On June 6, 2014, in Lewis Brothers Bakeries Incorporated and Chicago Baking Company v. Interstate Brands Corporation (In re Interstate Bakeries Corporation), 1 the United States Court of Appeals for the Eight Circuit, reversing the decisions of the United States District Court and the Bankruptcy Court for the Western District of Missouri, held in a 9-3 en banc decision that a trademark license agreement that was part of a larger integrated purchase agreement was not an executory contract subject to rejection pursuant to section 365(a) of the Bankruptcy Code.
What Is an Executory Contract?
Section 365(a) of the Bankruptcy Code provides that a debtor may assume or reject executory contracts and unexpired leases subject to bankruptcy court approval.2 If the debtor assumes a contract, it assumes the contract cum onere, meaning that the debtor will continue to receive both the benefits of and perform its obligations under the contract.3 Conversely, if the debtor rejects the contract, such rejection constitutes a breach of the contract immediately before the date of the filing of the debtor’s petition for relief, thereby giving the nondebtor party to the contract a prepetition claim against the estate for monetary damages.4
The right of a debtor to assume or reject under section 365(a) of the Bankruptcy Code, however, applies only with respect to contracts that are executory on the date when the bankruptcy case is commenced. The term “executory contract” is not defined in the Bankruptcy Code. The prevailing definition used by most courts, including those in the Eighth Circuit, is one commonly known as the “Countryman definition,” named after the late Professor Vern Countryman of Harvard Law School. For purposes of the Bankruptcy Code, Professor Countryman defined an executory contract as “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.”5 Background
Antitrust Judgment and Divestiture of Brands to LBB
In January 1996, in conjunction with Interstate Bakeries Corporation’s (“Interstate Bakeries”) acquisition of Continental Baking Company (then owner of the Wonder Bread and Hostess brands and trademarks), the United States District Court for the Northern District of Illinois entered a final judgment in an antitrust action brought by the United States Department of Justice against Interstate Bakeries (the “Judgment”). 6 The Judgment required that, as a condition of Interstate Bakeries’ acquisition of Continental Baking, Interstate Bakeries divest itself of certain rights and assets for the purpose of establishing viable
competitors in the sale of “White Pan Bread” in and around the Chicago, Illinois area.
To comply with the terms of the Judgment, in December 1996, Interstate Brands Corporation (“IBC”), a subsidiary of Interstate Bakeries, entered into an agreement to sell its Butternut bread operations and assets in the Chicago territory and its Sunbeam bread operations and assets in the Central Illinois territory to Lewis Brothers Bakeries, Inc. (“LBB”). To effectuate this transfer, IBC and LBB entered into two agreements: an “Asset Purchase Agreement” and a “License Agreement.”7 The Asset Purchase Agreement provided for the transfer to LBB of tangible assets and “the perpetual, royalty-free, assignable, transferable exclusive license to use the trademarks . . . pursuant to the terms of the License Agreement.” The License Agreement provided that for “a fee of ten dollars ($10.00), and other good and valuable consideration, set forth in the Allocation Agreement described in Section 2.3 of the Purchase Agreement,” “IBC grants to [LBB] . . . [a] license to use the Chicago Trademarks.” Of the $20 million purchase price, the parties agreed to allocate $8.12 million to the intangible assets, including the trademark licenses, and the remaining $11.88 million to the various tangible assets.
The Interstate Bakeries Bankruptcy Cases
In September 2004, Interstate Bakeries and eight of its subsidiaries and affiliates, including IBC, filed petitions for relief under chapter 11 in the Bankruptcy Court for the Western District of Missouri. 8 In December 2008, LBB filed an adversary complaint, seeking a declaratory judgment that the License Agreement is not an executory contract under section 365 of the Bankruptcy Code and is therefore not subject to assumption or rejection by the debtor. IBC countered by moving to reject the License Agreement and by seeking a declaration that it is an executory contract. Both parties moved for summary judgment.9 Before the bankruptcy court could rule, IBC withdrew its motion to reject the License Agreement, but reiterated its request for a declaration that the License Agreement is an executory contract.
The bankruptcy court, looking solely to the License Agreement, found that both IBC and LBB had material, outstanding obligations to perform and that, therefore, the License Agreement was executory and could be rejected.10 LBB appealed to the district court and the district court affirmed the bankruptcy court’s decision.11 Also looking solely to the License Agreement, the district court reasoned that LBB’s “failure to maintain the character and quality of goods sold under the Trademarks would constitute a material breach of the License Agreement, thus a material obligation remains under the License Agreement, and it is an executory contract.”12
Subsequently, LBB appealed to the Eighth Circuit. In August 2012, a divided panel of the Eighth Circuit affirmed the district court’s decision.13 However, after receiving the views of the Antitrust Division of the Department of Justice and the Federal Trade Commission, the full court for the Eighth Circuit granted LBB’s petition for rehearing en banc.14 Notably, the Antitrust Division and the Federal Trade Commission as amici curiae registered concern that allowing the License Agreement to be rejected in bankruptcy as an executory contract would thwart the remedial purpose of the Judgment.15
The Eighth Circuit’s En Banc Opinion
IBC argued that the case should be dismissed because there is no live controversy since it waived any right to reject the License Agreement, stating that it “has no reason to, and hereby acknowledges that it will not, seek rejection of the License Agreement under Section 365 of the Bankruptcy Code.”16 The Eighth Circuit rejected that argument, finding that there was still a live controversy because a declaration that the License Agreement is not an executory contract would affect its value by removing uncertainty as to its status and would allow LBB as licensee to plan its ongoing business without the possibility that a successor or assign of IBC could reject the License Agreement in a subsequent bankruptcy case.
In addressing the issue of whether the License Agreement is executory, unlike the focus that both the bankruptcy court and the district court placed on the License Agreement standing alone, the Eight Circuit found that “the proper analysis must consider an integrated agreement that includes both the Asset Purchase Agreement and the License Agreement.”17 The Eighth Circuit concluded that finding otherwise “would run counter to the plain language of both the Asset Purchase Agreement and the License Agreement, which describe the two as one piece, and would ignore the valuable consideration paid for the license.”18 Accordingly, the Eighth Circuit determined that the ultimate question is whether or not the integrated agreement is an executory contract under the Bankruptcy Code.
The Eighth Circuit determined that the essence of the integrated agreement was the sale of IBC’s Butternut bread and Sunbeam bread business operations in specific territories, not merely the licensing of IBC’s trademark. Moreover, the court explained that IBC’s remaining obligations under the integrated agreement pertained solely to the license and were limited to obligations (i) of notice and forbearance with regard to the trademarks, (ii) relating to maintenance and defense of the trademarks, and (iii) relating to infringement.19 The court concluded that the integrated agreement is not executory because IBC substantially performed its obligations under the Asset Purchase Agreement and License Agreement, and its failure to perform any of its relatively minor remaining obligations would not be a material breach of the integrated agreement.20 Because it found that the agreement was not executory, the Eighth Circuit did not have to address the question of whether rejection of a trademark license agreement terminates the licensee’s rights to use the trademark, an issue on which courts are divided.21
Three of the eleven judges sitting on the Eighth Circuit Court dissented in part to the majority’s holding. The dissenting judges disagreed with the majority’s conclusion that IBC had substantially performed its obligations under the integrated agreement and, therefore, also disagreed with the majority’s ultimate conclusion that the integrated agreement is not executory. The dissenting judges maintain that the license is of paramount importance to the integrated agreement, including the attendant ongoing obligations under the License Agreement, and that the majority failed to recognize the importance of the license because it failed to acknowledge the full purpose of the parties in entering into the integrated agreement.22 Since the terms of the Judgment called for IBC to “divest itself of the tangible assets reasonably necessary to allow the purchaser to make effective ongoing use of the license…,” the dissenting judges argue that the transfer of the license was central to the integrated agreement and that, “the multitude of tangible assets listed in the Asset Purchase Agreement were there for the purpose of allowing LBB to make effective ongoing use of the license”. 23
Trademarks are often licensed as part of a larger acquisition of a business. In determining whether the License Agreement is an executory contract, the Eighth Circuit considered all obligations under both the Asset Purchase Agreement and the License Agreement, and then applied the doctrine of substantial performance to conclude that the only remaining obligations were not material in the context of the acquisition. This approach should give licensees in such situations a reason to be optimistic about the survival of their right to continued use of their trademarks. Moreover, the lessons of Interstate Bakeries go beyond trademark licenses in that the court’s approach could be applied whenever a contract that may appear to be a stand-alone agreement is actually part of a larger integrated transaction that has been substantially performed.