11 U.S.C § 365(a) authorizes a bankruptcy trustee (and the Chapter 11 debtor under 11 U.S.C. § 1107(a)) to reject an executory contract or unexpired lease, subject to court approval. The rejection of an executory license for a trademark can have draconian consequences for the non‑debtor licensee, who may have invested heavily in, for example, trademarked inventory. The effect of rejection is the subject of a split between Circuit courts.
The law on what happens to a licensee’s rights in an executory trademark license when it is rejected in bankruptcy continues to evolve. The First Circuit’s opinion in Mission Prod. Holdings, Inc. v. Tempnology, LLC (In re Tempnology, LLC), No. 16-9016 (1st Cir. 2018) is the most recent Circuit Court ruling on the issue.
A brief history of prior cases and legislation helps provide context for the Tempnology decision.
NLRB v. Bildisco, 465 U.S. 513, 531-32 (1984)[1] held that when a debtor obtains an order rejecting an executory contract under 11 U.S.C. §§ 365(a) and 1107(a), the non-debtor counterparty has a damage claim for breach, but no ability to compel further performance, because 11 U.S.C. § 365(g) provides in part that “the rejection of an executory contract...constitutes a breach of such contract…”
In Lubrizol Enterprises Inc. v. Richmond Finishers Inc., 756 F.2d 1043 (4th Cir. 1985), the court confirmed a debtor’s rejection, in its sound business judgment, of a technology license pursuant to 11 U.S.C. § 365(a). Under Section 365(g), Lubrizol, as the licensee, could “treat rejection as a breach and seek a money damages remedy; however, it could not seek to retain its contract rights in the technology by specific performance even if that remedy would ordinarily be available upon breach of this type of contract.” Lubrizol at 1048. The court acknowledged that rejection could “impose[s] serious burdens upon contracting parties such as Lubrizol.” Lubrizol at 1048.
In response, Congress enacted 11 U.S.C. § 365(n) in 1988, which provides that if a trustee (or Chapter 11 debtor) rejects an executory contract under which the debtor is a licensor of rights to intellectual property, the licensee can elect to treat the contract as terminated, or retain its rights, including the right to enforce exclusivity, but not the right to specific performance. Congress also amended the definition of intellectual property, but did not include trademarks in that definition under 11 U.S.C. § 101(35A).[2]
In In re Exide Technologies, 607 F.3d 957, 965-67 (3d Cir. 2010), Judge Ambro, concurring in an opinion that found the subject contract was not executory, concluded that a trademark licensee’s rejection of a trademark agreement under 11 U.S.C. § 365 “does not necessarily deprive the trademark licensee of its rights in the licensed mark”. Exide at 965. Congress enacted 11 U.S.C. § 365(n) in a reaction to industry concerns that “after Lubrizol any patent or trademark licensor could go into Chapter 11 and invalidate a license perfectly valid under contract law.” Exide at 965, quoting Westbrook, A Functional Analysis of Executory Contracts, 74 Minn. L Rev. 277, 307 (1989). Rejection of a trademark license is a breach, not an automatic termination.
Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012) criticized Lubrizol, and held that rejection of a trademark license under 11 U.S.C. § 365(a) constitutes only a breach of the contract under Section 365(g), and the licensee’s rights remain in place. “Scholars uniformly criticize Lubrizol, concluding that it confuses rejection with the use of an avoiding power.” Sunbeam at 377.
That brings us to In re Tempnology, LLC, No. 16-9016 (1st Cir. 2018). It sided with Lubrizol, holding that Congress’s omission of trademarks from the definition of intellectual property under 11 U.S.C. § 101(35A) left trademark licensees without the protections of 11 U.S.C. § 365(n) and with Section 365(a) governing the outcome. The court noted that a licensor must affirmatively exercise oversight and control over a trademark, without which it could lose the mark. Thus, allowing the licensee’s rights to survive would impose burdens on the licensor contrary to 365(a).
This decision could be reviewed by the U.S. Supreme Court, given the split in the Circuit courts. But in the meantime, the effect on a licensee of the rejection of trademarks in bankruptcy remains unclear.