Maximizing Licensee Interests to the Detriment of the Bankruptcy Estate

Guest Post by University of Missouri Law Professor Brook Gotberg.  Prof. Gotberg is an expert in debtor-creditor relationships, including bankruptcy. I asked her for thoughts on the Supreme Court’s recent Bankruptcy-IP decision in Mission Product Holdings. – DC

by Brook Gotberg

As a guest blogger on this site invited to talk a bit about Mission Product Holdings, Inc. v. Tempnology, LLC, I approach this topic with some consternation.  The Supreme Court’s position in this case has broken the traditional understanding of § 365 of the Bankruptcy Code, and may have larger ramifications for how we read the Bankruptcy Code overall.

Let me back up a bit.  Bankruptcy provides some pretty fantastic opportunities for debtors to shift the traditional balance of power between them and their creditors, which is typically why companies are motivated to file.  A struggling or insolvent company doesn’t need bankruptcy – they could attempt a creditor-by-creditor workout, use state court proceedings, or just throw in the towel and let the creditors snap up assets in a race to the courthouse.  Provisions in the Bankruptcy Code are intended to preserve and maximize value, often by restraining creditors from invoking their rights under state law.  For example, the automatic stay prohibits secured creditors from repossessing the debtor’s property, even if the debtor has clearly defaulted on its security agreement.  As long as the debtor remains in bankruptcy, it retains control of the property and there is nothing the creditor can do about it, other than petition the court for so-called “adequate protection” to cover the risk of loss or depreciation, or for an order of relief from the automatic stay, which will only be granted if the debtor doesn’t need the property to reorganize.  The stay gives a debtor the chance to make more of the property, which benefits all creditors of the estate.  There are tons of other examples, all of which paint the picture of the Bankruptcy Code as a place where rights are reevaluated and often held in abeyance, so long as this reevaluation is in the interest of the debtor’s bankruptcy estate, and by extension, its creditors.

Under the view of § 365 that prevailed prior to this opinion, the debtor’s ability to reject executory contracts and all of their associated rights falls right in line with the idea of value preservation for the estate.  The debtor’s use of § 365 is typically unfortunate for any the creditor on the other side of the contract, but is only approved by the bankruptcy court when in the best interests of the estate.  Section 365 allows the debtor to cut off a creditor’s rights to ongoing performance under the contract at a discount rate – whatever percentage the debtor plans to pay all other unsecured creditors pursuant to the plan of distribution.  It also allows the debtor to put whatever resources or performance requirements that existed on its end of the contract to more advantageous uses.  The typical example of how § 365 works is a futures contract.  If the debtor made a contract to sell soybeans at $9.25 a bushel, but the price has since gone up to $10.00 a bushel, upon filing for bankruptcy the debtor can reject its contract and go sell the soybeans at the higher price, increasing the overall amount to be distributed while simultaneously decreasing the amount the original soybean purchaser will benefit from the transaction.

How does this view of § 365 apply in a case about trademark licenses?  Tempnology was able, pursuant to § 365, to reject its contract with Mission Products.  Tempnology had previously granted Mission Products the license to use its trademark and logo to sell and promote Tempnology products, while simultaneously granting a right to distribute those products.  Under a traditional view of § 365, this would mean that Mission Products loses the right to use the trademark and logo, but has a claim against Tempnology for damages caused, which is treated like a pre-petition debt.  Tempnology can pay that debt as an unsecured claim, and also give those trademark and logo rights to someone else, even if the original agreement was for exclusive rights.  (The one in this case was not.)

For many, including the original bankruptcy court and the First Circuit, who both ruled on this issue in Tempnology’s favor, this outcome is supported by the language of the statute and one of the stated exceptions, laid out in § 365(n), which gives a licensee of “intellectual property” the ability to retain its rights under the contract for the duration of the contract if it chooses.  “Intellectual property” is defined under the Bankruptcy Code to include patents, trade secrets, and copyrights to semiconductor chip products, but not trademarks.  See 11 U.S.C. § 101(35A).  If there is a carve out to retain contract rights under the exception in § 365(n), then by negative inference, that carve out doesn’t apply in other situations, even analogous situations involving trademarks.

But the Supreme Court reads it all differently.  They see § 365(n) as a manifestation of what the rule ought to be, rather than an exception.  They note that Congress drafted the exceptions in § 365(n) to “correct” former judicial rulings, and conclude that a breach of contract in a trademark licensing situation doesn’t give the licensor the right to claw back the trademark.

I find the rejection of the negative inference to be a bit shocking, along with the apparent willingness of the entire court to reinterpret the Code on Congress’ behalf to read out that inference.  I also wonder, how does Tempnology breach the contract by rejecting it if Mission Products retains all its rights to the trademark?

Perhaps even more alarming is the Court’s reference to the trustee’s avoidance actions as an argument for a more narrow reading of § 365.  The Court suggests that giving power to a debtor to pull value back into the estate should be limited to §§ 544-553, which allows a trustee to avoid transfers away from the state for fraudulent conveyances and preference actions.  These provisions are, again, intended to maximize the estate, even when doing so hurts individual creditors.  Rather than seeing these provisions as consistent with § 365, the Court notes how “far away” § 365 is from those provisions.  This is a bizarre argument from the perspective of individuals who work with the Code.  Both chapter 3 and 5 in the Code contain “general” provisions that apply to all bankruptcy cases, from chapter 7 to chapter 15.  (The automatic stay, which affects creditor rights as noted above, is in § 362).  It feels like the Justices just created a reason for the ordering of the Bankruptcy Code sections that didn’t exist previously, namely, that the drafters of the Code wanted to restrict any efforts to enlarge the bankruptcy estate to trustee avoidance actions, and that these actions themselves should be “cabined.”

So, wow.  Congressionally drafted exceptions to the rule in the Bankruptcy Code could just mean that we misinterpreted the rule to begin with, and bankruptcy isn’t about maximizing the estate by expanding the pie except for closely cabined provisions, which can be identified by virtue of their spatial separation from other provisions.  Maybe I need to rewrite my Bankruptcy syllabus.

 

 

15 thoughts on “Maximizing Licensee Interests to the Detriment of the Bankruptcy Estate

  1. 6

    That’s exactly the point. Licensor may no longer have the ability to provide QC. If I represent the bankrupt party they should have the right to void the license and then assign to a third party. Of course if I represent the Licensee, they should have the right to continue to use the trademark and an obligation to continue to pay the royalties. I believe the Sup. Ct,. did not properly balance the rights of the parties. Someone has to assume the obligation to maintain the quality of the goods.

    1. 6.1

      For what little quality control is actually required of trademark licensees, why would not the bankruptcy judge provide sufficient funds to maintain it, so as to preserve this valuable asset of the bankrupt for the creditors? [Just like they are supposed to provide essential maintenance funds to preserve real estate values].

      1. 6.1.1

        Good question, Paul.

        Not my balliwick, but are any such “maintenance fees” on the same order of magnitude as with, for example, real estate maintenance items?

        I know that running an actual product quality control program is NOT cheap, let alone de minimus. This pragmatic fact is one reason why the absence of oversight (on the part of the bankrupt party) will nearly always guarantee slacking on the part of the licensee.

  2. 5

    There were no amici briefs filed in favor of Tempnology. The IP specialty briefs (including INTA) were in favor of Mission Products.This is not a shockimg result, especially after Sumbeam.

  3. 4

    Thanks, Prof. Gotberg, and thanks to Prof. Crouch for hosting this. I found this explanation very helpful.

    1. 4.1

      Greg,

      How are you helped? What it the ‘right answer?’ (no snark)

  4. 3

    So basically the Licensee now owns the trademark and Licensor no longer has the right to control the quality of the goods bearing the trademark as long as Licensee continues to pay the royalty???

    1. 3.1

      Nope. The license must provide for QC. Otherwise the license is a naked license and results in an abandonment. So TM licenses provide for QC. If the licensee fails to abide by that, it will lose the license. And the goods will be infringing. See El Greco Leather Prods. Co. v. Shoe World, Inc., 806 F.2d 392, 395 (2d Cir. 1986).

      The problem is that the bankrupt licensor might not have the ability to continue to perform QC.

      1. 3.1.1

        Let’s say that being bankrupt means (de facto or de jute) that NO such QC can be undertaken (for example, any such incurring cost is not in the benefit of either the bankrupt party or a majority of the preferred debtors).

        What then?

        Or perhaps more importantly, how is such a situation even arrived at under this holding? I am not seeing the latitude, nor the compunction.

        1. 3.1.1.1

          That is in fact the problem generated by the holding. Not that the licensee can now refuse to cooperate in the QC. That it is required to do under the license. It is that the licensor may not be able to perform QC.

          That is the conundrum the SCOTUS created.

          It is worth noting that in 2013, there was a proposal in Congress to amend the Bankruptcy Code to include trademark licenses with patent licenses that are specifically provided for (i.e., the licensee does not lose its rights). The same proposal would have provided that the licensor cannot avoid its obligation to do QC. The proposal failed. Now SCOTUS has, in effect, enacted only the first part but not the second.

          1. 3.1.1.1.1

            Thanks, BL.

            However, I see LESS of a “licensee can now refuse to cooperate” and MORE of a “there is NO ONE THERE even trying to make sure that the licensee is cooperating at all.”

            This is not an insignificant difference.

    2. 3.2

      Michael, this was attempted termination solely by filing for bankruptcy. Presumably the trademark license has some kind of term limit and/or contractual cancellation provisions? If not, do you remember the “Listerine” trademark litigation?

  5. 2

    What makes sense for a soybeans purchase contract does not make sense for trademark licenses, in which the licensee is not just someone holding a contractual right. It should not be logically assumed that the Sup. Ct. would treat them the same in future bankruptcy decisions. A trademark licensee has invested in an entire business selling products labeled and advertised with that trademark, and known to consumers by that trademark, whereby the licensee has developed valuable intellectual property.

    1. 2.1

      I think that asking the question “what makes sense?” carries with it an implicit — but critical — sub question of “for whom?”

      Into that sub-question then, throw in the ramifications of an Efficient Infringer model, and you land on a very slippery slope.

  6. 1

    When does “interpretation” become “re-writing?”

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