Intellectual Property Law360, New York (November 02, 2012) — In In re Interstate Bakeries Corporation, ___ F.3d ___ (8th Cir. 2012) (IBC), the Eighth Circuit Court of Appeals ruled that a perpetual, royalty-free trademark license was an executory contract and therefore subject to assumption or rejection by the licensor/bankruptcy debtor under section 365 of the Bankruptcy Code.

This decision is at odds with a recent decision from the Third Circuit Court of Appeals, In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010), which found that such a license under similar circumstances was not an executory contract and could thus not be assumed or rejected by the licensor/bankruptcy debtor.

Licensors who wind up in bankruptcy tend to favor the interpretation that license agreements are executory contracts, as it allows the licensor to control whether or not it assumes the license agreement (essentially, allowing the agreement to continue while curing any defaults) or rejects the license agreement (causing the license agreement to be treated as though it were breached pre-bankruptcy filing, and leaving the licensee with a claim for damages that is unlikely to be satisfied in full).

Licensees generally do not want licensors to have the ability to reject license agreements, as such rejection causes, among other things, uncertainty as to the licensee’s ability to utilize the license. A determination that a license agreement is not an executory contract means that the license agreement is outside the purview of Bankruptcy Code section 365 and is not subject to rejection by the licensor. Instead, it is generally treated as though ownership of the license had been transferred, so the licensor can continue to utilize the license.

The transactions at the heart of both Exide and IBC involved prepetition sales pursuant to simultaneously executed asset purchase agreements and license agreements. To determine whether a contract is an executory contract in bankruptcy proceedings, courts examine whether the obligations of both parties to the contract are so far underperformed that failure to complete performance by either party would be a material breach.

In Exide, the Third Circuit held the sale and license agreement were part of an integrated transaction evidencing the sale of the business, under which the buyer substantially performed, despite the remaining obligations to observe quality standards. The Third Circuit reasoned that such obligations did not directly relate to the sale and were not specifically discussed by the parties. Therefore there was no remaining performance due by the buyer, and the license agreement was not an executory contract.

In IBC, the Eighth Circuit declined to follow Exide. It focused on a provision in the license agreement requiring the buyer to maintain quality standards, and a second provision identifying failure to comply with the first provision as a material breach. These two provisions, when read in conjunction, showed that material obligations remained as an explicit contractual provision on the buyer’s side, and were sufficient to distinguish IBC from Exide and render the IBC license agreement an executory contract.

Crucial to this determination was that the controls were clearly identified in the license agreement as material, whereas in Exide they were not. The Eighth Circuit noted that material obligations remained on the licensor/bankruptcy debtors’ side as well, including notice and forbearance obligations and trademark infringement-related obligations.

A written dissent in IBC pointed out that the Eighth Circuit majority refused to consider the sale and license agreement as a single integrated transaction with which the parties had substantially complied, foreclosing the potential for material breach, as the two concepts are antithetical. The dissenting judge would have followed the Exide roadmap.

The IBC decision sends a strong message to licensors to include quality control obligations in trademark licenses and to clearly identify such provisions as material to the contract, thereby preserving their potential future right to assume or reject the license agreement as an executory contract in a bankruptcy proceeding. Licensees, on the other hand, should negotiate to strike such provisions and obligations.