Supreme Court Hears Oral Argument on Rejection of Trademark Licenses

The Supreme Court heard oral argument in Mission Product Holdings Inc. v. Tempnology LLC on February 20, dealing with rejection of trademark licenses.

The outcome is difficult to predict, but the odds favor a ruling that rejection of a trademark license does not bar the licensee from continuing to use the mark. The result may turn on whether the justices believe there is a special rule outside of bankruptcy precluding a licensee from using a trademark following breach by the licensor.

The Circuit Split

Mission Product will allow the justices to decide whether the Fourth Circuit was correct 35 years ago in ruling that rejection of an executory license for intellectual property precludes the nonbankrupt licensee from continuing to use the license. Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985). Since then, Lubrizol has been subjected to withering criticism.

Congress rode to the rescue three years after Lubrizol by adopting Section 365(n) and the definition of “intellectual property” in Section 101(35A). Together, they allow a nondebtor to continue using patents, copyrights and trade secrets despite rejection of a license.

However, Congress did not add trademarks to the list of intellectual property that a licensee may continue to use despite rejection. Most courts interpreted the omission to mean that rejection cuts off the right to use trademarks.

The Seventh Circuit broke the mold in 2012 by ruling in Sunbeam Products Inc. v. Chicago American Manufacturing LLC, 686 F.3d 372 (7th Cir. 2012), that rejection does not preclude the continued use of a mark. Circuit Judge Frank Easterbrook held that “nothing about this process [of rejection] implies that any other rights of the other contracting party have been vaporized.” If a licensor’s breach outside of bankruptcy would not bar continued use of the mark, the same would hold true in bankruptcy after rejection by the licensor.

In the case at bar, the debtor had granted the licensee a nonexclusive, nontransferable, limited license to use the debtor’s trademarks. Following Lubrizol, the bankruptcy court rejected the license and ruled that the licensee could not continue using the license. The Bankruptcy Appellate Panel reversed, taking sides with Sunbeam.

The First Circuit reversed the BAP in January 2018. Mission Product Holdings Inc. v. Tempnology LLC (In re Tempnology LLC), 879 F.3d 389 (1st Cir. Jan. 12, 2018).

In a 2/1 opinion, the First Circuit majority in Tempnology sided with Lubrizol and criticized Sunbeam for “largely [resting] on the unstated premise that it is possible to free a debtor from any continuing performance obligations under a trademark license even while preserving the licensee’s right to use the trademark.” The majority favored “the categorical approach of leaving trademark licenses unprotected from court-approved rejection, unless and until Congress should decide otherwise.” To read ABI’s discussion of Tempnology, click here.

The licensee filed a petition for certiorari in June 2018. The high court granted the petition in October, limiting review to the question of whether rejection of a trademark license “terminates rights of the licensee that would survive the licensor’s breach under applicable nonbankruptcy law.”

Danielle Spinelli, a former Supreme Court law clerk, represented the licensee. Douglas Hallward-Driemeier, a former Assistant Solicitor General, argued for the debtor. Assistant Solicitor General Zachary D. Tripp argued on behalf of the government in favor of reversing Lubrizol.

How Will They Rule?

Guessing the outcome is difficult because only four justices participated actively in oral argument. In addition to the four, Justice Ruth Bader Ginsburg had two comments critical of Lubrizol, and Justice Neil M. Gorsuch asked probing questions about mootness, but his concerns were likely mollified.

On the merits, the justices seemed comfortable with the general notion, as Justice Ginsburg said, that “outside bankruptcy, one party’s rejection doesn’t terminate the rights of the opposing party.” However, the question remains: Does the result change in bankruptcy, or is the result different for a trademark license?

Justice Elena Kagan honed in on the question of a licensor’s breach of a trademark license outside of bankruptcy. “Is there any authority,” she asked, “for the idea that a licensee [must] stop using the mark” outside of bankruptcy?

Initially, counsel for the debtor responded, “I don’t have a case.” But later, he corrected himself by citing a Seventh Circuit opinion that, he said, means that breach “does end the licensee’s right to use the mark.”

In rebuttal, the licensee’s counsel took issue with the debtor’s understanding of the Seventh Circuit opinion. She said, “[T]he case does not hold that a trademark licensor can unilaterally terminate a license by ceasing to exercise quality control.” She said the Seventh Circuit dealt with a licensee who had defaulted on a license and attempted to continue using the license.

The outcome may therefore turn on whether the justices’ own research turns up persuasive authority holding that a licensor’s breach outside of bankruptcy stops the licensee from using the mark.

In the bankruptcy context, the debtor adopted the rationale of the First Circuit: Unless termination ends the licensee’s use of the mark, the debtor must continue shouldering the onerous burden of policing the quality of the licensee’s use of the mark. Absent quality control, the debtor contended, the licensor abandons the mark, and it reverts to the public domain. Rejection frees the debtor from the burden of policing the mark and is thus a necessary adjunct to the power of rejection.

The debtor also argued that the Bankruptcy Code commanded the result in the First Circuit. On rejection, the debtor said, the licensee only has an unsecured claim, and any other rights under the contract are discharged.

In that respect, several justices seemed troubled by a hypothetical about a licensee who invested millions of dollars in reliance on the ability to use the McDonald’s trademark. Could the holder of the trademark file bankruptcy and force licensees either to stop using the mark or pay more?

Counsel for the debtor appeared to answer the question forthrightly by saying that a franchisor could file bankruptcy, stripping franchisees of the ability to use the trademark and leaving them with nothing more than unsecured claims.

In response, Justice Kagan said, “[B]ut what you’re saying . . . is that [Section 365(g)] tells you that you can unwind the entire deal. And that’s not the effect of breach outside of bankruptcy . . . .”

Focusing on the statute, Justice Kagan alluded to the licensee’s argument that rejection is a breach, nothing more. On the other hand, she said the debtor contends that the effect of rejection is rescission. Suggesting that the Court’s opinion may focus on statutory construction, Justice Kagan pointed to Section 365(g) and its reference to rejection as breach.

Section 365(n) is an obstacle for the licensee to overcome. If the Court follows Sunbeam, licensees of trademarks could have greater rights following rejection than licensees of other types of intellectual property whose rights are defined by Section 365(n). Dealing with Section 365(n) gives the Court another opportunity to expound on rules of statutory construction, a favorite topic among the justices.

In terms of policy, the Solicitor General took sides with the licensee and said that the First Circuit made “damaging precedent . . . that we think really just undermines the stability and value of trademark licenses across the board.”

The debtor contended that the Court could write an opinion applicable only to trademarks. Justice Sonia Sotomayor responded, “[T]here’s no way to do that.”

On her second day on the bench following cancer surgery, Justice Ginsburg asked the debtor’s counsel, “[H]ow do you explain that the scholars in this field . . . disagree with your interpretation and they say Lubrizol was wrong and Sunbeam was right?” Counsel responded by saying that some commentators agree with the debtor.

An educated guess: The Supreme Court reverses, holding that rejecting a trademark license under the facts of the case did not bar the licensee from continuing to use the mark.

A wild guess: Justice Kagan writes the opinion.

An outside possibility: The justices duck the issue, find the case moot and dismiss the petition as having been improvidently granted.

To read the transcript of oral argument, click here.