If a trademark licensor declares bankruptcy, can the licensor as debtor cancel pre-existing trademark licenses as part of the licensor’s business reorganization? A very recent federal appellate decision answered, “no,” at least for the circumstances of that case.
Contracts of Bankrupt Companies
When a company declares bankruptcy, it is still bound by its contracts with others that don’t require the company’s future performance. A company that has leased out undeveloped land, for example, cannot cancel such a lease. Contracts that require both parties’ future performance, however, are called “executory” contracts, and as part of the bankruptcy reorganization the debtor has the authority to decide whether future resources should be allocated to performing them.
If the debtor believes that it is not in the bankruptcy estate’s best interest to expend future resources performing under an executory contract, in most instances the debtor can reject the contract, and the other party loses the benefit of its contract, regardless of its full performance under it. If the debtor thinks that the executory contract is helpful to the reorganization, however, the debtor can “assume” the contract, which then remains in place. (A cynic might say that the technical term for this process is “cherry picking.”) As to any executory contract that the debtor assumes, the bankrupt company must continue to fully perform to the end of the term of the contract.
Trademark Law Enters The Picture
A principle of trademark law is that if a trademark owner enters into a mere “naked license,” whereby a licensee is free to sell products or services of any origin or quality and has no contractual risk of losing the license, the validity of the trademark itself is placed at risk. The essence of trademark law is that a brand informs consumers of the nature and quality of what is being offered for sale. If a trademark licensor abandons all quality control, then it risks losing the ability to enforce its trademark.
Every well written trademark license will therefore have, at minimum, references to the quality of the goods and services that the licensee is permitted to sell under the mark. The level of licensor supervision of quality varies from one license to another. The most common licenses with high levels of supervision are in franchise organizations, which typically empower the trademark licensing franchisor to conduct unannounced site inspections of the franchisee/licensee’s business premises.
Bankruptcy of a Trademark Licensor
If a trademark licensor declares bankruptcy, are its trademark licenses non-executory and binding, so that the debtor does not have the authority to reject them? Or do they require future performance by the licensor so that the debtor may have the possibility to decide whether to assume or reject them?
In June a federal court of appeals (for the Eighth Circuit, headquartered in Missouri) decided that a debtor in bankruptcy could not assume or reject a trademark license since it was part of a larger integrated agreement that had been substantially performed. Thus, In re Interstate Bakeries Corporation, 751 F.3d 955 (8th Cir. 2014) followed a similar decision from a different federal court of appeals (In re Exide Technologies, 607 F.3d 957 (3rd Cir. 2010)). These decisions also provide templates for planning purposes for both trademark licensors and licensees.
In resolving an antitrust dispute in 1996, Interstate Bakeries Corporation (“Interstate”) sold various operations and granted to the buyer a perpetual, royalty-free, assignable, transferrable, exclusive license for use of relevant trademarks. One of the sales was to Louis Brothers Bakeries, Inc. (“Lou Bro”). In order to effectuate the transfer, two agreements were used – an asset purchase agreement and a license agreement. Of the $20,000,000 purchase price, $11,800,000 was allocated to the tangible assets and the remaining $8,200,000 to the intangible assets, including the trademark license.
In September 2004, Interstate filed a voluntary Chapter 11 bankruptcy case. A plan was proposed in 2008 and scheduled the License Agreement with Lou Bro that it was planning to assume pursuant to Section 365 of the Bankruptcy Code. A dispute arose as to whether the License Agreement was an executory contract subject to Section 365 or not. The bankruptcy court, the district court and a three-judge panel of the Eighth Circuit all agreed with Interstate that the License Agreement was executory and therefore could be assumed or rejected at Interstate’s option. However, the full panel of the Eighth Circuit agreed to rehear the case, and in an 8-3 decision reversed.
The initial issue on appeal was to determine whether the agreement between Interstate and Lou Bro was executory or not. The court determined that the parties’ Asset Purchase Agreement and the License Agreement must be considered as one integrated agreement, not two separate contracts. In order to come to that conclusion, the court noted 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.” [p. 961]
Using this approach, the court noted that both the Asset Purchase Agreement and License Agreement were entered into contemporaneously on December 28, 1996. The Asset Purchase Agreement listed the trademark license as an asset. It directed the parties to enter into the License Agreement as outlined in the Asset Purchase Agreement. Both documents were defined as the “Entire Agreement”. The Asset Purchase Agreement’s definition included all exhibits and schedules, and that included a form of the License Agreement. The license referred to the Asset Purchase Agreement throughout the body of the License Agreement. So based on the foregoing, the court determined that both the Asset Purchase Agreement and the License Agreement should be considered as one agreement.
The next question was whether or not the integrated agreement was still executory for purposes of the Bankruptcy Code. To determine its status, the court applied the doctrine of “substantial performance” for determining whether the contract was executory or not. That doctrine essentially states that “the non-breaching party’s performance [i.e., Lou Bro’s performance] is not excused if the breaching party [Interstate] has ‘substantially performed’.” [p. 962]
Using this principle, the court determined that Interstate had substantially performed its obligations under the agreement and therefore there was no executory contract to assume or reject. The court noted that the essence of the agreement between the parties was the sale of assets and not merely the licensing of Interstate’s trademark. After the sale was completed, Interstate’s remaining obligations concerned relatively minor matters regarding the license such as the obligations of notice and forbearance, maintenance and defense of the trademarks. In reviewing the overall transaction the court determined that these remaining obligations were minor and did not relate to the central purpose of the sale transaction. The court concluded by referring to an analogous situation in the Third Circuit’s decision in In re Exide.
There was a substantial dissent, essentially stating that the majority failed to acknowledge the centrality of the trademark license.
While not controlling law in California, these are important decisions regarding trademarks in bankruptcy, since the present relevant provisions of the Bankruptcy Code do not grant special protections to trademark licensees if a debtor rejects a license. Thus in general, the debtor-licensor will want a court to find that a license agreement is executory, since under Section 365 it would retain the option to assume or reject the license. On the other hand, the licensee would prefer that its license not be executory, to avoid the potential situation where the debtor-licensor rejects the trademark license and the licensee is required to cease use.In Interstate Bakeries Corporation the court never mentioned the presence of an “integration” or “merger” clause in the agreements in finding that the Asset Purchase Agreement and the License Agreement should be treated together as one integrated contract. This was a critical fact to the decision and Interstate might well have avoided the result with this type of provision in its trademark license. Under California law, such provision would typically provide conclusive proof of a single agreement and prevent the court from considering other evidence. Licensors and licensees would be well advised to consider this type of provision in their current or future agreements.