Difficult to Avoid: Supreme Court Leans Against Avoidance Actions
A review of the two bankruptcy law decisions issued by the Supreme Court in its most recent term (Mission Product Holdings Inc. v. Tempnology, LLC and Taggart v. Lorenzen) shows that the Court may be tilting against avoidance actions in ways that should provide comfort to avoidance defendants.
Mission Product Holdings Inc. v. Tempnology, LLC
Mission Product resolved a circuit split regarding the intersection of bankruptcy law and intellectual property law and provided protection to licensees of trademarks against rejection of the license in the event of a licensor bankruptcy. The case concerned the consequences of the rejection by debtor/licensor Tempnology of a prepetition nonexclusive worldwide license to use a trademark for athletic apparel, which had been granted to licensee Mission Product Holdings. The debtor contended that the rejection had the consequence of terminating the license. Mission Product contended that its rights as licensee survived rejection. The bankruptcy court sided with the debtor but was reversed by the bankruptcy appellate panel. The First Circuit Court of Appeals reinstated the bankruptcy court’s opinion.
The Supreme Court reversed, ruling for the licensee by an 8-1 margin. (The dissenting vote was based on mootness concerns rather than a dispute on the merits.) The decision noted that under Code section 365, the rejection of any executory contract (such as a trademark license) is deemed to be a breach of the contract but does not have the effect of terminating the contract. The Court reasoned that the consequences of a breach are generally determined by state law, and while state law may give the non-breaching party the option of terminating the contract following breach, termination does not result simply due to the breach. In the context of a rejection of a trademark license, that result means that the rejection “does not revoke the license or stop the licensee from doing what [the license] allows.”
Going forward, licensees of trademarks need not fear that the bankruptcy of a licensor could lead to a premature termination of the license. Conversely, debtors and trustees of estates with trademark licenses will have less leverage to obtain value from those licenses for the benefit of the estate.
Taggart v. Lorenzen
Taggart established a standard for holding a creditor in contempt for violation of a bankruptcy discharge injunction. After Taggart had filed a chapter 7 petition and had received a discharge, a creditor sought from a state court an attorneys’ fee award regarding prepetition litigation; the parties disputed whether the debtor had “returned to the fray” post-discharge, thereby waiving the discharge. The Ninth Circuit Court of Appeals held that a creditor that has violated the discharge injunction should not be held in contempt where the creditor had a good faith belief that the debtor had waived the discharge injunction. In a unanimous decision, the Supreme Court chose instead an objective standard under which contempt would be appropriate “when the creditor violates a discharge order based upon an objectively unreasonable understanding” of the applicable law or the scope of the discharge order.
Consequences for Avoidance Actions and the Safe Harbor
The Supreme Court’s 2018 Merit Management decision (discussed in our prior alert), which concerned the scope of the Bankruptcy Safe Harbor defense to avoidance actions, was based on a “plain language” approach and disclaimed any dispositive effect for legislative history or policy considerations. However, in neither Mission Product nor Taggart was the Court’s ruling determined by the plain language of the Bankruptcy Code. To the contrary, the Court’s reasoning in Taggart was based upon an analysis of general federal equity practice and supported by policy and prudential considerations, such as which standard would lead to more litigation and whether such litigation would be expected to be in federal or state courts. Likewise, in Mission Product, the Court first reviewed state contract law and then supported the result with an analysis of the consequences of the alternative interpretations proffered by the parties.
More broadly, as noted in our prior alerts (see here and here), the arguments in Safe Harbor cases often invoke the imputed policies of the Bankruptcy Code and whether the avoidance provisions should be interpreted broadly or narrowly. Mission Product provides strong support for the proposition that avoidance powers should be interpreted narrowly. In critiquing debtor Tempnology’s position (that is, that rejection would rescind the license), the Court reasoned that rescission would be the “functional equivalent” of an avoidance of the license and concluded that such a result would be improper, because it would produce the effect of an avoidance even though the debtor had not established the predicates required for avoidance. Indeed, the opinion stressed that the Bankruptcy Code has “stringent” limits on avoidance, which can be invoked only in “narrow circumstances.”
Further tilting the policy arguments against debtors, the Court held that assisting debtors is not a relevant policy consideration. Taggart stated that its resolution “strikes the careful balance between the interests of creditors and debtors that the Bankruptcy Code often seeks to achieve.” Likewise, Mission Product specifically rejected the debtor’s arguments based on the purported legislative purpose of facilitating reorganizations, noting that its decision might make it more difficult for debtors to reorganize but reasoning that the Bankruptcy Code contains a “balance among multiple interests.”
The full effect of these decisions has yet to be explored, but the trend seems auspicious for defendants who are looking to the Safe Harbor to defend avoidance claims against them.