Business Bankruptcy Issues

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Business Bankruptcy Issues Recent Developments

Third Circuit Decision Suggests Another Way For Trademark Licensees To Protect Against License Rejection In Bankruptcy

Trademark licensees have long faced the serious risk of losing all license rights to a trademark if the licensor files bankruptcy and rejects the trademark license as an executory contract. However, a recent decision from the U.S. Court of Appeals for the Third Circuit in the In re: Exide Technologies case may give some trademark licensees new hope of retaining their license rights even in bankruptcy.

Limited protection of Section 365(n). It can be devastating for a licensee to lose access to licensed intellectual property. Often a licensee will build in licensed technology into its products or develop an entire business line or brand around a licensed trademark.  Recognizing how important in-licensed IP can be, in 1988 Congress added Section 365(n) of the Bankruptcy Code, giving licensees of certain types of intellectual property special protections in bankruptcy. These protections allow licensees to retain their rights to the licensed intellectual property – but there’s a catch. The Bankruptcy Code’s definition of “intellectual property” includes, among other things, patents, patent applications, copyrights, and trade secrets, but unfortunately for trademark licensees, it does not include trademarks. Follow the link in this sentence for more on Section 365(n)’s licensee protections other than in the trademark area.

Trademark licensee’s special risk. With no special protection, the trademark licensee faces the risk of having its license, usually considered to be an executory contract, rejected by the trademark owner in bankruptcy. If the trademark owner decides that the license is now unfavorable and a better deal can be had under a new license agreement with someone else, the trademark owner likely will reject the existing trademark license agreement and, generally, terminate the licensee’s rights to use the mark. The enforceability of phase-out provisions, which allow a licensee to continue to use a mark for a limited time period after a license is terminated, is unclear. Regardless, most courts hold that the trademark licensee eventually will lose its rights to the trademark following rejection. In some cases the ability to re-license can be of great value to a trademark owner in bankruptcy, and thus to its creditors, but it puts the licensee at substantial risk. For more on this topic, you may find this earlier blog post on the trademark licensee’s predicament of interest.

The Third Circuit’s Exide Decision. In a June 1, 2010 decision in In re: Exide Technologies (a copy of the decision is available by clicking on the preceding link), the Third Circuit examined a series of agreements, determined to constitute one integrated agreement, pursuant to which Exide Technologies sold an industrial battery business, and licensed certain trademark rights, to EnerSys. When Exide filed Chapter 11 bankruptcy in 2002, it sought to reject the agreement as an executory contract. The bankruptcy court granted Exide’s motion to reject the agreement, and that decision was affirmed by the district court. On appeal to the Third Circuit, that court held that under New York law, which governed the agreement, once a party has substantially performed, a later breach by that party does not excuse performance. The Third Circuit further held that EnerSys had substantially performed the agreement in the more than ten years since it was signed, rendering the agreement no longer an executory contract. 

  • The Third Circuit held that EnerSys had substantially performed by paying the full purchase price and operating under the agreement for ten years, as well as assuming certain liabilities related to the business EnerSys purchased when it obtained the trademark license.
  • The Court of Appeals also held that EnerSys’s obligation not to use the trademark outside of the licensed business was not a material obligation because it was a condition subsequent and, in any event, did not relate to the agreement’s purpose — the transfer of the industrial battery business in return for a $135 million payment.
  • Likewise, the Third Circuit concluded that a quality standards provision was minor because it related only to the standards of the mark for each battery produced and not to the transfer of industrial battery business that was the agreement’s purpose.
  • In addition, an indemnity obligation that had subsequently expired, and a further assurances obligation where no remaining required cooperation was identified, were held not to outweigh the factors supporting a finding of substantial performance.

A Concurring Opinion On The Effect Of Rejection. Judge Ambro wrote a concurring opinion to address the bankruptcy court’s conclusion that rejection of a trademark license left EnerSys without the right to use the Exide mark. In his concurrence, Judge Ambro analyzed the history of Section 365(n), disagreed that the exclusion of trademarks from its reach created a negative inference that rejection of a trademark license should be tantamount to termination, and stated that courts should be able to prevent the extinguishment of all rights upon rejection. As Judge Ambro wrote in his conclusion:

Courts may use § 365 to free a bankrupt trademark licensor from burdensome duties that hinder its reorganization. They should not—as occurred in this case—use it to let a licensor take back trademark rights it bargained away. This makes bankruptcy more a sword than a shield, putting debtor-licensors in a catbird seat they often do not deserve.

It will be interesting to see whether other courts follow Judge Ambro’s views or continue to hold that trademark licensees whose licenses have been rejected no longer retain any rights to use the trademarks at issue.

A New Argument For Trademark Licensees? For trademark licensees looking to preserve their rights in the face of a motion to reject a trademark license, the Exide Technologies decision may provide some additional support.

  • However, before breathing a sigh of relief, trademark licensees should remember that the decision involved a series of agreements that had been largely performed over the decade since they were signed. In many ways, the trademark licensee was just a part of what the Third Circuit found was, chiefly, an agreement to sell a business division. In essence, although the trademark itself was not sold, the trademark license rights went along with the business. 
  • Typically, trademark licenses more often arise not in connection with a sale of a business but as a separate, often stand-alone, license of certain trademarks for commercial exploitation by the licensee. In that context, it may be far more difficult to establish that the agreement has been substantially performed such that it is no longer an executory contract.

Still, for those situations in which the argument is available, the Third Circuit’s decision in Exide Technologies underscores that all trademark licenses are not executory contracts and, at least in some cases, the trademark licensee might just get to keep the license rights after all, even in the face of a rejection motion in bankruptcy. 

Business Bankruptcy Issues Recent Developments

Official Bankruptcy Forms Revised To Reflect April 1, 2010 Dollar Amount Adjustments

As discussed in an earlier post called "On The Rise: Bankruptcy Dollar Amounts Will Increase On April 1, 2010," various dollar amounts in the Bankruptcy Code and related statutory provisions were increased for cases filed on or after April 1, 2010. Now several official bankruptcy forms have been revised to reflect these new dollar amounts.

Remember, the increased dollar amounts reflected on these forms apply only to cases filed on or after April 1st.

Business Bankruptcy Issues Recent Developments

Recent Decision Holds That Section 503(b)(9) “20 Day” Claims Can Be Used As Part Of New Value Preference Defense

Earlier this year, the U.S. Bankruptcy Court for the Middle District of Tennessee issued a decision holding that creditors sued for preferences can assert a new value defense based on the goods provided to a debtor in the 20 days before the bankruptcy case was filed. The debtor had challenged the effort to use those 20 day goods as new value because they are entitled to administrative claim priority under Section 503(b)(9) of the Bankruptcy Code. 

The law in this area continues to develop and trade vendors and suppliers of goods will find this update of particular interest.

Business Bankruptcy Issues Recent Developments

Winter 2010 Edition Of Bankruptcy Resource Now Available

The Winter 2010 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

This edition also reports on some of our recent representations, including the successful Chapter 11 reorganization of our client, retailer Crabtree & Evelyn, Ltd., and our work for official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers. Recent committee cases include Eddie Bauer, Uno Restaurant Holdings, Ritz Camera, Filene’s Basement, BT Tires Group, Gottschalk’s, Bernie’s Audio Video TV Appliance, G.I. Joe’s, Against All Odds, Samsonite Company Stores, Mervyn’s Holdings, The Ski Market, and Lenox Sales, among others.

I hope you find the latest edition of Absolute Priority to be of interest.

Business Bankruptcy Issues Recent Developments

On The Rise: Bankruptcy Dollar Amounts Will Increase On April 1, 2010

It hasn’t gotten much publicity yet, but certain dollar amounts in the Bankruptcy Code will be increased for cases filed on or after April 1, 2010. You can find a chart listing all of the changes on this Federal Register page, which printed last month’s official notice from the Judicial Conference of the United States.

Among the most meaningful increases for Chapter 11 and other business bankruptcy cases:

  • The total amount of claims required to file an involuntary petition rises to $14,425 from $13,475;
  • The employee compensation priority under Section 507(a)(4) increases to $11,725 from $10,950;
  • The consumer deposit priority under Section 507(a)(7) rises to $2,600 from $2,425;
  • The dollar amount in the bankruptcy venue provision, 28 U.S.C. Section 1409(b), that requires actions for non-consumer, non-insider debt to be brought against defendants in the district in which they reside, has increased to $11,725 from $10,950; and
  • The minimum amount required to bring a preference claim against a defendant in a non-consumer debtor case, specified in Section 547(c)(9), rises from $5,475 to $5,850.

Other adjustments will affect consumers more than business debtors. For example, the debt limit for an individual to qualify to file a Chapter 13 bankruptcy case will rise to $1,081,400 of secured debt, and certain exemption amounts will also rise.

Although the changes aren’t substantial, be sure to keep them in mind when assessing cases filed after April 1st.

Business Bankruptcy Issues

Who’s SARE Now? Bankruptcy’s Single Asset Real Estate Rules And Their Impact On Commercial Real Estate

Given the state of commercial real estate, the prospect for defaults by commercial borrowers has greatly increased. The last time there was a significant downturn in the commercial real estate sector in the early 1990s, owners of buildings and other real estate often turned to Chapter 11 bankruptcy as a method of buying time and, in some cases, lowering or at least restructuring the amount of secured debt against the real property through a plan of reorganization. This raises the question — will the same story play out again in this downturn?

Major Bankruptcy Law Changes In 2005. As many readers of this blog know, major amendments were made to the Bankruptcy Code in 2005 — formally known as the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”) — including ones that affect real estate. One of the better-known changes was the addition of strict limitations on the time bankrupt tenants could have to assume or reject commercial real estate leases.

However, there was another amendment that may have a significant impact on some owners of real estate in Chapter 11, and could complicate the prospects for using bankruptcy to restructure debt on certain distressed projects. This change was the elimination of a valuation cap that had previously limited the number of real estate debtors subject to the Bankruptcy Code’s single asset real estate (“SARE”) rules, most notably provisions that impose special requirements on single asset real estate debtors to keep in place the benefits of bankruptcy’s automatic stay. 

The Bankruptcy Code’s SARE Definition. Prior to BAPCPA, there were relatively few SARE cases because the definition was limited to debtors with less than $4 million of secured debt against the real property. This meant that only smaller real estate cases were covered by the more restrictive SARE rules. BAPCPA, however, removed the $4 million secured debt ceiling. As a result, a real estate entity owing hundreds of millions of dollars in secured debt may be subject to the SARE rules. Consequently, the number of real estate cases potentially subject to the SARE provisions has increased dramatically.

The Bankruptcy Code’s current definition of SARE provides:

The term ‘single asset real estate’ means real property constituting a single property or project, other than residential real property with fewer than 4 residential units, which generates substantially all of the gross income of a debtor who is not a family farmer and on which no substantial business is being conducted by a debtor other than the business of operating the real property and activities incidental.

11 U.S.C. §101 (51B).

Impact Of A SARE Designation. A SARE designation can have a big effect on the debtor. When a debtor states on its petition that it is a SARE, or a secured creditor files a motion and the Court rules that the debtor is in fact a SARE, the dynamics of the Chapter 11 case will change. As discussed below, a SARE debtor must either file a plan of reorganization with a reasonable chance of being confirmed within the later of (i) 90 days after the order for relief is entered in the case (in a voluntary bankruptcy case this is when the case is filed) or (ii) 30 days after the date the court determines that the debtor is subject to the provisions of SARE, or must start making monthly payments to the secured creditor at the loan’s non-default interest rate. If a SARE debtor fails to satisfy these requirements, the court is likely to grant a secured creditor relief from stay to commence or continue with a foreclosure of the real property.

Who’s A SARE? Not every owner of commercial real estate in bankruptcy will be a SARE debtor. To determine what types of commercial properties and developments qualify as a SARE case, courts focus on interpreting the meaning of “a single property or project.” In cases in which one debtor owns one piece of real property, this issue will likely be straightforward. In other cases, however, the question may be more difficult to determine. For example, a real estate business owning many interrelated projects through separate, multiple limited liability companies ("LLCs") or partnerships may be able to avoid a SARE ruling. On the other hand, an entity owning more than one property, if considered a single project, may be deemed to be a SARE. To read one court’s analysis of these issues in a series of related bankruptcy cases involving multiple entities and properties, click here, here, and here.

If a single property or project is involved, courts then analyze whether the single real estate asset is used in the operation of a business or whether it is simply held for income. A SARE case usually involves passive rent collection without other active business activities that generate revenue for the debtor. The SARE standard is factually driven and generally looks to “whether [the debtors] conduct substantial business other than operating the real property.” In the Matter of Scotia Pacific Company, LLC, 508 F.3d 214, 221 (5th Cir. 2007) (debtor’s substantial entrepreneurial business operations went beyond mere passive collection of money). As the Scotia Pacific court held:

In order to be single asset real estate, the revenues received by the owner must be passive in nature; the owner must not be conducting any active business, other than merely operating the real property and activities incidental thereto. Under the prior jurisprudence, those passive types of activities are the mere receipt of rent and truly incidental activities such as arranging for maintenance or perhaps some marketing activity, or … mowing the grass and waiting for the market to turn.

A business would not be a SARE if a reasonable and prudent business person would expect to generate substantial revenues from the operation activities–separate and apart from the sale or lease of the underlying real estate.

For example, a golf club where the owners are actively engaged in activities such as employing third party workers, selling club memberships and merchandise, and charging green fees, has been held not to be a SARE. Likewise, a debtor in the hotel or marina business also may not be held to be a SARE.

Limited Automatic Stay Benefits For SAREs. A SARE debtor cannot count on the automatic stay remaining in force for an extended period of time. Instead, to maintain the benefit of the automatic stay, Section 362(d)(3) of the Bankruptcy Code requires a SARE debtor, within 90 days after filing bankruptcy, to file a plan that has a reasonable possibility of being confirmed or commence regular payments to the secured creditor at the non-default interest rate.

  • A SARE debtor that is not in a position to file a plan will, in effect, have to pay for the continuation of the automatic stay. This can prove difficult for projects that are not producing significant cash flow.
  • If a plan is filed instead, the debtor does not have to establish that the proposed plan will in fact be confirmed but must show that the assumptions that underpin the plan are reasonable. What constitutes a reasonable time to confirm a plan will vary from case to case.
  • If the debtor fails to satisfy either of these requirements, the secured creditor will likely be able to obtain relief from the automatic stay to foreclose on the property.
  • These rules do not preclude a secured creditor from seeking relief from stay on other grounds, such as a lack of adequate protection or other cause.

Overall Impact On Commercial Real Estate. Owners of distressed commercial real estate projects that are SAREs may find Chapter 11 to be less useful than in past down cycles.

  • With careful planning, some SARE debtors will be able to restructure through bankruptcy. Yet as an interesting study shows, many SARE (and non-SARE) real estate cases in the past few years have ended with the secured creditor obtaining relief from the automatic stay to foreclose. Faced with this prospect, some owners have simply decided to turn over distressed real property to the lender, often through a deed in lieu of foreclosure before bankruptcy.
  • In today’s environment, some lenders are willing to work with real property owners to extend loans and avoid foreclosure or taking back the property. However, if the SARE rules would apply in a potential bankruptcy, this fact may give the secured lender more leverage in those negotiations. 

What’s likely to be the end result of the SARE rules and the 2005 removal of the valuation cap? As single asset real estate projects face default, although some will certainly be able to restructure their debts, many may end up in the hands of lenders as real estate owned ("REO") properties. With distressed borrowers working through hundreds of billions of dollars in commercial real estate loan problems across the country, the negative impact defaulting commercial real estate loans and resulting REO may have on banks and other lenders could end up being the bigger part of this SARE story. 

Business Bankruptcy Issues Recent Developments

Two More Decisions Issued On Whether Bankruptcy Rule 2019 Requires Informal Groups To Disclose Their Trades

The First Two Delaware Decisions. In the past two months, I have reported on decisions by two Delaware bankruptcy judges in the In re Washington Mutual, Inc. case and in In re Premier International Holdings, Inc. (aka, the Six Flags case), taking opposing views on whether Federal Rule of Bankruptcy Procedure 2019 requires ad hoc committees and informal groups to disclose their trading activities. The Court in the Washington Mutual case held that it does, while the Court in the Six Flags case came out strongly with the opposite view. Follow the links in the prior sentence for more on both decisions, including copies of the respective opinions, as well as the earlier Northwest Airlines and Scotia Pacific decisions from the Southern Districts of New York and Texas, respectively.

A Third Delaware Decision. Two days after the Six Flags opinion was issued, Delaware Bankruptcy Judge Brendan L. Shannon issued a short order granting a motion to compel an Ad Hoc Noteholder Group in the In re Accuride Corporation Chapter 11 case to disclose details of their trades. A copy of Judge Shannon’s two-page order is available by clicking on the link in this sentence. The ruling reflects the Court’s comments from the bench agreeing with the conclusions in the Northwest Airlines and Washington Mutual decisions, although Judge Shannon stated that he did not necessarily concur that fiduciary obligations arise in this context, as the Washington Mutual opinion had stated.

The Philadelphia Newspapers Court Weighs In. Then last week, on February 4, 2010, Judge Stephen Raslavich, Chief Judge of the U.S. Bankruptcy Court for the Eastern District of Pennsylvania, issued another opinion on the issue, this time involving a "Steering Group of Pre-petition Lenders" in the In re Philadelphia Newspapers, LLC Chapter 11 bankruptcy case. After reviewing the analysis in each of the prior decisions from the Delaware, New York, and Texas courts, Chief Judge Raslavich held that Rule 2019 does not require such disclosure by the Steering Committee, essentially agreeing with the reasoning of Delaware Bankruptcy Judge Sontchi in the Six Flags case. Follow the link in this sentence for a copy of Chief Judge Raslavich’s 28-page opinion in the Philadelphia Newspapers case.

More To Come? We have now had six opinions or orders on the Rule 2019 issue involving ad hoc committees or informal groups, with three judges holding disclosure is required (Northwest Airlines, Washington Mutual, and Accuride Corporation) and three holding it is not (Scotia Pacific, Six Flags, and Philadelphia Newspapers). Although the issue may gain more clarity on appeal or the question may be superseded by an amended version of Rule 2019, now under consideration by the Advisory Committee, in the meantime more courts will likely be asked to decide this thorny Rule 2019 issue. Given the split in authority — with each judge finding that the "plain meaning" of Rule 2019 supports its view — it has become even more difficult to predict how the next court will rule.