In the case of In re: Exide Technologies, decided on June 1, 2010, the US Court of Appeals for the Third Circuit reversed two lower court decisions and held that a 1991 agreement between Exide Technologies and EnerSys Delaware Inc., which included a license to EnerSys for use of the “EXIDE” trademark, is not an executory contract that can be rejected by Exide in bankruptcy proceedings. The Third Circuit held that it was not an executory contract because EnerSys had substantially performed the agreement and did not have any unperformed material obligations that would excuse Exide from performance. This is an important decision for trademark licensees regarding the implications that potential unforeseen bankruptcy proceedings may have on such licenses.
Originally, Exide executed an agreement with EnerSys in which Exide sold its industrial battery business to EnerSys and granted EnerSys a perpetual, exclusive, royalty-free license to use its “EXIDE” trademark in connection with the purchased industrial battery business. In 2000, Exide decided it wanted to return to the industrial battery market but, because of the previous license to EnerSys, could not use the “EXIDE” trademark. Exide attempted to regain the “EXIDE” trademark from EnerSys, but EnerSys refused. On April 15, 2002, Exide filed a voluntary petition for bankruptcy protection under Chapter 11 and sought, with the US Bankruptcy Court’s approval, to reject the 1991 agreement with EnerSys in order to regain rights to the “EXIDE” mark.
Section 365(a) of the US Bankruptcy Code allows a debtor in possession, or the trustee, to reject any executory contract where the rejection benefits the estate. While the US Bankruptcy Code does not specifically define what an “executory contract” is, it is generally held that a contract is considered “executory” if there are unperformed obligations owed by the debtor and the other contracting party, which, if not performed, would constitute a material breach of the contract. Often intellectual property licenses, including trademark licenses, will be considered executory contracts because such licenses usually require continuing obligations by both the licensor and licensee.
The bankruptcy court granted Exide’s motion to reject the license agreement holding that the agreement was executory and, therefore, was subject to rejection under 11 U.S.C. §365(a). The bankruptcy court subsequently entered an order approving a transition plan for the mark and denying EnerSys’s motion to stay. EnerSys appealed to the district court, which affirmed the bankruptcy court’s decision. EnerSys subsequently appealed to the Third Circuit.
On appeal, the Third Circuit reversed both lower courts and found that both the bankruptcy court and the district court had improperly held that the license agreement to use the trademark was an executory contract subject to rejection under 11 U.S.C. §365(a). The Third Circuit did not disagree that an executory contract is “…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.” The point of departure between the lower courts and the Third Circuit was over the application of the test applied by the lower courts. According to the Third Circuit’s analysis, neither party to the trademark license owed obligations to the other that were material.
To determine whether obligations would constitute a material breach if not performed, the Third Circuit looked to applicable non-bankruptcy contract law. In its review, the Third Circuit held that the bankruptcy court failed to properly measure whether either party had substantially, performed under the license and found that EnerSys had substantially performed. The Third Circuit was unswayed by Exide’s arguments that EnerSys had ongoing unperformed obligations under the agreement that created grounds for rejection, namely: (i) an obligation to satisfy the quality standards provision in the license, (ii) an obligation to observe the use restriction for the trademark, (iii) an indemnity obligation and (iv) a further assurances obligation.
The Third Circuit considered these obligations of EnerSys under the license to be minor and found that the performance already rendered by EnerSys outweighed its remaining performance and that the extent to which the parties benefitted under the agreement was substantial. Specifically, the Third Circuit found that EnerSys had substantially performed by paying the full $135 million purchase price, operating under the agreement since 1991, using all assets transferred in the agreement (including the “EXIDE” mark) and assuming all of Exide’s liabilities and obligations. Accordingly, the Third Circuit held that the agreement was not an executory contract because it did not contain at least one ongoing material obligation for EnerSys. Because the agreement was not an executory contract, Exide could not reject it.
This decision demonstrates the importance for a trademark licensee to perform all of its obligations under the license agreement and to carefully draft license provisions so that there are not unperformed obligations which would be considered a material breach if not performed. Guarding against license obligations which could be considered unperformed will help a trademark licensee avoid the possibility of losing its licensed trademark if the licensor later declares bankruptcy and attempts to regain the trademark through rejection of the license in bankruptcy court. Similarly, a trademark licensor looking to preserve its right to reject should clearly draft ongoing quality control provisions that are acknowledged as material.
For more information about the In re: Exide decision, or intellectual property issues in bankruptcy proceedings, please contact Richard Assmus at +1 312 701 8623, Deborah Schavey Ruff at +1 312 701 8601 or John J. Voorhees Jr. at +1 312 701 7748.