2019 Bankruptcy Truisms: "rejection" of an Executory Contract Means "breach," and Not "rescission," and a Trademark Is Not a Type of Intellectual Property
| Publication year | 2019 |
| Author | Sonia Singh and Zev Shechtman |
Sonia Singh and Zev Shechtman
Sonia Singh is an associate at Danning, Gill, Israel & Krasnoff, a boutique Los Angeles law firm specializing in business bankruptcy, insolvency and restructuring.
Zev Shechtman is a partner at Danning, Gill, Israel & Krasnoff, a boutique Los Angeles law firm specializing in business bankruptcy, insolvency and restructuring.
The Supreme Court recently held, in Mission Product Holdings, Inc. v. Tempnology, LLC,1 that a debtor-licensor's choice in bankruptcy to reject an executory trademark licensing agreement does not necessarily deprive the non-debtor licensee of its rights to use the trademark moving forward. The Supreme Court determined that the licensor's choice to reject an executory contract under 11 U.S.C. § 365(a) functions as a breach of contract and has the same effect as a breach outside of bankruptcy, instead of unwinding the rejected contract as if it never existed. Specifically, the Supreme Court found that Mission Product Holdings, Inc.'s ("MPH") right to use the trademark "Coolcore," which was granted to it by Tempnology, LLC ("Tempnology") pursuant to a nonexclusive license, was not necessarily disturbed by Tempnology's rejection of the license in its bankruptcy proceeding.
The Supreme Court's decision is significant not only for bankruptcy attorneys, but also for other attorneys who deal with contracts and contract disputes in their practice, whose clients' post-rejection rights may be affected by the decision.
The Supreme Court's decision was a highly-anticipated ruling in the bankruptcy world because it ended a long-running split in circuit authority regarding the consequences of a debtor's rejection of a trademark license agreement.
The statutory underpinning of the Tempnology decision is section 365(a) of the Bankruptcy Code,2 which gives a debtor the ability to assume or reject executory contracts and unexpired leases. But what is considered an "executory contract"? The term is not defined in the Bankruptcy Code. The leading definition is the so-called Countryman definition, which observes that the term executory contract "generally includes contracts on which performance remains due to some extent on both sides."3
It is a contract between a debtor who has filed for bankruptcy and a non-debtor party, where both parties to the agreement still have obligations remaining on their respective sides.4 These types of agreements constitute both an asset (the debtor's right to the non-debtor's future performance under the agreement) and a liability (the debtor's own obligations to perform under the agreement).5
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Some examples of an executory contract include a vehicle lease where the lessor owns the vehicle and allows the lessee to keep possession of its vehicle day by day or month by month. Or, relevant to the Tempnology decision, an intellectual property license, pursuant to which a licensee can continue to use the intellectual property only within the defined scope of the license, and the licensor must continue to refrain from suing the licensee for licensed uses of the intellectual property.6 Or, to cite the example provided in Justice Kagan's majority decision, a dealer who leases a photocopier to a law firm and agrees to service it every month, in exchange for the firm committing to pay a monthly fee.7
The choice of whether to assume or reject an executory contract under section 365(a) is governed by the bankruptcy court's application of the deferential "business judgment" rule.8 Section 365(a) gives the debtor or its trustee the option, once a bankruptcy case is commenced, to decide whether the debtor's executory contract is beneficial to the bankruptcy estate moving forward.9 If the contract is seen as a "good deal," then the debtor or its trustee may seek to assume the contract.10 If the contract is assumed, the debtor must cure any defaults and fulfill its obligations under the agreement.11 The debtor, in turn, benefits from the non-debtor counterparty's performance under the agreement.12 If the contract is seen as a "bad deal," then the debtor will likely decide to reject the contract, which essentially means the repudiation of the debtor's duties moving forward.13
The effect of rejecting an executory contract is governed by section 365(g), which provides that rejection of a contract constitutes a breach of that agreement. Accordingly, the non-debtor party will have a claim against the debtor's estate for damages arising from the debtor's nonperformance under the contract.14 The debtor's breach is deemed to occur "immediately before the date of the filing of the [bankruptcy]," instead of on the actual rejection date.15 This puts the non-debtor party to the rejected executory contract in the same position as the debtor's other unsecured creditors.16
The Bankruptcy Code expressly protects rights to certain types of intellectual property.17 "Intellectual property" is defined as: "(A) trade secret; (B) invention, process, design, or plant protected under title 35; (C) patent application; (D) plant variety; (E) work of authorship protected under title 17; or (F) mask work protected under chapter 9 of title 17."18 Licensees of these types of intellectual property retain contractual rights after rejection.19 Notably missing from the Bankruptcy Code's definition of "intellectual property" is "trademark."20
Section 365(n) was enacted by Congress in response to the threat posed to the technology industry by the Fourth Circuit's 1985 ruling in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.21 That decision held that if a debtor rejects an executory intellectual property license, the non-debtor licensee is deprived of its right to use the license moving forward. The court further found that the licensee's only remedy in this situation would be to file a claim for money damages. The licensee would not be able to seek specific performance of the license agreement upon rejection.22
Congress amended the Bankruptcy Code in 1988 after the Lubrizol decision by adding section 365(n). Specifically, section 365(n) provides that licensees of rejected intellectual property licenses have two options when a debtor-in-possession or trustee rejects their license agreement: (A) the licensee can treat the agreement as terminated and assert a claim for damages, or (B) the licensee can retain the right to use the licensed intellectual property moving forward for the duration of the license, with certain limitations. However, these special protections added to the Bankruptcy Code by Congress omitted trademarks from the definition of rejected "intellectual property" licenses.23 Other kinds of intellectual property, such as trade names and service marks, are also not included in the definition of "intellectual property" pursuant to section 101(35A). As a result, since Congress's amendment in 1988, courts have had to...
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