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"Third Circuit Does Not Permit Debtor to Reject Non-Executory Trademark License Agreement"

June 21, 2010 | Skadden, Arps, Slate, Meagher & Flom LLP | Mark S. Chehi, Robert A. Weber

The Bankruptcy Code generally protects licensees of intellectual property by restricting the ability of debtor licensors to “reject” licenses of intellectual property they have granted to third party licensees. See 11 U.S.C. § 365(n). Importantly, however, trademarks are excluded from the Bankruptcy Code’s definition of “intellectual property.”1 Accordingly, bankruptcy courts have held that, because trademarks are not intellectual property, Chapter 11 debtors may assume or reject trademark license agreements like any other executory contract.2 In Chapter 11 cases, debtor companies that have licensed trademarks to others may seek to reject such trademark licenses and extinguish licensee rights by using a debtor’s broad power to reject executory contracts.3

A recent Third Circuit Court of Appeals decision, Exide Technologies v. EnerSys Delaware Inc., ___ F.3d ___, 2010 WL 2163190, Case No. 08-1872 (3d Cir. June 1, 2010), focuses on a critical limitation on a debtor’s right to reject a trademark license — namely, that the license arrangement must be “executory” in order to be rejected. If a non-debtor licensee has substantially performed its material obligations under a license agreement, the license may not be executory. If not executory, the license cannot be rejected by a Chapter 11 debtor.

Background 

In 1991, Exide Technologies, a well-known battery manufacturer, sold its industrial battery business to EnerSys for $135 million pursuant to an asset purchase agreement and related agreements. These included a trademark licensing agreement and several related agreements giving EnerSys a perpetual and exclusive royalty-free license to use the “Exide” trademark in the industrial battery business.4  EnerSys paid the purchase price and, for nearly 10 years under its license agreement with Exide, used the “Exide” trademark.

In 2000, Exide wanted to re-enter the industrial battery business. EnerSys agreed to early termination of a noncompete agreement between the parties, and Exide acquired a competing manufacturer of industrial batteries. Exide also sought to regain the “Exide” trademark from EnerSys, but EnerSys refused. The terms of the exclusive license that Exide granted to EnerSys in 1991 precluded Exide from using its own name on industrial batteries it made and sold.

In 2002, Exide filed a petition in the Bankruptcy Court for the District of Delaware to commence its Chapter 11 reorganization case. Thereafter, Exide as a Chapter 11 debtor sought again to end EnerSys’ use of the Exide trademark. In 2006, relying on Bankruptcy Code Section 365(a) and the limited Bankruptcy Code definition of “intellectual property,” Chapter 11 debtor Exide obtained an order from the Bankruptcy Court authoring Exide to reject the 1991 trademark license with EnerSys.5 The Bankruptcy Court ruled that rejection extinguished the rights of EnerSys as licensee of the licensed “Exide” trademark.6 The District of Delaware affirmed.7

The Third Circuit’s Decision 

In Exide Technologies v. EnerSys Delaware Inc., a panel of the Third Circuit vacated the District Court’s order and remanded the case back to the Bankruptcy Court for further proceedings. The Third Circuit held that Exide could not reject the agreement that licensed the “Exide” trademark to EnerSys, because the agreement between the parties was not executory as of the date Exide commenced its bankruptcy case.

Quoting its prior decisions, the Third Circuit panel instructed that an executory contract is a contract under which, as of the commencement of a Chapter 11 case, “the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Thus, “unless both parties have unperformed obligations that would constitute a material breach if not performed, the contract is not executory” under Section 365 of the Bankruptcy Code. “[T]he time for testing whether there are material unperformed obligations on both sides is when the bankruptcy petition is filed,” and the inquiry requires consideration of “contract principles under relevant nonbankruptcy law.”

In vacating the District Court that affirmed the Bankruptcy Court order authorizing Exide’s rejection of the trademark license to EnerSys, the Third Circuit applied New York8 contract law, including its “substantial performance” doctrine, to determine whether a breach by EnerSys of its remaining obligations under the license would constitute a material breach that would excuse Exide from further performance of its obligations.9 The Third Circuit observed that under New York law, when a breaching party “has substantially performed” before breaching, “the other party’s performance is not excused.” Citing Hadden v. Consolidated Edison Co., 312 N.E.2d 445 (N.Y. 1974), the Third Circuit recognized and applied the multi-factor test in New York for determining when a party has rendered substantial performance. That test considers “the ratio of the performance already rendered to that unperformed, the quantitative character of the default, the degree to which the purpose of the contract has been frustrated, the willfulness of the default, and the extent to which the aggrieved party has already received the substantial benefit of the promised performance.”

The Third Circuit decided that the Bankruptcy Court had “failed to properly measure whether either party had substantially performed” under New York law. Based upon the record on appeal, the appellate panel determined that “EnerSys has substantially performed its obligations” under the 1991 trademark license agreement because, among other things, EnerSys had paid the $135 million purchase price in the 1991 transaction, had operated and used the licensed “Exide” mark for 10 years, and had assumed certain Exide liabilities as part of the 1991 transaction. The Third Circuit rejected Exide’s argument that EnerSys’ ongoing, unperformed obligations under the trademark license (including a limitation on use of the Exide mark to industrial batteries, a quality control requirement, and certain indemnification and further assurances obligations) outweighed the importance of EnerSys’ performance prior to the bankruptcy petition date. Accordingly, the Third Circuit concluded that the license agreement was not executory and could not be rejected by Exide as a Chapter 11 debtor-in-possession.

Because the Third Circuit panel’s majority opinion held that the Exide-EnerSys license agreement was not executory, it did not address the lower courts’ conclusion that debtor-licensor rejection of a trademark license agreement eliminates the licensee’s rights in the licensed trademark.

In a concurring opinion, however, Circuit Judge Thomas Ambro disagreed with the traditional view that debtor-licensor rejection of a trademark license agreement eliminates a licensee’s rights in the trademark. Judge Ambro posited that a Chapter 11 debtor-licensor’s rejection of a trademark license merely ends the debtor-licensor’s obligations, and should not extinguish the non-debtor licensee’s rights in the licensed trademark: Rejection “should not let a licensor take back trademark rights it bargained away.” 

Implications 

The Exide ruling is an important reminder for debtors who seek to assume or reject contracts (including without limitation trademark license agreements) under Section 365(a) of the Bankruptcy Code. Debtors must meet their threshold burden to demonstrate that a contract to be rejected is “executory” because material obligations of each of the debtor and its non-debtor counterparty remain unperformed as of the commencement of the Chapter 11 case.

_______________________

1 See 11 U.S.C. § 101(35A) (“intellectual property” includes trade secrets, copyrights, mask work, and patents and other intellectual property protected under title 35, but does not include trademarks).

2 See, e.g., In re Old Carco LLC, 406 B.R. 180, 211 (Bankr. S.D.N.Y. 2009); In re HQ Global Holdings, Inc., 290 B.R. 507, 513 (Bankr. D. Del. 2003); In re Centura Software Corp., 281 B.R. 660, 674-75 (Bankr. N.D. Cal. 2002).

3 Section 365(a) of the Bankruptcy Code permits a debtor or trustee to reject or assume executory contracts. 11 U.S.C. § 365(a).

4 The Bankruptcy Court held that four agreements, including a Trademark and Trade Name License Agreement, an Asset Purchase Agreement, an Administrative Services Agreement, and a related letter agreement, constituted a single, integrated agreement, and the parties did not challenge that determination on appeal. See In re Exide Techs., 340 B.R. 222, 227 (Bankr. D. Del. 2006).

5 In re Exide Techs., 340 B.R. at 252.

6 Id. at 250.

7 EnerSys Delaware, Inc. v. Exide Technologies. Inc., 2008 WL 522516, Case No. 02-11125 (D. Del. Feb. 27, 2008).

8 The parties designated New York in the choice of law term of their agreement.

9 Exide argued that New York law limited the substantial performance doctrine to cases involving construction or employment disputes. The Third Circuit expressly rejected that argument, citing contrary New York precedent.

This memorandum is provided by Skadden, Arps, Slate, Meagher & Flom LLP and its affiliates for educational and informational purposes only and is not intended and should not be construed as legal advice. This memorandum is considered advertising under applicable state laws.

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