Publications Protecting a Trademark Licensor’s Rights in its Licensee’s Bankruptcy Case

A recent bankruptcy case from the District of Delaware underscores the need for a trademark licensor to be alert to filings made in its licensee’s bankruptcy case that may require prompt action by the licensor to protect its valuable rights under a license agreement. In re Armstrong Flooring, Inc. , Chapter 11 Case No. 22-10426 (MFW) (Bankr. D. Del. July 22, 2022).

In that case, at the request of the debtor licensee, Armstrong Flooring, Inc., the bankruptcy court issued a temporary restraining order and preliminary injunction that directed Armstrong World Industries, Inc. and AWI Licensing LLC, the licensors under a trademark license agreement with the debtor licensee (the License Agreement), to execute written consents to the assignment by the debtor licensee of its rights and obligations under the License Agreement to the successful bidders for the debtor licensee’s assets at sales conducted under section Code 363 of the Bankruptcy.

The License Agreement

The License Agreement had its genesis in 2016, when Armstrong World Industries, Inc. (AWI) divested itself of its floor tile products business by spinning off its subsidiary, Armstrong Flooring, Inc. (AF). In connection with that transaction, AWI and its licensing subsidiary, AWI Licensing LLC (AWI Licensing), entered into the License Agreement with AF.

Under the License Agreement, while AWI retained the exclusive right to market and sell ceiling products under the “Armstrong” name and marks, AWI and AWI Licensing (collectively, the Licensor) granted AF: i) a perpetual, royalty-free, exclusive license to market and sell floor tile products under the “Armstrong” name and marks; and ii) a non-exclusive license to use the same name and marks for certain wall products.

The License Agreement expressly prohibits the assignment of the licensee’s rights and obligations under it to a third-party without the Licensor’s consent, except in connection with a change-in-control transaction.

The Interplay Between the License Agreement and AF’s Bankruptcy Case

Unable to successfully navigate the challenges of the COVID-19 pandemic, AF filed for relief under Chapter 11 of the Bankruptcy Code on May 8, 2022, intent on accomplishing an expedited sale of its businesses throughout the world under a competitive bidding process.

The sale process that was contemplated likely would result in different successful bidders for assets in different geographic locations, and it was unlikely that these dispositions would qualify as change-in-control transactions for purposes of the License Agreement.

Because the businesses were worth more with the license granted under the License Agreement than without it, prospective purchasers could be expected to bid substantially more for the businesses if they were accompanied by effective assignments of AF’s rights under the License Agreement.

Thus, unless the Bankruptcy Code negated the Licensor’s consent rights, the Licensor’s consent to such assignments would be indispensable.

Effect of Bankruptcy on the Licensor’s Consent Rights

In most instances, a license agreement, including a trademark license agreement, is treated as a so-called “executory contract” for purposes of bankruptcy law, when a party to the agreement (the debtor party) becomes the subject of a bankruptcy case.

As a general proposition, a provision in an executable contract that prohibits assignment of the debtor party’s rights and obligations under the contract without the other party’s (the counter-party) consent is overridden by section 365 of the Bankruptcy Code. To somewhat that undersimplify, provision if the debtor party cures any monetary defaults under the contract and compensates the counter-party for actual pecuniary loss caused by such defaults, it can assign its rights and obligations under the contract to a third-party over the objection of the counter-party , if adequate assurance of future performance by the third-party is provided — a requirement that usually is not difficult to satisfy.

Yet, notwithstanding the overriding of counter-party consent rights that generally takes place in bankruptcy, the Licensor’s unwillingness to voluntarily consent to the assignments that were integral to the closing of the sales in the Armstrong Flooring case posed a formidable legal acquisition. that: i) an exception exists, for a certain type of executable contract, to the general neutering of non-assignment provisions by section 365 of the Bankruptcy Code; and ii) trademark license agreements fall within this exception.

This exception, found in section 365(c)(1) of the Bankruptcy Code, disables a debtor party or its trustee from assuming or assigning an executable contract without the consent of the counter-party if, under applicable non-bankruptcy law, the The counter-party is excused from accepting performance from, or rendering performance to, an entity other than the debtor, whether or not the contract expressly prohibits assignment without the counter-party’s consent.

Personal services contracts are a prime example of contracts that fall within this exception. If, for example, a studio contracts with an actor to play a role in a television series, and the actor goes into bankruptcy, under applicable non-bankruptcy law (state contract law), the actor cannot assign the contract to another actor without the studio’s consent, regardless of whether the contract specifically prohibits such an assignment.

Personal services contracts are not the only type of contracts that fall within the section 365(c)(1) exception. More than ten years ago, the Seventh Circuit held that trademark license agreements also fall within this exception. The Seventh Circuit interpreted federal non -bankruptcy law as rendering trademark license agreements non-assignable by a licensee without the licensor’s consent, because of the necessity for the licensor to monitor the quality of the licensed products. See, In re XMH Corp. , 647 F.3d 690 (7th Cir. 2011) (Posner, J.).

This appears to be the prevailing view, and the bankruptcy court in the Armstrong Flooring case appears to have acknowledged in its bench ruling that trademark licenses typically require licensor consent before assignment of a licensee’s rights and obligations can occur. Consequently, bankruptcy case, the Licensor appears to have had a blocking position that gave it great negotiating leverage. That advantage was subjected to the risk of loss, however, and, at a minimum, was diluted because of the Licensor’s failure to take prompt action in the face of notices it received in connection with the establishment by the court of bidding procedures in the bankruptcy case.

The Bidding Procedures Order

As stated earlier, AF filed its Chapter 11 case on May 8, 2022. It also sought with alacrity the entry by the bankruptcy court of a bidding procedures order that did more than just specify the procedures to be followed by prospective purchasers to qualify to bid , and actually bid, on AF’s assets. The court entered the bidding procedures order on May 31, 2022 (the BPO).

Evidencing that it applied to more than just prospective bidders, the BPO provided that a Contract Assumption Notice would be served by the debtor, by May 31, 2022 (the date of the BPO), on counter-parties to executive contracts that potentially would be assigned to a successful bidder or successful bidders (Assigned Contracts). Under the BPO, a Contract Assumption Notice was to inform a counter-party of its obligation to file any objections to the proposed assumption and assignment within 14 days after service of the notice.

Of paramount importance, paragraph 25 of the BPO provided, in relevant part:

Any party failing to timely file an objection to … the proposed assumption and assignment of an Assigned Contract … listed on a Contract Assumption Notice . . . is deemed to have consented to … the assumption and assignment of such Assigned Contract …. Such party shall be forever barred and stopped from objecting to … the assumption and assignment of the Assigned Contract . . . , whether applicable law excuses such counterparty from accepting performance by, or rendering performance to, the Successful Bidder or Successful Bidders for purposes of Bankruptcy 6 c)(1)  ….

On May 31, 2022, AF’s notifying agent mailed a Contract Assumption Notice to AWI Licensing addressed to the attention of its general counsel. This notice described the terms of the bidding procedures, the deadlines for objections, and the consequences of failing to timely object. It also included the language from paragraph 25 of the BPO quoted above.

Neither AWI nor AWI Licensing filed a timely objection to the proposed assumption and assignment of the License Agreement.

Events Following the Mailing of the Contract Assumption Notice

On June 2, 2022, shortly after AWI Licensing was mailed a Contract Assumption Notice, AF’s general counsel contacted AWI’s general counsel about the sale process and advised him that AF would need consents to the assignments of AF’s cc suulicense rights under the Licensing that emerged from the sale process.

In that regard, the asset purchase agreements being negotiated with prospective bidders conditioned their obligations to close, in the event they were the successful bidders, on receipt of a written consent from the Licensor to the assignment to them of the debtor licensee’s rights under the License Agreement with respect to the applicable geographic territory.

Thereafter, AWI signed a non-disclosure agreement so that it could receive information about the sale process, including the identities of potential buyers.

On June 14, 2022, AF’s general counsel called AWI’s general counsel, provided the names of likely bidders, and advised that it was likely that AF’s assets would be divided geographically and sold to two or three buyers.

On June 26, 2022, AF’s general counsel emailed AWI’s general counsel a list of names of likely qualified bidders at the auction. He also emailed him a copy of the form of written consent of the Licensor (the Written Consent Form) required by the asset Purchase agreements being negotiated with bidders, asking that AF be advised if AWI had any substantial concerns with the form of written consent. AWI did not respond with any comments on the Written Consent Form.

On June 28, 2022, AWI’s general counsel advised AF’s general counsel for the first time that providing executed written consents to the contemplated assignments was “looking like a no-go.”

Thereafter, a flurry of communications between the respective CEOs and general counsel of AWI and AF did not result in an agreement by the Licensor to execute and deliver the Written Consent Forms. A reasonable inference from an alleged communication between the CEOs and a statement by the Licensor’s counsel at the hearing that later ensued is that the Licensor wanted to negotiate royalty arrangements with the successful bidders in return for executing the consents. This was anathema to the debtor licensee, which took the position that the Licensor already was deemed to have con The assignments because it had not timely filed objections to them.

While those communications were taking place, on July 11, 2022, the debtor licensee publicly announced the identities of the winning bidders (the Successful Bidders) for: i) the debtor licensee’s North American Assets; and iii) the debtor licensee’s China assets, respectively. The aggregate consideration to the estate from these sales was expected to be slightly more than $200 million.

The Adversary Proceeding

As of July 20, 2022, with the July 22, 2022 closing date for the sale of the North American assets looming, the Licensor still declined to execute the written consents. This state of affairs precipitated the filing by the debtor licensee of an adversary proceeding In the bankruptcy court, seeking declaratory relief and affirmative injunctive relief against the Licensor in connection with the debtor licensee’s assignment of its rights and obligations under the License Agreement to the Successful Bidders.

At the expedited hearing on July 22, 2022 on the debtor licensee’s request for coercive relief, the bankruptcy court was confronted with the specter that the debtor licensee lacked the liquidity to continue its North American operations beyond the closing date for the sale of the North American business, and that the failure to close for want of written consents would result in the loss of many jobs and the loss of going-concern value.

In issuing its ruling on the debtor licensee’s request for relief, the bankruptcy court declared that the Licensor was deemed to have consented to the assignments by not timely objecting as required by the BPO. The court further entered an order on July 22, 2022 (the Assignment Order), directing the Licensor to deliver written consents to the Successful Bidders before the respective scheduled closings of the asset sales, and, in the case of the sale of the North American assets, no later than 3:00 pm ET on July 22 , 2022.

When the court announced its ruling, the Licensor’s counsel moved for a stay of the Assignment Order pending appeal. The court denied that request.

The Licensor executed and delivered the Written Consent Form for the sale of the North American assets on July 22, 2022, a Friday. That same day, it filed a notice of appeal to the district court of the Assignment Order. The next day, it sought a stay pending appeal from the district court.

The Settlement

Notwithstanding the high bar that must be surmounted to obtain a stay that will derail a court-approved sale of substantially all of a debtor’s assets and the risk that the unstayed closing of such a sale will be found to moot an appeal of an order integral to The accomplishment of such sale, the filings of the notice of appeal and the motion with the district court for a stay brought the debtor licensee to the table.

Over the course of the July 23-24, 2022 weekend, a settlement, subject to bankruptcy court approval, was negotiated under which, among other things: i) the Licensor would withdraw the notice of appeal and the stay motion and deliver the remaining consents ; and ii) the Licensor would be paid $1,000,000.

On Monday, July 25, 2022, the debtor licensee filed a motion in the bankruptcy case seeking expedited approval of this settlement by the bankruptcy court. The bankruptcy court approved the settlement on July 29, 2022.

conclusion

Although the Licensor in the Armstrong Flooring case ultimately was able to salvage a substantial financial benefit from its position as a trademark licensor, there is no assurance that negotiating leverage diluted by inaction always will be partially or fully restored. be tight. When a trademark licensee goes into bankruptcy, it behooves the licensor to scrutinize notices it receives relating to the bankruptcy case and pay particular attention to deadlines that implicate its interests.