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.
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