In re Exide Technologies, 607 F3d 957 (3rd Cir June 1, 2010)

CASE SNAPSHOT

This is an interesting case of seller’s remorse. Debtor Exide sought to take back its battery trademark from EnerSys by rejecting the licensing agreement under section 365 of the Bankruptcy Code. Exide attempted to do this even though EnerSys had long since purchased Exide’s battery business and exclusively used the trademark for 10 years under the parties’ agreements. The Bankruptcy Court and District Court ruled that the agreement was executory and, therefore, subject to rejection under section 365. The Third Circuit Court of Appeals disagreed, and found that EnerSys had substantially performed its obligations under the agreements; thus, the agreements were not executory and could not be rejected by Exide. The court further held that it was expanding the substantialperformance test beyond construction and employment law cases.

FACTUAL BACKGROUND

In 1991, Exide agreed to sell its industrial battery business to EnerSys Delaware, Inc., for $135 million. The assets sold included manufacturing plants, inventory, and, at issue here, a perpetual, exclusive, royalty-free license to use the “Exide” trademark in the battery business.

Exide continued to operate its other business lines under its own trademark, and EnerSys made and sold batteries under the Exide name and trademark. In 2000, Exide desired to re-enter the battery business, and attempted to regain its name and trademark from EnerSys as part of a strategic goal to unify its corporate image, and use its name and trademark on all products that it produced. EnerSys agreed to shorten the non-competition provisions in the agreements to permit Exide to re-enter the business, but refused to sell the “Exide” trademark back to Exide. Exide purchased a battery company, and began selling batteries under a different name. This put Exide in direct competition with EnerSys products sold as “Exide” batteries. This endeavor did not succeed, and Exide filed for chapter 11 bankruptcy protection in 2002.

Seeing an opportunity to take back the deal, Exide filed a motion to reject its agreement with EnerSys under section 365(a) of the Bankruptcy Code, arguing that the contract was executory, and that rejection of the agreement terminated EnerSys’ rights under the agreement. The Bankruptcy Court and the District Court agreed, and held for Exide. EnerSys appealed to the Circuit Court of Appeals.

COURT ANALYSIS

The Bankruptcy Code does not define “executory contract.” Courts have defined the term to mean a contract under which the obligations of both the bankrupt and the other party are so far underperformed that the failure of either party to complete performance constitutes a material breach, excusing the performance of the other party.

Conversely, if either party has substantially performed—in other words, if neither party had any material obligations remaining—the agreement could not be executory. To determine whether substantial performance had been rendered here, the court considered several factors:

  • The ratio of performance rendered to that not rendered
  • The quantitative character of the default
  • The degree to which the purpose behind the contract had been frustrated
  • The willfulness of the default
  • The extent to which the aggrieved party had already received the substantial benefit of the promised performance  

The Court of Appeals did not buy Exide’s arguments that the contract had not yet been substantially performed. EnerSys paid the $135 million purchase price in full, used all of the assets transferred, assumed Exide’s liabilities, and had used the Exide trademark consistently for 10 years. Indeed, the court ruled that both parties had already substantially benefitted from their performance. The remaining terms of the agreement were minor, i.e., use restrictions, quality standards provisions, indemnity obligations, and further assurances obligations, and had either expired or had been treated by Exide as unimportant terms. As such, the facts were clear that the contract had substantially been performed.

Exide also argued that the substantial-performance test was irrelevant, because it had previously applied only in construction and employment cases. The Court of Appeals disagreed, identifying a 2007 case from the Second Circuit that had applied the test in another context. Moreover, the Court of Appeals also “conclude[d] that we will not confine the doctrine to construction and employment contract cases.”

Accordingly, because the agreement did not contain at least one ongoing material obligation, it was not an executory contract and could not be rejected by Exide.

CONCURRING OPINION DISCUSSES THE REJECTION OF TRADEMARKS

Circuit Judge Ambro wrote separately to address the Bankruptcy Court’s determination that “[r]ejection of the Agreement leaves EnerSys without the right to use the Exide mark.” Judge Ambro reasoned that the rejection of a trademark license agreement did not deprive the non-debtor party of its use of the trademark. The debtor’s rejection would permit it to use the trademark, as before, but it did not take away the other party’s contractual rights to use the trademark.

Judge Ambro cited a string of decisions in other circuits holding that the rejection of a contract was not the same as a rescission of the contract. Although rejection relieved the debtor of its burdens under the contract, it did not, per se, take away the benefits of the contract from a non-debtor party. (Interestingly, section 365(n) of the Bankruptcy Code creates similar protections for non-debtor parties for intellectual property, but does not include trademarks in its definition of “intellectual property.”)

This concurring opinion cannot be relied upon as precedent, since it is not part of the central holding of the case. It is informative, however, and could be useful in a trademark licensee’s argument that trademark license rejection should not be used to freely allow a licensor to take back trademark rights it bargained away.

PRACTICAL CONSIDERATIONS

Although companies considering filing for bankruptcy often think that section 365’s rejection provisions are a panacea, they should analyze—with an experienced bankruptcy attorney’s help—whether key contracts can actually be rejected before filing for bankruptcy.