An official notice from the Judicial Conference of the United States was just published announcing that certain dollar amounts in the Bankruptcy Code will be increased ever so slightly — only about 3% this time — for new cases filed on or after April 1, 2016. Follow this link for the Federal Register page with a chart listing all of the updated dollar amounts.  Among the most meaningful increases for Chapter 11 and other business bankruptcy cases:

  • The employee compensation and employee benefit plan contribution priorities under Sections 507(a)(4) and 507(a)(5) both increase to $12,850 from $12,475;
  • The consumer deposit priority under Section 507(a)(7) rises to $2,850 from $2,775;
  • The total amount of claims required to file an involuntary petition rises to $15,775 from $15,325;
  • The dollar amount in the bankruptcy venue provision, 28 U.S.C. Section 1409(b), which requires that actions to recover for non-consumer, non-insider debt be brought against defendants in the district in which they reside, has increased to $12,850 from $12,475;
  • 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 to $6,425 from $6,225; and
  • The total debt amount in the definition of small business debtor in Section 101(51D) will rise to $2,566,050.

Other adjustments will affect consumers more than business debtors. For example, the debt limit for an individual to qualify for a Chapter 13 bankruptcy case will rise to $1,184,200 of secured debt, and certain exemption amounts will also increase.

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

boardroom

Many start-up companies backed by venture capital financing, especially those still in the development phase or which otherwise are not cash flow breakeven, at some point may face the prospect of running out of cash. Although many will timely close another round of financing, others may not. This post focuses on options available to companies when investors have decided not to fund and the company needs to consider a wind down.

Fiduciary Duties And Maximizing Value. Let’s start with a refresher on the fiduciary duties of directors and officers of a Delaware corporation in financial distress. Please note that this high-level overview is no substitute for actual legal advice on a company’s specific situation.

  • Under Delaware law, directors and officers owe fiduciary duties of due care and loyalty. The duty of due care requires directors and officers to make fully-informed, good faith decisions in the best interests of the company. The duty of loyalty imposes on directors and officers the obligation not to engage in self-dealing and instead to put the interests of the company ahead of their own.
  • When a company is solvent, the directors and officers owe their fiduciary duties of due care and loyalty to the corporation and its stockholders. That remains true even if the company is in the so-called “zone of insolvency.”
  • When a company is insolvent and will not be able to pay its creditors in full, the directors and officers still owe their fiduciary duties of due care and loyalty to the corporation. However, upon insolvency, the creditors have the right to bring derivative (but not direct) claims for breach of fiduciary duty against directors and officers.
  • Follow this link for more on the key Delaware decision discussing the fiduciary duties of directors and officers in the insolvency context.
  • Remember, it can be challenging to determine whether a company is just in the zone of insolvency (meaning still solvent but approaching insolvency) or whether it has crossed the line into actual insolvency.
  • Discharging fiduciary duties when a company is insolvent means a focus on maximizing enterprise value. This is a highly fact-dependent exercise with no one-size-fits-all approach. In some cases, maximizing value may mean continuing operations — even though that burns dwindling cash — to allow the company to complete a sale that the directors believe is likely to close and produce significant value for creditors. In other cases, it may mean winding down (or even shutting down) operations quickly to conserve cash, especially if any asset sale is not expected to generate more than the cash required to pursue it.
  • These complexities make it critical for directors and officers of a company in financial distress to get legal advice tailored to the specific facts and circumstances at hand.

Legal Options For A Wind Down. When the board decides that the company needs to wind down, options range from an informal approach all the way to a public bankruptcy filing. Note that if the company owes money to a bank or other secured creditor, the lender’s right to foreclose on the company’s assets could become a paramount consideration and affect how the wind down is accomplished. Although beyond the scope of this post to analyze each wind down option in detail, the following is a brief overview of different approaches, together with links giving more information.

  • Informal wind down: In an informal wind down, the company typically tries to find a buyer for its assets, eventually lays off its employees, and shuts down any unsold business operations, but does not complete a formal end to the corporate existence. This lack of finality can leave legal loose ends, so alternatives should be carefully considered.
  • Corporate dissolution: A corporate dissolution is a formal process under Delaware law, typically managed by a company officer, for winding up the affairs of the corporation, liquidating assets, and ending the company’s legal existence. A company may choose to do a corporate dissolution when it doesn’t need bankruptcy protection (and prefers not to file bankruptcy) but wants a formal, legal wind down of the corporate entity. Follow this link for more details on corporate dissolution.
  • Assignment for the benefit of creditors: Many states, notably including California and Delaware, recognize a formal process through which a company can hire a professional fiduciary and make a general assignment of the company’s assets and liabilities to that fiduciary, known as the Assignee. In California, no court filing is involved. The Assignee in turn is charged with liquidating the company’s assets for the benefit of creditors, who are notified of the ABC process and instructed to submit claims to the Assignee. If a buyer has been identified, an Assignee may be able to close an asset sale soon after the ABC is made. Follow this link for a an in-depth look at the ABC process.
  • Chapter 7 bankruptcy: A Chapter 7 bankruptcy is a public filing with the United States Bankruptcy Court. A bankruptcy trustee is appointed to take control of all of the company’s assets, including the company’s attorney-client privilege, and the directors and officers no longer have any decision-making authority over the company or its assets. A Chapter 7 trustee rarely operates the business and instead typically terminates any remaining employees and liquidates all assets of the company. The filing triggers the bankruptcy automatic stay, which prevents secured creditors from foreclosing on the company’s assets and creditors from pursuing or continuing lawsuits. The trustee has authority to bring litigation claims on behalf of the corporation, often to recover preferential transfers but sometimes asserting breach of fiduciary duty claims against directors or officers. Unlike a dissolution or an ABC, the bankruptcy trustee in charge of the liquidation process is not chosen by the company.
  • Chapter 11 bankruptcy: A Chapter 11 bankruptcy is also a public filing with the U.S. Bankruptcy Court, and it similarly triggers the bankruptcy automatic stay. Unlike a Chapter 7 bankruptcy, in Chapter 11 — often known as a reorganization bankruptcy — the board and management remain in control of the company’s assets (at least initially) as a “debtor in possession” or DIP. Business operations often continue and funding them and the higher cost of the Chapter 11 process require DIP financing and/or use of a lender’s cash collateral. One primary use of Chapter 11 by a venture-backed company is to sell assets “free and clear” of liens, claims and interests through a Bankruptcy Court-approved sale process under Section 363 of the Bankruptcy Code. Follow this link for a discussion of how a Section 363 bankruptcy sale in the right circumstances can maximize value for creditors and shareholders.

Conclusion. When a company’s cash is running out and investors have decided not to provide additional financing, the board may conclude that a wind down is required to fulfill fiduciary duties and maximize value. The discussion above is a general description of certain wind down options. Determining whether any of these paths is best for a particular company is fact-specific and dependent on many factors. Be sure to get advice from experienced corporate and insolvency counsel when considering wind down or other restructuring options.

379303639_4c768a3bf5_z

A decision last month by the U.S. Bankruptcy Court for the District of New Hampshire serves as a good reminder that, although helpful, Bankruptcy Code Section 365(n)’s protection for intellectual property licensees definitely has its limits. That’s especially true for a commercial agreement whose central purpose is something other than as a technology license. Since we don’t get many Section 365(n) cases, let’s examine this one more closely.

Distribution And License Rights. In In re Tempnology, LLC (use link to access decision), the Debtor had entered into a Co-Marketing and Distribution Agreement (“Agreement”) with Mission Product Holdings, Inc. (“Mission”) for the sale and distribution of certain cooling material products developed by the Debtor. The Agreement granted Mission “exclusive distribution rights” in the United States and an opportunity to obtain similar rights in other countries. The Debtor agreed not to “license or sell” the products involved to others during the term of the Agreement. In another section of the Agreement the Debtor agreed not to take actions that would “directly or indirectly frustrate its exclusivity obligations” and agreed to enforce the Debtor’s “intellectual property rights and contractual rights against third parties.”

Another section of the Agreement addressed intellectual property. “Intellectual Property Rights” were defined to include, among others, the Debtor’s copyrights, patentable and unpatentable inventions, discoveries, designs, technology, trademarks, and trade secrets.” In addition, the Debtor granted Mission the following “Non-Exclusive License”:

Excluding those elements of the CC Property consisting of Marks, Domain Names, [the Debtor] hereby grants to [Mission] and its agents and contractors a non-exclusive, irrevocable, royalty-free, fully paid-up, perpetual, worldwide, fully-transferable license, with the right to sublicense (through multiple tiers), use, reproduce, modify, and create derivative work based on and otherwise freely exploit the CC Property in any manner for the benefit of [Mission], its licensees and other third parties.

The “CC Property” covered all products developed or provided by the Debtor and all IP rights with respect to those products. The Debtor also granted Mission “a non-exclusive, non-transferable, limited license . . . to use its Coolcore trademark and logo (as well as any other Marks licensed hereunder) for the limited purpose of performing its obligations hereunder” during the Agreement’s term. If the Agreement were terminated, it would trigger a two-year wind down period during which Mission would retain the right to purchase, distribute, and sell the relevant products, including use of the trademark rights.

Feeling Rejected. On September 1, 2015, the Debtor filed a Chapter 11 bankruptcy case and the next day moved to reject the Agreement. The court approved the rejection subject to Mission’s election to retain its rights under Section 365(n). With a sale also taking place, the Debtor then filed a second motion seeking a determination that Mission’s Section 365(n) rights were limited only to the grant of the Non-Exclusive License and not the exclusive distribution rights or the trademark license. Mission argued that Section 365(n) also extended to its exclusive distribution rights because Section 365(n)(1)(B) permits a licensee to enforce “any exclusivity provision of such contract.” Citing to the In re Crumbs Bake Shop case (follow link for full discussion of that case), Mission also argued that under Section 365(n) and the court’s equitable authority, it should be allowed to use the Debtor’s trademarks during the remainder of the wind down period expiring in July 2016.

The Court Rules Mission’s Section 365(n) Rights Are Limited. In issuing its decision, the court ruled in favor of the Debtor and did not accept either of Mission’s arguments.

  • First, the court concluded that the exclusivity and other protections of Section 365(n) extend only to the intellectual property rights in the Agreement. The court held that the exclusive distribution rights granted to Mission were not a right to intellectual property, even if the products were patented. Instead, they were unrelated to the Non-Exclusive License, which gave Mission the right, directly or through sublicensees,to exploit the underlying intellectual property free of distribution of the Debtor’s products. Although the Non-Exclusive License was protected under Section 365(n), the distribution rights were not. As a result, the court held that the exclusive distribution rights did not survive rejection of the Agreement.
  • Second, with respect to the trademark license, the court declined to follow the In re Crumbs Bake Shop case and instead held that Bankruptcy Code Section 101(35A)’s definition of “intellectual property” does not include trademarks. The court ruled that Section 365(n) therefore does not protect Mission’s trademark license post-rejection.

A Few Observations. The In re Tempnology, LLC decision is interesting for what it does and does not do.

  • The court’s holding that Section 365(n) extends only to non-trademark IP license rights, and not to exclusive rights to distribute products, serves as a good reminder that Section 365(n) protection is limited principally to the continued right to use intellectual property.
  • The court’s rejection of the In re Crumbs Bake Shop case applying Section 365(n) to trademarks is not a surprise. The overwhelming majority of cases likewise hold that the absence of trademarks in Section 101(35A)’s definition of “intellectual property” means no Section 365(n) protection for trademarks.
  • The Tempnology court applied the seminal 1985 decision that led to the adoption of Section 365(n), Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), to hold rejection of the Agreement meant that Mission lost both the exclusive distribution rights and any continued rights to the trademark license.
  • However, given Circuit level decisions over the last few years involving trademarks and bankruptcy, it’s interesting that the Tempnology court did not mention in particular the Seventh Circuit’s 2012 decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 382 (7th Cir. 2012). In Sunbeam, the Seventh Circuit expressly rejected the Lubrizol decision and its analysis of the effects of rejection (follow the link for a full analysis of the Sunbeam decision). The Sunbeam court permitted a non-debtor trademark licensee to continue using licensed trademarks after the underlying trademark license had been rejected, holding that rejection is a breach by the debtor and does not terminate rights of the non-breaching party.
  • Perhaps the Tempnology court had no interest in following Sunbeam over Lubrizol and perhaps Mission chose not to advance Sunbeam’s analysis for other reasons. In any event, if the Tempnology court had followed Sunbeam’s analysis of the impact of rejection (and, for our purposes, if courts in the future decide to follow Sunbeam), the result might have been different.
  • On another note, in this case the core IP rights apparently involved patented products, not copyrighted works. When the products at issue are copyrighted works, however, the licensee might be able to argue that exclusive distribution rights are part of the licensed intellectual property rights. The Copyright Act, specifically 17 U.S.C. Section 106(3), includes among the exclusive rights of the copyright owner (subject to being licensed) the right to “distribute copies or phonorecords of the copyrighted work to the public by sale or other transfer of ownership, or by rental, lease, or lending.” It’s not a certainty, but a licensee granted the exclusive right to distribute copyrighted works might be able to argue that its exclusive distribution rights are part of IP (copyright) rights protected under Section 365(n).

Conclusion. The Tempnology decision underscores the limits of Section 365(n), particularly in commercial agreements with essentially only a back-up IP license. The decision has been appealed so it’s possible we may get an opinion in the months ahead from an appellate court. With Section 365(n) decisions about as rare as hen’s teeth, be sure to stayed tuned.

 

Image Courtesy of Flickr by Alexander Dulaunoy

IMG_3500

Almost every year, changes are made to the set of rules that govern how bankruptcy cases are managed — the Federal Rules of Bankruptcy Procedure. The changes address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others. Often there are revisions to the official bankruptcy forms as well.

One Little Rule Amendment? This year’s amendments impact only one rule, Federal Rule of Bankruptcy Procedure 1007. On the surface, the change is only a small revision to a reference to one of the official bankruptcy schedules. A link to a copy of the amendment, including the transmittal correspondence and a clean and redline version, can be found using the link in this sentence (and if you keep reading you will get the amendments to the Federal Rules of Civil Procedure as a bonus).

Big Changes Are Coming To The Bankruptcy Forms. Don’t let the minor rule amendment fool you. As one presidential candidate these days might put it, the changes coming to the official bankruptcy forms are “huge.”

  • As part of a modernizing of the official forms, virtually every bankruptcy form is being substantially revised.
  • Many forms, including the bankruptcy petition, list of 20 largest creditors, bankruptcy schedules, and statement of financial affairs, will now have customized versions for cases involving individual and non-individual debtors. The non-individual voluntary petition form pictured at the beginning of this post gives you an idea of how different the new forms look.
  • Going forward, business bankruptcy cases filed by corporations, LLCs, and partnerships will use a set of forms designed specifically for businesses instead of having to respond to questions meant for individuals.
  • The numbering system for the official bankruptcy forms is also changing. For example, forms bearing numbers in the 100 sequence will be reserved for individual debtors while those in the 200 sequence will apply to non-individual and business debtors.

Read All About It: Access The Revised Bankruptcy Forms. The U.S. Courts system has made the revised bankruptcy forms available now so you can get ready for the changes.

Get Ready. These major changes go into effect December 1st so bankruptcy attorneys and others should take the time now to review the new forms and get ready to use them.

37621686_0dcd0e12e5_z

The continuing saga of the impact of the U.S. Supreme Court’s Stern v. Marshall decision took a major turn Tuesday when the Court issued its ruling in the Wellness International Network, Limited v. Sharif case (follow link for copy of opinion). Before considering the decision and its significance, let’s first take a look at some past hits — bankruptcy court authority-style.

The Big Picture: The Stern v. Marshall Decision. In its 2011 summer blockbuster Stern v. Marshall, decided by a 5-4 vote, the U.S. Supreme Court held that even though Congress designated certain state law counterclaims as “core” proceedings, Article III of the U.S. Constitution prohibits bankruptcy courts from finally adjudicating those claims.  Like a good cliffhanger, Stern v. Marshall left a number of questions unanswered, including the following:

  1. Can a bankruptcy court enter a final judgment on “Stern claims” with the parties’ consent?; and
  2. Can a bankruptcy court treat a “core” Stern claim as “non-core” under 28 U.S.C. Section 157 and follow the statutory procedures for submitting proposed findings of fact and conclusions of law to the district court for de novo review, even though there appears to be a gap in the statute and it does not expressly provide for that approach?

A Limited Sequel: The Arkinson Decision. In a narrow 2014 decision in Executive Benefits Insurance Agency v. Arkinson, the Court answered only the second question, unanimously ruling that when hearing core Stern claims, bankruptcy courts can follow the non-core statutory procedure of submitting proposed findings of fact and conclusions of law to the district court for de novo review. However, the Court did not address the first question, leaving the issue of consent to live or die “another day.”

“Another Day” Finally Arrives: The Wellness Decision. With this week’s decision in Wellness, that other day arrived. In a 6-3 decision written by Justice Sotomayor, the Court held that parties to a Stern claim can constitutionally consent to having final judgment issued by a non-Article III bankruptcy judge. The Court further held, with the support of only five justices, that the requisite consent can be implied and need not be express as long as it’s “knowing and voluntary.”

The Wellness case involved an adversary proceeding by a creditor seeking declaratory relief on alter ego and other grounds, among other claims, that certain trust assets were property of the estate. In its decision, the Court apparently assumed without deciding that this presented a potential Stern claim.

In reaching its conclusion that “litigants may validly consent to adjudication by bankruptcy courts,” the Court relied heavily on the 1986 decision in Commodity Futures Trading Comm’n v. Schor, 478 U. S. 833 (1986), and two decisions involving federal magistrates, Gomez v. United States, 490 U. S. 858 (1989), and Peretz v. United States, 501 U. S. 923 (1991):

The lesson of Schor, Peretz, and the history that preceded them is plain: The entitlement to an Article III adjudicator is ‘a personal right’ and thus ordinarily ‘subject to waiver,’ Schor, 478 U. S., at 848. Article III also serves a structural purpose, ‘barring congressional attempts ‘to transfer jurisdiction [to non-Article III tribunals] for the purpose of emasculating’ constitutional courts and thereby prevent[ing] ‘the encroachment or aggrandizement of one branch at the expense of the other.” Id., at 850 (citations omitted). But allowing Article I adjudicators to decide claims submitted to them by consent does not offend the separation of powers so long as Article III courts retain supervisory authority over the process.

The question here, then, is whether allowing bankruptcy courts to decide Stern claims by consent would ‘impermissibly threate[n] the institutional integrity of the Judicial Branch.’ Schor, 478 U. S., at 851.

*     *     *

[W]e conclude that allowing bankruptcy litigants to waive the right to Article III adjudication of Stern claims does not usurp the constitutional prerogatives of Article III courts. Bankruptcy judges, like magistrate judges, ‘are appointed and subject to removal by Article III judges,’ Peretz, 501 U. S., at 937; see 28 U. S. C. §§152(a)(1), (e). They ‘serve as judicial officers of the United States district court,’ §151, and collectively ‘constitute a unit of the district court’ for that district, §152(a)(1). Just as ‘[t]he ‘ultimate decision’ whether to invoke [a] magistrate [judge]’s assistance is made by the district court,’ Peretz, 501 U. S., at 937, bankruptcy courts hear matters solely on a district court’s reference, §157(a),which the district court may withdraw sua sponte or at the request of a party, §157(d). ‘[S]eparation of powers concerns are diminished’ when, as here, ‘the decision to invoke [a non-Article III] forum is left entirely to the parties and the power of the federal judiciary to take jurisdiction’ remains in place. Schor, 478 U. S., at 855.

Importantly, the Court distinguished and limited Stern:

Our recent decision in Stern, on which Sharif and the principal dissent rely heavily, does not compel a different result. That is because Stern—like its predecessor, Northern Pipeline—turned on the fact that the litigant “did not truly consent to” resolution of the claim against it in a non-Article III forum. 564 U. S., at ___ (slip op., at 27).

*     *     *

Because Stern was premised on non-consent to adjudication by the Bankruptcy Court, the ‘constitutional bar’ it announced, see post, at 14 (ROBERTS, C. J., dissenting), simply does not govern the question whether litigants may validly consent to adjudication by a bankruptcy court.

An expansive reading of Stern, moreover, would be inconsistent with the opinion’s own description of its holding. The Court in Stern took pains to note that the question before it was ‘a ‘narrow’ one,’ and that its answer did ‘not change all that much’ about the division of labor between district courts and bankruptcy courts. Id., at ___ (slip op., at 37); see also id., at ___ (slip op., at 38) (stating that Congress had exceeded the limitations of Article III ‘in one isolated respect’). That could not have been a fair characterization of the decision if it meant that bankruptcy judges could no longer exercise their longstanding authority to resolve claims submitted to them by consent. Interpreting Stern to bar consensual adjudications by bankruptcy courts would ‘meaningfully chang[e] the division of labor’ in our judicial system, contra, id., at ___ (slip op., at 37).

Reacting to Chief Justice Roberts’s dissent predicting future encroachment by Congress on Article III courts, the Court responded with a memorable phrase:

To hear the principal dissent tell it, the world will end not in fire, or ice, but in a bankruptcy court.

(Some debtors and creditors might agree — great plot for a movie?)

On whether express consent is required, the Court stated:

Nothing in the Constitution requires that consent to adjudication by a bankruptcy court be express. Nor does the relevant statute, 28 U. S. C. §157, mandate express consent; it states only that a bankruptcy court must obtain“the consent”—consent simpliciter—“of all parties to the proceeding” before hearing and determining a non-core claim. §157(c)(2).

*     *     *

It bears emphasizing, however, that a litigant’s consent—whether express or implied—must still be knowing and voluntary. Roell [v. Withrow, 538 U. S. 580 (2003)] makes clear that the key inquiry is whether ‘the litigant or counsel was made aware of the need for consent and the right to refuse it, and still voluntarily appeared to try the case’ before the non-Article III adjudicator.

The Critics. In a vigorous dissent, Chief Justice Roberts, the author of the Court’s Stern decision, accused the Wellness majority of “an imaginative reconstruction” of Stern:

As the majority sees it, Stern ‘turned on the fact that the litigant ‘did not truly consent to’ resolution of the claim’ against him in the Bankruptcy Court. Ante, at 15 (quoting 564 U. S., at___ (slip op., at 27)). That is not a proper reading of the decision. The constitutional analysis in Stern, spanning 22 pages, contained exactly one affirmative reference to the lack of consent. See ibid. That reference came amid a long list of factors distinguishing the proceeding in Stern from the proceedings in Schor and other ‘public rights’ cases. 564 U. S., at ___–___ (slip op., at 27–29). Stern’s subsequent sentences made clear that the notions of consent relied upon by the Court in Schor did not apply in bankruptcy because ‘creditors lack an alternative forum to the bankruptcy court in which to pursue their claims.’ 564 U. S., at ___ (slip op., at 28) (quoting Granfinanciera, 492 U. S., at 59, n. 14). Put simply, the litigant in Stern did not consent because he could not consent given the nature of bankruptcy.

There was an opinion in Stern that turned heavily on consent: the dissent. 564 U. S., at ___–___ (opinion of BREYER, J.) (slip op., at 12–14). The Stern majority responded to the dissent with a counterfactual: Even if consent were relevant to the analysis, that factor would not change the result because the litigant did not truly consent. Id., at ___–___ (slip op., at 28–29). Moreover, Stern held that ‘it does not matter who’ authorizes a bankruptcy judge to render final judgments on Stern claims, because the ‘constitutional bar remains.’ Id., at ___ (slip op., at 36). That holding is incompatible with the majority’s conclusion today that two litigants can authorize a bankruptcy judge to render final judgments on Stern claims, despite the constitutional bar that remains.

Chief Justice Roberts’s comment that it was the Stern dissent that relied heavily on consent highlights that two members of the Stern majority, Justices Kennedy and Alito, joined the four dissenting Justices in Stern to form the 6-3 majority in Wellness. Perhaps with practical considerations in mind, Justices Kennedy and Alito voted in Wellness to limit Stern’s constitutional bar to situations in which the parties do not consent to entry of a final judgment by the bankruptcy court.

Justice Thomas filed his own dissenting opinion, raising interesting questions he believed both the majority and Chief Justice Roberts overlooked. These included the nature of consent, separation of powers issues, and historical exceptions in which non-Article III adjudications have been permitted.

Bankruptcy Courts In A Leading Role. Together, Wellness and Arkinson mean that bankruptcy courts will continue to land a big part in hearing all types of bankruptcy matters, including Stern claims, despite the fears of some following the Stern decision.

  • For a Stern claim, if the parties give “knowing and voluntary” consent, even if not express consent, the bankruptcy court will have constitutional authority to enter a final judgment. (As the Court noted in footnote 13 of the Wellness decision, if proposed revisions to Federal Rules of Bankruptcy Procedure 7008 and 7012 take effect, a statement giving or withholding express consent will be required by rule in adversary proceedings.)
  • For a Stern claim, if the parties do not consent, the bankruptcy court will still be able to follow the non-core statutory procedure and submit proposed findings of fact and conclusions of law to the district court for de novo review.
  • For core claims that are not Stern claims, as before, the bankruptcy court can enter a final judgment without consent of the parties.
  • For non-core claims, as before, the bankruptcy court can enter final judgment if the parties consent and, if not, will submit proposed findings of fact and conclusions of law to the district court for de novo review.

Conclusion. In what will likely be a box office hit with bankruptcy attorneys, the Supreme Court in Wellness substantially limited the impact of the Stern v. Marshall decision, allowing bankruptcy courts to enter final judgments, even on Stern claims, with consent of the parties. Consent has to be knowing and voluntary, but as often happens with non-core claims, parties may well choose to buy a ticket and have the bankruptcy court enter final judgment on Stern claims. Had Wellness gone the other way, the already overloaded district courts could have been faced with many more de novo review proceedings. The prospect of such coming attractions has likely been averted with the Wellness opinion, written — perhaps not coincidentally — by the only former district court judge on the Supreme Court, Justice Sotomayor.

 

Image Courtesy of Flickr by David

9547580380_42104f9574_z

When an insolvent entity files for bankruptcy, it can be tough to be a creditor. But holding equity — stock in a corporation or a membership interest in an LLC, a limited liability company — can be even worse. Under bankruptcy’s “absolute priority rule,” creditors generally must be paid in full before equity gets anything. That usually means that holders of equity, or claims treated as equity, get nothing.

Section 510(b) Mandatory Subordination. A recent decision by the U.S. Court of Appeals for the Ninth Circuit in In re Tristar Esperanza Properties, LLC serves as a good reminder of the special bankruptcy rules involving mandatory subordination of certain equity-like claims. More on the Tristar case in a minute, but first let’s take a look at the provision that spells out the mandatory subordination rule. Section 510(b) of the Bankruptcy Code provides:

For the purpose of distribution under this title, a claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under section 502 on account of such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except that if such security is common stock, such claim has the same priority as common stock.

Whole Categories Of Claims Subordinated. Unlike equitable subordination of claims under Section 510(c) of the Bankruptcy Code, which the bankruptcy court may impose if the specific circumstances merit it, Section 510(b) subordination is mandatory and applies to entire categories of claims. These include securities fraud or rescission claims, whether individually or as part of a class action, against the bankrupt company arising from the purchase or sale of its stock or other security.

  • A securities fraud claim by current or former stockholders alleging fraud in the purchase of common stock, leading to damages when the stock price dropped? Subordinated to the level of common stock.
  • A lawsuit for damages to stockholders for breach of an agreement to register or issue shares of common stock? Subordinated to the level of common stock.
  • A lawsuit seeking to rescind a purchase of common stock, and get back the purchase price, due to alleged fraud? Subordinated to the level of common stock.
  • A judgment in any of those cases against the issuer of the stock? You guessed it — subordinated to the level of common stock.

Why Are These Claims Subordinated? Congress enacted Bankruptcy Code Section 510(b), as one court said, “to prevent disappointed shareholders . . . from recouping their investment in parity with unsecured creditors.” Put another way, Section 510(b) ensures that claims of true creditors are not diluted by claims of stockholders or former stockholders seeking damages arising from their stock interests.

  • As the old saying goes, creditors just want to get paid. Stockholders, on the other hand, invest risk capital in hopes of sharing in a company’s profits and “upside” potential. With that chance, however, comes the risk of losing their equity investment.
  • If claims arising out of the purchase or sale of securities were not subordinated, creditors would recover less and shareholders (or former shareholders) would effectively be paid on the same level as creditors, not below them as the absolute priority rule dictates.
  • To avoid this outcome, the Bankruptcy Code imposes mandatory subordination on these types of equity-related claims, preventing shareholders from transforming an equity-like claim into a judgment or proof of claim entitled to creditor treatment in bankruptcy.
  • As a side note, mandatory subordination is similar in concept but nevertheless different from recharacterization of a debt as equity, which involves an analysis on a case by case, rather than category, basis.

Subordination Only As To The Bankrupt Entity. The fact that these claims are subject to mandatory subordination in a bankruptcy of the issuer or its affiliate does not mean that securities fraud or other claims will be subordinated against third parties, including underwriters or directors and officers, or that insurance proceeds might not still be available to settle those claims. However, once an issuer files bankruptcy, claims against its assets in the bankruptcy estate will face mandatory subordination.

Are There Any Exceptions? Lower courts have held that mandatory subordination does not apply to convertible promissory notes where the conversion feature was never invoked, or to an “old and cold” promissory note for an equity repurchase made many years before the bankruptcy (although in the Tristar decision the Ninth Circuit noted that it was not reaching that issue). The Ninth Circuit held in In re American Wagering, Inc., 493 F.3d 1067 (9th Cir. 2007), that a claim under an employment agreement, where the claimant was never an equity investor and compensation was simply calculated based on the price of stock, should not be subordinated under Section 510(b). Depending on the circumstances, particular claims might be subject to an equitable subordination challenge under Section 510(c) of the Bankruptcy Code but, as noted, that is a separate legal standard and analysis.

The Tristar Esperanza Properties Decision. On April 2, 2015, the U.S. Court of Appeals for the Ninth Circuit issued a 12-page decision in In re Tristar Esperanza Properties affirming the lower courts’ decisions to subordinate under Section 510(b) a money judgment in favor of Jane O’Donnell, a member of the LLC. O’Donnell had exercised her right to withdraw from the LLC and require Tristar to purchase her membership interest based on the valuation procedure in the LLC operating agreement. She and Tristar could not agree on a valuation, and O’Donnell brought an arbitration action, receiving a $410,000 award in her favor. When Tristar failed to pay she confirmed the arbitration award in state court and got a state court judgment.

  • Less than a year later Tristar filed a Chapter 11 bankruptcy case, and O’Donnell filed a proof of claim based on the state court judgment.
  • Tristar filed an adversary proceeding seeking to subordinate her claim under Section 510(b), among other challenges. The bankruptcy court granted Tristar summary judgment and the Bankruptcy Appellate Panel affirmed.
  • On appeal to the Ninth Circuit, O’Donnell’s main arguments were that although her LLC membership interest was a security of the debtor, her claim was neither for “damages” nor “arising from the purchase or sale” of the membership interest.
  • The Ninth Circuit rejected both arguments, interpreting both clauses of Section 510(b) broadly.
    • First, it held that her claim was for “damages,” in this case for breach of contract, and Section 510(b)’s damages clause should be read broadly. It rejected her argument that fixed, admitted debts should be excluded from the scope of “damages” in Section 510(b), noting that the very broad definition of “claim” in Section 101(5)(A) of the Bankruptcy Code makes no such distinction.
    • Second, even though O’Donnell was a judgment creditor and no longer an equity holder at the time Tristar filed bankruptcy, the Ninth Circuit emphasized that Section 510(b) applies if a creditor claim “arises from the purchase or sale of a security.” A claim will be subordinated if there is a sufficient nexus or causal relationship between the claim and the purchase or sale of securities.

The Ninth Circuit’s Rationale. The Ninth Circuit elaborated on the rationale for mandatory subordination, quoting from its earlier decision in In re Betacom of Phx., Inc., 240 F.3d 823 (9th Cir. 2001) and explaining:

Our straightforward reading of the ‘arises from’ language in § 510(b) comports with congressional intent. As we have said, ‘[t]here are two main rationales for mandatory subordination: 1) the dissimilar risk and return expectations of shareholders and creditors; and 2) the reliance of creditors on the equity cushion provided by shareholder investment.’ Although O’Donnell did not enjoy the benefits of equity ownership on the date of the petition, she bargained for an equity position and thus embraced the risks that position entails.

Conclusion. The Ninth Circuit is essentially telling investors “once a shareholder, always a shareholder,” at least if a claim in bankruptcy arises from an equity interest. Even though O’Donnell had transformed her LLC membership interest into a money judgment, it was still subordinated and treated like equity. This new decision reminds us once again that Section 510(b)’s mandatory subordination rules impact entire categories of claims and make it extremely difficult to collect on any equity-like claim in bankruptcy.

 

Image Courtesy of Flickr by Ervins Strauhmanis

15114711161_ae75e9f25e_z

Risky Business. When a debtor is a licensee under a trademark license agreement, does it risk losing those license rights when it files bankruptcy? The question had not been answered in a Delaware bankruptcy case until Judge Kevin Gross recently addressed it in the In re Trump Entertainment Resorts, Inc. Chapter 11 case. A lot was riding on the decision, not just for the parties involved but, given how many Chapter 11 cases are filed in Delaware, more generally for other trademark licensees and owners as well.

The Debtors were licensees of trademarks and other rights from Donald and Ivanka Trump, through an entity called Trump AC. Trump AC sought relief from the automatic stay to proceed with a state court action it had filed against the Debtors before the bankruptcy in New Jersey Superior Court, seeking to terminate the underlying trademark license agreement.

In a 21-page opinion issued on February 20, 2015, a copy of which is available by following the link, Judge Gross granted Trump AC’s motion for relief from stay. With the decision, Delaware joined the growing trend of courts giving “veto rights” to trademark owners, similar to those enjoyed by patent and copyright owners, over the assignment — and in some courts, even over the assumption — of trademark licenses.

The Key Bankruptcy Code Section. Judge Gross first examined whether the Debtors could assume the trademark license, which no one disputed was executory, in light of Bankruptcy Code Section 365(c)(1). That section provides:

(c) The trustee may not assume or assign any executory contract or unexpired lease of the debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties, if—

(1)(A) applicable law excuses a party, other than the debtor, to such contract or lease from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession, whether or not such contract or lease prohibits or restricts assignment of rights or delegation of duties; and

(B) such party does not consent to such assumption or assignment.

The Hypothetical Test Applies In Delaware. Judge Gross noted that in In re West Elecs. Inc., 852 F.2d 79 (3d Cir. 1988), the Third Circuit interpreted Section 365(c)(1) to require a court to ask, hypothetically, whether a debtor could assign the executory contract at issue (even if the debtor didn’t seek to assign it). If the debtor couldn’t assign it under applicable non-bankruptcy law, then it couldn’t assume it either. This is the so-called “hypothetical test” interpretation. The Court also held that Section 365(f)(1), which generally overrides anti-assignment provisions in an executory contract or applicable law, is itself subject to Section 365(c)(1)’s carve-back when applicable law makes the identity of the contracting party crucial to the contract.

Does Applicable Law Prohibit Assignment? Having addressed these threshold issues, Judge Gross next considered whether applicable non-bankruptcy law, here federal trademark law, makes a trademark license agreement non-assignable without the trademark owner’s consent. Ultimately, the Court answered yes, and followed the Seventh Circuit’s 2011 decision in In re XMH Corp., 647 F.3d 690 (7th Cir. 2011):

Based on the Court’s research and cases cited by Trump AC, it appears that the substantial weight of authority holds that under federal trademark law, trademark licenses are not assignable in the absence of some express authorization from the licensor, such as a clause in the license agreement itself. See, e.g., XMH, 647 F.3d at 695 (“as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment”); Miller v. Glenn Miller Prods., Inc., 454 F.3d 975, 988, 992-93 (9th Cir. 2006); N.C.P. Mktg. Group, Inc. v. Billy Blanks (In re N.C.P. Mktg. Group, Inc.), 337 B.R. 230, 235-37 (D. Nev. 2005); 3 McCarthy on Trademarks § 18:43 (4th ed. 2010).

However, as recognized in the Ninth Circuit’s Catapult decision, it is not sufficient to simply recognize a general ban on contract assignment under the applicable nonbankruptcy law, the Court must understand why the applicable non-bankruptcy law bans assignment. As explained by the Seventh Circuit in XMH:

Often the owner of a trademark will find that the most efficient way to exploit it is to license the production of the trademarked good to another company, which may have lower costs of production or other advantages over the trademark’s owner. Normally the owner who does this will not want the licensee to be allowed to assign the license (that is, sublicense the trademark) without the owner’s consent, because while the owner will have picked his licensee because of confidence that he will not degrade the quality of the trademarked product he can have no similar assurance with respect to some unknown future sublicensee.

647 F.3d at 696. “The purpose of a trademark, after all, is to identify a good or service to the consumer, and identity implies consistency and a correlative duty to make sure that the good or service really is of consistent quality, i.e., really is the same good or service.” Id. at 695. Accord 4 McCarthy on Trademarks § 25:33 (4th ed. 2010) (“Since the licensor-trademark owner has the duty to control the quality of goods sold under its mark, it must have the right to pass upon the abilities of new potential licensees.”).

The Court determined that Trump AC had not waived this default rule against assignments in the trademark license agreement. The Court also clarified that a separate consent Trump AC had given for the benefit of the Debtors’ first lien lenders had not been triggered and did not apply to the Debtors. As a result, Trump AC had not consented to assignment or assumption of the trademark license.

What About Exclusive Trademark Licenses? The Debtors argued that the Court should hold the agreement to be an exclusive trademark license, apply patent and copyright license case law suggesting that exclusive licenses should be treated differently, and deny the stay relief motion. The Court’s short answer: no dice.

The distinction between exclusive and non-exclusive licenses is simply not relevant in the trademark context. The general prohibition against the assignment of trademark licenses absent the licensor’s consent is equally applicable to both exclusive and non-exclusive trademark licenses. A trademark licensor would have the same concerns with respect to the identity of the licensee and the quality of products bearing its trademark whether the trademark license is exclusive or non-exclusive. Thus, a rule distinguishing between exclusive and non-exclusive licenses for purposes of assignability makes little sense in the trademark context. Further, trademarks, copyrights, and patents are governed by different sets of laws and influenced by different policy concerns. “[W]hile the basic policies underlying copyright and patent protection are to encourage creative authorship and invention, the purposes of trademark protection are to protect the public’s expectation regarding the source and quality of goods.” Miller, 454 F.3d at 938. The Catapult and Golden Books decisions, while persuasive so far as they apply, simply address different circumstances than are before the Court here.

The Power To Consent. Although it prevailed on the relief from stay motion, Trump AC ultimately reached an agreement with the Debtors, allowing the continued use of the Trump trademarks at the Taj Mahal casino, in conjunction with confirmation of the Debtors’ plan of reorganization. That new agreement provided the “consent” required under Section 365(c)(1)(B) for the Debtors to assume the otherwise non-assignable, and therefore non-assumable, trademark license agreement.

The Stakes Are Raised. Debtors with in-bound trademark licensees better take note of this decision. First it was the Nevada District Court and later the Ninth Circuit in the N.C.P. Marketing case, followed a few years later by the Seventh Circuit in the XMH case. Now, with the Trump Entertainment decision, add Delaware to the list of courts holding that trademark licenses are not assignable without the trademark owner’s consent. In Delaware, California, and other hypothetical test jurisdictions, these licenses will also be non-assumable, giving trademark owners — not their debtor licensees — the winning hand.

Image Courtesy of Flickr by Poker Photos

5802530663_45c7b853d7_z (1)

Winding Down. If a corporation’s board of directors decides that the business needs to be wound down, there are a number of legal paths to consider. Determining the best approach is fact-dependent, and the corporation and its board should get legal advice before making a decision. Sometimes a bankruptcy filing is needed, either a Chapter 11 reorganization (perhaps to complete a going-concern sale) or a Chapter 7 liquidation bankruptcy (in which a trustee will be appointed to liquidate the business). In other cases, an assignment for the benefit of creditors might be a good choice.

A Delaware Corporate Dissolution. This post takes a high-level look at another, often simpler option: the corporate dissolution.  It assumes that the business is a Delaware corporation, since many corporations incorporate there. The laws of the state of incorporation govern the dissolution process, so it’s important to remember that the process described below will differ if the business is incorporated in another state.

Why A Corporate Dissolution? Corporations typically choose to do a corporate dissolution when they don’t need bankruptcy protection (and prefer to avoid filing bankruptcy) but want to have the corporation formally wound down. The dissolution process can be less expensive than other alternatives, particularly when litigation or disputes over claims is unlikely.

  • When properly conducted, a dissolution can bar late claims against the corporation and provide directors with protection from personal liability to claimants.
  • Unlike a bankruptcy filing (but similar to an assignment for the benefit of creditors), a dissolution requires shareholder approval; that often makes it a better fit for privately held corporations.
  • A dissolution typically requires at least one director to supervise the process and at least one officer to manage the wind down and liquidation, although some professional firms will step into those roles.
  • Corporations often elect to dissolve at a point when they anticipate being able to pay creditors in full and return some funds to shareholders or, if they are insolvent, find their creditors generally to be cooperative. If the corporation has a bank or other secured creditor, it helps if they are willing to work with the corporation to liquidate the assets without a foreclosure.

A Corporation In Dissolution. Under Delaware law, once the dissolution commences the corporation is no longer permitted to operate as a normal business. Instead, as the Delaware statute provides, the corporation continues only “gradually to settle and close their business, to dispose of and convey their property, to discharge their liabilities and to distribute to their stockholders any remaining assets, but not for the purpose of continuing the business for which the corporation was organized.” The corporation is allowed up to three years to complete the dissolution process; if more time is required, a request has to be made to the Delaware Court of Chancery (although a corporation in dissolution remains in existence, without having to go to the Chancery Court, to complete lawsuits that are pending when the three year period expires).

Key Aspects Of A Dissolution. To give you a sense of the process involved, below is a list of some of the main steps in a dissolution. However, please note that important details go beyond the scope of this post. Examples include special voting procedures that may be required if preferred stock has been issued, possible alternatives to the claims process, establishing reserves for claims, payment of the costs of the liquidation, winding down subsidiaries, and the impact of foreign affiliates. It bears repeating: a corporation considering a dissolution should get legal advice on all aspects of the process.

With that caveat, a dissolution generally involves the following:

  • Board approval of a decision to dissolve and adoption of a plan of liquidation;
  • Shareholder approval of the dissolution and plan of liquidation in requisite majorities as provided under the corporation’s then-current Certificate of Incorporation;
  • Filing of a Delaware Annual Franchise Tax Report and payment of franchise taxes, including a partial-year final franchise tax report;
  • Filing a Certificate of Dissolution with the Delaware Secretary of State’s office;
  • Timely reporting to the Internal Revenue Service of the dissolution;
  • A formal claims process, with at least 60 days notice to potential claimants of the dissolution and deadline to file claims, together with publication of the notice in required newspapers;
  • Review of filed claims, with appropriate offers to claimants or rejections of claims;
  • Resolution of any lawsuits, including any timely-filed by claimants whose claims the corporation rejected;
  • Liquidation of remaining corporate assets in accordance with the plan of liquidation;
  • Preparation and filing of all final tax returns;
  • Withdrawals or surrender of qualifications to do business in other states; and
  • Final distributions to creditors and, if funds remain, to applicable shareholders.

Conclusion. In the right situation, a dissolution can be the best approach to formally wind down a corporation’s business and corporate existence. As with all corporate governance matters, however, the corporation’s board and management should get legal advice tailored to the corporation, its business, and creditors, and guidance throughout the dissolution process.

 

Image courtesy of Flickr by JBrazito

3089698096_e33b630292_z

The American Bankruptcy Institute‘s Commission to Study the Reform of Chapter 11 issued its report last week, capping more than two years of hearings, meetings, and hard work. Having had the honor of testifying before the Commission on intellectual property and bankruptcy issues at one of its hearings in New York in June 2013, I wanted to take a closer look at its intellectual property recommendations when a licensor or licensee files bankruptcy.

You can download the Commission’s entire report for all the details, but the Commission’s main IP recommendations address five key issues:

  1. Should rejection of an intellectual property license under Section 365(g) terminate an IP licensee’s rights to the IP (absent Section 365(n) protection);
  2. Should a bankrupt licensee or trustee be able to assume an in-bound IP license;
  3. Should a bankrupt licensee or trustee be able to assign an in-bound IP license;
  4. Should Section 365(n) expressly cover foreign IP when a licensor is in bankruptcy; and
  5. Should trademarks be covered by Section 365(n)’s protections when a licensor is in bankruptcy?

Let’s examine the Commission’s recommendations on each in turn.

The Consequences Of Rejection. A threshold issue addressed was the proper impact of rejection of an executory contract, including an intellectual property license, under Section 365(g). The Commission recommended that rejection end a non-debtor counterparty’s right to continued use of property of the estate, subject to specific protections such as Section 365(n). In doing so, it appeared to follow the long-standing Fourth Circuit decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985) and not the Seventh Circuit’s more recent decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC,  686 F.3d 372 (7th Cir. 2012). As a side note, the Commission also recommended that all IP licenses be deemed executory. In combination, these positions would make the scope of Section 365(n) even more important and, as we will see on the final two questions, the Commission had a series of specific recommendations on Section 365(n) protections.

Resolving The Hypothetical/Actual Test Issue. A key question that arises when a licensee files bankruptcy is whether the debtor licensee can assume an in-bound license of another party’s intellectual property. The circuits have split on this “hypothetical vs. actual test” reading of Section 365(c)(1) and the Commission sided squarely with the actual test when a debtor in possession, as licensee, proposes to assume but not assign an IP license. The Commission believed a licensor would be receiving the benefit of its bargain in that situation since the debtor in possession as licensee would be assuming, and therefore continuing to perform under, the license. This makes sense for a debtor in possession, but the Commission’s recommendation speaks of the right of a “trustee” to assume a license, which would introduce a new party (the trustee) in the role of licensee. Although a full discussion of this “hypothetical vs. actual test” split is beyond the scope of this post, you can read about it — and the Supreme Court’s interest in the issue a few years ago– in this earlier post discussing the issues, or of course in the Commission’s report.

Making IP Licenses Assignable To Non-Competitors. In addition to voting to codify the actual test when a debtor in possession or trustee proposes to assume an IP license, the Commission also recommended that debtor licensees and their trustees be permitted to assign those licenses to a single assignee under Section 365(f), notwithstanding applicable nonbankruptcy law such as federal patent, copyright, or trademark law, or any contrary provision in the license.

  • If the proposed assignee is a competitor of the licensor or an affiliate of such competitor, the Commission recommended that the bankruptcy court be permitted to deny the assignment if it determined, after notice and a hearing, that the harm to the nondebtor licensor resulting from the proposed assignment “significantly outweighs the benefit to the estate derived the assignment.”
  • The burden of proof would be on the nondebtor licensor in such a hearing.
  • If adopted, this would make in-bound IP licenses more assignable in bankruptcy than out, similar to non-residential real property leases, and licenses could potentially become a source of value for creditors.
  • However, even if owners of patents, copyrights, and trademarks could accept adoption of the actual test for assumption of IP licenses, they might have a harder time giving up control over whether and to whom licenses of their IP could be assigned.

The Foreign IP Issue. Section 101(35A) of the Bankruptcy Code defines “intellectual property” for purposes of the protections of Section 365(n), using either general terms or references to provisions of the United States Code. The Commission seemed to believe foreign IP was not covered by the current definitions (although several arguments suggest that it is), and to resolve any uncertainty the Commission recommended that foreign patents and copyrights expressly be included in Section 101(35A)’s definitions. It found no reasonable basis for treating foreign IP differently. In addition, the Commission recommended that foreign trademarks also be included in this definition subject to the same limitations and conditions, discussed below, as it proposed should apply to domestic trademarks.

Giving Trademark Licensees Protections Under Section 365(n). An important recent trend at the intersection of IP and bankruptcy law has been the efforts of courts to protect trademark licensees from the effects of rejection of their licenses by trademark licensors in bankruptcy. The Third, Seventh, and Eighth Circuits have sided with trademark licensees in recent cases, and a New Jersey bankruptcy court recently went so far as to extend Section 365(n) protections to trademark licensees on equitable grounds. In addition, the House of Representatives (but not the Senate) passed the Innovation Act, which would have added trademarks to Section 101(35A) and therefore grant them Section 365(n) protection. Addressing this issue, the Commission recommended the following:

  • Trademarks, service marks, and trade names as defined in Section 1127 of Title 15 of the U.S. Code should be added to the definition of Section 101(35A).
  • If the trustee or debtor in possession rejects a license of a trademark, service mark, or trade name, Section 365(n) would apply with certain modifications. First,  the nondebtor licensee would be required to comply with the license and related agreement, including with respect to (i) the products, materials, and processes the license permitted or required, and (ii) its obligations to maintain sourcing and quality of the licensed products or services. The trustee (or debtor in possession) should maintain the right to oversee and enforce quality control but without any continuing obligation to provide further products or services.
  • The concept of “royalty payments” would be expanded to include “other payments” contemplated by the license of the trademark, service mark, or trade name.

These trademark recommendations are similar to the Innovation Act’s provisions and, as such, might find support in Congress.

Conclusion. The ABI’s Chapter 11 Commission has presented a comprehensive set of recommendations on many fundamental aspects of Chapter 11. In its intellectual property recommendations, the Commission tackled some of the most common bankruptcy and IP issues being litigated today. If enacted by Congress, its recommendations would resolve circuit splits, clarify licensee and licensor’s rights in bankruptcy, and squarely extend protection to trademark licensees. Whether or not you agree with every recommendation, the Commission should be commended for its serious, thoughtful, and diligent effort to improve Chapter 11 for debtors, creditors, and the general public.

Image Courtesy of Flickr by O Palsson

Summons2 IMG_2094

Almost every year, changes are made to the set of rules that govern how bankruptcy cases are managed — the Federal Rules of Bankruptcy Procedure. The changes address issues identified by an Advisory Committee made up of federal judges, bankruptcy attorneys, and others.

Rule Amendments. This year the rule amendments, which go into effect on December 1, 2014, mainly address bankruptcy appeals, as well as an important one on service of a summons (discussed below).

  • Follow this link for a copy of the amendments, in both clean and redline, together with the transmittal letters and helpful Advisory Committee comments.  
  • This year’s rule changes include revisions to the Federal Rules of Appellate Procedure governing bankruptcy appeals, including direct appeals from a district court exercising bankruptcy jurisdiction, rule and form revisions regarding elections to appeal to a bankruptcy appellate panel or a district court, rules favoring the use of electronic notice in bankruptcy appeals, the impact on a bankruptcy appeal of a post-judgment motion for a new trial or to amend a judgment, and technical amendments to implement these revisions. 

No Waiting On Service Of A Summons. Aside from the appeals-related amendments, one rule change will impact every bankruptcy lawyer that files an adversary proceeding, the bankruptcy term for a lawsuit filed within a bankruptcy case.

  • Federal Rule of Bankruptcy Procedure 7004(e) has been revised to require service of a summons in an adversary proceeding within seven days of its issuance, cutting in half the fourteen day time period that had previously been permitted.
  • Although nationwide service of process via U.S. mail is still allowed as before, the summons and complaint will need to be served promptly after issuance of the summons. Otherwise, the originally issued summons will become “stale” — meaning ineffective — and a new summons will have to be issued and promptly served.
  • Why the change? In adversary proceedings, Federal Rule of Bankruptcy Procedure 7012(a) provides that a defendant has 30 days from the date the summons is issued to respond, not from the date of service. The rule change will give defendants an extra week, give or take depending on the mail, to respond to a complaint.

Revised Bankruptcy Forms And Fees. To implement the rule amendments, several national bankruptcy forms will also be revised. Copies of the revised bankruptcy forms are available at the link in this sentence, and you should also check your local bankruptcy court’s website for local rule and form revisions. There are also fee changes, specifically, the fee for direct appeals from the bankruptcy court to the court of appeals goes up, and a new $25 fee kicks in for redacting documents previously filed in a bankruptcy case.