The Supreme Court, bankruptcy, trademarks and service marks

Trademark and service mark licensees had an uncertain life. In some federal courts, a bankrupt licensor could just reject the license and revoke it. But in others, that didn’t work. The Supreme Court has now resolved the split.

Rejecting executory licenses

The Bankruptcy Code generally provides that a debtor has the option of assuming or rejecting executory contracts. Executory contracts are those which neither party has finished performing. Leases are a typical example.

Licenses of intellectual property are usually executory contracts. Royalties are paid during the course of the license. Neither party is done performing until the license is over. 

Revoking a license could be pretty harsh in an intellectual property setting. Imagine building up a substantial business making and selling, for example, an electronics product using an invention licensed from a patent owner. Then imagine that, after the product is launched and is becoming successful, the patent owner declares bankruptcy and revokes the license. This would leave the licensee with a manufacturing plant, plenty of sunk costs in advertising and distribution, but no license to allow it to continue to make and sell the products. That’s harsh. And it’s no way to encourage innovation.

Congress reacts and protects innovation

In 1988, Congress amended the bankruptcy code to avoid this harsh result. Even though they are executory contracts, and therefore subject to rejection by a bankrupt licensor, the bankruptcy code excluded “intellectual property” licenses. See 11 U.S.C. § 365(n). The licensor cannot revoke the licensee’s right to use the licensed IP by rejecting the contract. The licensee can elect to retain its rights under the license and continue to pay royalties.

What about trademarks?

But here was the rub. The bankruptcy code’s definition of “intellectual property “ included things like patents, patent applications, copyrights, and trade secrets. But it did not include trademarks or service marks. 

A circuit split

Circuit Courts came to different conclusions about whether that meant a bankrupt licensor could revoke a trademark license. For example, the First Circuit ruled that the debtor could reject the trademark license and extinguish the licensee’s rights. That’s pretty harsh. But if Congress did not include trademarks in the exemption, it wasn’t for the court to include it.

By contrast, the Seventh Circuit noted that section 365(g) of the code treats rejection of a contract as a breach. And it held that the licensor cannot simply revoke the contract by breaching it in a bankruptcy setting any more than it could in any other setting. The licensee could continue to use the rights granted it under the license. 

The Supreme Court speaks

The Supreme Court recently adopted the Seventh Circuit’s approach in an 8 to 1 decision. It stated: “We reject the competing claim that by specifically enabling the counterparties in some contracts to retain rights after rejection, Congress showed that it wanted the counterparties in all other contracts to lose their rights. . . .. Rejection of a contract— any contract—in bankruptcy operates not as a rescission but as a breach.” Mission Product Holding, Inc. v. Tempnology, LLC, No. 17-1657, slip op. at 8 (May 20, 2019) https://www.supremecourt.gov/opinions/18pdf/17-1657_4f15.pdf.

The Court noted that Congress enacted 365(n) as a reaction to a holding by the Fourth Circuit in Lubrizol Enterprises v. Richmond Metal Finishers, 756 F. 2d 1043, 1045 (4th Cir. 1985). The Lubrizol court held that a patent owner could revoke a patent license in bankruptcy. But, that Congress enacted legislation to avoid that harsh result for a patent license, reasoned the Supreme Court, does not mean it meant to embrace the same harsh result for a trademark license. And Congress did nothing to alter a reading of section 365(g) that a rejection is a breach with the same result as a breach. 

In short, a trademark or service mark licensee cannot rescind the rights granted under a license by rejecting it in bankruptcy any more than in any other setting. 

What does it all mean?

This decision is a pretty big deal in the world of trademark and service mark licensing. A licensee clearly had a significant risk of losing its license after building up a brand over many years. And a trademark owner or its trustee in bankruptcy had an upper hand in dealing with license. It could probably coerce a higher royalty for a valuable trademark by threatening to terminate the license. That threat is no longer viable. 

Probably most importantly, this decision brings some clarity to what was an uncertain issue in trademark and service mark licensing. That allows parties to more clearly understand their rights. Eliminating uncertainly should be a benefit to licensing in general. 

But some questions remain. For example, section 365(n) specifically requires the licensee to continue to make payments to continue to enjoy IP rights. Because trademarks and service marks aren’t mentioned in 365(n), does that requirement apply to them?

Also, one of the arguments for allowing the debtor to rescind IP rights by rejecting the license was the need for the licensor to continue to monitor the quality of goods and services sold under the mark to avoid naked licensing, which can invalidate the mark. The Supreme Court rejected this as a reason to allow the licensor to rescind IP rights. But the issue of naked licensing caused by inattention of a bankrupt mark owner remains. 

These issues will need to be clarified. But in the meantime, trademark and service mark licensees are in a much better spot than they were before the Supreme Court addressed the problem.