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New Supreme Court Decision Could Make It More Difficult for Franchisors to Negotiate with Franchisees During Chapter 11 Bankruptcy

Posted on Date: Jun 13, 2019

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Franchisors have used Chapter 11 bankruptcy to both restructure their debts and to demand concessions from franchisees. A new Supreme Court decision could take away, or at least blunt, this practice. 

In the past, it wasn’t uncommon for a franchisor to try and use a Chapter 11 bankruptcy filing to secure better terms for itself at the cost of its franchisees. For example, a franchisor might have old franchise agreements that require significant support services and contain royalty rates of 2-4%.  A franchisor filing for Chapter 11 might as well try to force upon franchisees contracts with no support obligations and 5-10% fees.  The franchisees who tried to argue their contracts could now be “rejected” in bankruptcy lost. The term “rejected” was understood to mean franchisees who would not “play ball” and sign new, worse contract. These rejected franchisees were then then left with nothing.  If you owned an ABC Car Rental franchise in Oklahoma and you got “rejected,” you had no business.  Most franchisees decided to “play ball,” and the franchisor forced upon them worse franchise agreements.     

Over the years, some courts began to rule that a trademark licensee (so long as it required no services from the trademark holder) could maintain the trademark after “rejection” in bankruptcy if it paid the agreed-upon fee. Other courts ruled the other way, stating that it was unfair for a trademark holder to choose either monitoring its trademark (costing itself money) or allowing a trademark use with no supervision (possibly losing the mark altogether).  

On May 20, the Supreme Court decided Mission Product Holdings, Inc. v. Tempnology, LLC, No. 17–1657 (May 20, 2019), siding with the cases stating that a “rejection” does not end the trademark licensee’s right to use the mark. Therefore, if a franchisor wants to file Chapter 11 to get rid of its franchise agreements, the franchisor need not perform any support services going forward, but the franchisee, if it pays, may continue to use the trademark. The court found that the bankruptcy debtor’s rejection of an executory trademark license is a breach of the contract, not a rescission.   

Tempnology is probably not a devastating blow for franchisors who perform key services or provide key products. For example, the right of a Chrysler dealer to be “Chrysler” is worth little without Chrysler new cars and parts. But a number of franchisors today provide no valuable services or products. These franchisors treat the relationship as a bare trademark license. In these situations, if a franchisee calls itself “XYZ Ice Cream” but gets no services or ice cream from the franchisor, it may be worth that franchisee staying on as “XYZ Ice Cream” after Chapter 11. The Tempnology case is a big benefit for franchisees in this situation.  

Franchisors will argue against future trademark use because the franchisee either as a practical matter, needs franchisor support/products, cannot operate unless the franchisor specifically approves, or would be illegally selling “counterfeit” products or services. Franchisor advocates point to a concurring opinion in Tempnology arguing that a right to continue trademark use will not always exist.  

Nevertheless, Tempnology, unless reversed by statute, will remove the Chapter 11 “blunt object” franchisors have used to force franchisees to “play ball” or go out of business.   

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