New Perspectives for Trademark Licensees in Licensor Bankruptcies
As this article goes to press, an en banc panel of the U.S. Court of Appeals for the Eighth Circuit is scheduled to rehear arguments in In re Interstate Bakeries, relating to the rights of trademark licensees in the event of a licensor's bankruptcy.1 The original panel of circuit judges determined that a perpetual, royalty-free, exclusive trademark license granted as part of a larger asset sale was subject to rejection as an executory contract pursuant to §365 of the Bankruptcy Code. However, that decision seemingly conflicts with other recent circuit court decisions allowing trademark licensees the continued use of licensed trademarks notwithstanding efforts by debtors to reject the licenses.
If the Eighth Circuit decides to proceed with the hearing en banc and the en banc panel reaches a different conclusion than the original panel that allows the licensee continued use of the license, this outcome could reflect an emerging trend among courts to provide protection to trademark licensees in the event of a licensor bankruptcy. If, on the other hand, the Eighth Circuit decides the appeal is moot and, as requested by Interstate Brands Corporation (Brands), vacates both the lower court decisions, then the Third Circuit's decision in In re Exide Technologies and the Seventh Circuit's decision in Sunbeam Products v. Chicago American Manufacturing, will be the key cases providing guidance to trademark licensees on the expected treatment in bankruptcy of trademark licenses that the debtor seeks to reject. This article examines the law regarding the rights of a trademark licensee in a licensor bankruptcy and provides certain suggestions for licensees to protect their rights in the event of a licensor bankruptcy.
One of the strongest tools a debtor in bankruptcy has is the ability to reject burdensome executory contracts under §365 of the Bankruptcy Code. Courts generally have adopted the so-called "Countryman definition" of executory contracts, which provides that a contract is executory where, as of the petition date, each of the parties still has unperformed obligations of such a nature that if either party fails to perform, such failure would be a material breach.2 Under the Bankruptcy Code, rejection generally constitutes a breach of the debtor's obligations as of the petition date, giving rise to a pre-petition damage claim.
Protections for IP. Where the debtor licenses intellectual property (IP), there is a tension between the rejection power and the licensee's right to continued use of the intellectual property. This tension was resolved by the U.S. Court of Appeals for the Fourth Circuit soundly in favor of the debtor in Lubrizol Enters. v. Richmond Metal Finishers,3 in which the court permitted the rejection of an IP license by a debtor-licensor, thereby depriving the licensee of continued use of the IP.
To correct the perceived inequity of the Lubrizol decision, Congress promptly enacted §365(n) of the Bankruptcy Code. Pursuant to §365(n), if a debtor-licensor rejects a license for "intellectual property" (as such term is defined in §101(35)(A) of the Bankruptcy Code), the non-debtor licensee may elect either (i) to treat the license as terminated if the breach caused by the rejection would, by the terms of the license, applicable non-bankruptcy law or an agreement made by the licensee with another entity, allow the licensee to do so, or (ii) as a general matter, to retain its rights under the license and any agreement supplementary to the license (including any exclusivity provision) and continue to use the licensed "intellectual property" (as such rights existed immediately before the filing of the bankruptcy case) as provided by the license for the term of the license and any term for which the license may be extended.3
Trademarks are not considered "intellectual property" under the Bankruptcy Code definition and are, therefore, expressly excluded from protection under §365(n). As a result, debtor-licensors have sought to use bankruptcy to reject trademark licenses and deprive licensees of their rights. To counter such actions, the non-debtor trademark licensee must address two issues: (i) whether the license is an executory contract and (ii)??if the license is determined to be executory and is rejected, whether rejection is the equivalent of termination of the licensee's rights rather than just a breach by the rejecting debtor that allows the non-debtor licensee to retain the use of the trademark.
Recent Decisions on Licensee Rights
'Interstate Bakeries': Eighth Circuit Permits Rejection of Trademark License. In Interstate Bakeries, the debtor, Interstate Bakeries Corp. (IBC) had, through one of its subsidiaries, Brands, divested certain of its assets prior to bankruptcy pursuant to an asset purchase agreement (APA).5 In connection with the APA, Brands granted Lewis Brothers Bakeries (LB) a "'perpetual, royalty-free, assignable, transferable, [and] exclusive' license to use the brands and trademarks" in certain designated territories (the LB License).6 The APA allocated approximately $12 million to the actual operations and the remaining $8.82 million to the intangible assets, which included the license.7
Almost 10 years later, IBC filed for bankruptcy along with Brands. IBC proposed a Chapter 11 plan that sought to utilize the trademarks held by LB and reject the LB License as an executory contract. LB argued the LB License was non-executory such that rejection would not terminate the LB License.
The Eighth Circuit affirmed the lower court decisions, which held that the LB License was an executory contract subject to rejection under §365 of the Bankruptcy Code.8 The Eighth Circuit found that a provision of the LB License indicating that a breach of its quality standards provision would be a "material breach" was important evidence of remaining material obligations.9 The court found that the quality standards provision in the LB License was a material remaining obligation for LB, and that, for Brands, (i) the notice and forbearance and (ii) the trademark enforcement provisions were the remaining material performance obligations.10 The court rejected LB's arguments that the quality standards provision was vague and, alternatively, that IBC should be estopped from arguing the LB License and the trademarks were not part of the sale under the APA because IBC had not listed the LB License as an asset or executory contract in its bankruptcy schedules.11
There was a vigorous dissent. The dissent noted that while the majority had focused on the LB License in isolation, the license was part of an integrated agreement that included the APA, which was not executory. For example, the APA contained an integration clause that included all the "exhibits and schedules thereto," including the LB License. Thus, the dissent argued, the proper inquiry should have been whether the integrated agreement was an executory contract.12 Under such construct, when LB paid $20 million dollars for the operations and the trademarks, it had substantially performed its obligations under the APA. Following the lead of a recent decision from the Third Circuit, In re Exide Technologies,13 the dissent reasoned that IBC's "obligations" in the LB License were not material to the APA and, therefore, the APA was not executory.14
Third Circuit Finds a Non-Executory Integrated Contract. Two years prior to the Eighth Circuit's decision in Interstate Bakeries, the Third Circuit in Exide, confronting essentially the same fact pattern, found that a trademark license was not an executory contract.15
Over a decade before its bankruptcy filing, Exide sold its industrial battery operations and trademark to EnerSys.16 The sale was documented through 23 agreements, which included an Asset Purchase Agreement (the Exide APA) and a Trademark and Trade Name License Agreement (the EnerSys License).17 Under the EnerSys License, Exide granted a perpetual, exclusive and royalty-free license to EnerSys to use the trademark "Exide" in the industrial battery business.18