What would happen if your counterparty to a trademark license entered bankruptcy proceedings?
The question has implications for licensors and licensees alike, and should be a standard consideration when drafting any trademark license.
Recent opinions from several federal appellate courts underscore the importance of understanding how bankruptcy proceedings can affect the rights of a trademark licensee, even years after a license agreement was signed.
Further, these decisions provide some guidance to drafters of license agreements seeking to anticipate the risks and challenges presented by a counterparty’s bankruptcy. Finally, the Sunbeam Products case, discussed below, tees up questions about the rights of trademark licensees for potential decision by the U.S. Supreme Court.
A trustee (or debtor-in-possession) in a Chapter 11 bankruptcy is typically allowed to assume or reject any of the debtor’s “executory contracts,” which are generally understood to mean those contracts in which material obligations have yet to be performed by each contracting party.
Recognizing the difficulty and uncertainty that the rejection of license agreements can cause for licensees of intellectual property, Congress enacted § 365(n) of the Bankruptcy Code, which aimed to protect licensees by extending the right to continue using certain intellectual property despite a debtor-licensor’s rejection of an executory contract.
The protections of § 365(n), however, do not apply to the trademark licensee, as the Bankruptcy Code’s definition of “intellectual property” includes patents, copyrights and trade secrets, but does not include trademarks. See 11 U.S.C. §101(35A).
In re Interstate Bakeries Corporation
On August 30, 2012, the Eighth Circuit affirmed that a perpetual, royalty-free, assignable, transferable and exclusive license for trademarks associated with two lines of white bread was an executory contract, which could be assumed or rejected under Bankruptcy Code § 365(a)). See Aug. 30, 2012 In re Interstate Bakeries Corporation Opinion.
In 1995, as part of its acquisition of Continental Baking Company (owner of the Wonder Bread and Hostess brands and trademarks), Interstate Bakeries Corporation responded to antitrust concerns about the deal by agreeing to “to divest itself of certain rights and assets to allow the acquisition to go through, in order to create viable competition of ‘White Pan Bread’ in and around the Chicago, Illinois, area.” In re Interstate Bakeries Corp. Opinion, 690 F.3d 1069 (8th Cir. 2012).
As a result, Interstate entered into an asset purchase agreement to sell two lines of bread—Butternut Bread and Sunbeam Bread—to a third-party, Lewis Brothers Bakeries, along with a “‘perpetual, royalty-free, assignable, transferable, exclusive’” license to use the brands and trademarks in the [companies’] respective areas.”
Nearly ten years later, Interstate filed Chapter 11. See Bankruptcy Petition.
In the bankruptcy proceedings, the trustee for Interstate sought to classify the license agreement with Lewis Brothers as an executory contract, subject to assumption or rejection under § 365. See Motion.
In turn, Lewis Brothers sought a declaratory judgment that the license agreement was not executory—or in other words, that it was not subject to assumption or rejection. See Complaint for Declaratory Judgment.
In deciding this issue, the appellate court focused on the Countryman test, which considers whether material obligations remain unperformed on each side of the contract.
In this regard, the court found the contract to be executory because the licensee, Lewis Brothers, remained subject to quality-control standards while the licensor, Interstate, was bound by notice and forbearance provisions, along with infringement-related obligations related to the trademarks at issue. See Aug. 30, 2012 In re Interstate Bakeries Corporation Opinion.
In reaching its decision, the Eighth Circuit distinguished the Third Circuit’s opinion in In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010), which also involved a “perpetual, exclusive, royalty-free license” incident to an asset purchase agreement.
The Eighth Circuit found that—unlike the license agreement at issue in Exide Technologies, which included weak quality-control provisions—the quality-control provisions in the agreement between Interstate and Lewis Brothers were more robust and therefore material to the parties’ bargain, which meant that the license agreement continued to be an executory contract long after its execution. June 1, 2010 Opinion.
In July 2012, the Seventh Circuit also issued an opinion with potentially far-reaching effects for trademark licensees.
In Sunbeam Products, the Seventh Circuit squarely rejected the Fourth Circuit’s longstanding decision in Lubrizol Enterprises, and set the stage for a potential Supreme Court ruling on the effect of a debtor-licensor’s decision to reject a trademark license. July 9, 2012 Sunbeam Opinion; see Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985).
Lubrizo held that when a trustee acting on behalf of a debtor/licensor rejects a license agreement, the licensee loses the right to use the licensed intellectual property—in light of subsequent amendments to the Bankruptcy Code.
In Sunbeam Products, however, the Seventh Circuit, ultimately held that while a debtor is able to reject an executory contract pursuant to § 365(n), “nothing about this process implies that any rights of the other contracting party have been vaporized.” Sunbeam Prods., 686 F.3d at 377.
As the court noted, “outside of bankruptcy, [the debtor/licensor] could not have ended [the licensee’s] right to sell the box fans by failing to perform its own duties . . . ,” and that nothing in §365 affects this. Id. at 377. For a further discussion of Sunbeam Products, see July 11, 2012 Publication.
The Sunbeam Products decision also echoes elements of the concurrence in the Third Circuit’s opinion in Exide Technologies (discussed above), which suggested that a rejection of a license in bankruptcy should operate simply as a breach of the contract rather than a termination of the licensee’s right to use the mark. See In re Exide Technologies, 607 F.3d 957, 964 (3d Cir. 2010), as amended (June 24, 2010) (Ambro, J., concurring).
Sources: In re Interstate Bakeries Corp., No. 11–1850, (8th Cir. Aug. 30, 2012); Sunbeam Prods. Inc. v. Chi. Am. Mfg. LLC, 686 F.3d 372, 375 (7th Cir. 2012); Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985); In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010); In re Interstate Bakeries Corp., Bankruptcy Petition No: 04-45814-jwv11 (W.D. of Missouri).