“Justices Breyer and Kagan pressed on both possible non-trademark analogies for the proposition that the lessor of personal property can reclaim it from a lessee upon lessor’s own breach and the existence of any non-bankruptcy case law support for the proposition that a licensor breach results in the licensee being required to stop using a trademark.”
On Wednesday, February 20, the U.S. Supreme Court heard oral arguments in Mission Product Holdings, Inc. v. Tempnology, LLC, where the Court was asked to address one of the most important issues at the intersection of trademark law and bankruptcy law: whether a debtor-licensor’s rejection of a trademark license terminates the rights of the licensee to use that trademark. Taking seriously the language of the question presented, and generally acknowledging that 11 U.S.C. § 365(g) provides that rejection constitutes a “breach” of the contract, the justices focused on the remedies for breach outside of bankruptcy law and whether, because trademarks (and quality control issues) are involved, deviation from ordinary, contract law principles is warranted. Both the advocates and the justices returned to whether analogies, including with respect to breaches of apartment and photocopier leases, are apposite. The question of whether the case was moot also received some attention, though it seems unlikely that the case will be dismissed on that ground.
Justices Sonia Sotomayor, Steven Breyer, Elena Kagan and Samuel Alito were the most vigorous questioners, with Justice Ruth Bader Ginsburg, Chief Justice John Roberts and Justice Neil Gorsuch (regarding mootness) also participating. Justices Brett Kavanagh and Clarence Thomas didn’t participate in the questioning.
Petitioner: “Rejection” Results in Prepetition Claim for Damages, Not Termination
Danielle Spinelli, Partner at Wilmer Cutler Pickering Hale and Dorr LLP, argued for the petitioner, Mission Product Holdings. She asserted that the “plain text” of Section 365 provides that rejection constitutes a breach giving rise to a pre-petition claim for damages and repeatedly returned to the theme that, outside bankruptcy, a licensor’s “breach” would not give it the right to terminate the licensee’s rights under a contract.
Justice Alito stressed that rejection means that a debtor has no obligation to perform future duties—a point on which none of the justices seemed to disagree—but asked whether non-performance of quality control would imperil the trademark. Throughout the argument, the justices focused on quality control, including whether the licensor’s obligations to maintain quality were based on underlying law or the license agreement and whether the licensee would want (or be able) to maintain quality control for its own sake.
Justice Sotomayor seemed skeptical of Spinelli’s argument, posturing that rejection should relieve the licensor of quality control obligations, as the licensor was withdrawing its approval to use the trademark.
Justice Kagan, who focused on underlying non-bankruptcy law, asked both the petitioner and respondent for the sources of the principle that a breaching licensor cannot terminate an agreement. Spinelli responded that the license itself would be a “complete defense” to an action by licensor to terminate. Justice Kagan also questioned whether state law contract principles ought to vary due to trademark quality control requirements, to which Spinelli decisively responded “no.”
Justice Sotomayor was troubled by the possibility that the default rule of Section 365 might give more or less rights to trademark owners than Section 365(n) gives to other non-trademark IP rights owners. Spinelli responded by stating that Congress, in enacting Section 365(n), clearly reversed Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), which held that rejection of an executory license agreement by a debtor-licensor terminates the license. Some of the justices (particularly Justice Sotomayor) were skeptical that the principle in Lubrizol had been decisively and broadly rejected by Congress. Justice Ginsburg asserted that Congress had not taken any position as to whether Lubrizol applied in the trademark context. Justice Kagan thought that Congress had clearly stated that quality control obligations are a key difference between trademarks and other forms of intellectual property. Spinelli responded by explaining why Section 365(n) did not include trademarks—she said that, with respect to the issues raised in Lubrizol, Congress was dealing with an “emergency” relating to patents—a subject to which Zachary Tripp, arguing for the United States, later returned.
Some justices were also interested in what happens when quality control is not maintained—whether the licensee can maintain quality control and whether the licensee (and others) can use a trademark that has been abandoned due to a lack of quality control. Chief Justice Roberts, for example, asked about a licensee’s rights with respect to quality control if the licensor is “not fulfilling its duty,” with Spinelli responding that licensees also have an interest in maintaining quality control.
United States: First Circuit is “Wrong”
Tripp’s straightforward argument was that the First Circuit—from which the Mission Product case was appealed to the Supreme Court—precedent is damaging and “undermines” the “stability and value of trademark licenses.” Its rule would put a franchisee to “an extortionate choice between paying a higher royalty payment or shutting down their business and firing all their workers.”
Justice Breyer struggled with the real estate analogy suggested by the government’s brief, which proposed that a tenant’s right under an apartment lease may be separable from the landlord’s “upkeep” obligations. Maybe, there are not two separable rights, e.g., “It’s like a house that would collapse unless you keep it up; maybe like an igloo that you promised to air condition.” Here, the “upkeep business”—i.e., quality control—is inseparable from the license itself. Tripp responded that (unlike an igloo) licensees can still use the trademark even if the licensor no longer performs quality control.
Finally, Tripp stated that the point of Section 365(n) was to “overwhelmingly overrule” Lubrizol and that Congress at no point endorsed the principle in that case. He then backtracked somewhat, in the face of questioning from Justice Sotomayor, stating that Section 365(n) “doesn’t put a thumb on the scale one way or the other.” Rather, the general rule of Section 365(g)—which does not provide a “claw back”—should apply. Justice Sotomayor also had issues with Tripp’s argument that Section 365(n) is not an exception to the rule, focusing both on what it might mean to “reject” a contract under contract law, and that respondent’s reading of rejection (to apply rejection to an entire contract) might be correct.
Respondent: Trademark Licensee is Like Any Other Creditor
Douglas Hallward-Driemeier, a Partner at Ropes & Gray LLC, representing the respondent, Tempnology, LLC, was called upon to address the analogies to leasing a photocopier to someone and then failing to maintain it (which he said was similar in that such a lease would require the lessee to return the copier to the estate in the case of bankruptcy) or a real estate lease (which he said was not relevant because there are specific statutory exceptions for real estate), as well as the effect of respondent’s rule on a franchisee who has spent, and may lose, millions of dollars (which he argued was not distinguishable from any other creditors of a bankrupt estate that may have significant losses). The focus of his argument was that a licensee, faced with rejection, has only a prepetition claim for breach of contract, meaning that it has the right to seek damages.
Hallward-Driemeier acknowledged, however, that outside bankruptcy only the non-breaching party has the right to terminate or seek to enforce the contract. He argued that the “nature of the trademark is that it is the trademark owner’s reputation” and trademarks have a “unique character” based on the “rule of unitary ownership” and that analogies to other forms of property are, therefore, inappropriate. Justice Alito expressed skepticism that there was a special rule for trademarks outside of bankruptcy that would be “predicated on the licensor’s failure to exercise the quality control.” Justice Sotomayor was concerned that the effect of respondent’s proposed rule could never be limited to trademarks. Justices Breyer and Kagan continued to press on both possible non-trademark analogies for the proposition that the lessor of personal property can reclaim it from a lessee upon lessor’s own breach and the existence of any non-bankruptcy case law support for the proposition that a licensor breach results in the licensee being required to stop using a trademark.
Responding to Hallward-Driemeier’s argument that Section 365 has exceptions to a general rule that do not include trademark licensees, Justice Kagan said, “honestly,” Section 365(g) says that rejection constitutes a breach, for which one then looks to non-bankruptcy law. Hallward-Driemeier responded that rejection is a pre-petition breach, the effect of which is laid out in Section 502(g)(1) and related provisions of the “very convoluted” Bankruptcy Code. Justice Kagan’s statement that “we can understand it” provoked laughter.
Justice Ginsburg asked Hallward-Driemeier to explain why all the scholarly material disagreed with him. Hallward-Driemeier said that “it’s not the uniform view,” pointing to an article that states that rejection means use is terminated. He also noted that INTA and other amici have gone to Congress to ask for an exception for trademark licenses similar to Section 365(n), that Congress has “refused to do so,” and that these parties are now asking the Court to give them what they could not get from Congress.
No Right to Take Back Rights and Resell
Spinelli made two points in her rebuttal. First, that the estate cannot take back rights in the license and resell them to somebody else just to distribute the sale proceeds to other creditors. Second, that rejection does not allow a claw back of interests conveyed pre-bankruptcy, as rejection is not avoidance, which is governed by separate Bankruptcy Code provisions.
In response to a question from Justice Sotomayor as to the nature of the damages petitioner incurred, and an apparent concern by Justice Sotomayor that those damages would be subject to priority, Spinelli responded that the petitioner has an administrative claim arising from deprivation of the right to use the trademark post-rejection. Justice Sotomayor seemed troubled that that would give petitioner more rights than Section 365(n) gives other intellectual property rights owner. Finally, in response to a question from Justice Breyer about the effect of a lessor not maintaining quality control, Spinelli said that the cessation of quality control does not “dissolve the license” and that, in or outside of bankruptcy, a trademark lessor cannot transfer the trademark license: the “license belongs to the licensee.”
Gorsuch: Is the Case Moot?
Justice Neil Gorsuch asked Spinelli to address whether the case is moot. As exclusive distribution is not at issue, how was petitioner injured (petitioner had already stopped ordering any goods) and what damages might it have? Spinelli responded that petitioner was wrongly prevented from using the trademark on goods post-rejection and, prior to bankruptcy, respondent had refused to fill petitioner’s purchase orders.
Then, once Tripp stood up, Justice Gorsuch immediately asked him about mootness and the source of petitioners’ damages. He responded that the respondent’s argument on mootness “prove[s] way too much” because, if right, it would mean that no damages would ever be available to a counterparty and that would leave it with no remedies at all. Justice Sotomayor joined in, asking Tripp why the case is not moot if petitioner is not obtaining goods. He responded that petitioner still has money claims and that it could have “sourced the goods from somewhere else.”
Hallward-Driemeier also began his argument by asserting that the case is in fact moot because the non-exclusive license has expired, any dispute under that license is moot, and petitioner did not use the trademark during the post-rejection period. Justice Gorsuch largely concluded this line of questioning by suggesting that the bankruptcy court’s declaratory ruling with respect to the meaning of rejection created uncertainty for the petitioner that might be “enough” to avoid mootness because it was “an acorn of injury for Article III purposes.”