A recent opinion from the Supreme Court in Mission Prod. Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), reaffirms that bankruptcy does not change all that much. The Supreme Court has long recognized the distinction between the equitable administration of property and claims imposed by federal bankruptcy law and the creation and definition of property and claims under applicable non-bankruptcy law.[1] But, practitioners, whether wily or oblivious, have not always heeded this well-established “basic federal rule in bankruptcy.”
The basic federal rule in bankruptcy as the name implies is fundamental and embraces federalism concepts. The best articulation of the basic federal rule from the Supreme Court comes in Butner v. United States, 440 U.S. 48, 55 (1979) and has been reaffirmed on numerous occasions:
Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests by both state and federal courts within a State serves to reduce uncertainty, to discourage forum shopping, and to prevent a party from receiving a windfall merely by reason of the happenstance of bankruptcy.[2]
Despite these clear proclamations from the Supreme Court, questions regarding the basic federal rule continue to arise. The Mission Prod. case is the most recent example.
The Mission Prod. case began with Tempnology filing a chapter 11 bankruptcy case attempting to reject its trademark license agreement with Mission Products Holding. Tempnology trademarked the brand name “Coolcore” and gave Mission a non-exclusive trademark license to use the mark in the United States and throughout the world.[3]
The Bankruptcy Code permits debtors to discretionarily determine that an executory contract, like a trademark license, is financially burdensome and, thereupon, “reject” the executory contract.[4] The Bankruptcy Code expressly states that “rejection . . . constitutes a breach” but does not define a breach.[5] Tempnology argued that a rejection breach effected a termination of the trademark license and merely gave rise to a damages claim for Mission. Mission argued that a rejection breach did give rise to a damages claim but it did not terminate its use of the trademark. Thus, there was no dispute that Tempnology could stop performing under the contract and Mission has a damages claim. The disagreement solely focused on whether a breach terminates all rights under a contract or merely monetizes the failed performance of the breaching party while leaving vested rights in place.
The Court addressed Tempnology’s argument head-on: “it offers no account of how to read Section 365(g) (recall, rejection ‘constitutes a breach’) to say essentially its opposite (i.e., that rejection and breach have divergent consequences).”[6] The Court then based its entire holding on the basic federal rule.
As one bankruptcy scholar has put the point: Whatever limitations on the debtor’s property apply outside of bankruptcy apply inside of bankruptcy as well. A debtor’s property does not shrink by happenstance of bankruptcy, but it does not expand, either.[7]
The Court acknowledged that “[t]he Code of course aims to make reorganizations possible. But it does not permit anything and everything that might advance that goal.”[8] The ultimate holding succinctly applies the basic federal rule to trademark licenses and reminds all that bankruptcy does not change all that much.
[U]nder Section 365, a debtor’s rejection of an executory contract in bankruptcy has the same effect as a breach outside bankruptcy. Such an act cannot rescind rights that the contract previously granted. Here, that construction of Section 365 means that the debtor-licensor’s rejection cannot revoke the trademark license.[9]
As Justices Sotomayor stated in her concurrence “[t]his result follows from traditional bankruptcy principles.” As if it was not already certain enough, Mission Prod. trademarks the basic federal rule.
FootNotes
[1] Vanston Bondholders Protective Comm. v. Green, 329 U.S. 156, 161 (1946) (“A purpose of bankruptcy is so to administer an estate as to bring about a ratable distribution of assets among the bankrupt’s creditors. What claims of creditors are valid and subsisting obligations against the bankrupt at the time a petition in bankruptcy is filed, is a question which, in the absence of overruling federal law, is to be determined by reference to state law.”).
[2] See also Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 549 U.S. 443, 450–51 (2007) (citations and marks omitted) (“[T]he ‘basic federal rule’ in bankruptcy is that state law governs the substance of claims, Congress having generally left the determination of property rights in the assets of a bankrupt’s estate to state law.”); see also Nobelman v. American Sav. Bank, 508 U.S. 324, 329 (1993) (“[W]e generally assume that Congress has left the determination of property rights in the assets of a bankrupt’s estate to state law, since such [p]roperty interests are created and defined by state law.”) (citation omitted).
[3] Mission Prod., 139 S. Ct. at 1658.
[4] 11 U.S.C. § 365(a).
[5] Id. § 365(g).
[6] Mission Prod., 139 S. Ct. at 1664.
[7] Id. at 1663 (D. Baird, Elements of Bankruptcy 97 (6th ed. 2014)) (editorial marks omitted).
[8] Id. at 1665.
[9] Id. at 1666.
