In June 2014, the Eighth Circuit reversed its own August 2012 panel decision that had allowed a chapter 11 debtor/licensor to “reject” a perpetual, royalty-free trademark license agreement as an “executory contract.” The entire Eighth Circuit determined that a perpetual, royalty-free trademark license was not an executory contract and not subject to an assumption or rejection by a licensor debtor. [1]
The Eighth Circuit decision stands in harmony with the Third Circuit’s decision in In re Exide Technologies.[2] In joining the Third Circuit in adopting a similar approach to determining “executoriness,” the Eighth Circuit has harmonized the views of the two circuits on a critical issue: When is a trademark license considered “executory” and thus subject to assumption or rejection in bankruptcy?
The decision is also a major win for nondebtor trademark licensees that have not been afforded the level of protection accorded nondebtor licensees of patents and copyrights under the Bankruptcy Code. Nondebtor trademark licensees may now point to rulings from the Third and Eighth Circuit to challenge the “executory” nature of an agreement when critical rights are at stake in a bankruptcy proceeding of a licensor debtor.
Executory Contract Basics
In a chapter 11 proceeding, a debtor company will seek to reorganize itself or sell its assets to the highest bidder. A debtor (or a chapter 11 trustee in the rare case where one is appointed to displace the debtor’s management) has the ability to reject, assume, or assume and assign "executory contracts" unless it has been prohibited by applicable nonbankruptcy law. Most courts have adopted Prof. Vern Countryman’s seminal definition of an executory contract: It is a contract “under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.”[3]
Thus, as part of a restructuring or a chapter 11 sale, a debtor company will make a determination on each contract (which includes each license) as to whether it deems such contract as "executory" and if so, if it desires to assume, assume and assign, or reject such a contract. In a chapter 7 liquidation case, the chapter 7 trustee will make a similar determination on each contract. Once the assumption or rejection decision has been made, the decision will be presented to the court for its review and approval in accordance with § 365 of the Bankruptcy Code.
A critical initial issue is whether a license is in fact executory and therefore subject to an assumption or rejection in the first place. The Bankruptcy Code does not contain a definition of the term “executory contract.” In In re Exide Technologies,[4] the Third Circuit determined that a perpetual, royalty-free trademark license was not an executory contract and thus was not subject to an assumption or rejection by the licensor debtor. In contrast, the Eighth Circuit 2012 panel decision in In re Interstate Bakeries Corp.[5] determined that a similar license was executory and could thus be assumed or rejected by the licensor debtor. As previously noted, the Eighth Circuit vacated that decision, heard the matter en banc and released its decision overruling the panel decision, instead following the Exide decision.
The Eighth Circuit’s Decision
The Eighth Circuit heard oral argument en banc on Oct. 22, 2013, and issued its opinion on June 6, 2014. During the oral arguments, the licensee argued that the agreement was not executory because no obligations of any material nature were outstanding and that the overall transaction evidenced by the license and other agreements was essentially a sale with performance fully completed.
The licensee emphasized that the panel’s decision imperiled its rights as it had paid $20 million to purchase the business from the licensor and had successfully operated and improved it for 16 years independently of the seller. The licensee urged the full court to follow Exide and view the trademark license as part of a larger business sale contract, which it contended had been substantially performed.
Background
The license agreement at issue arose as a result of an antitrust judgment that required the licensor to divest certain regional bakery businesses by selling the relevant operating assets and granting “a perpetual, royalty-free, assignable, transferable [and] exclusive license” to use the associated regional bread trademarks. To comply, the licensor divested the trademarks and businesses by selling them for $20 million to the licensee through an asset-purchase agreement (APA) and a license agreement. The licensor subsequently filed for bankruptcy and sought to reject the license as an exectutory contract. The bankruptcy court determined the license to be executory and allowed the rejection — a result affirmed by the three-judge panel in August 2013. The bankruptcy court’s decision holding the license as executory relied on a lower court decision[6] — a decision that the Third Circuit ultimately reversed.[7]
Key Rulings
The Eighth Circuit’s en banc opinion consists of two critical components on the executory contract issue. First, the court rejected the views of the lower courts that only the license agreement standing alone should be considered in making a determination of “executoriness.” Rather, the court concluded that both the APA and license agreement should be considered together as one contract based on the factual record. The court summed up its conclusion with the following point: “To treat the License Agreement as a separate agreement would run counter to the plain language of both the [APA] and the License Agreement, which describe the two as one piece, and would ignore the valuable consideration paid for the license.”[8]
Second, the court embraced the licensee’s arguments about substantial performance — ruling that the doctrine is inherent in the Countryman definition. Specifically, the court opined that a court evaluating any contract that has been alleged to be executory must “examine whether the obligations of the parties to the contract ‘are so far unperformed’ that a failure to complete performance would be a material breach. This inquiry requires a comparison of the performed obligations with the unperformed obligations.”[9] When implementing the test, the court concluded that the contract at issue was not executory because the licensor substantially performed its obligations under the contract and that any failure to perform any remaining obligation would not be a material breach of the integrated contract. The court evaluated the remaining obligations of the licensor and concluded that such obligations (mainly infringement related) were “relatively minor” and did not “relate to the central purpose of the agreement” to sell the bread operation to the licensee in the relevant territories.
The decision was not unanimous. Three judges concurred in part and dissented in part — writing separately that they viewed each party as having ongoing obligations under the integrated agreement, which, in the minority’s view, should have lead to a decision that the contract was executory and capable of rejection. Unquestionably, whether a contract is executory or not is not always apparent — even to seasoned appellate judges reviewing a factual record developed over years of litigation.
Conclusion
Since the power to reject a license agreement is so powerful, trademark licensees should take comfort in the Eighth Circuit’s decision to vacate its earlier panel decision and render an en banc decision agreeing with the Third Circuit in Exide. Nondebtor licensees of patents and copyrights have certain protections afforded by § 365(n) — protections that do not cover trademark licensees. The Seventh Circuit’s decision in Sunbeam Products Inc. v. Chicago American Manufacturing Inc.[10] does provide some comfort to trademark licensees because it concluded that a trademark licensor’s rejection did not necessarily deprive a licensee of its rights in the trademark. Sunbeam is at odds with the well-known Fourth Circuit decision in Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc.,[11] which reached a contrary result.
The best way for a trademark licensee to hold onto its rights when a licensor debtor threatens to reject is to argue that the agreement is not executory and rely on the reasoning of Interstate and Exide. If that fails, the logic of Sunbeam may provide an alternative path to retention of rights — but the licensee’s first defense should be to argue that the license is not executory and not capable of rejection.
[1] Lewis Brothers Bakeries Inc. and Chicago Baking Co. v. Interstate Brands Corp., 751 F.3d 955 (8th Cir. 2014).
[2] 607 F. 3d 957 (3d Cir. 2010).
[3] Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. R. 439, 460 (1973).
[4] 607 F.3d 957 (3d Cir. 2010).
[5] 690 F.3d 1069 (8th Cir. 2012).
[6] In re Exide Technologies Inc., 340 B.R. 222 (Bankr. D. Del. 2006), aff’d, 2008 WL 522516 (D. Del. Feb. 27, 2008).
[7] Exide, 607 F.3d 957 (3d Cir. 2010).
[8] 751 F.3d at 962.
[9] 751 F.3d at 963 (citations omitted).
[10] 686 F.3d 373 (7th Cir. 2012).
[11] 756 F. 2d 1043 (4th Cir. 1985).