Douglas Hallward-Driemeier, Ropes & Gray / Photo by Diego M. Radzinschi/THE NATIONAL LAW JOURNAL

Supreme Court justices grappled Wednesday with a question at the intersection of bankruptcy and trademark law that has split the circuits and stumped Congress.

The question posed by Mission Product Holdings v. Tempnology is what happens when a bankrupt entity “rejects” its trademark licenses. New Hampshire-based Tempnology LLC argues the licenses are swept into the bankruptcy estate as would any other “executory” contract, leaving the licensee with a pre-petition claim for damages that’s typically worth pennies on the dollar.

New York-based Mission Product Holdings Inc. and a squadron of amici curiae are calling on the Supreme Court to adopt the Seventh Circuit’s position that licensees should be free to continue using the marks they’ve bargained for and, in many cases, invested their own money in.

Assistant to the Solicitor General Zachary Tripp asked the justices to imagine a McDonald’s franchisee who spends millions developing a restaurant. Under the rule adopted by the First Circuit in this case, “they can pull the rug out from under every single one of its franchisees and basically put them to an extortionate choice between paying a higher royalty payment or shutting down their business and firing all their workers.”

Ropes & Gray’s Douglas Hallward-Driemeier argued for Tempnology that that’s simply one of the unfortunate breaks of bankruptcy. “A person might have invested millions of dollars as a bondholder in the estate,” Hallward-Driemeier said. “All of those claims are reduced to often pennies on the dollar because they’re prepetition claims.”

The Second Circuit had followed the logic of the Fourth Circuit’s 1985 ruling in Lubrizol Enterprises v. Richmond Metal Finishers, which said the rejection of an IP license under Section 365(a) of the Bankruptcy Code abrogates the licensee’s rights. Congress overruled Lubrizol three years later, but only for patents and copyrights. It carved out trademarks, saying they require more study because of the ongoing quality control licensors must maintain over their marks.

Since then the Seventh Circuit has held in Sunbeam Products v. Chicago American that rejection of a trademark license should not “vaporize the licensee’s right to continue using the mark.”

On Wednesday, Wilmer Cutler Pickering Hale and Dorr partner Danielle Spinelli argued that Congress “did completely repudiate the Lubrizol rule.”

“Not really,” Justice Sonia Sotomayor replied. “It kept some of it and replaced others because of the situational difference” with trademarks.

“Congress never thought that rejection would enable the estate to take back rights already conveyed to the licensee,” Spinelli insisted.

“Could one say it didn’t take any position on Lubrizol one way or another in the trademark context?” Justice Ruth Bader Ginsburg asked. “It did quite specifically in the patent context, but it didn’t either approve or disapprove” on trademarks.

It was difficult drawing a bead on where the justices stood on the big-picture issue because there are so many small issues subject to dispute in the case.

Tempnology is a developer of chemical-free cooling fabrics designed to make towels, socks and headbands stay cool during exercise. The products were marketed under the brand name Coolcore and Dr. Cool.

Tempnology and Mission Product entered into a co-marketing and distribution agreement in 2012 that gave Mission the exclusive right to sell certain Coolcore products in the United States. Either party could terminate the agreement without cause, subject to a two-year winding-down period.

The relationship soured in 2014. Mission Product initiated the two-year wind-down in June of that year. Tempnology alleged breach of the agreement and the parties entered arbitration. During the arbitration, Mission Products stated that it didn’t intend to purchase any more Coolcore products because, it contends, Tempnology wasn’t filling its orders. An arbitrator ruled that Mission was entitled to maintain its distribution and trademark rights through July 2016.

Two months later, in September 2015, Tempnology filed for Chapter 11 protection, saying that Mission had “starved” it of income. The company moved to reject its executory contracts—that is, contracts like the marketing agreement where both sides had ongoing obligations to perform—and sold off its assets, including its trademarks.

Hallward-Driemeier argued Wednesday for Tempnology that the dispute is moot because the license has expired. Justice Neil Gorsuch said there might be “an acorn of injury for Article III purposes” from the bankruptcy court’s declaration that Mission could not use the license for a few months.

On the merits, Hallward-Driemeier argued that trademark licenses are unique. “The property is really just the property interest in the owner’s reputation,” he said. “Without that control, it ceases to exist.”

Justice Stephen Breyer seemed sympathetic, analogizing a trademark licensor to a landlord who leases an igloo. “You know, you break your promise to air condition, no more igloo,” he told Tripp.

“It’s not really like that,” Tripp said. “If the trademark owner stops performing the quality control … that does not instantly destroy the mark. That is a process, gradual.” In the meantime, “the licensee should maintain its rights, and can perform quality control itself.”

Tripp tried to keep the court focused on the big picture. “We’re really urging the court just to adopt the Sunbeam rule and to reverse,” he said.

Ginsburg seemed in a similar place. “How do you explain that the scholars in this field, the bankruptcy field, disagree with your interpretation and they say Lubrizol was wrong and Sunbeam was right?” she asked Hallward-Driemeier.

Hallward-Driemeier said it’s not a uniform view. Berkeley Law’s Peter Menell has endorsed the Lubrizol position, he said, as has James Wilton in the ABA’s The Business Lawyer.

“Mr. Wilton is my co-counsel, so I understand you may discount that,” Hallward-Driemeier quipped, to laughter in the courtroom.