In a long-awaited, nearly unanimous opinion written by Justice Kagan, resolving a circuit split described in our earlier blog post, the Supreme Court reversed the First Circuit and held that rejection by the licensor of a trademark license under Section 365 of the Bankruptcy Code does not divest the licensee of its rights to continue to use the trademark under the license. Rejection has the same effect as a breach of the contract outside of bankruptcy and cannot be used to rescind the grant of the license. The licensee’s damages may be limited to prepetition, unsecured status, but that is not all the licensee is entitled to. The opinion was not unanimous not for any substantive reason, but because Justice Gorsuch felt that the dispute was moot, notwithstanding the majority’s explanation that the licensee still had a claim for money damages that the decision could have an impact on, which kept the matter live on appeal.
The opinion was driven by Section 365(g)’s reference to rejection as constituting “a breach.” There is no definition of a breach in the Bankruptcy Code, so the term just means whatever it would mean in contract law outside of bankruptcy. The estate of a debtor in bankruptcy does not get anything additional by virtue of that status than it would have before bankruptcy. Rejection is not the same as an avoidance power, which is dealt with in other parts of the Bankruptcy Code, such as unwinding fraudulent transfers to bring the property back into the bankruptcy estate. The Supreme Court’s opinion does not explain specifically in this case what the effect of the breach would be under the contract law of the state applicable to this particular license. That consequence will have to be addressed by the bankruptcy court on remand.
The Court noted that the fact that trademarks are not included in the Bankruptcy Code’s definition of “intellectual property” does not mean that the license is terminated by rejection. Section 365(n) of the Bankruptcy Code, which specifies certain rights for licensees of “intellectual property” as defined in Section 101(35A) (such as patents and copyrights), is consistent with the principle that rejection does not give the licensor a special right to terminate the license, but leaves it to the licensee to decide, and simply reflects a clarification of those rights to address a problem identified by Congress at the time. The Bankruptcy Code’s silence as to trademarks means that trademark licenses, just like all other executory contracts without any remedy custom-made by Congress, are governed by the general principle that a breach is not a rescission.
A concurring opinion by Judge Sotomayor is instructive for parties who will be drafting trademark licensing agreements with this decision in mind. The licensee’s rights survive rejection, but what are those rights? “Special terms in a licensing contract or state law could bear on that question in individual cases.” As a result, it will be important to negotiate provisions to clearly delineate the parties’ rights in the event of a breach of the license. And the choice of law provision could make a huge difference if state law provides, however unlikely it may be, that the licensor can breach the license and thereby terminate the licensee’s rights. Miller Nash Graham & Dunn attorneys are available to assist with drafting these kinds of provisions and evaluating applicable state law.