By: Crystal H. Thornton-Illar, Esq.
On May 20, 2019, the Supreme Court issued its opinion in Mission Product Holdings, Inc. v. Tempnology, LLC (“Tempnology”) deciding that rejection of an executory contract by a debtor is only a prepetition breach and not a termination of the contract.
Justice Elena Kagan wrote the 8-1 opinion resolving the long-standing dispute in the lower courts about what happens when a bankrupt debtor exercises its statutory right to reject an executory contract under Section 365 of the Bankruptcy Code. Some lower courts have found that rejection of an executory contract rescinds the entire contract while others have found that only a breach has occurred.
In Tempnology, the Debtor, Tempnology, Inc. (the “Debtor”) manufactured athletic clothing, which it marketed under the name “Coolcore.” The Debtor provided Mission Product Holdings, Inc. (“Mission Products”) with an exclusive license to use the Coolcore trademarks. The license was set to expire in July 2016. The Debtor filed a Chapter 11 bankruptcy petition in September 2015 in the United States Bankruptcy Court for the District of New Hampshire (the “Bankruptcy Court”). The Debtor rejected the licensing agreement with Mission Products and sought a declaratory judgment that the rejection of the executory contract terminated the contract and extinguished the rights Mission Products had in the trademarks. The Bankruptcy Court agreed that the contract was terminated. The Bankruptcy Appellate Panel reversed, and the First Circuit reinstated the Bankruptcy Court’s decision. The Supreme Court granted certiorari to resolve the dispute.
Section 365 of the Bankruptcy Code enables a debtor to reject any executory contract or unexpired lease. Section 365(g) states that “the rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease.” Justice Kagan relied on the plain language of Section 365(g) to determine that a rejection of a contract is a breach. Justice Kagan stated that “breach” is neither defined in the Bankruptcy Code nor a specialized bankruptcy term; therefore, a breach has the same meaning it has in contract law outside of bankruptcy. Outside of bankruptcy, a party to an executory contract that is breached generally has the option of terminating the contract or continuing the contract and suing for damages. That choice belongs solely to the counterparty of such an agreement. Justice Kagan noted that the same result should occur in bankruptcy because bankruptcy does not alter the debtor’s property rights. Therefore, debtors do not have the ability to terminate an agreement based on the debtor’s breach.
Section 365 identifies several categories of contracts under which a counterparty may retain specified contract rights after rejection. For instance, certain purchasers or lessees of real estate and timeshare interests continue to exercise rights after rejection. Likewise, holders of certain intellectual property rights also retain contractual rights after rejection. Some lower courts found by negative inference that contracts were terminated unless the counterparty’s rights were specially retained in Section 365. While Section 365 does retain the rights of certain counterparties, Justice Kagan noted that the specifically identified categories were not exceptions to the rule but were added to correct judicial rulings. Justice Kagan noted that “whenever Congress has been confronted with the consequences of the view that rejection terminates all contractual rights, it has expressed its disapproval by enacting specific provisions to reinforce or clarify the general rule that rejection is only a breach of the executory contract or unexpired lease and not a termination or recession.”
The Tempnology opinion will have far reaching consequences as it will apply to all executory contracts and unexpired leases, not just trademarks. This decision halted the somewhat unfettered rights debtors had in rejecting contracts in some circuits. Because of this decision, debtors may be less likely to reject certain executory contracts, including trademark licenses and options contracts. Contract counterparties may have greater leverage in negotiating with distressed companies. Of course, the parties to such agreements may consider certain language to protect their interests.
If you have questions about the implications of this ruling or how it may affect your business, please contact Leech Tishman’s Bankruptcy and Creditors’ Rights Practice Group.
Crystal H. Thornton-Illar is a Partner with Leech Tishman, and a member of the firm’s Bankruptcy & Creditors’ Rights Practice Group. Crystal is based in the firm’s Pittsburgh, PA office and can be reached at 412.261.1600 or email@example.com. Please feel free to contact Crystal with any questions you may have on this and other bankruptcy matters. For more information on Leech Tishman’s legal services, please visit www.leechtishman.com.
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Leech Tishman Fuscaldo & Lampl is a full-service law firm dedicated to assisting individuals, businesses, and institutions. Leech Tishman offers legal services in alternative dispute resolution, aviation & aerospace, bankruptcy & creditors’ rights, construction, corporate, employee benefits, employment, energy, environmental, estates & trusts, family law, government relations, immigration, insurance coverage & corporate risk mitigation, intellectual property, internal investigations, international legal matters, litigation, real estate, and taxation. Headquartered in Pittsburgh, PA, Leech Tishman also has offices in Chicago, Los Angeles, New York, Sarasota and Wilmington, DE.