This past May, in a highly-anticipated decision, the Supreme Court held in Mission Product Holdings, Inc. v. Tempnology, LLC that a debtor’s rejection of an executory contract under Section 365 of the Bankruptcy Code has the same effect as a breach of contract outside of bankruptcy.  The decision resolves an inter-circuit split on the effect of a bankrupt trademark licensor’s rejection of a trademark license, a question regarded by legal experts in the trademark community as the most significant unresolved legal issue in trademark licensing.  The outcome of this case will have different impacts on trademark licensors and licensees, which are explained in detail below.

Under Section 365(a) of the Bankruptcy Code, a debtor has the right to assume or reject an executory contract.  In the event a debtor rejects a contract, the effect of such rejection is governed by Section 365(g), which provides that a debtor’s rejection constitutes a breach of that agreement.  Generally, the effect of a breach of contract vis-a-vis rejection under Section 365 is governed by non-bankruptcy law.  However, a debtor’s rejection of certain intellectual property is specifically governed by Section 365(n).  The Bankruptcy Code defines “intellectual property” to include, inter alia, trade secrets and patent applications; however, trademarks are not included within the definition.  In reaching its decision, the Supreme Court held that a debtor’s rejection of a trademark agreement is governed by Section 365(g) and rejected the debtor-licensor’s argument that the effect of such rejection is influenced by the provision governing the rejection of agreements related to intellectual property, as that term is defined by the Bankruptcy Code.

Prior to the decision, in some circuits, a trademark licensor’s rejection of a license agreement would terminate the licensee’s rights to use the trademark.  This was particularly damaging to licensees whose business was largely built around their procured trademark license.  Under this decision, however, the Supreme Court has stated that a debtor-licensor’s rejection of a trademark license agreement is a breach, not a rescission, of that agreement.  As a result, in the event of such a rejection, it is possible that a licensee may retain certain rights under a license agreement provided that such rights are available to the licensee under applicable non-bankruptcy law governing the debtor-licensor’s breach of the agreement.  As discussed in the decision, it may now be possible for a licensee to continue to use a trademark or license even after the debtor-licensor’s rejection of the relevant agreement so long as the licensee is entitled to such rights under applicable non-bankruptcy law.  In addition to such potential rights under non-bankruptcy law, the Bankruptcy Code also provides licensees with the right to assert a claim for damages under Section 365(g) resulting from the debtor-licensor’s rejection, i.e. breach, of an agreement.

Although this ruling may seem like a disadvantageous outcome for licensors, Justice Sotomayor stated in her concurring opinion:

[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 non-bankruptcy law. Special terms in a licensing contract or state law could bear on that question in individual cases.

Slip Op., 1 (Emphasis added).

As such, Justice Sotomayor’s concurrence seems to indicate that licensors could draft trademark licensing agreements to include, for example, provisions that rescind or revoke licensee rights in the event a breach of the agreement.  Licensees will have to be mindful of such provisions during license negotiations.