In re Pinnacle Foods of California LLC: Court Denies Assumption of Franchise Agreements Under the Lanham Act and Hypothetical Test

Citation:

In re Pinnacle Foods of California LLC, 2024 WL 4481070 (Bankr. E.D. Cal. Oct. 10, 2024)

Executive Summary:

In this unpublished decision, Judge René Lastreto II of the United States Bankruptcy Court for the Eastern District of California denied Pinnacle Foods of California LLC’s motion to assume six franchise agreements with Popeyes Louisiana Kitchen Inc. (“Popeyes”) as part of its Chapter 11 Subchapter V bankruptcy reorganization. The court applied the “hypothetical test” under 11 U.S.C. § 365(c)(1), which bars assumption of executory contracts when applicable law excuses the non-debtor party (here, Popeyes) from accepting performance from a third party.

Relevant Background:

Pinnacle Foods is a business that operates six Popeyes restaurants in California. Facing financial difficulties, the company filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code, which allows businesses to restructure their debts and continue operations. As part of this process, Pinnacle sought court approval to retain its franchise agreements with Popeyes Louisiana Kitchen Inc., which are critical for running its restaurants.

These franchise agreements granted Pinnacle the right to use Popeyes’ trademarks and required compliance with operational standards set by the franchisor. Pinnacle argued that it could resolve any financial obligations that were overdue (known as monetary defaults) and would comply with the agreements’ terms going forward. Its proposed reorganization plan also relied on support from two related companies, Tyco Group LLC and California QSR Management Inc., which were also undergoing bankruptcy proceedings.

Popeyes opposed the request, asserting that the agreements could not be retained without its consent due to federal and state laws protecting its rights as a franchisor. It cited the Lanham Act, which governs trademarks, and the California Franchise Relations Act (CFRA), which regulates franchise relationships, to support its claim. Popeyes also argued that Pinnacle had committed breaches of the agreements that could not be fixed and that there were still unresolved financial issues.

The court’s task was to determine whether Pinnacle could retain the franchise agreements under bankruptcy law, considering the protections afforded to franchisors by both federal and state laws.

Decision:

The court denied Pinnacle’s motion to assume the franchise agreements, issuing several key findings:

• The court applied the hypothetical test, as adopted in Catapult Entertainment, Inc. v. Perlman, 165 F.3d 747 (9th Cir. 1999), and held that Pinnacle could not assume the franchise agreements without Popeyes’ consent. Under the hypothetical test, a debtor cannot assume or assign an executory contract if applicable law excuses the non-debtor party from accepting performance from or rendering performance to a third party, even if no actual assignment is intended.

The court reasoned that § 365(c)(1) of the Bankruptcy Code, which governs assumption of executory contracts, prioritizes the rights of the non-debtor party under applicable law. Here, Popeyes demonstrated that the Lanham Act and CFRA qualified as such applicable law, which excused it from accepting performance from Pinnacle or any hypothetical third party.

• The court found that the Lanham Act (15 U.S.C. §§ 1051, 1060) protected Popeyes’ rights as a trademark owner to control how its marks were used, ensuring the quality and goodwill associated with its brand. The court emphasized that trademarks are personal rights that cannot be assigned or assumed without the owner’s consent unless explicitly authorized.

The court cited In re N.C.P. Marketing Group, Inc., 337 B.R. 230 (D. Nev. 2005), as persuasive authority, where the application of Catapult was extended to trademark licensing agreements. The rationale was that allowing Pinnacle to assume the agreements without Popeyes’ consent would undermine the franchisor’s ability to maintain quality control over its trademarks, a central principle under the Lanham Act.

• The court addressed Pinnacle’s reliance on the CFRA (Cal. Bus. & Prof. Code § 20028), which it argued allowed assumption of franchise agreements. However, the court held that CFRA does not override federal law or the protections afforded by the Lanham Act. While CFRA generally permits the transfer of franchise agreements under specific conditions, it also allows franchisors to withhold consent if their standards are not met. The court determined that Popeyes had validly exercised its rights under CFRA to refuse consent.

• Popeyes alleged that Pinnacle had committed breaches of the franchise agreements, including failure to meet operational standards, which it argued were non-curable defaults. The court acknowledged these claims but did not make a definitive ruling on whether the defaults were curable. However, it found that unresolved disputes over such defaults weighed against granting Pinnacle’s motion.

• Pinnacle argued that the court should apply the “actual test,” which permits assumption when no actual assignment to a third party is intended. The court rejected this argument, reiterating that the Ninth Circuit’s binding precedent in Catapult required application of the hypothetical test.

• The court also addressed Pinnacle’s claims that CFRA and § 365(f) allowed assignment by encouraging reorganization. It rejected these arguments, noting that § 365(c)(1) expressly limits the scope of § 365(f) when applicable law excuses a party from accepting or rendering performance.

In sum, the court found that Pinnacle failed to meet the requirements for assumption under § 365(a) because the Lanham Act and CFRA excused Popeyes from accepting performance without its consent.

Looking Forward:

This case offers key insights for franchisors navigating bankruptcy scenarios where franchise agreements and trademark rights intersect with federal and state law protections.

• The court’s decision reaffirms that the Lanham Act’s protections over trademark rights can limit a franchisee’s ability to assume agreements in bankruptcy. Franchisors should ensure their agreements clearly articulate quality control and assignment provisions to maintain these protections.

• Additionally, while the California Franchise Relations Act provides significant rights to franchisees, courts will balance these protections against federal law, as demonstrated by the court’s strict application of the hypothetical test under 11 U.S.C. § 365(c)(1). Franchisors should remain vigilant about ensuring compliance with both federal and state laws in their agreements.

By reinforcing the need for well-structured agreements and highlighting the interplay between federal bankruptcy law and franchise relationships, this case underscores the importance of proactively addressing potential legal conflicts in contract drafting and enforcement.