JANUARY 2020
DEVOTED TO LEADERS IN THE INTELLECTUAL PROPERTY AND ENTERTAINMENT COMMUNITY
Licensing Journal VOLUME 40
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Edited by Gregory J. Battersby and Charles W. Grimes
NUMBER 1
The Supreme Court’s Rescue Mission for Trademark Licenses in Bankruptcy: The Legal and Licensing Implications of the Court’s Ruling in the Mission Products Case Jed Ferdinand and Olivia Ferdinand Jed Ferdinand is the founding member of Ferdinand IP Law Group, an intellectual property and licensing boutique law firm with offices in New York, San Diego, Silicon Valley and Westport, CT, and serves as an Adjunct Professor at Fordham Law School in New York. Olivia Ferdinand is a student at Harvard University who interns at the firm.
Trademark licenses are at the heart of the merchandise licensing industry, which accounted for $280 billion in global retail sales in 2018.1 To be sure, “trademark licenses undoubtedly are omnipresent; the rights they convey to licensees are of enormous economic significance; and substantial investments are made in reliance on these rights.”2 Yet, for many years, despite the fact that trademark licenses provide the legal foundation for the global merchandise licensing industry and that the majority of US bankruptcy filings concerning intellectual property involved trademarks,3 the law governing the state of trademark licenses in bankruptcy remained uncertain because Congress failed to include trademarks when it protected other areas of IP in an important update to the Bankruptcy Code in 1988. Could a licensee-manufacturer continue to use the licensed trademark even after a licensor-debtor’s rejection of the underlying trademark license agreement in bankruptcy? The courts were split on this critical question, and as a result, it created uncertainty for licensing industry professionals and the legal practitioners who advised them. Unfortunately, the parties facing the greatest uncertainty were the licensee-manufacturers who often make substantial financial investments towards designing and developing licensed products. Without the protection of the
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Bankruptcy Code, licensee-manufacturers were at risk of losing the license before the end of the term if a trademark-licensor filed for bankruptcy. This led to a chilling effect on license negotiations, particularly if the trademark-licensor posed a credit risk. It was thus welcome news to the licensing industry when the Supreme Court granted review in the case of Mission Product Holdings, Inc. v. Tempnology, LLC. In a near-unanimous decision issued on May 20, 2019, the Court ruled that a debtor-licensor’s rejection of a trademark license agreement does not “deprive the licensee of its rights to use the trademark.”4 Hence, by ruling that a licensee-manufacturer can continue to exploit its rights under the license agreement even after a licensor-debtor files bankruptcy and rejects the license, the Court harmonized the treatment of trademark licenses with other IP licenses under Section 365(n) of the Bankruptcy Code. This outcome was well-received by licensing industry professionals and legal practitioners alike for it is certain to have a positive impact on licensing deal flow. This article will address the Court’s ruling in the Mission Products case and its impact on the licensing industry, both in terms of the question that the case resolved and questions that remain after the Court’s ruling. Importantly, the extent of the rights of trademark licensors in the event that a licensee-manufacturer files for bankruptcy still remains unclear. This article will offer legal and practical guidance to address that important question.
Background The most common form of bankruptcy proceedings involves voluntary filings by a debtor under either Chapter 7 or 11 of the Bankruptcy Code. In a Chapter 7 filing, the Court appoints a trustee to
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liquidate the debtor’s assets, whereas Chapter 11 cases set out a framework for the debtor’s survival, reorganization, and emergence from bankruptcy. The filing of a Chapter 11 bankruptcy petition “creates a bankruptcy estate consisting of all the debtors’ assets and rights,” which forms “the pot out of which creditors’ claims are paid.”5 The Bankruptcy Code authorizes debtors to assume or reject executory contracts. Assumption of a contract is the debtor’s agreement to be bound by its terms, whereas rejection of a contract and refusal to be bound by its terms is tantamount to a court sanctioned breach of the contract. This is a critical tool for the debtor’s survival as the “Bankruptcy Code allows a debtor to keep in place favorable contracts, and discard and relieve it of burdensome contracts, and thus avoid future performance obligations under such contracts.”6 The key is that only executory contracts may be assumed, assigned or rejected under Section 365 of the Bankruptcy Code. A contract is executory if “performance remains due to some extent on both sides.”7 The legislative and judicial treatment of intellectual property licenses in bankruptcy has an uneven history. In the seminal case of Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., the Fourth Circuit held that a debtor-licensor’s rejection of a patent license rescinded the right of the licensee to use the patent.8 Recognizing the inherent unfairness of this outcome and the concomitant disruption that it would cause to the licensing industry, Congress “sprang into action”9 by enacting Section 365(n) of the Bankruptcy Code in 1988 with the intent to ensure that an IP licensee’s rights could not be unilaterally cut-off during bankruptcy. The key purpose of Section 365(n) was to empower a licensee of intellectual property with “a powerful and important option not available to other kinds of contracting parties: to retain certain rights in the face of a debtor’s rejection.”10 In other words, Section 365(n) ensured the continuation of a licensee’s right to exploit the licensed IP as originally agreed in the license agreement even after a debtor’s rejection of the executory contract in bankruptcy. Section 365(n) of the Bankruptcy Code thus restored a sense of order to the licensing industry, with one glaring exception—trademark licenses. This is because Congress failed to include trademarks under the definition of intellectual property in Section 365(n) due to its belief that trademarks presented a unique set of rights distinct from other forms of IP. Congress believed that trademarks licenses should be considered on a case-by-case basis and adjudicated under principles of equity to determine the parties’ rights:
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In particular, trademark, trade name and service mark licensing relationships depend to a large extent on control of the quality of the products or services sold by the licensee. Since these matters could not be addressed without more extensive study, it was determined to postpone congressional action in this area and to allow the development of equitable treatment of this situation by bankruptcy courts.11 Congress’ failure to afford trademark licensees the same type of protection as copyright, trade secret and patent licensees under Section 365(n) of the Bankruptcy Code led to a great deal of uncertainty in the merchandise licensing industry. With a cloud over the status of a trademark license in bankruptcy and the possible risk of termination of the agreement, parties often negotiated “complex provisions to manage or allocate that risk,” and this “uncertainty ha[d] an adverse effect on the broader business community.”12 Hence, before the Mission Products case, it remained an open question whether trademark licensees could lose their rights in bankruptcy. The licensing community and trademark practitioners therefore welcomed the news that the Supreme Court granted review in the Mission Products case in 2019 to determine the status of a trademark license in bankruptcy after a licensor-debtor rejects the license.
The Court’s Decision in Mission Products As the Court described, the Mission Products case involved “a licensing agreement gone wrong.”13 Tempnology manufactured functional athletic apparel which it marketed under its “Coolcore” trademark. By virtue of a written contract, Tempnology granted Mission the exclusive right to distribute “Coolcore” branded products in the United States, and the nonexclusive license to use the “Coolcore” trademark in connection with product distribution both in the United States and internationally. Prior to expiration of the contract, Tempnology filed for Chapter 11 bankruptcy protection and the bankruptcy court approved Tempnology’s request to reject the Mission agreement.14 Under Section 365(g) of the Bankruptcy Code, Tempnology’s rejection of the Mission agreement constituted a breach of contract for which Mission could then file a pre-petition claim in the bankruptcy proceeding for damages. Although Tempnology could stop performing under its agreement with Mission following its rejection in the bankruptcy court,
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Tempnology went a step further and petitioned the court for a ruling that rejection of the contract also terminated Mission’s right to continue the license. Tempnology argued that a “negative inference” should be drawn from the fact that Section 365(n) did not cover trademark licenses and, as a result, the counterparty, in this case, Mission, could not continue with the license following rejection in the bankruptcy case.15 Essentially, Tempnology’s position was to apply the holding of the Lubrizol Enterprises case since Congress failed to include trademarks when it enacted Section 365(n). The First Circuit agreed with Tempnology’s argument in a ruling that conflicted with decisions of other Circuit Courts of Appeal. The Supreme Court granted review to resolve the split among the Circuit Courts. In seeking to resolve the question of the effect of a debtor’s rejection of a contract in bankruptcy, the Court closely examined all relevant provisions of the Bankruptcy Code. The Court noted that preserving a counterparty’s rights to continue the license postrejection “reflects the general bankruptcy rule that the estate cannot possess anything more than the debtor did outside of bankruptcy.”16 The Court also rejected Tempnology’s “negative inference” argument about the absence of trademark coverage in Section 365, reasoning that “Congress’ repudiation of Lubrizol for patent contracts does not show any intent to ratify that decisions 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.”17 Accordingly, the Court held that “the construction of Section 365 means that the debtor-licensor’s rejection cannot revoke the trademark license.”18 In so doing, the Court engaged in judicial activism to fix a statutory problem that Congress intentionally left open.
Implications of Mission Products and Open Questions The Court’s ruling was received positively by the licensing community and by trademark practitioners. The International Trademark Association, which filed an Amicus Brief supporting Mission’s position, argued that permitting the licensee-manufacturer to continue with the license post-rejection in bankruptcy served several important industry goals and would enhance the value of trademark licenses: Licensors benefit because Licensees will pay more up front or in royalties for licensed rights
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that are likely to survive a potential bankruptcy filing by the licensor. Licensees, who have substantial reliance interests in the licensed trademarks (e.g., having hired employees and/or established manufacturing capacity to take advantage of the rights), will not suddenly find their rights invalidated by the licensor’s termination of a trademark license agreement.19 Similarly, another trademark commentator noted that greater stability in the licensing industry following the Mission Products case “makes trademark licenses better collateral for underwriting loans.”20 The Supreme Court’s decision in the Mission Products case unquestionably brought much needed clarity to the trademark merchandise licensing industry by reducing licensee-counterparty risk. Licensees now have greater comfort that they can continue to exploit the licensed trademark rights even if the licensor rejects the license in bankruptcy. Notably, however, the case does not address all bankruptcy-related issues for licensors or licensees. As a threshold matter, there is a question whether the Court’s decision will apply in all circumstances. Indeed, the Court itself left open the possibility that the parties’ agreement could modify or limit postrejection rights: [T]he Court does not decide that every trademark licensee has the unfettered right to continue using licensed marks post rejection. The Court granted certiorari to decide whether rejection “terminates rights of the licensee that would survive the licensor’s breach under applicable non-bankruptcy law.’ …The answer is no, for the reasons the Court explains. But the baseline inquiry remains whether the licensee’s rights would survive a breach under applicable nonbankruptcy law. Special terms in a licensing contract or state law could bear on that question in individual cases.21 Although the Court itself did not define the “special terms” in a parties’ agreement that could impact the post-rejection termination, the Court cited to the Amicus Brief of INTA for examples it provided for bankruptcy avoidance, which included (1) the licensor establishing an off-shore IP holding company to hold and license the trademarks which would not be swept up in a US bankruptcy case; and (2) the licensee requiring “stringent financial covenants so that the license agreement will then not be subject to
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rejection.”22 It appears the Court blessed these “special terms” as ones that could impact the post-rejection termination analysis in future bankruptcy cases. Finally, the Mission Products case dealt with a statutory interpretation of Section 365 of the Bankruptcy Code, which is a licensee-protection provision. That begs the question—what are the rights of trademark licensors when a licensee-manufacturer files for bankruptcy protection? Can a licensee-debtor assign the license to a third-party without the licensor’s consent? The licensee-debtor in bankruptcy has several choices: reject the license, assume it and continue, or seek to assign the license to a third-party. From a legal standpoint, the operative provision of the Bankruptcy Code is not Section 365(n), but rather 365(c), which prohibits a covered contract’s assumption and assignment without the permission of the counterparty, in this case the trademark owner-licensor. The great weight of case authority holds that the licensor has the power to decide the license’s fate under section 365(c), thus protecting the licensor’s interest that no one can use the licensor’s valuable trademark rights without its consent.23 This has practical significance because a licensor is in a much stronger position to dictate preferred terms under this framework. For example, a licensor can insist that any shortfall in royalty payments be cured before agreeing to allow the licensee to assume or assign the license. In addition to the legal aspects of bankruptcy law, there are a number of practical drafting tips for trademark licensors to put themselves in the best possible position to allocate and manage risk. In terms of drafting the agreement, the first consideration for a licensor is to seek a grant of a nonexclusive license. Although it does not remove the license from the auspices of the bankruptcy court, the practical reality is that the licensor can seek new or additional licensing partners for the same rights granted to the licensee-debtor if the license was granted on a nonexclusive basis. For this reason, nonexclusive licenses are the preferred form of licensing relationship for movie studios, sports leagues and universities. It is also increasingly common for a licensor to seek a security interest in the licensee’s inventory of licensed goods. As a secured creditor, the licensor will move to the head of the line in any bankruptcy proceeding.
Another common provision is to have an antiassignment provision barring the licensee from transferring the contract to a third-party. Aside from bankruptcy, it is also important for the licensor to have strong termination rights in the event the licensee begins to experience financial difficulty. The licensor can look to include the right to terminate the contract immediately if the licensee is deemed insolvent, or cannot meet its debts when they are due and owing, or even if they laid off a certain number of employees. These are all signs of financial difficulty, short of an actual bankruptcy filing, that signal that the licensee may be in serious trouble. In addition to bankruptcy and insolvency, it is now more common for licensors to demand a letter of credit from a financial institution to stand behind the guaranteed minimum royalties owed during the life of the agreement. In the fashion industry, it is common for licenseemanufacturers to enter into “factoring” agreements to provide financing for the transaction. Typically the factor will step into the shoes of the licensee and acquire any remaining inventory in the event of the licensee’s insolvency. For this reason, it is critical for the licensor to require the factor to enter into a separate agreement that requires the factor to comply with all of the obligations of the license agreement between the licensor and licensee. This will ensure, for example, that the factor uses the same established channels of distribution to sell the remaining inventory and cannot merely dump the property in the lowest possible tier upon termination. In summary, the Supreme Court’s Mission Products decision was a victory for licensee-manufacturers and the decision brought long overdue clarity to the trademark merchandise licensing industry. As noted, the decision is also likely to enhance licensing deal activity as licensee-manufacturers now have the comfort of knowing that they can continue to exploit the license even if the licensor files for bankruptcy. Nevertheless, questions remain in the bankruptcy process both for trademark licensors and licensees. As such, expect more decisions on both sides as courts interpret the scope of the Mission Products decision in related areas of bankruptcy law and practice.
1. “Annual Global Licensing Industry Survey 2019 Report,” Licensing International (2019). 2. Amicus Brief of the International Trademark Association in Mission Products Holding, Inc. v. Tempnology, LLC, No. 17-1657 (US Dec. 17, 2018) at 15. 3. Kayvan Ghaffari, The End to an Era of Neglect: The Need for Effective Protection of Trademark Licenses, 87 S. Cal. L. Rev. 1053, 1054 (2014). 4. 139 S.Ct at 1662 (US 2019).
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5. Mission Products, 139 S.Ct. at 1657. 6. Bruce Buechler, “A General Overview of the Treatment of Intellectual Property Licenses in Bankruptcy,” Credit Research Foundation (2017). 7. Mission Products, 139 S.Ct. at 1658. 8. 756 F.2d 1043, 1045-48 (4th Cir. 1985). 9. Mission Products, 139 S.Ct. at 1664). 10. “The Impact of Bankruptcy on IP Litigation and Licensing,” Jones Day (April 2010).
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11. S. Rep. No. 100-505, at 5 (1988), as reprinted in 1988 U.S.C.C.A.N. 3200, 3204. 12. INTA Amicus Brief at 5. 13. Mission Products, 139 S.Ct. at 1657. 14. Id. 15. Id. 16. Id. 17. Id.
8. Id. at 1666. 1 19. INTA Amicus Brief at 8. 20. Stephen B. Selbst, “Supreme Court Holds that Licensee of Rejected Trademark License May Continue to Use the Trademark,” ABA Journal (August 2019). 21. Mission Products, 139 S.Ct. at 1666 (Sotomayor, concurring). 22. Id., citing INTA Amicus Brief at 20–25. 23. See In re Catapult Entm’t., 165 F.3d 747, 750 (9th Cir. 1999).
Copyright © 2020 CCH Incorporated. All Rights Reserved. Reprinted from The Licensing Journal, January 2020, Volume 40, Number 1, pages 5–9, with permission from Wolters Kluwer, New York, NY, 1-800-638-8437, www.WoltersKluwerLR.com
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