U.S. Supreme Court to Resolve Circuit Split Regarding Trademark Licensees’ Rights Upon Licensor Bankruptcy

Author: Benni Amato

According to the International Trademark Association (“INTA”), “whether a debtor-licensor can terminate a trademark license by rejection, thereby ‘taking back’ trademark rights it has licensed and precluding its licensee from using the trademark” is “the most significant unresolved legal issue in trademark licensing.” It likely will not stay unresolved for much longer; on October 26, 2018, the United States Supreme Court granted a petition for certiorari to resolve this specific issue as part of the Mission Product Holdings Inc. v. Tempnology LLC case.

Tempnology is a New Hampshire-based company that developed chemical-free cooling fabrics. It used this fabric to produce clothing that were designed to remain cool during exercise. Tempnology and Mission entered into a distribution agreement in November of 2012 that gave Mission the non-exclusive right to sell certain patented and trademarked Tempnology products throughout the world and the exclusive right to sell some of those products within the United States.

After a complex factual and procedural history, Tempnology filed for Chapter 11 bankruptcy in September 2015. The day after the filing, Tempnology moved to reject the agreement under 11 U.S.C. §365(a). After two appeals, a split First Circuit panel held that Tempnology’s rejection terminated the trademark rights licensed to Mission under the agreement.

As explained by the majority in the First Circuit decision, after a debtor-licensor files for Chapter 11 bankruptcy, it may secure court approval to “reject” any executory contract so that the other party to the contract is “left with a damages claim for breach, but not the ability to compel further performance.” Mission Prod. Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), 879 F.3d 389, 404 (1st Cir. 2018). “When the rejected contract, however, is one ‘under which the debtor is a licensor of a right to intellectual property,’ the licensee may elect to ‘retain its rights . . . to such intellectual property,’ thereby continuing the debtor’s duty to license the intellectual property.” The problem begins, however, with the fact that Congress left trademarks off the definitional list of intellectual properties in 11 U.S.C. §101(35A).

The First Circuit found that it made sense for Congress to have excluded trademarks. After all, “the effective licensing of a trademark requires that the trademark owner—here the debtor, followed by any purchaser of its assets—monitor and exercise control over the quality of the goods sold to the public under cover of the trademark.” Should the licensor fail to exercise reasonable control, that could result in the abandonment of its trademarks.

Thus, the First Circuit reasoned that should Mission be allowed to continue to use Tempnology’s trademarks, that would force Tempnology to choose between performing executory obligations in monitoring and controlling the quality of goods or risk losing its trademarks and diminishing their value to Tempnology. The loss of the contractual licensing value to Mission should instead be compensated via damages.

The First Circuit decision, however, was a direct split from the Seventh Circuit decision six years prior in Sunbeam Prods. v. Chi. Am. Mfg., LLC, 686 F.3d 372, 377 (7th Cir. 2012). The Seventh Circuit, with an opinion from its Chief Judge Easterbrook, stated that “[t]he limited definition in §101(35A) means that §365(n) does not affect trademarks one way or the other. According to the Senate committee report on the bill that included §365(n), the omission was designed to allow more time for study….” “What §365(g) does by classifying rejection as breach is establish that in bankruptcy, as outside of it, the other party’s rights remain in place. After rejecting a contract, a debtor is not subject to an order of specific performance…The debtor’s unfulfilled obligations are converted to damages…But nothing about this process implies that any rights of the other contracting party have been vaporized.”

Mission and its amici have urged the Supreme Court to adopt the Sunbeam approach, which allows licensees to keep their licensed trademark rights even when the debtor-licensor has successfully rejected the contract. Their reasons include:

• Enabling the debtor to take back rights already granted to a licensee encourages them to “cut a better deal for those rights” to the detriment of the licensee through no fault of licensee’s. (Mission’s petition for writ of certiorari.)
• “If the debtor believes its trademarks are worth the cost of monitoring, it will presumably incur that cost to preserve the value of the asset…. That decision is no different than the cost-benefit analysis debtors undertake every day when deciding whether to make an investment in an estate asset to maximize its value. It has no bearing on the question whether rejection terminates a licensee’s trademark rights.” (Mission’s petition for writ of certiorari.)
• “A licensee who is confident that the licensor’s bankruptcy will not upend its continued right to use licensed trademarks or sell the debtor’s products under an exclusive-distribution agreement will be more inclined to enter into an agreement that creates net efficiencies for distribution and production arrangements.” (Mission’s petition for writ of certiorari.)
• “Licensors benefit because licensees will pay more up front or in royalties for licensed rights that survive a potential bankruptcy filing by the licensor.” (INTA’s amicus brief.)
• “Licensees, who have substantial reliance interests in the licensed trademarks (g., having hired employees and/or established manufacturing capacity to take advantage of the rights), will not suddenly find their rights rendered valueless by the licensor’s decision to terminate a trademark license agreement through rejection in bankruptcy.” (INTA’s amicus brief.)
• “Under the First Circuit’s rule, a debtor/licensor can use the power to reject to destroy a licensee’s business or hold the licensee hostage, forcing it to pay twice for a license it had already purchased.” (Law professors’ amicus brief.)

Tempnology, on the other hand, sought to distinguish its case from that of Sunbeam’s. Sunbeam involved a “short term transitional license for sale of a finished product,” whereas the Tempnology-Misson agreement was a complex joint venture/joint marketing and distribution arrangement with a two-year wind-period that would require post-rejection interaction between the parties to ensure maintenance of quality control.

Regardless of how the Supreme Court eventually rules, having this issue settled will at least provide clarity for trademark licensors and licensees in the event of bankruptcy. We will report on the high court’s final decision.

About the author: Benni Amato is a partner in Gordon Rees Scully Mansukhani’s Intellectual Property Practice Group. Her practice focuses on litigation matters involving trademarks, copyright, trade secrets, patents, internet issues, cybersecurity, and contractual disputes, as well as domain name arbitrations and trademark and copyright prosecution and licensing. Ms. Amato’s biography can be found here.