Contributed by Rich Mullen
In 1988, Congress added section 365(n) to the Bankruptcy Code to provide special protections for licensees of intellectual property upon a debtor’s rejection of an intellectual property license agreement. Whether trademarks are within the ambit of section 365(n) protection, though, is open to question. Accordingly, one way that licensees of trademarks have sought to protect their trademark licenses is to challenge the ability of a debtor to reject license agreements on the ground that the agreement is not an executory contract. The United States Court of Appeals for the Third Circuit has already addressed this issue in In re Exide Techs., 607 F.3d 957 (3rd Cir. 2010), concluding that a license agreement granting a perpetual, royalty-free, and exclusive trademark license in connection with a completed sale transaction should not be treated as an executory contract. Now the Eighth Circuit has weighed in on a similar issue with Lewis Brothers Bakeries Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.). In Interstate Bakeries Corp., the United States Court of Appeals for the Eighth Circuit, sitting en banc, reversed a divided panel decision and concluded, among other things, that the debtor could not reject a perpetual, royalty-free, and exclusive trademark license agreement because the license agreement was part of a larger, integrated agreement that had been substantially performed by the debtor, and, thus, was not an executory contract.
As part of a divestiture required by an antitrust decree, Interstate Brands entered into an agreement with Lewis Brothers Bakeries to sell certain of its bread operations and assets located in territories in Illinois. This agreement was effectuated by the execution of two agreements, an Asset Purchase Agreement and a License Agreement. The Asset Purchase Agreement provided for the transfer to Lewis Brothers certain of Interstate Brands’ tangible assets and the grant of a “perpetual, royalty-free, assignable, transferable exclusive license to the trademarks . . . pursuant to the License Agreement.” The License Agreement provided Lewis Brothers a fully paid-up, perpetual license to use certain of Interstate Brands’ trademarks. Of the $20 million purchase price paid by Lewis Brothers, the parties allocated $8.12 million to the intangible assets, including the trademarks.
Nearly eight years after the completion of the sale to Lewis Brothers, Interstate Brands filed for chapter 11 protection. Interestingly, Interstate Brands proposed in its plan of reorganization to assume the License Agreement. Although the opinion does not discuss why Lewis Brothers should have been content with such decision (perhaps filing a reservation of rights with respect to the characterization of the License Agreement as executory in the event the debtor were to change its mind and seek rejection), Lewis Brothers required more clarity and sought to cure its uncertainties by commencing an adversary proceeding seeking a declaratory judgment that the License Agreement was not an executory contract and was therefore not subject to assumption or rejection.
The Prior Decisions
Looking solely to the License Agreement and relying on the lower courts’ decisions in In re Exide Techs. which was later vacated and remanded by the Third Circuit in In re Exide Techs., 607 F.3d 957 (3rd Cir. 2010), the bankruptcy court concluded that both Interstate Brands and Lewis Brothers had material, outstanding obligations that caused the License Agreement to be an executory contract and subject to assumption and rejection under section 365 of the Bankruptcy Code. Such obligations included, among others, (i) Interstate Brands’ duties to maintain and defend the trademarks, control the quality of goods produced under the trademarks, provide certain notice to Lewis Brothers, and refrain from using the trademarks in certain territories, and (ii) Lewis Brothers’ obligations to refrain from sublicensing the trademarks, limit its use of the trademarks to certain territories and products, maintain the character and quality of all goods sold under the trademarks, and assist Interstate Brands in any infringement litigation.
On appeal, the district court affirmed the bankruptcy court’s decision, again only looking to the License Agreement. Specifically, the district court reasoned that Lewis Brothers’ “failure 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.”
On appeal to the Eighth Circuit, a divided panel affirmed the district court. In a lengthy dissent, though, Judge Colloton argued that the Asset Purchase Agreement and the License Agreement should be reviewed as an integrated asset sale agreement and that the parties’ ongoing obligations were not substantial.
Citing to the Third Circuit’s recent decision in Exide Technologies and Judge Colloton’s dissent, Lewis Brothers petitioned for rehearing en banc. After soliciting views from the Antitrust Division of the Department of Justice and the Federal Trade Commission, which opposed the termination of a license that was granted following an antitrust decree, the Eighth Circuit granted Lewis Brothers’ petition.
The En Banc Decision
Judge Colloton wrote the Eighth Circuit’s en banc decision, which started its inquiry by identifying the precise agreement that was at issue. Noting that the lower courts had focused on the License Agreement standing alone, the Eighth Circuit stated that proper analysis must consider the integrated agreement that includes both the Asset Purchase Agreement and the License Agreement. In reaching this conclusion, the Eighth Circuit turned to Illinois state contract law and its “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.” Additionally, the Eighth Circuit pointed out that treating the License Agreement as a separate agreement would run counter to the plain language of both the Asset Purchase Agreement and the License Agreement.
Turning then to the fundamental question, whether the integrated agreement is an executory contract under the Bankruptcy Code, the Eighth Circuit implemented Professor 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 the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Additionally, the Eighth Circuit stated that the doctrine of substantial performance, under which the nonbreaching party’s performance is not excused if the breaching party has “substantially performed,” is “inherent in the Countryman definition of executory contract” and that substantial performance and material breach are “interrelated concepts” as substantial performance is the “antithesis” of material breach.
Ultimately, the Eighth Circuit concluded that the integrated contract was not executory in nature because Interstate Brands substantially performed its obligations under the Asset Purchase Agreement and the License Agreement, and its failure to perform any of the remaining obligations would not be a material breach of the integrated agreement. The Eighth Circuit reasoned that the “root or essence” of the integrated agreement was the sale of certain of Interstate Brands’ bread operations in specific territories, not the mere licensing of any trademarks, and that the full purchase price had been paid, the tangible assets had been transferred, and the License Agreement had been executed. Because the only remaining obligations (such as obligations of notice and forbearance with regard to the trademarks, obligations relating to maintenance and defense of the marks, and other infringement-related obligations) of Interstate Brands arose under the License Agreement and were “relatively minor and do not relate to the central purpose” of the integrated agreement to sell certain of Interstate Brands’ bread operations, the Eighth Circuit concluded that Interstate Brands had substantially performed its obligations.
The Eighth Circuit’s en banc decision was not without dissent, which was written by Judge Bye and joined by Judges Smith and Kelly. In the dissent’s view, the trademark license was of primary importance to the integrated agreement, as were the ongoing obligations under the License Agreement, and, accordingly, it was not appropriate to tally the various assets transferred through the integrated agreement and conclude that the license played a minor role in the transaction. This was especially true, in the dissent’s opinion, given the “central character” of the trademark license to the antitrust decree. To support its position, the dissent compared the language of the agreements and, specifically, the severability provisions of the Asset Purchase Agreement, which indicated that if a provision would be declared invalid, the provision was severable and the remaining provisions were valid, and the License Agreement, which indicated that if any provision of the License Agreement were determined to be invalid, either party could request a renegotiation of the License Agreement. Thus, the dissent reasoned that Interstate Brands had not substantially performed its obligations under the integrated agreement, and a breach of those obligations would be material.
Parties considering trademark license agreements in connection with larger asset sales should be made aware of decisions such as the Eighth Circuit’s en banc decision in Interstate Bakeries. Interstate Bakeries may provide some assurance to licensees in such deals, especially in conjunction with the Third Circuit’s recent decision in Exide Technologies, that there are at least some courts willing to examine license agreements in the context of larger, related transactions such that it is more difficult for a debtor to escape its obligations under a license agreement via rejection pursuant to section 365 of the Bankruptcy Code. In addition, licensees of trademarks facing possible rejection of such licenses should consider the Seventh Circuit’s approach in Sunbeam, which upheld rejection of a license agreement, but nevertheless found that the licensee was not limited to a claim for money damages, but was instead entitled to retain its trademark licensing rights post-rejection.