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Delaware Bankruptcy Law Update - The Grossman's and Exide Decisions

June 4, 2010

In two recent decisions by the Third Circuit Court of Appeals (the "Third Circuit"), the Court: (1) en banc overruled the controversial Frenville test and set a new standard as to when a “claim” arises, and (2) found an agreement containing a trademark license not to be executory, with a concurring opinion criticizing those courts which have followed the Lubrizol decision.

In the first of the two Third Circuit decisions discussed in this Delaware Bankruptcy Law Update, JELD-WEN, Inc. v. Van Brunt (In re: Grossman’s Inc.), No. 09-1563 (3d Cir. June 2, 2010) ("Grossman's"), the Court en banc overruled its long-established and often criticized standard set forth in Avellino & Bienes v. M. Frenville Co. (Matter of M. Frenville Co.), 744 F.2d 332 (3d Cir. 1984), governing when a “claim” arises under section 101(5) of the Bankruptcy Code. In so doing, the Third Circuit has adopted a significantly expanded definition of the term “claim” that is in line with the approach adhered to in most other circuits. In the second decision, EnerSys Delaware, Inc. v. Exide Techs. (In re Exide Techs.), No. 08-1872 (3d Cir. June 1, 2010) ("Exide"), the Third Circuit applied New York law to determine that there were no unperformed obligations of Exide or EnerSys that would constitute a material breach if not performed and, thus, held that the contract was not an executory contract. Judge Ambro penned a noteworthy concurring opinion criticizing the bankruptcy court and district court for following Lubrizol Enterprises, Inv. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), and suggesting that courts should not permit a debtor to use rejection under section 365 of the Bankruptcy Code to take back trademark rights that had been previously bargained away.

The Grossman's Decision

In Grossman’s, Mary Van Brunt (the “Claimant”) purchased, in 1977, products from Grossman’s that allegedly contained asbestos. At the time that Grossman’s filed its chapter 11 bankruptcy petition in 1997, Grossman’s had actual knowledge that it had previously sold asbestos-containing products, but it was unaware of any asbestos-related lawsuits pending against it. Grossman’s plan of reorganization, which contained a claims discharge provision, was confirmed in December 1997. Because the Claimant did not manifest any symptoms of an asbestos-related illness until 2006 and was not actually diagnosed with mesothelioma until March 2007, she did not file a proof of claim in Grossman’s chapter 11 case.

Following her diagnosis, the Claimant commenced a tort and breach of warranty action against JELD-WEN, Inc. (“JELD-WEN”), the successor-in-interest to Grossman’s. JELD-WEN sought a ruling from the bankruptcy court that the claims were discharged. Applying the Third Circuit’s “accrual test” set forth in Frenville, the bankruptcy court concluded that the claims were not discharged. The “accrual test” provides that a “claim” only arises under the Bankruptcy Code when the underlying cause of action accrues under applicable non-bankruptcy law and a claimant possesses a “right to payment.” Because the Claimant’s injury did not accrue under applicable state law until 2006, when the Claimant began to experience asbestos-related illness symptoms, the bankruptcy court concluded that the claim was not discharged because it had not arisen pre-confirmation. The district court affirmed.

Although the Third Circuit concluded that the bankruptcy and district courts had both correctly applied the Frenville standard, it nevertheless reversed by overturning Frenville. The Court recognized that the Frenville standard has been expressly rejected by at least six circuit courts. It also noted that the Frenville court placed too much focus on the “right to payment” language in section 101(5) of the Bankruptcy Code while “failing to give sufficient weight to the words modifying it: ‘contingent,’ ‘unmatured,’ and ‘unliquidated,’” thereby too narrowly interpreting when a “claim” under the Bankruptcy Code exists. Slip op. at 11.

The Third Circuit canvassed the decisions of its sister circuit courts in fashioning a new test for when a “claim” arises. Noting “something approaching a consensus” among courts in other circuits, the Third Circuit held that “a ‘claim’ arises when an individual is exposed pre-petition to a product or other conduct giving rise to an injury, which underlies a ‘right to payment’ under the Bankruptcy Code.” Slip op. at 18.

Grossman’s thus overturns Frenville and changes the standard in the Third Circuit for determining when a “claim” arises under section 101(5) the Bankruptcy Code. Thus, Frenville’s holding that a claim does not arise until the creditor has an actual right to payment based upon the accrual of a cause of action under state law has now been rejected. Under the more liberal Grossman’s interpretation, the claim will arise earlier -- when a claimant is exposed to conduct or a product that ultimately gives rise to a right to payment. The Grossman’s decision is sure to significantly impact claims analysis, which claims are stayed by the automatic stay, and which claims are discharged in future bankruptcy cases in the Third Circuit.

The Exide Decision

In connection with a sale of its industrial battery business to EnerSys, Exide granted EnerSys a perpetual, exclusive, royalty-free license to use the “Exide” trademark in the industrial battery business. Exide later re-entered the industrial battery business, but under the terms of the license, it could not use the Exide trademark for as long as the license remained in effect. When Exide filed its chapter 11 cases in 2002, it sought to reject the agreement under which Exide had provided the license. The bankruptcy court granted Exide’s motion to reject the agreement, and the district court affirmed. The Third Circuit found that, under New York law, EnerSys had no material unperformed obligations under the agreement. As it was not contested that Exide had no material unperformed obligations, the Third Circuit held that the agreement was not executory and could not be rejected.

In an interesting concurring opinion, Judge Ambro focused on the bankruptcy and district courts’ determination that the rejection of the agreement would leave EnerSys without the right to use the Exide trademark. The concurrence disapproved of reasoning applied by certain bankruptcy courts, following the enactment of Bankruptcy Code section 365(n), that Congress intended the holding in Lubrizol to control rejection of trademark licenses based on Congress’s failure to include trademark licenses in the definition of “intellectual property” in section 101(35) of the Bankruptcy Code. Instead, the concurrence relies on statements in the legislative history of section 365(n) asserting that the bill did not address the rejection of trademark licenses because Congress did not feel it could address certain issues related to trademark licenses without further study and therefore determined to allow the development of equitable treatment of such licenses by bankruptcy courts. Instead of following Lubrizol, Judge Ambro suggests that the bankruptcy and district courts should have used “their equitable powers to give Exide a fresh start without stripping EnerSys of its fairly procured trademark rights.” The concurrence reasons that rejection of a contract only frees the estate from the obligation to perform and does not effect a rescission or avoidance of the contract. Based on that interpretation of the effect of rejection, a licensee could retain the right to continued use of a trademark.

Even after the enactment of Bankruptcy Code section 365(n), Lubrizol has been followed by bankruptcy courts in the District of Delaware and the Southern District of New York, as well as others. See, e.g., In re Old Carco LLC, 406 B.R. 180 (Bankr. S.D.N.Y. 2009); In re HQ Global Holdings, Inc., 290 B.R. 507 (Bankr. D. Del. 2003); In re Centura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002). As the Third Circuit’s opinion determined that the agreement between Exide and EnerSys was not executory, Judge Ambro’s concurrence does not appear to be controlling precedent for bankruptcy and district courts in the District of Delaware. The persuasive effect of the concurring opinion on bankruptcy courts in the Third Circuit will be an issue to watch.