U.S Supreme Court to Potentially Rule on the Rights of a Non-Debtor Licensee Under a License Agreement Rejected in Bankruptcy, in a Case at the Intersection of Bankruptcy and Intellectual Property Law

The Bankruptcy Code gives the debtor in a bankruptcy case unique and extraordinary powers. For example, under section 365 of the Bankruptcy Code, the debtor may “reject” an existing lease of non-residential real property. Thus, a debtor operating retail stores may, as part of its reorganization strategy, pick and choose among those store locations that have above-market leases and, essentially, get out of those unfavorable leases by using the power to reject the lease under section 365 of the Bankruptcy Code. Rejection means that the lease is lawfully breached under the authority of the Bankruptcy Code. The landlord is entitled to take back the space and assert a claim for damages against the bankruptcy estate. A similar power is afforded to the debtor with respect to its intellectual property. Section 101(35A) of the Bankruptcy Code defines intellectual property as including a trade secret; invention; process, design, or plant; patent application; plant variety; work of authorship; and mask work, all to the extent protected by applicable non-bankruptcy law. The power to “reject” the debtor’s rights as a licensor of intellectual property is provided under prior case law and section 365(n) of the Bankruptcy Code which section also specifies the rights of the non-bankrupt party who holds the license that has been rejected. The non-debtor licensee has the right to continue using the intellectual property notwithstanding rejection of the license in bankruptcy. However, this right applies only to patents, trade secrets and copyrights, among others set forth in Section 101(35A). The law omits trademarks from the definition of intellectual property subject to these rules. There is now a significant difference in the way that courts around the country treat the effect of the debtor-licensor’s rejection of a license to use a trademark. This split of authority centers around the question of whether the debtor’s rejection of the license agreement terminates the license agreement in its entirety, such that the non-debtor licensee’s right to use the trademark is extinguished; or whether the licensee has rights to continue to use the property, akin to those of other intellectual property licensees under section 365(n) of the Bankruptcy Code. The United States Court of Appeals for the Fourth Circuit, in Lubrizol Enter., Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers, Inc.), 756 F.2d 1043 (4th Cir. 1985), ruled that the rejection of a non-exclusive technology license agreement terminated all of licensee’s rights under that agreement. The ruling in Lubrizol largely held sway with most courts until 2012 when the Seventh Circuit, in Sunbeam Prods. Inc. v. Chicago Am. Mfg. LLC, 686 F.3d 372 (7th Cir. 2012), found Lubrizol unpersuasive and held that rejection of an executory trademark license contract only extinguished the debtor-trademark-licensor’s obligations, but not the license itself. Sunbeam, 686 F.3d at 377-78. The Sunbeam court found that Congress did not intend to eliminate a contracting party’s rights through rejection. Id. at 375. Under Sunbeam, a licensee retains its right to use the trademark after rejection even though the debtor is absolved of its relevant obligations under that license agreement. Id. at 377-78. Other cases are similarly split. Compare In re HQ Global Holdings, Inc., 290 B.R. 507 (Bankr. D. Del. 2003) (following Lubrizol); In re Centura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002) (following Lubrizol) and In re Crumbs Bake Shop, Inc., 522 B.R. 766, 770 (Bankr. D.N.J. 2014) (calling the reasoning of Lubrizol “discredited” and following the approach in Sunbeam); Banning Lewis Ranch Co. v. City of Colo. Springs (In re Banning Lewis Ranch Co.), 532 B.R. 335 (Bankr. D. Co. 2015) (following Sunbeam). On February 20, 2019, the U.S. Supreme Court heard oral argument on this issue as it arose in the case of Mission Product Holdings Inc. v. Tempnology LLC (In re Tempnology LLC). The First Circuit, in the Tempnology case, effectively rejected the Seventh Circuit’s Sunbeam decision and sided with the Fourth Circuit’s Lubrizol decision by holding that a debtor’s rejection of a trademark licensing agreement ended the licensing arrangement and thus prohibited the licensee from continuing to use the license. See Missing Product Holdings Inc. v. Tempnology, LLC, 879 F.3d 389 (1st Cir. 2018). The Tempnology case may resolve the split of authority as to the continued existence of the licensee’s rights to use the trademark. The parties’ oral argument before the Supreme Court and the Court’s questioning of counsel did not provide clear signals as to the Court’s likely decision. Check back to our blog later this year for an update and further guidance as to this important transactional issue in the intersection of intellectual property and bankruptcy law.