Whether a contract is executory and therefore subject to assumption or rejection can have profound consequences on both the debtor and nondebtor parties to such contract. If both parties have material obligations to the other, then a contract is executory. If no material obligations remain, the contract is not executory. If a contract is not executory, there may still be obligations to the other parties, but a party’s failure to perform such obligations will result in damages and not termination of the contract.
This straightforward analysis, however, is complicated when a potentially executory contract is integrated with a potentially nonexecutory contract. Such was the case in In re Interstate Bakeries Corp.[1] In Interstate Bakeries,[2] the Eighth Circuit considered whether a sale agreement and a license agreement were integrated contracts, and if so, whether the integrated contracts were executory. The court ultimately determined that the contracts were integrated but not executor, and its reasoning is instructive.
Summary of Decision
In Interstate Bakeries, the debtor entered into an asset-purchase agreement with Lewis Brothers Bakeries (LBB) in 1996, pursuant to which the debtor sold certain operations and assets to LBB (APA). As part of that agreement, the debtor agreed to permit LBB to use certain trademarks in limited territories in conjunction with LBB’s use of the purchased operations. So the parties entered into a trademark license agreement that transferred to LBB a “perpetual, royalty-free, assignable, transferable exclusive license to use the trademarks ... pursuant to the terms of the License Agreement.”[3] The parties allocated the $20 million sales price between the APA and the license, assigning a value of $11.88 million to the assets LBB purchased under the APA, and $8.12 million to the intangible assets licensed under the license.
Subsequently, the debtor filed for chapter 11 protection and filed a plan that sought to assume the license.[4] LBB responded by commencing an adversary proceeding to determine whether the license was an executory contract. The debtor then moved to reject the license, before changing course and moving to assume the license.[5] The bankruptcy court determined that the license was executory. On appeal, the district court and a divided panel of the Eighth Circuit affirmed. However, the en banc Eighth Circuit granted LBB’s petition for rehearing.
The court began its analysis by stating that “[t]he issue on the merits is whether the agreement between IBC and LBB is an executory contract under 11 U.S.C. § 365(a).”[6] As a threshold matter, the court examined what constituted “the agreement”: the license alone, or the APA and the license as an integrated agreement. The court first considered the general rule 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.”[7]
The court evaluated several factors to determine whether the documents were integrated contracts, including the fact that the two documents referenced the other and that the APA incorporated the license. However, the court ultimately looked to the purpose of the two documents. In this regard, the court found that “the essence of the agreement here was the sale of” the debtor’s assets and “not merely the licensing of the debtor’s trademarks.”[8] The court thus concluded that the APA and the license were a single integrated agreement.[9]
The court then looked at whether the integrated agreement was executory. To this end, the court stated that “[t]o conclude that a contract is executory for purposes of § 365, the bankruptcy court must find that both parties have so far underperformed that a failure of either to complete performance would constitute a material breach excusing the performance of the other.”[10] Given its finding that the purpose of the integrated contract was the sale of the assets, the court reasoned that the debtor “substantially performed its obligations under the Asset Purchase Agreement and License Agreement, and its failure to perform any of its remaining obligations would not be a material breach of the integrated agreement” and that “[w]hen considered in the context of the entire agreement, these remaining obligations are relatively minor and do not relate to the central purpose of the agreement to sell the assets.”[11]
Discussion
Absent from the license in the Interstate Bakeries case was any language expressing the parties’ intent that the license operate a stand-alone agreement separate and apart from the APA or that the parties did not intend the license, the APA and other related agreements to constitute a single, integrated agreement. As the Eighth Circuit observed, parties can provide evidence of an intention not to integrate two agreements executed at the same time.[12] While not necessarily dispositive of the issue, attorneys should consider including such clauses in their trademark license agreements as an added argument against integration.
Also noteworthy is the court’s focus on the remaining obligations of the debtor. This is because the license contained express language that the failure of LBB to maintain the quality and nature of the baked goods sold under the trademarks would be a material breach entitling the debtor to terminate the license.[13] In holding that the debtor had substantially performed its obligations under the integrated agreement, the court did not consider the argument raised by the debtor that inherent in every trademark license agreement are the obligations of the licensor not to sue the licensee for infringement and to protect and defend the trademark. Surely a loss of the trademark by the licensor would destroy the central purpose of the agreement, but this obligation was not defined as material in the license. Because the court impliedly accepted the parties’ contractual designation of a material obligation as to LBB and rejected as immaterial certain obligations raised by the debtor that were not written into the license, attorneys may want to consider laying out expressly in license agreements a nonexhaustive list of what obligations the parties consider to be material. This could be a way to determine by contractual agreement whether any material obligations remain under a contract.
Finally, it is important to note that the court did not find that all license agreements were not executory contracts. Rather, the debtor’s remaining obligations under the license were not of sufficient nature or quality in light of the nature of the transaction as a sale. Stated another way, the context of an overall transaction will in some ways determine the nature of a license of intellectual property. Attorneys should consider the context of any license to determine whether other documents executed contemporaneously with the license will affect the parties’ intended transaction.
[1] In re Interstate Bakeries Corp. (Lewis Brothers Bakeries Inc. v. Interstate Brands Corp.), 751 F.3d 955 (8th Cir. 2014).
[2] Stinson Leonard Street LLP represented Interstate Bakeries Corp. in the Eighth Circuit appeal.
[3] Id. at 958.
[4] Id. at 959.
[5] Id.
[6] Id. at 961.
[7] Id.
[8] Id. at 963.
[9] Id. at 962 (“[T]he Asset Purchase Agreement and the License Agreement should be considered together as one contract.”).
[10] Id.
[11] Id. at 963-64.
[12] Id. at 961.
[13] Id. at 963.