Tempnology and Janger Too!

The Supreme Court granted cert today in the bankruptcy case of Mission Product Holdings v. Tempnology, LLC. It sounds like another one of those cases only bankruptcy nerds can love, but it has potentially broad implications. On its face, it is about trademark licenses, but the Supreme Court could fix some case law about all contracts in bankruptcy. Several Credit Slips bloggers (including me) signed a "law professors" amicus brief in support of certiorari. 

I asked the inimitable Professor Ted Janger of Brooklyn Law School (and former Credit Slips guest blogger) to write with his thoughts on the case. Ted had a lot to do with the professors' brief. Here is what he wrote:

The split in the lower courts arose when the First Circuit inexplicably resuscitated the questionable proposition, first articulated in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), that rejection of an intellectual property license rescinds that license and terminates the licensee’s rights. Congress reversed Lubrizol for copyright and patent by enacting section 365(n), and in 2012, the Seventh Circuit rejected the reasoning of Lubrizol for trademarks, in Sunbeam Prods., Inc. v. Chi. Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012). While there remained some question as to the continued vitality of Lubrizol outside the patent and copyright context, the holding was, at best moribund. At least, that is, until the First Circuit’s decision in Tempnology.

In Tempnology, the debtor manufactured branded sportswear with a patented wicking technology. The debtor gave an exclusive territorial license to Mission Products to sell these branded goods. When Tempnology filed for bankruptcy, it rejected the license, and sought to transfer those exclusive rights to a purchaser. Under the reasoning in Sunbeam and the language of section 506(g), the effect of rejection would be merely to “breach” the contract. By contrast, under the reasoning in Lubrizol, the effect of rejection would be to rescind the license. This potentially left Mission Products with a large amount of inventory that it could not sell without infringing. Or to put it another way, if Mission wanted to liquidate the inventory, they would have to pay a second time for trademark rights they had already purchased.

By taking this case, the Supreme Court has the opportunity to answer a question that has long haunted courts – whether the power to reject a contract under section 365 is an avoiding power. As both Jay Westbrook and Michael Andrew pointed out over twenty years ago, the answer to that question is a resounding, “no.” The trustee’s power to reject is merely the power to breach.

Simple examples illustrate the importance of this distinction. Consider a solvent merchant who sells a laptop along with warranties and a service contract, delivers the laptop, and then breaches by failing to perform the ongoing warranties and/or service obligations. The breach would not “unsell” the laptop. Similarly, if the seller were to file for bankruptcy, rejection of the contract by the seller/debtor would free the debtor of its warranty obligations and obligations under the service contract, but it would not undo the sale and entitle the debtor to get the laptop back. A trademark license similarly grants the licensee the right to use the trademark under certain conditions and a defense against an infringement lawsuit brought by anyone (including non-parties) for any covered use. The licensor may have other ongoing obligations, too—akin to the service and warranty obligations above—but if the licensor fails to perform on those obligations under the license (i.e., “breaches”), the license will nonetheless continue to operate as a defense against any claim of infringement, provided that the licensee continues to live up to its own obligations under the license. The same result is specified by Section 365(g) if the breach occurs through rejection in the bankruptcy context; the debtor/licensor’s rejection is simply given effect as a breach of the debtor’s obligations under the license agreement as of the bankruptcy petition date.

While this case has come up in the context of trademark rights, the implications are broader than that. The question arises any time contract rights and property rights are entwined in a contract, and it is time for the Supreme Court to put the ghost of Lubrizol to rest.

Thank you, Ted. And, stayed tuned for more.

Comments

[Nate J]

Bob,

Do you see a risk of a holding that too broadly emphasizes that a rejection is a mere breach? I’m thinking along the lines of the cases that have allowed for equitable enforcement of rejected executory contracts (arguing there was no “claim” to discharge). See generally Westbrook’s Functional Analysis note 215

[Ted Janger]

Nate, Ted Janger here. I'm sorry to be slow to respond. I don’t think that the “rejection is breach” position affects the result in the cases you referenced. Our point is that 502(g) leaves the question of the “effect of breach” to applicable non-bankruptcy law and to other sections of the Code.

So here's how I think it should work generally:

(1) The effect of rejection is limited to “breach,” per 502(g);
(2) Look to applicable non-bankruptcy law to determine the effect of breach; then
(3) Look to 101(5) to see if the resulting claim is subject to discharge; and finally,
(4) Look to 544, 545, 547, 548 and 549 to find out whether the prepetition transfer of any (property) rights (property) is subject to avoidance.

The only one of these points at issue in Mission Products v. Tempnology is (1). I hope this helps.