What Happens When Executory Contracts are Rejected? U.S. Supreme Court to Decide (Mission v. Tempnology)

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A Trademark (photo by Marilyn Swanson)

By: Donald L. Swanson

When an executory contract is rejected in bankruptcy, what happens to the rights of the other party under that contract:

Are those rights vaporized?
Do those rights continue as if nothing happened? or
Are those rights affected in some other way?

The U.S Supreme Court will tackle this question in the case of Mission Product Holdings, Inc. v. Tempnology, LLC (Case No. 17-1657) (Cert. granted, October 26, 2018)) [Fn. 1].

The case involves a rejected trademark license — and the licensee wants to continue using the trademark.

Facts of the Case

Debtor produced cooling fabrics (e.g., towels, wraps, hoodies, bandanas) and sold them through a distribution agreement with Distributor, which agreement included a trademark license.

Debtor filed bankruptcy, where it sold all assets under § 363 and rejected the distribution agreement.

Distributor asserted post-petition rights to continue using Debtor’s trademarks, based on § 365(n) protections for holders of intellectual property rights.

Rulings of Lower Courts

–Bankruptcy Court

The Bankruptcy Court addressed the trademark issue and ruled in Debtor’s favor: it held that trademark license rights “are not afforded any protection under § 365(n)” and that Distributor could not continue using the trademarks.

–Bankruptcy Appellate Panel

The Bankruptcy Appellate Panel for the First Circuit (“BAP”) reversed. It ignored the § 365(n) issue and focused, instead, on general rejection rules of § 365(g), holding that Distributor’s rights under the distribution agreement continued in full force and effect, notwithstanding the rejection. Here is its rationale:

(i) A debtor’s rejection of an executory contract is not a “termination” of the contract—instead, rejection is a mere “breach” that “frees the estate from the obligation to perform,” while “the non-rejecting party’s rights remain in place”; and

(ii) “Debtor’s rejection of the Agreement did not vaporize [Distributor’s] trademark rights,” and Distributor’s right to continue using Debtor’s trademarks continued in effect, under § 365(g).

–First Circuit Court of Appeals

The First Circuit Court of Appeals used practical arguments to reverse, saying the BAP’s position:

(i) “entirely ignores the residual enforcement burden it would impose on the debtor just as the Code otherwise allows the debtor to free itself from executory burdens”;

(ii) “rests on a logic that invites further degradation of the debtor’s fresh start options,” since Distributor is demanding “to continue using the debtor’s property”; and

(iii) “has the added drawback of imposing increased uncertainty and costs on the parties in bankruptcy proceedings.”

Two Predictions

–Prediction # 1

I wrote about the Petition for certiorari in this case, back on August 16, 2018, [Fn. 2] and reached this conclusion:

“Prospects for granting certiorari appear favorable, due to a significant circuit split and two amici curae briefs on file.”

–Prediction # 2

Having lucked out on the prior prediction, I’ll venture another. My prior article makes these two additional observations:

“Upon initial evaluation, the Mission v. Tempnology rulings appear specific to intellectual property rights under § 365(n), with little impact beyond that context”; and

“Upon closer review, however, Mission v. Tempnology has the potential to affect every rejection of every executory contract in a wide variety of contexts—under § 365(g)!”

I’m going out on a limb and saying the Supreme Court will take the latter approach here: it’s decision will affect rejected contracts, generally, under § 365(g) and will not be limited to intellectual property rights under §365(n). Here’s why:

The Supreme Court granted certiorari on only one of two questions presented in the Petition, with these words: “The petition for a writ of certiorari is granted limited to
Question 1 presented by the petition” [Fn. 3];

“Question 1” identifies § 365(g) (the subsection affecting all executory contracts) and makes no mention of § 365(n) (the subsection explicitly limited to intellectual property licenses); and

The rejected Question 2 explicitly identifies a § 365(n) issue [Fn. 4], and you’d think the Court would have granted this Question 2 as well, if its ruling would be limited to § 365(n) issues.

A Late Skirmish on Mootness

The term of Debtor’s distribution agreement expired during the bankruptcy. That event converted the practicalities of the dispute into this question:

–Whether Distributor holds an administrative claim or a general unsecured claim in Debtor’s bankruptcy?

On October 23, 2018 (three days before the Supreme Court granted certiorari), Debtor’s counsel submits a letter to the Supreme Court Clerk, saying that a secured creditor had obtained relief from the automatic stay. The letter argues: “there are simply no assets in the bankruptcy estate to satisfy [Distributor’s] claim.”

On October 25, 2018 (one day before the Supreme Court granted certiorari), Distributor’s counsel responds, saying that Debtor’s October 23 letter implies that Mission v. Tempnology is moot. Distributor’s letter makes these arguments against mootness:

The secured creditor’s lien claim is subject to dispute;

Other sources of potential recovery exist, such as claims of disgorgement against others who received payments on administrative claims; and

A case is not moot, if there is “even a slim prospect of recovery.”

The Supreme Court apparently found Distributor’s response letter persuasive, because it granted certiorari on October 26, 2018.

Conclusion

Can’t wait to see what the Supreme Court does with this executory contract question!

Footnotes

Footnote 1: The Supreme Court granted certiorari on this Question 1:

“Whether, under §365 of the Bankruptcy Code, a debtor-licensor’s “rejection” of a license agreement—which “constitutes a breach of such contract,” 11 U.S.C. §365(g)—terminates rights of the licensee that would survive the licensor’s breach under applicable nonbankruptcy law.”

Footnote 2: The article is titled (and linked): “Effects of Executory Contract Rejection—At U.S. Supreme Court

Footnote 3:  Such ruling appears on the second page of this Supreme Court document.

Footnote 4: The Supreme Court denied certiorari on this Question 2:

Whether an exclusive right to sell certain products practicing a patent in a particular geographic territory is a “right to intellectual property” within the meaning of §365(n) of the Bankruptcy Code.

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