Bankruptcy Update Blog

Trademark Licenses . . . Again (Update No. 7): The Supreme Court Decides! (Part 1)

Our January 22, May 23, June 28, July 13, August 3, September 11 and October 29, 2018 and January 11, 2019 posts discussed the First Circuit’s January 12, 2018 decision in Mission Product Holdings, Inc. v. Tempnology, LLC.[1] and the appeal therefrom to the Supreme Court.[2]  On May 20, the Supreme Court issued its decision reversing the First Circuit in a 8-1 opinion clarifying the consequences of the rejection of a trademark license by the licensor.[3]  Justice Kagan’s majority opinion was joined by every Justice except Justice Gorsuch, and Justice Sotomayor also filed a concurring opinion.  Justice Gorsuch dissented.[4]

Justice Kagan’s analysis begins with Section 365(g)’s statement that “the rejection of an executory contract . . . constitutes a breach of such contract,” drawing from that statement that the consequences of rejection are therefore identical to the consequences of breach under non-bankruptcy law and not also anything else:[5] 

[A] debtor’s rejection of an executory contract in bankruptcy has the same effect as a breach outside bankruptcy.[6]

The Court appears to have assumed that the consequence of a rejection could only be either a breach or rescission,[7] not a unique bankruptcy cluster of consequences that one might call “breach plus,” and not to have considered that Section 365(g)’s “rejection . . . constitutes a breach” might have been intended to prescribe only the method of calculation and priority of the non-debtor’s rejection damage claim but not to have exhausted all there is to say about the consequences of rejection.  Subsection (g)’s statement that “rejection . . . constitutes a breach” need not necessarily have been read to exclude any possible consequences of rejection that are not also consequences of a breach, but the Court does not address why it implicitly attributes such an exclusive effect to it.

And what is the result of the “rejection equals breach, not rescission” rule?  The non-debtor licensee may retain its rights as licensee notwithstanding rejection:

A rejection does not terminate the contract.  When it occurs, the debtor and counterparty do not go back to their pre-contract positions.  Instead, the counterparty retains the rights it has received under the agreement.  As after a breach, so too after a rejection, those rights survive.

* * *

If the licensor breaches the agreement outside bankruptcy . . ., the breach does not revoke the license or stop the licensee from doing what it allows. . . .  [B]ecause rejection “constitutes a breach,” §365(g), the same consequences  follow in bankruptcy.  The debtor can stop performing its remaining obligations under the agreement.  But the debtor cannot rescind the license already conveyed.[8]

A major argument in the courts below and the Supreme Court briefing concerned the negative inference from the subsections of Section 365 in which Congress authorized the non-debtor party to retain its interest in some contracts notwithstanding rejection and not others.  Most pointedly, subsection (n) authorized the non-debtor intellectual property licensee to continue to use the licensed property notwithstanding rejection, on the conditions expressed therein, but omitted trademarks from the intellectual property to which (n) could apply.  Justice Kagan dismissed all those subsections as a “mash-up of legislative interventions”[9] enacted to counteract judicial failures to discern and apply the general rule of rejection-equals-breach.[10]

Finally, Justice Kagan rejected the appellee’s argument based on the legal obligations of a trademark licensor to exercise quality controls over its licensees, failing which the trademark is at risk of invalidity.  Because the argument was offered to consign all contracts other than those to which an (n)-type exception applied (and not only trademark licenses) to rejection-equals-termination, she said it “allow[ed] the tail to wag the Doberman.”[11]

Our January 11 post stated that “[i]f the outcome is reversal . . ., this blogger believes that an intellectually honest and satisfying decision must address at least” four specific issues.  My next post will address how well this week’s decision addressed them.

 

[1]  879 F.3d 389 (1st Cir. 2018), petition for cert. granted, No. 17-1657 (Oct. 26, 2018). 

[2]  This post assumes that its readers are familiar with the prior posts.

[3]  __ U.S. __ (May 20, 2019).

[4]  The majority rejected the appellee’s contention that the case was moot.  Justice Gorsuch’s dissent is based solely on mootness.

[5]  Slip op. at 7-12.

[6]  Slip op. at 17.

[7]  “Rejection of a contract--any contract--in bankruptcy operates not as a rescission but as a breach.”  Slip op. at 8.  The Court appears to have used “revocation” several times as a synonym for “rescission.”  See, e.g., slip op. at 17 (“the debtor-licensor’s rejection cannot revoke the trademark license”).

[8]  Slip op. at 10.  In addition to Section 365(g), the opinion based its rejection-equals-breach holding on the general principle that “[t]he estate cannot possess anything more than the debtor itself did outside bankruptcy” and the disparity in non-debtor protections in rejection vs. avoidance actions (and, said Justice Kagan, rejection-equals-rescission would be tantamount to avoidance without those protections).  Slip op. at 11-12.

[9]  Slip op. at 13.

[10]  Justice Sotomayor noted that the constrains on an electing non-debtor patent licensee under subsection (n) do not apply to the non-debtor trademark licensee in the relatively unconstrained “rejection equals breach” context, but she says this dichotomy does not change the general rule and presents Congress with an opportunity “to tailor a provision for trademark licensees.”  Concurring opinion at 2.  She did not note the possibility that a patent licensee may seek to avoid the constraints of subsection (n) by invoking the general “rejection equals breach” rule without purporting to resort to (n).

[11]  Slip op. at 14-16.