Supreme Court Says Rejection of Trademark License Does Not Extinguish Rights

Reuel Ash

Ulmer & Berne, LLP

Cincinnati, Ohio

In an important ruling, the Supreme Court held earlier this week that a trademark licensee can continue to use a bankruptcy debtor’s trademark license even where the debtor-licensor rejects the license. Mission Product Holdings, Inc. v. Tempnology, LLC, 2019 Westlaw 2166392 (U.S. May 20, 2019)   This decision should be welcome news to the business community, because the decision will provide a uniform standard governing a licensee’s right to use a rejecting debtor’s trademark license, which is especially significant given the rapid growth of intellectual property’s role in the domestic economy over the past several years. 

The ruling puts trademark licensees in bankruptcy on equal footing with non-debtor licensees of users of patents, copyrights, and trade secrets, which since 1988 have enjoyed continued use of that intellectual property even where the bankruptcy debtor owner of the intellectual property rejects those contracts.  Congress codified such continued use by amending the Bankruptcy Code in 1988 to add Section 365(n), in response to the Fourth Circuit’s decision of Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4^th Cir. 1985).  That case held that a debtor’s rejection of a license agreement terminated the licensee’s rights to use the intellectual property and provided only money damages to the licensee.  Such a result was consistent with Code Section 365(g)(1), which provides the non-debtor party solely with pre-petition damages for breach of contract when the debtor rejects that contract.  Congress’ enactment of Section 365(n) fixed that problem for non-debtor holders of patents, copyrights, and trade secrets whose licenses are rejected in bankruptcy. Congress’ 1988 fix, however, did not extend to trademark licensees, since only patents, copyrights, and trade secrets came within the ambit of the Bankruptcy Code's definition of intellectual property in Code Section 101(35A), which excluded trademarks. 

The Supreme Court’s 8-1 decision, authored by Justice Elena Kagan, reversed the First Circuit and resolved a circuit split by providing trademark licensees with the same protection under the Bankruptcy Code as the other licensees of intellectual property.  The Supreme Court restored the licensee’s rights under the license, explaining that the debtor’s rejection of the license agreement constituted a breach, but not a recission or termination of the agreement.  The Supreme Court explained that a debtor has no greater rights in bankruptcy than outside of bankruptcy, and that the result of a breach in bankruptcy is the same as it is under non-bankruptcy law, which does not give the debtor a unilateral right to vitiate the licensee’s rights under the agreement.  According to the Supreme Court, the licensee, Mission Product, could continue to use the license as provided under the agreement, which would have been the result had the debtor breached the license agreement outside of bankruptcy.

CLLA Pursues Legislative Goals on Capital Hill

CLLA members blanketed Capital Hill on February 27, 2017 to pursue their legislative agenda with House and Senate staffers.   Members hailed from states across the country, including California, Georgia, Iowa, Massachusetts, Michigan, Ohio and Texas.   The league advanced proposals to reform the bankruptcy venue and preference law.   Links to the league's legislative positions can be found here and here.

On venue, the CLLA would like to eliminate state of incorporation venue and limit affiliate filing to cases where lower tier entities file with parent company instead of allowing the venue for one minor subsidiary to set venue for the entire group of companies.

  

The CLLA offered a package of three preference reforms:  requiring a meet and confer before filing suit, requiring that cases under $50,000 be filed in the defendant's forum and allowing payments under settlement agreements to fall within the ordinary course of business defense.   

Fourth Circuit Precludes Modifying Default Interest on Home Mortgage Loan

By Reuel Ash

Ulmer & Berne, LLP

Cincinnati, OH

The Fourth Circuit recently decided that the provisions of Bankruptcy Code Sections 1322(b) allowing Chapter 13 debtors to cure a prepetition mortgage arrearage do not enable debtors to bring the interest rate on the mortgage note to its original rate, where the default rate had been in place prepetition. Anderson v. Hancock, No. 15-1505, 2016 WL 1660178 (4th Cir.Apr. 27, 2016)(click on citation for link to opinion). This case sensibly limits the scope of modification by debtors of residential first mortgages, which is consistent with Congress’ intention of protecting mortgage holders in the residential market.

What Happened

The facts of the case may stated simply.  The debtors bought a $255,000 house, which was financed by a seller mortgage for a 30–year term at an interest rate of 5%.  The promissory note provided a default rate of interest of 7%.  The debtors defaulted, and the mortgagees sent the debtors a notice of default invoking the default rate of interest, but the mortgagees did not accelerate the note.  The debtors made no payments after being notified of the default, and the mortgagees initiated foreclosure proceedings.  The debtors filed a Chapter 13 bankruptcy case to stop the foreclosure. 

The debtors filed a Chapter 13 plan that proposed paying off the arrearage over a 60 month term at the note’s original interest rate of 5%, and reinstating the original maturity date along with proposing post-petition note payments at the 5% original interest rate.  The mortgagees objected to the plan, contending that the default interest rate of 7% must apply to both the repayment of the arrearage and the post-petition payments going forward.

The Fourth Circuit’s Ruling

In finding for the seller mortgagees, the Fourth Circuit harmonized three provisions of Bankruptcy Code Section 1322(b): (b)(2), on the one hand, and (b)(3) and (b)(5) on the other hand.  On the one hand, Section 1322(b)(2) prohibits a debtor from modifying a first mortgage on the debtor’s residence.  On the other hand, Section 1322(b)(3) says that a plan may “provide for the “cure or waiver of any default,” and Section 1322(b)(5) provides that “notwithstanding  paragraph (2) of this subsection, provide for the curing of any default within a reasonable time and maintenance of payments while the case is pending on any unsecured claim or secured claim on which the last payment after the date on which the final payment under the plan is due.”

The question before the court was whether the plan’s proposed change to the debtors’ rate of interest was part of a permissible cure under Sections 1322(b)(3) and (b)(5), or an impermissible modification of the note under Section 1322(b)(2).  The Fourth Circuit ruled that the plan’s providing for the original, pre-default interest rate was an impermissible modification of the note, and sustained the mortgagees’ objection to the Chapter 13 plan.  The debtor must pay the default rate of interest both on the arrearage and the note payments going forward.  The Fourth Circuit observed that while the “rights” that cannot be modified under Section 1322(b)(2) are not defined in the Code, case authority from the Supreme Court in Nobelman v. Am. Savings Bk, 508 U.S. 324, 329, 113 S. Ct. 2106 (1993), and the Fourth Circuit in In re Litton, 330 F.3d 636, 643 (4^th Cir. 2003) held that such rights included those bargained for by the two parties and enforceable under state law (Nobelman), and that Section 1322(b)(2) prohibited “any fundamental alteration of a debtor’s obligations, e.g., lowering monthly payments, converting a variable interest rate to a fixed interest rate, or extending the repayment term of a note.” (Litton)  The Fourth Circuit also found that the core of Section 1322(b)(5) concerns the maintenance of payments, i.e. decelerating the promissory note and continuing paying the loan, thereby avoiding foreclosure.  

Analysis

The Fourth Circuit reached the proper result. Allowing Chapter 13 debtors to change material terms of a loan contract post-petition, including a default interest rate provision, would cause a major torrent of problems in the first mortgage market, and conflict with secured creditors’ legitimate expectations that the terms of their loan documents cannot be altered in bankruptcy, other than deceleration.

 

That said, the Code language appears not to answer the question raised, since Section 1322(b)(5) does not define the limits of what note and mortgage rights a debtor may modify when its plan proposes to cure arrearages.  The Fourth Circuit had to fill in the silence in (b)(5) through case authority, policy arguments, and legislative history.  Clarity might be promoted by the inclusion in Section 1322(b) of a provision stating that contract rights other than acceleration clauses in first residential mortgages and notes may not be modified.