning it did not devote resources to exercising the necessary quality control to maintain trademark rights. If this occurred, then the trademark would be deemed "abandoned" under trademark law and the trademark holder may very well have no right to enforce its mark.
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