US Supreme Court Reverses First Circuit in Trademark Rejection Case

Licensee May Continue Using a Trademark after Rejection, Supreme Court Rules, by Rochelle's Daily Wire, ABI 5-20-19

Supreme Court gets around to overruling Lubrizol almost 35 years later.

Today, the Supreme Court handed down its decision in Mission Product Holdings Inc. v. Tempnology LLC, 17-1657 (Sup. Ct.), reversed the First Circuit and held that rejection of an executory trademark license does not bar the licensee from continuing to use the mark. As Justice Elena Kagan said, “A rejection breaches a contract but does not rescind it.”

The opinion was almost unanimous, with Justice Neil M. Gorsuch dissenting; he believes the petition for certiorari should have been dismissed as improvidently granted. In his view, the Court could not grant effective relief.

Justice Sonia Sotomayor wrote a concurring opinion to say that nondebtor parties to rejected trademark licenses may have more rights following rejection than parties to other types of intellectual property licenses whose rights are limited by Section 363(n).

The Court granted certiorari in October to resolve a split of circuits.

The Circuit Split

It took decades, but the Supreme Court ruled on May 20 that the Fourth Circuit was wrong almost 35 years ago when it held that rejection of an executory license for intellectual property precludes the nonbankrupt licensee from continuing to use the license. Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985).

Lubrizol was subjected to withering criticism, prompting Congress three years later to adopt Section 365(n) and the definition of “intellectual property” in Section 101(35A). Together, they allow a nondebtor to continue using patents, copyrights and trade secrets despite rejection of a license.

Congress did not mention trademarks, leading most lower courts to interpret the omission as meaning that rejection cuts off the right to use trademarks.

In 2012, the Seventh Circuit differed with Lubrizol when it handed down Sunbeam Products Inc. v. Chicago American Manufacturing LLC, 686 F.3d 372 (7th Cir. 2012), and held that rejection does not preclude the continued use of a mark. According to Circuit Judge Frank Easterbrook, “nothing about this process [of rejection] implies that any other rights of the other contracting party have been vaporized.” If a licensor’s breach outside of bankruptcy would not bar continued use of the mark, the same would hold true in bankruptcy after rejection by the licensor, he said.

In Tempnology’s chapter 11 case, the debtor had granted the licensee a nonexclusive, nontransferable, limited license to use the debtor’s trademarks. Following Lubrizol, the bankruptcy court rejected the license and ruled that the licensee could not continue using the license. The Bankruptcy Appellate Panel reversed, following Sunbeam.

The First Circuit reversed the BAP in January 2018. Mission Product Holdings Inc. v. Tempnology LLC (In re Tempnology LLC), 879 F.3d 389 (1st Cir. Jan. 12, 2018).

In a 2/1 opinion, the First Circuit majority in Tempnology sided with Lubrizol and criticized Sunbeam for “largely [resting] on the unstated premise that it is possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark.” The majority favored “the categorical approach of leaving trademark licenses unprotected from court-approved rejection, unless and until Congress should decide otherwise.” To read ABI’s discussion of the First Circuit’s opinion in Tempnology, click here.

As it had done in the First Circuit, the debtor argued in the Supreme Court that allowing the licensee to continue using the trademark would force the debtor to continue shouldering the onerous burden of policing the quality of the licensee’s use of the mark. Absent quality control, the debtor contended, the licensor abandons the mark, and it reverts to the public domain. Rejection frees the debtor from the burden of policing the mark and is thus a necessary adjunct to the power of rejection, according to the debtor.

Justice Kagan’s Opinion

Mootness

Joined by all justices except Justice Gorsuch, Justice Kagan began by holding that the appeal was not moot.

Initially, the bankruptcy judge had only granted a plain, vanilla motion to reject the trademark license. Following rejection, the debtor returned to court, where the bankruptcy judge issued a declaration saying that rejection terminated the licensee’s use of the mark. Later still, the license terminated by its own terms.

To counter the notion of mootness, the licensee contended that it had a claim for damages resulting from its inability to use the mark. The debtor responded by saying that the bankruptcy court had authorized distribution of the last funds in the estate. The licensee countered by saying it might prevail on the bankruptcy court to compel other creditors to disgorge distributions.

Justice Kagan held that the appeal remained “a live controversy.” “If there is any chance of money changing hands, [the licensee’s] suit remains alive.” Citing the Court’s precedent, she said that “courts often adjudicate disputes whose ‘practical impact’ is unsure at best, as when ‘a defendant is insolvent.’”

The Merits: Rejection Isn’t Rescission

Justice Kagan said that the text of Section 365 and “fundamental principles of bankruptcy law” lead to a conclusion that rejection is not rescission. In particular, she relied on Section 365(g), which provides that rejection “constitutes a breach of such contract” immediately before the filing of the bankruptcy petition.

Or “more pithily for current purposes,” Justice Kagan said that “rejection is a breach.” In turn, breach “means in the Code what it means in contract law outside bankruptcy.”

As an example, Justice Kagan supposed that a debtor had leased a copy machine to a law firm. Were the debtor to reject the lease, she said the debtor could stop servicing the machine, but the debtor “cannot take it back.”

Applying the same notion to trademarks, Justice Kagan said that “breach does not revoke the license or stop the licensee from doing what it allows.”

Justice Kagan also bought into the idea that the power to reject does not convey the same remedies as avoidance actions, which, she said, are “exceptional cases in which trustees . . . may indeed unwind pre-bankruptcy transfers.”

No Negative Inference from Section 365(n)

The debtor argued that the omission of trademarks from Section 365(n) meant that Congress intended for rejection to cut off use of a mark.

“Still,” Justice Kagan said, “Congress’s repudiation of Lubrizol for patent contracts does not show any intent to ratify that decision’s approach for almost all others. Which is to say that no negative inference arises. Congress did nothing in adding Section 365(n) to alter the natural reading of Section 365(g) — that rejection and breach have the same results.” [Emphasis in original.]

Aiding Reorganization

The debtor argued that it would be better able to reorganize if the court relieved it of the burden of policing the use of the mark. To that, Justice Kagan said, “The Code of course aims to make reorganization possible. But it does not permit anything and everything that might advance that goal.”

Justice Kagan said that Section 365 therefore does not “relieve the debtor of the need . . . to invest the resources needed to maintain a trademark. . . . The resulting balance may indeed impede some reorganizations, of trademark licensors and others.”

For the Court, Justice Kagan held that rejection “has the same effect as a breach outside of bankruptcy. Such an act cannot rescind rights that the contract previously granted. Here, that construction of Section 365 means that the debtor-licensor’s rejection cannot revoke the trademark license.”

Danielle Spinelli, a former Supreme Court law clerk, represented the licensee. Douglas Hallward-Driemeier, a former Assistant Solicitor General, argued for the debtor. Assistant Solicitor General Zachary D. Tripp argued on behalf of the government in favor of reversing Lubrizol.

Justice Sotomayor’s Concurrence

Justice Sotomayor said she concurred “in full.” She wrote “to highlight two potentially significant features of today’s holding.”

First, Justice Sotomayor said the opinion does not mean that “every trademark licensee has the unfettered right to continue using licensed marks post rejection.” The opinion may not apply, she said, if provisions in the license or “state law” might “bear” on continued use of the mark.

Second, and of greater significance, Justice Sotomayor said that the “holding confirms that trademark licensees’ postrejection rights and remedies are more expansive in some respects than those possessed by other types of intellectual property.” For instance, she said that licensees of patents, copyrights and four other types of intellectual property (which are covered by Section 365(n)) “must make all [their] royalty payments.”

The Dissent

Dissenting, Justice Gorsuch said nothing about the merits. He would have dismissed the certiorari petition for having been improvidently granted.

The case should have been considered moot, Justice Gorsuch said, because the licensee “hasn’t come close to articulating a viable legal theory on which a claim for damages could succeed. And where our jurisdiction is so much in doubt, I would decline to proceed to the merits . . . . [T]here is no need to press the bounds of our constitutional authority . . . .”

The Irony, Import and Utility of the Decision

For appellate jurisprudence, the inability of Justice Gorsuch to prevail in his view about mootness seems to mean that the Court can reach the merits even when the existence of a live controversy is in doubt.

James M. Wilton of Ropes & Gray LLP in Boston, one of the counsel for the debtor, told ABI that “the decision will enhance the negotiating leverage of trademark licensees vis a vis secured lenders and other creditors and make it more difficult for debtor-licensors to rebrand their businesses and reorganize.”

In the very hypothetical that Justice Kagan mentioned, the bankruptcy of a lessor of personal property will not enable the debtor to use rejection as a means for recovering the equipment for lease to someone else at a higher price.

Ironically, some non-debtor third parties would now be better off had Congress not come to their aid. Section 365(n) is not the only Code provision where a party to a rejected contract or lease would have greater rights after Mission Product.

Judge Kagan mentioned real property leases, contracts for the sale of real property and time-share interests in Sections 365(h) and (i). Having balanced the interests of debtor and creditors in those sections, Congress could have given third parties fewer rights and remedies than they might otherwise have been found to have following Mission Product. Nonetheless, the certainty provided by Sections 365(h) and (i) is perhaps a fair trade-off.