United States: Questioning The Executoriness Of Trademark Licenses In Integrated Agreements

Protections added to the Bankruptcy Code in 1988 that give some intellectual property ("IP") licensees the right to continued use of licensed property notwithstanding rejection of the underlying license agreement do not expressly apply to trademark licenses. As a consequence, a trademark licensee faces a great deal of uncertainty concerning its ability to continue using a licensed trademark if the licensor files for bankruptcy. This uncertainty has been compounded by inconsistent court rulings addressing the ramifications of rejection of an executory trademark license by a chapter 11 debtor-in-possession ("DIP") or a bankruptcy trustee. Another layer of confusion has been added by recent court decisions suggesting that certain pre-bankruptcy trademark licenses may not be either assumed or rejected by a DIP or trustee because they are no longer executory at the time the debtor files for bankruptcy protection. This was the issue recently confronted by the Eighth Circuit Court of Appeals in Lewis Bros. Bakeries, Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), 751 F.3d 955 (8th Cir. 2014). The court held that a license agreement was not executory and thus could not be assumed or rejected because the license was part of a larger, integrated agreement which had been substantially performed by the debtor prior to filing for bankruptcy. 

Assumption and Rejection of

Executory Contracts and Unexpired Leases

Section 365 of the Bankruptcy Code authorizes a DIP or trustee to assume or reject most kinds of executory contracts and unexpired leases. When a contract or lease is assumed, the debtor must cure existing defaults (with certain exceptions), compensate the other party to the agreement for actual pecuniary loss resulting from any default, and provide adequate assurance of future performance under the agreement. Therefore, when a contract or lease is assumed, the parties' ongoing obligations under the assumed contract or lease are effectively reinstated. When a contract or lease is rejected, however, the rejection is treated as a court-authorized breach of the agreement arising immediately prior to the bankruptcy filing date, and any damages suffered by the creditor will typically be treated as a general unsecured claim against the debtor's estate.

In general terms, an "executory" contract is defined as a contract with material obligations remaining on both sides as of the bankruptcy petition date. Most courts rely on the late Harvard Law School professor Vern Countryman's well-known definition of an executory contract: "a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that a failure of either to complete performance would constitute a material breach excusing performance of the other."

Special Rules for Certain IP Licenses

Prior to 1988, the rejection of an IP license, particularly a license of IP that was critical to a licensee's business operations, could have a severe impact on the licensee's business and leave the licensee scrambling to procure other IP to keep its business afloat. This concern was heightened by the Fourth Circuit's ruling in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), that if a debtor rejects an executory IP license, the licensee loses the right to use any licensed copyrights, trademarks, and patents.

In order to better protect such licensees, Congress amended the Bankruptcy Code in 1988 to add section 365(n). Under section 365(n), licensees of some (but not all) IP licenses have two options when a DIP or trustee rejects the license. The licensee may either: (i) treat the agreement as terminated and assert a claim for damages; or (ii) retain the right to use the licensed IP for the duration of the license (with certain limitations). By adding section 365(n), Congress intended to make clear that the rights of an IP licensee to use licensed property cannot be unilaterally cut off as a result of the rejection of the license.

However, notwithstanding the addition of section 365(n) to the Bankruptcy Code, the legacy of Lubrizol endures—since by its terms, section 365(n) does not apply to trademark licenses and other kinds of "intellectual property" outside the Bankruptcy Code's definition of the term. In particular, trademarks, trade names, and service marks are not included in the definition of "intellectual property" under section 101(35A) of the Bankruptcy Code. Due to this omission, courts continue to struggle when determining the proper treatment of trademark licenses in bankruptcy.

Circuit Courts Weigh In on Trademark Licenses After Lubrizol

During the last few years, several federal courts of appeal have had the opportunity to weigh in on how rejection in bankruptcy of a trademark license impacts the rights of the non-debtor licensee.

For example, in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010), the Third Circuit concluded that a trademark license agreement was not executory because the non-debtor licensee had materially completed its performance under the agreement prior to the debtor's bankruptcy filing. Thus, the court held that the agreement could not be assumed or rejected at all. As a consequence, the Third Circuit never addressed whether rejection of the agreement (had it been found to be executory) would have terminated the licensee's right to use the debtor's trademarks.

In Sunbeam Prods., Inc. v. Chicago Am. Manuf., LLC, 686 F.3d 372 (7th Cir. 2012), cert. denied, 133 S. Ct. 790 (2012), the Seventh Circuit held as a matter of first impression that when a trademark license is rejected in bankruptcy, the licensee does not lose the ability to use the licensed IP. In so ruling, the Seventh Circuit expressly rejected Lubrizol. The Seventh Circuit reasoned that lawmakers' failure to include trademark licenses within the ambit of section 365(n) should not be viewed as an endorsement of any particular approach regarding rejection of a trademark license agreement, observing that "an omission is just an omission."

The Eighth Circuit recently had the opportunity to address this issue in Interstate Bakeries

Interstate Bakeries

Pursuant to an antitrust judgment, Interstate Brands Corporation ("Interstate Brands"), a subsidiary of Interstate Bakeries Corp. ("IBC"), entered into an agreement to sell certain bread operations and assets to Lewis Brothers Bakeries, Inc. ("Lewis Brothers"). To effectuate the transfer, Interstate Brands and Lewis Brothers entered into two agreements: an Asset Purchase Agreement ("APA") and a License Agreement. The APA provided for the transfer to Lewis Brothers of tangible assets and "the perpetual, royalty-free, assignable, transferable exclusive license to use the trademarks . . . pursuant to the terms of the License Agreement." Of the $20 million purchase price, the parties agreed to allocate $8.12 million to the intangible assets, including the 13 trademarks covered by the License Agreement.

Nearly eight years following the completion of the sale to Lewis Brothers, Interstate Brands filed for chapter 11 protection in the Western District of Missouri. Interstate Brands identified the License Agreement as an executory contract that it intended to assume as part of its chapter 11 plan. Lewis Brothers responded by commencing an adversary proceeding seeking a declaration that the License Agreement was not an executory contract and thus not subject to assumption or rejection.

The bankruptcy court, looking solely to the License Agreement and relying on Exide Technologies, held that the License Agreement was executory because both Interstate Brands and Lewis Brothers had material, outstanding obligations under the agreement as of the bankruptcy petition date. A district court affirmed on appeal, reasoning that the failure of Lewis Brothers "to maintain the character and quality of goods sold under the [t]rademarks would constitute a material breach of the License Agreement, thus a material obligation remains under the License Agreement, and it is an executory contract."

Lewis Brothers appealed to the Eighth Circuit. While the appeal was pending, IBC changed its name to Hostess Brands, Inc., which in January 2012 filed for chapter 11 protection in the Southern District of New York. The New York bankruptcy court later authorized IBC to wind down its business.

In August 2012, a divided panel of the Eighth Circuit affirmed the lower courts' rulings that the License Agreement was executory and therefore subject to assumption or rejection. See In re Interstate Bakeries Corp., 690 F.3d 1069 (8th Cir. 2012). In reaching this conclusion, the majority of the panel focused solely on the License Agreement itself, but the dissenting judge argued that "[t]he APA and the License Agreement should be considered together" in assessing whether the integrated contract was executory. After soliciting the views of the Federal Trade Commission and the Antitrust Division of the U.S. Department of Justice, the Eighth Circuit granted Lewis Brothers' petition for rehearing en banc.

The Eighth Circuit's Ruling on Rehearing

On rehearing, the Eighth Circuit began its inquiry by identifying what constituted the agreement at issue, relying on the "general rule" under Illinois law that "in the absence of evidence of a contrary intention, where two or more instruments are executed by the same contracting parties in the course of the same transaction, the instruments will be considered together . . . because they are, in the eyes of the law, one contract." Applying this rule to the APA and the License Agreement, the court determined that the lower courts did not analyze the documents at issue properly. According to the Eighth Circuit, the proper inquiry for the courts was whether the integrated agreement—as distinguished from the License Agreement alone—was executory.

Applying the Countryman definition of "executoriness," the court concluded that the integrated contract at issue was not executory. The Eighth Circuit explained that the doctrine of substantial performance is inherent in the Countryman definition of an executory contract, stressing that "substantial performance is the antithesis of material breach." According to the court, the essence of the integrated agreement was the sale of Interstate Brands' bread business and operations, not merely the licensing of the company's trademarks.

Distinguishing the case before it from Exide Technologies, the Eighth Circuit explained that Interstate Brands' remaining obligations under the APA and the License Agreement (e.g., notice and forbearance, maintenance and defense, and other infringement-related obligations) concerned only one of the many assets included in the sale—the trademark license.

The Eighth Circuit considered such obligations, when considered in the context of the integrated agreement as a whole, to be relatively minor and unrelated to the central purpose of the agreement to sell the bread operations and assets. It also found that, because Interstate Brands had substantially performed its obligations under the APA and the License Agreement, its failure to perform any remaining obligations would not be a material breach of the integrated agreement. Thus, the court ruled, the integrated agreement was not executory and could not be assumed or rejected.

Three judges issued an opinion in which they concurred in part and dissented in part. Among other things, these judges stated that "the license and the attendant ongoing obligations were of primary importance to the parties and their integrated agreement" and that the importance of those obligations should be considered when assessing whether "the parties have substantially performed their obligations to determine whether the contract is executory."

Outlook

The ruling in Interstate Bakeries provides useful guidance in assessing whether a trademark license granted as part of an integrated transaction involving other related agreements is executory and may therefore be assumed or rejected in a bankruptcy case. However, like Exide Technologies, it falls short of addressing the issues raised by Lubrizol and Sunbeam. Indeed, in a footnote, the Eighth Circuit remarked that "[b]ecause the agreement is not executory, we need not address whether rejection of a trademark-licensing agreement terminates the licensee's rights to use the trademark." As such, at least in the Eighth Circuit, trademark licensees remain caught in a limbo of uncertainty concerning this important question.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Mark G. Douglas
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