Can A Chapter 11 Debtor Terminate A Trademark License By Rejecting It?

By David Shaiken

When I was in law school, the late Professor Nathan Levy, who taught bankruptcy and secured transactions at UConn, said over and over again, in his Vicksburg, Mississippi Southern drawl, “Read on, Mr. Shaiken, read on.” A Third Circuit Court of Appeals decision illustrates the value of reading on.

In 1991, Exide Technologies sold its industrial battery business to what is now EnerSys for $135 million. The sale included an exclusive, perpetual, royalty-free license to use the name “Exide” in the industrial battery business. After the sale, EnerSys used the Exide name in the industrial battery business and Exide used it in other businesses. Almost 10 years later, when Exide wanted back into industrial batteries in North America, it bought GNB Industrial Battery Company. So Exide was selling batteries again, but could not call them Exide.

In 2002, Exide filed for Chapter 11 bankruptcy, and filed a motion under 11 U.S.C. § 365 to reject the licensing agreement. Under § 365, if a contract is “executory,” the Chapter 11 debtor-in-possession can move to reject the contract. Of course, EnerSys, having paid a lot of money in 1991 for the Exide name, and having spent 11 years building up the Exide brand, objected to the motion. The Bankruptcy Court granted the motion to reject the licensing agreement, and the District Court affirmed.

The Third Circuit Court of Appeals reversed, holding that Exide could not reject the agreement. The Court reasoned that EnerSys owed very little performance to Exide, and therefore the contract did not meet the definition of “executory.” The phrase “executory contract” is not defined in the Bankruptcy Code, so the Court relied on earlier cases that had adopted the Countryman definition: “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 the performance would constitute a material breach excusing performance of the other.”

The Court then applied New York law (because the parties had agreed that New York law would govern the contract) and held that because EnerSys had substantially performed all of its obligations under the contract, the contract was not executory, and therefore could not be rejected under § 365. In particular, the Court held that under New York law the Court must balance the performance rendered by EnerSys, i.e., the payment of $135 million and EnerSys’s compliance with the Licensing Agreement for more than 10 years, against any performance remaining due by EnerSys to Exide. The Third Circuit concluded that EnerSys’s performance already rendered outweighed any performance it owed under the agreement.

So the first lesson is don’t be too quick to concede that a contract is executory. The Exide case illustrates that not all contracts are subject to rejection under § 365.

Judge Ambro wrote a concurring opinion, and this is where reading on, in this case to the concurrence, really pays off. (Thanks to Nathan for a lifelong lesson in reading on). In Exide, the Bankruptcy and District Courts had written that Exide’s rejection of the Licensing Agreement meant that EnerSys could no longer use the Exide trademark. Judge Ambro wrote separately to express his disagreement with the lower courts’ ruling on the effect of rejecting a trademark license agreement.

In 1985, the Fourth Circuit Court of Appeals held that a debtor-licensor’s rejection in bankruptcy of a technology license meant that the licensee could no longer use the licensed technology. Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F. 2d 1043 (4th Cir. 1985), cert. denied, 475 U.S. 1057 (1986). This is exactly the conclusion reached by the Bankruptcy and District Courts in Exide. In response to Lubrizol, Congress added a new subsection (n) to § 365, which provides that, upon rejection of an “intellectual property” license, the licensee has the option of (a) treating the contract as terminated, or (b) retaining its rights under the contract (including the right to exclusivity if the contract is exclusive) through the end of the term of the contract. Under § 365(n), the licensee may retain its use of the “intellectual property,” but cannot enforce any obligations other than exclusivity that are owed to it by the debtor-licensor. Why have I put “intellectual property” in quotes? Read on.

The problem is that Congress defined “intellectual property” in Bankruptcy Code § 101 as a trade secret; invention, process, design, or plant protected by patent law; patent application; plant variety; copyrighted work; and mask work protected under copyright law as a semiconductor chip product. Trademark is conspicuously missing from this definition. If a trademark is not “intellectual property,” then the protections of § 365(n) do not apply, and therefore, upon rejection, a trademark licensee would have no right to continue to use the trademark, just as one would expect under Lubrizol.

This is where reading on to concurring opinions gets really interesting. Judge Ambro noted that in the legislative history to § 365(n), Congress stated that dealing with trademarks and service marks is complicated and would require further study. Instead of delaying the passage of § 365(n) in order to determine what the rule should be for trademarks, Congress decided to “allow the development of equitable treatment of this situation by bankruptcy courts.” S. Rep. No. 100-505.

Judge Ambro cited the legislative history and held that the omission of trademarks from the Bankruptcy Code definition of intellectual property did not mean that Congress intended that upon rejection of a trademark license agreement the licensee automatically loses its rights. Instead, Judge Ambro wrote, Congress punted this issue to the courts.

On the receiving end of this punt, Judge Ambro cited a number of authorities that argue that rejection does not terminate a contract. Indeed, the Bankruptcy Code does not say that rejection equals termination. Rather, Judge Ambro argued, rejection is simply an abandonment of the bankruptcy estate’s rights in the contract, so that the estate is no longer burdened by it. The abandonment idea does not necessarily imply that the non-debtor party has lost its benefits under the contract, other than those benefits that would burden the bankruptcy estate, such as payment by the debtor. So, Judge Ambro concluded, courts should use their equitable powers to relieve debtor-licensors of the burdensome aspects of trademark licensing agreements, short of permitting the debtor-licensor to “take back trademark rights it bargained away.”

In the absence of a convincing argument why trademark licensees should get a worse deal than other intellectual property licensees, I think Judge Ambro has it right. Here are my questions for discussion:

1.    What makes trademark and service mark licenses more complicated than those licenses, such as patent licenses, already protected by § 365(n)?
2.    What obligations would a trademark licensor typically have to a licensee that would be burdensome, beyond exclusivity? (Recall that exclusivity is protected under § 365(n).)
3.    Should Congress make amendments to § 365(n) to deal with trademarks and service marks, to make clear what a licensee’s rights are following rejection of a license agreement?

Certiorari is pending so the Supreme Court might have a say on this important issue.

See In re Exide Technologies, 607 F.3d 957 (3rd Cir. 2010), cert. pending.