Determining whether a contract is executory and, thereby, subject to assumption or rejection under Section 365(a) of the Bankruptcy Code, can be a difficult and fact intensive inquiry. The Eighth Circuit Court of Appeals recently held, in an en banc decision, that continuing obligations under a trademark licensing agreement were insufficient to render the agreement executory. The unstated implication was that negative contractual obligations were “less material” than positive obligations in determining whether the parties had substantially performed under the contract.
In Lewis Bros. Bakeries, Inc. v. Interstate Brands Corp. (In re Interstate Bakeries Corp.), Interstate Bakeries (“IBC”) entered into an asset purchase agreement and a trademark licensing agreement with Lewis Bros. Bakeries (“LBB”). The purchase agreement sold facilities, equipment and other tangibles necessary for LBB to produce a line of bread products, and the licensing agreement gave LBB the exclusive right to use and market particular brand names for those products in the Chicago area. The agreements were part of the same transaction and referenced each other extensively. IBC subsequently filed for bankruptcy and sought to assume the licensing agreement as an executory contract in its Chapter 11 plan. LBB objected and argued that the licensing agreement was not executor.
The bankruptcy court, district court, and a panel of the Eighth Circuit Court of Appeals all agreed that the licensing agreement was executory because it required LBB to maintain specific product quality controls and limited the geographic area within which it could use the brand names. It also required IBC to refrain from using those same brands within LBB’s territory, to maintain and defend the trademarks, and to report any known third-party trademark infringement. On rehearing, en banc, the Court of Appeals reversed, holding that the licensing agreement was only one part of the transaction and had to be considered together with the purchase agreement as part of a single overall agreement. Thus, looking at the totality of the parties’ obligations under their overall agreement, the parties had substantially performed their obligations. By comparison, the remaining obligations imposed upon LBB and IBC after the closing, most of which simply prohibited the parties from taking certain actions rather than obligating them to act, were simply too minor to be considered material.
The dissent, by three of the eleven judges, pointed out that either side’s failure to carry out the remaining obligations of the licensing agreement would be actionable as a material breach of contract. The dissent also noted that a failure to comply with the remaining obligations could destroy the entire value of both the licensing agreement and the purchase agreement because the tangible assets were primarily useful only insofar as they facilitated branding the manufactured products.
The cautionary take away from the case is that, at least in the Eighth Circuit, when parties enter into a series of contracts that can be considered part of one overarching transaction, courts may combine the contracts into a single agreement to determine whether one of them is executory under Section 365(a). Moreover, where the remaining obligations in a licensing agreement are primarily negative (i.e., an obligation to refrain from taking certain actions), it is possible that the agreement will be deemed not to be executory, especially if the agreement is combined with other contracts in the court’s analysis.
In light of these issues, when documenting transactions that require multiple contracts, parties would be well-advised to clearly state whether or not they intend those contracts to be considered as part of a single transaction, or if they intend each contract to stand alone in determining whether it is executory. Also, in preparing a trademark licensing agreement in the context of a multipronged transaction, parties should consider including express statements that failure to perform the negative covenants contained in the licensing agreement constitutes a material breach of the parties’ obligations under the entire transaction.