Business Bankruptcy Issues

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Business Bankruptcy Issues

Bankruptcy Asset Sales: What Parties With Contracts Should Watch For

In many corporate bankruptcy cases, the debtor will use the bankruptcy process to sell its assets and to assume and assign valuable leases, executory contracts, and licenses (see earlier posts on what happens to leases in bankruptcy, to executory contracts, and to intellectual property licenses, a special type of executory contract). 

This post discusses some mechanics of the bankruptcy sale process and points out how parties to executory contracts and leases can protect their rights. (A discussion of the sale process from the buyer’s perspective can be found here.)

The Section 363 sale.  A bankruptcy asset sale often will happen in the first few weeks or months of a Chapter 11 case, rather than as part of a plan of reorganization. Frequently this will involve a sale of all or substantially all of a debtor’s business as a going concern. You may hear the sale referred to as a "Section 363 sale" because Section 363 is the key Bankruptcy Code section that governs a debtor’s sale of assets in bankruptcy. Regardless of what is being sold, the debtor must seek bankruptcy court approval of the sale and of any effort to transfer executory contracts, licenses, and leases to the buyer. 

Sales "free and clear" of liens. When the debtor files a motion seeking to sell its assets, it usually will ask to do so free and clear of liens. The term "lien" includes everything from UCC security interests filed by banks or other secured lenders taking the debtor’s assets as collateral for loans to judgment and other types of liens. In a Section 363 sale, a debtor may propose to sell the assets and hold the sale proceeds in a separate account, with the secured creditors’ liens being transferred over to those funds. Debtors ask for authority to sell the assets "free and clear" of liens because the buyer wants clear title to the assets, unencumbered with any of the debtor’s old debts and liens.

Motion to assume and assign executory contracts and leases. The debtor will typically file another motion (or may combine it with the motion to sell free and clear) seeking authority to assume and assign to the buyer certain executory contracts and leases.  If you are a party to an executory contract or lease, you should follow the sale process closely because your rights could well be affected. 

  • The debtor will likely send out a notice to parties to executory contracts and to landlords with a list of the contracts and leases proposed to be assumed and assigned. This is a very important document and you or your counsel should review every page carefully. 
  • The notice typically will list the amount the debtor proposes to pay to “cure” any defaults. The debtor must cure any defaults in cash before the contract or lease can be assumed and assigned to the buyer. Very often the notice will indicate that the proposed cure amount for some contracts or leases is zero or it may leave the amount blank with an asterisk stating that the debtor believes that no cure amount is owed. 
  • Here’s an example of a notice, with a fairly typical multi-page chart listing scores of contracts to be assumed and assigned as part of the sale and indicating proposed cure amounts. 

Scream or die. This isn’t a warning in a horror film but a phrase bankruptcy lawyers have coined to describe a creditor’s requirement to file an objection by the stated deadline or face the loss of your rights. (You have to admit it’s catchy.) To put it in less vivid terms, if you want to object (1) to the assignment of your executory contract, license, or lease at all, (2) to its assignment to the particular buyer proposed, or (3) even to the amount proposed to be paid to cure defaults, you have to file a written objection by the deadline listed in the notice. If you don’t, the debtor will ask the bankruptcy court for an order approving the transfer of your contract, license, or lease, and that may well involve no cure payment at all. Because bankruptcy cases move quickly by necessity, "screaming" after the deadline will generally be too late.

Got counsel?  If you have an important executory contract, intellectual property license, or commercial lease with a debtor, having your counsel monitor the bankruptcy case and review any sale motions and assumption and assignment notices is the best way to protect your rights. Otherwise, you may miss an opportunity to receive a cure payment, to object to an assignment of an intellectual property license, or otherwise to exercise your rights in the bankruptcy case.

Business Bankruptcy Issues

Doing Business With A Customer In Bankruptcy: What You Need To Know

An issue that comes up for creditors when a customer files bankruptcy is whether to keep doing business or end the relationship. Since debtors usually cannot survive without at least some level of trade support, generally they reach out to suppliers in an attempt to obtain trade terms, or at least a steady supply of goods, after a Chapter 11 bankruptcy is filed.  Often they put information about doing business in light of the bankruptcy (see this example from Delta Airlines) on a restructuring website or send out written communications to suppliers.

This post looks at the issue from the creditor’s perspective. When a smaller customer files bankruptcy the "keep doing business" question is less critical, and the bankruptcy filing may just be the final straw that leads you to want to stop selling or providing services to the customer.  When one of your bigger customers files bankruptcy, the stakes go up — often way up.  In either case, it’s important to know the ground rules about doing business with a bankrupt customer.

Administrative claim for post-bankruptcy sales. In general, if the bankrupt customer is a Chapter 11 debtor in possession, it is legally permitted to pay for post-petition (post-bankruptcy filing) purchases of goods and services in the ordinary course of business. Such amounts are generally accorded administrative claim status, with priority over unsecured and certain other claims, and the debtor is authorized to pay them currently. (Chapter 7 trustees usually close a business down and do not place further orders.)

Make sure you have an administrative claim. The standard for allowance of administrative claims requires proof of the necessity and the value to the estate of the goods or services.  While this usually is the amount set forth in a contract or purchase order, to avoid any dispute it’s best to reach a clear understanding with the debtor (or a bankruptcy trustee in the rarer instances when a Chapter 11 or Chapter 7 trustee is purchasing goods or services) before providing post-petition goods or services. Moreover, if there’s any chance that your transaction would not be considered an "ordinary course" transaction, for example if it’s an unusually large purchase or on unusual terms, you should consider seeking bankruptcy court approval to make sure the transaction is authorized and that your rights are protected.

Be careful of the executory contract twist. Your dealings with the debtor post-petition may also depend on the nature of your pre-petition relationship. 

  • If you have sold products through separate purchase orders or individual transactions without an overarching contract (see earlier post for a fuller discussion of such executory contracts) governing the relationship, generally you may choose whether to continue dealing with the debtor post-petition and on what terms you do so (e.g., whether to require cash in advance or continue with trade credit terms). If you have unpaid amounts based on your pre-petition transactions with the debtor, that claim would be treated like other unsecured claims separate from any post-petition claim. 
  • If you and the debtor are parties to a pre-petition contract that is executory (meaning both you and the debtor have material obligations to continue to perform), you cannot automatically stop performing post-petition unless the debtor has officially rejected the contract. Rejection means that the debtor has decided to stop performing and the bankruptcy court has approved that decision. Alternatively, if the debtor has decided to continue to perform (assume) the contract, and the bankruptcy court has approved this assumption decision, the debtor will have to cure, in cash, any pre-petition amounts owed.
  • Until the debtor has made a decision about your contract, the debtor may be willing to make current post-petition payments under the contract. You should consider confirming this understanding with the debtor or its counsel in writing to protect your rights.
  • If you’re concerned that you won’t be paid for your post-petition performance or if you don’t want to continue to perform for other reasons, you may need an attorney to file a motion to compel the debtor or trustee to assume or reject the contract, or to seek “adequate protection” payments pending that decision. Bankruptcy courts often give a Chapter 11 debtor a long time to make this decision, even until a plan of reorganization is confirmed.  However, the court may be willing to order that you be paid currently for post-petition amounts and/or clarify that you have an administrative priority claim for your post-petition performance.

Is the debtor creditworthy? While these legal issues are important, it’s equally critical to assess the debtor’s financial condition after bankruptcy.  A bankruptcy filing relieves a debtor from the obligation to pay pre-petition unsecured creditor claims, and this can make a substantial difference to a debtor’s cash flow. Still, the debtor has to have sufficient liquidity to pay its post-petition administrative claims.

  • Many debtors obtain post-petition financing from lenders — known as debtor in possession or DIP financing — and this can provide the necessary liquidity to pay administrative claims. DIP financings are usually secured by a blanket security interest on all of the debtor’s assets, however, putting the DIP lender ahead of even administrative claims in the event of default.  
  • While not common, debtors do sometimes default under DIP financings. When that happens, the DIP lender will often foreclose on the debtor’s assets and the bankruptcy case will be converted to Chapter 7 liquidation. If so, not only will the DIP lender’s debt be paid first from the estate’s assets, but the administrative claims generated during the Chapter 11 case will become second in line to Chapter 7 administrative claims, such as the Chapter 7 trustee’s fees and expenses and those of his or her counsel. 
  • For these reasons, it’s still very important to be comfortable with a Chapter 11 debtor’s financial condition and its wherewithal to pay for post-petition sales before extending post-petition credit. Most debtors are required to file post-petition monthly financial reports (here’s an example from Delphi’s bankruptcy case), and they can serve as one source of financial information.

Consult with bankruptcy counsel. These general rules govern most scenarios, but dealing with a debtor post-petition can be complicated and raise many issues unique to your situation. For this reason, it’s best to get an attorney’s advice before engaging in any significant transactions with a debtor.

Business Bankruptcy Issues

Commercial Real Estate Leases: How Are They Treated In Bankruptcy?

Much like executory contracts, commercial real estate leases are governed by special rules in bankruptcy. If a lease’s term has not yet expired, it is known as an “unexpired lease” (yet more clever bankruptcy terminology). This post explores how landlords and tenants are treated in bankruptcy, first in the more common situation of a tenant’s bankruptcy and then briefly in the context of a landlord’s bankruptcy.

Assumption and rejection. If the debtor is the tenant under an unexpired commercial lease, it must either assume or reject the lease within 120 days of the filing of bankruptcy. The court can extend this time period without the landlord’s consent for 90 additional days, making a total of 210 days, but any further extensions require the landlord’s prior written consent. If the lease is not assumed (or assumed and assigned) within this period, the lease automatically will be deemed rejected and the debtor will have to move out. 

  • Assumption of a lease requires the debtor to reaffirm the lease, cure all pre- and post-filing defaults, and show that it will be able to perform its obligations in the future. Additional restrictions must be met before a lease located in a shopping center can be assumed or assigned. 
  • Rejection of a lease means that the lease is breached, the debtor tenant has to vacate the property, and the landlord can file a claim against the debtor’s estate for the amount of any past or future rent. 

Capping a landlord’s claim. If a lease is rejected, the landlord’s damage claim for termination of the lease will be treated as a pre-filing unsecured claim.  In addition, the claim for future rent under the lease will be capped at an amount equal to the greater of one year’s rent or fifteen percent of the remaining lease term, up to a maximum of three years’ worth of rent, calculated from the earlier of the date the bankruptcy petition was filed or the date when the landlord recovered possession of, or the tenant surrendered, the premises. This ability to cap a landlord’s claim in bankruptcy is often a major benefit to a debtor tenant, especially when the lease rejected is a long-term lease with rent obligations higher than current market rates. Landlords with security deposits, either in the form of cash or letters of credit, generally will be able to retain or draw on that security at least up to the amount of their capped bankruptcy claim.

Assignments of leases in bankruptcy. Although some leases contain restrictions or outright prohibitions on the tenant’s ability to assign the lease, many of these provisions will be unenforceable in bankruptcy. This can allow a debtor to “assume and assign” a lease to a third party over the landlord’s objection. Since third parties will often pay substantial sums to take over a lease with rent obligations below current market rates, these below-market leases can be valuable assets for debtors.   

The recent bankruptcy law changes. The 210 day maximum lease decision period represents one of the major changes enacted with the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA"), discussed in an earlier post. Before these amendments took effect in October 2005, although debtors initially had only 60 days to assume or reject leases, they were permitted to seek extensions of this period without any statutory limitation. Cumulative extensions of a year or more, over a landlord’s objection, were not uncommon under the pre-BAPCPA version of the Bankruptcy Code. That is no longer possible under BAPCPA.

Impact on retailers. This change is particularly significant for retailers with dozens or even hundreds of leased stores. In the past, retailers usually evaluated sales at stores for at least one holiday shopping season, and sometimes two, before deciding whether to retain the store. Now a retailer has only seven months to make that decision. This shortened period also impacts a retailer’s ability to sell off its unwanted leases, especially through a sale of "designation rights" (the right to designate the assignee of a lease), as the buyer of those rights now will have a limited time to find buyers for those leases.

Landlord as debtor. Sometimes the debtor is not a tenant but a landlord. In that situation, although the debtor can reject a lease and no longer perform any of its duties as landlord, it cannot use bankruptcy to evict a tenant that prefers to stay in possession of the premises. In Section 365(h)(1) of the Bankruptcy Code, a special provision reminiscent of the rights of a licensee of intellectual property under Section 365(n), a tenant may elect to remain in the premises for the remaining term of the lease, plus any renewal or extension of the term that may be provided in the lease if enforceable under applicable state law. If it so elects, the tenant must continue to pay the rent required under the lease but can offset against that rent any damages caused by the landlord’s nonperformance. 

Sublandlord as debtor. When the debtor is a sublandlord (also known as a sublessor), these protections generally do not apply and the subtenant is at risk of losing possession of the premises.  Because a sublandlord is a tenant under a master lease (with the "real" landlord), if the debtor rejects the master lease it, and its subtenants, usually will not have any continuing rights to possession of the premises. Subtenants looking to protect themselves in such a situation often obtain, as part of their sublease, a non-disturbance agreement, direct lease right, or similar protection from the master landlord.

Get good advice. Whether the debtor is a tenant or a landlord (or both), bankruptcy can have a significant impact on commercial real estate leases and subleases. For this reason, it is important to get prompt legal advice on your particular lease, both at the time the lease is negotiated and in the event of bankruptcy, to protect your rights.

Business Bankruptcy Issues

Objections To Bankruptcy Claims: Ignore Them At Your Peril

If you’re a creditor in a bankruptcy case and diligently file a proof of claim on time, often months or even years may go by before you hear anything further about your claim from the debtor, bankruptcy trustee, or any other party. In fact, the only thing you may hear about your claim for a long time is an offer to purchase it made by one or more claims buyers. 

No news is not always good news. Unfortunately, the passage of time may lead you to believe that no objection to your claim will ever be filed. However, the urgency of reorganizing a debtor’s business or liquidating its assets means that the claims objection process is typically left until near the end of the bankruptcy case, often after a plan of reorganization has been confirmed in a Chapter 11 case. As a result, an objection to your claim may be brought long after you filed it. When filed, the objection may assert that your claim amount doesn’t square with the debtor’s books and records or it may be based on any number of other grounds specific to the nature of your claim. 

Is that an objection to my claim? When an objection is filed, it may not always be obvious at first. While an objection may clearly identify that it is directed to your claim, in large cases the debtor or other estate representative has so many claims to address that the objection to your claim will most likely be combined with others. Instead of a pleading specifically mentioning your name in its title or text, the objection may have a name such as “Notice of Debtors’ Fourteenth Omnibus Objections To Claims (Substantive)” or some similarly titled document. 

  • Be careful: the format of these objections can be a trap for the unwary.  Buried within the objection’s many pages of text and attached exhibits may be a few lines, often in a list or chart, identifying that your claim is one of dozens to which an objection has been filed. 
  • Whatever the objection’s name or format, the point is the same: ignore it at your peril.  If you don’t respond to the objection timely your claim will likely be disallowed and you will recover absolutely nothing from the bankruptcy estate.

Diligence is critical. As in other legal contexts, protecting your rights in a bankruptcy case requires diligence. This can be a significant task. In major bankruptcy cases, literally thousands of pleadings can be filed during the course of a case. Many of these will be served on creditors and other parties, whether in paper or electronic form, yet only a few may be important to you or your claim. For this reason, it is critical that you or your attorney keep track of the pleadings filed in a bankruptcy case. As mentioned in an earlier post, there are often special websites designed to assist creditors in following large bankruptcy cases, in addition to the Court’s own electronic filing system. 

Protect your rights.  The bottom line is, if you see anything that looks like a claim objection, you should review all of the pages carefully, including its exhibits. If an objection to your claim is filed, a timely response will be required to protect your rights. Otherwise, you may find yourself with a disallowed and worthless claim.

Business Bankruptcy Issues

Trademark Licensor In Bankruptcy: Special Risk For Licensees

In an earlier post I discussed how a recent district court case gave trademark owners a leg up when a licensee files for bankruptcy. This begs the question: Does the advantage switch back to the licensee if the trademark owner files for bankruptcy? The answer generally, and perhaps surprisingly, is no. 

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

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

The bundled license. What about a license covering both trademarks and other intellectual property that is protected by Section 365(n)? Often a license of software or other products that involve copyrights or patents will include a license to use an associated trademark. In that case, even if the license were rejected, the licensee would have Section 365(n) rights to retain the "bankruptcy intellectual property" — in this example the rights to the copyrighted or patented IP — but would still lose the trademark license.  One case so holding is In re Centura Software Corp., 281 B.R. 660 (Bankr. N.D. Cal. 2002).  You can read that interesting decision here.

How can trademark licensees protect themselves? There are a few, albeit limited, strategies available for trademark licensees to protect themselves. Whether you are a trademark licensee or licensor, be sure to get advice from a bankruptcy attorney on your specific situation.

  • Unbundle the payments. In negotiating bundled licenses, the licensee should anticipate the prospect of losing rights to the trademark if a bankruptcy is filed. One approach would be to separate out any royalty or license payments for the trademark from those related to the other intellectual property being licensed. This way, the licensee can avoid having to pay amounts allocable to the rejected trademark license in order to retain its other IP license rights under Section 365(n). 
  • Take ownership of the mark. Would-be licensees with enough leverage sometimes demand that the trademark and its goodwill be transferred to them, coupled with a license back to the now-former trademark owner. This is perhaps the most effective method, but also the least likely to be achieved.
  • Get a security interest. Another strategy involves taking a security interest in the mark or the licensor’s other assets to secure the damage claim that the licensee would have if the trademark owner rejects the license. Licensees pressing for a security interest do so in part hoping that a debtor licensor faced with a secured claim for rejection damages may decide against rejecting the license in the first place.
  • Oppose a rejection motion. Once a bankruptcy is filed, a trademark licensee should engage counsel right away and consider challenging a debtor or trustee’s decision to reject the trademark license. If little good would come of the rejection for the debtor or its creditors, the licensee could oppose the motion arguing that the decision to reject is an inappropriate exercise of the debtor’s business judgment. Although such objections are rarely sustained, if successful this strategy could allow the licensee to continue to use the trademark without facing the consequences of a rejected license.

Short of these approaches, there is precious little trademark licensees can do to protect themselves from this bankruptcy risk. It is a fact that gives debtor licensors clear advantages and sometimes keeps trademark licensees up at night.

Business Bankruptcy Issues

Infringement Claims: Is Bankruptcy The End Of The Line?

Defending intellectual property ("IP") litigation can be expensive and, if unsuccessful, often crippling for the defendant’s business. Sometimes an accused infringer facing IP litigation will seek bankruptcy protection to invoke the automatic stay. Unless lifted by the bankruptcy court, the automatic stay will prevent further litigation against the debtor, outside of the bankruptcy claims process, for pre-bankruptcy claims. 

The collision between infringement litigation and bankruptcy, however, raises issues beyond the automatic stay, especially with respect to continuing and past infringement claims. This post addresses these questions in the context of both corporate and individual debtors.

Continuing Infringement

What if a corporate debtor continues to infringe?

If a corporation or other business debtor in Chapter 11 is continuing to infringe intellectual property rights, the IP owner may have what’s known as an "administrative claim" in the debtor’s bankruptcy case.  Administrative claims, as the name implies, are claims that result from the administration of the bankruptcy estate and include claims for payment for products and services delivered to a debtor post-petition and for fees and expenses of bankruptcy lawyers and other professionals advising the Chapter 11 debtor in possession and creditors committee. Administrative claims are paid ahead of all pre-petition unsecured claims and almost all other priority claims, and sometimes can have a major impact on a debtor’s ability to reorganize. 

A recent decision by the U.S. Court of Appeals for the Sixth Circuit in the Eagle-Picher Industries Chapter 11 case held that post-petition patent infringement claims qualify as administrative claims. In that case, although the debtor faced a $20 million administrative claim related to patent infringement litigation, the court held that the claim survived confirmation of the debtor’s bankruptcy plan.

A non-debtor IP owner may also be able to get relief from the automatic stay (see my earlier post on that topic) to pursue infringement claims, including to seek injunctive relief for continuing infringement, in a court other than the bankruptcy court. It is possible that the automatic stay will not even apply to post-petition acts of infringement, but IP owners and debtors should get advice from a bankruptcy attorney about their specific situation.

Are continuing infringement claims covered by an individual’s bankruptcy discharge?

Individual debtors will generally get a discharge of their pre-bankruptcy debts. A decision from the U.S. Court of Appeals for the Federal Circuit earlier this year, however, makes clear that an individual who files bankruptcy does not get a free pass to keep on infringing a patent. In Hazelquist v. Guchi Moochie Tackle Company, Inc., 437 F.3d 1178 (Fed. Cir. 2006), the court held that the debtor’s bankruptcy discharge was only retrospective, covering claims relating to acts prior to bankruptcy, and did not immunize the debtor from claims for continuing infringement. As a result, the court ruled that the patent holder could assert claims against the debtor outside of bankruptcy court for each act of post-petition infringement.  It’s an interesting decision and the full opinion is available here.  You might also enjoy reading the Patently-O blog’s post on the decision by Dennis Crouch, who seems to like the tackle company’s name as much as I do. 

Past Infringement

What about claims for past infringement? 

An IP owner can file a proof of claim for past infringement claims, but that claim will most likely be considered an unsecured claim and may end up being paid cents on the dollar. Filing a proof of claim is certainly the less costly way to go, and with a corporate debtor may be the principal remedy available for past infringement damages. 

If the infringer is an individual, however, another question is whether claims for past infringement can be declared nondischargeable, allowing the IP owner to pursue the debt notwithstanding the bankruptcy discharge. (As discussed in an earlier post, the notion of nondischargeable debts applies only to individuals and not to corporations or other entities.) Although seeking a nondischargeability determination often doesn’t make economic sense, owners of intellectual property sometimes believe that it’s important to protect those rights through vigorous pursuit of infringers, even against those who file bankruptcy. 

So is an infringement claim nondischargeable? A recent decision from the Bankruptcy Appellate Panel (known in the trade as "the BAP") of the U.S. Court of Appeals for the Ninth Circuit said yes, at least when the claim is for truly willful copyright infringement.  Why?  Well, under the Bankruptcy Code, a debt that results from a "willful and malicious injury" is nondischargeable. In In re: Albarran, decided on July 24, 2006, the BAP held that a judgment for willful copyright infringement, which included an award of statutory damages, interest, and attorney’s fees, involved "willful and malicious injury." The BAP’s decision is available here. 

In essence, the BAP held that willful copyright infringement, involving an intent to harm or knowledge that one’s actions were substantially certain to cause harm, (1) is an injury to the copyright holder and (2) statutory damages under the Copyright Act qualify as a debt arising from this injury even though the plaintiff may not have suffered identifiable economic damage.  Willful injury under the Bankruptcy Code requires that the debtor intend the consequences of his action, generally excluding negligent or reckless conduct.  In In re: Albarran, the BAP concluded that the particularly willful nature of the copyright infringement involved satisfied this requirement.  With willfulness determined, the court was able to imply the element of malice. 

Does the answer depend on the type of IP infringed?

The BAP’s decision involves copyrights and not patents or trademarks, so the question remains whether willful patent or trademark infringement would also be considered a nondischargeable "willful and malicious injury" under the Bankruptcy Code. The BAP’s decision did make several references to the kinship between copyright and patent law and noted that "patent infringement has historically been viewed as a tort because of its invasion of another’s rights."  In 2004, in a case called In re Trantham, a BAP from a different circuit, the Sixth Circuit, held that a claim for willful patent infringement was nondischargeable. You can read that decision here. Although the answer is not settled yet, if a debtor were found to have engaged in intentional patent or trademark infringement, the odds are that a bankruptcy court would find damages for such conduct to be nondischargeable.

Is a BAP the same as the U.S. Court of Appeals?  

Although these BAP decisions are very instructive, a word of caution is in order.  Unlike a U.S. Court of Appeals itself, a BAP is made up of bankruptcy judges only, not federal circuit judges. Given a BAP’s place in the judicial system’s hierarchy, its decisions are not given the same precedential weigh as U.S. Court of Appeals decisions.  This means that it’s possible for a U.S. Court of Appeals itself to reach a different conclusion. (In fact, an appeal to the Ninth Circuit from the BAP’s In re: Albarran decision was just filed last week.) Still, the two BAP decisions in In re: Albarran and In re Trantham are well-reasoned and may be followed by other courts. 

Impact Of Asset Sale

Can a debtor sell assets free and clear of infringement claims?

Generally, a debtor will be able to sell its assets in a Section 363 bankruptcy sale free and clear of claims (see earlier post on asset sales), including claims for past infringement.  However, if an IP owner asserts claims for continuing infringement related to the assets and how they are used, the sale will in all likelihood not be free and clear of those continuing infringement claims. Instead, the purchaser could well end up buying the defense of an infringement lawsuit along with the assets.

A Final Note

Do last year’s bankruptcy law changes have an impact?

Given the amendments to the Bankruptcy Code made by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, even if an individual debtor got a discharge of a willful infringement claim, he or she would have a very hard time getting another discharge within the next eight years. The message to individual infringers in bankruptcy: discharge or not, better stop infringing.

Business Bankruptcy Issues Recent Developments

Trademark Licensees In Bankruptcy: A Leg Up For Trademark Owners?

Apparently, until last November, no court had been called upon to resolve whether a trademark licensee in bankruptcy can assume, or assume and assign, a non-exclusive trademark license without the trademark owner’s consent.  

The decision. We got the first answer to that question in a case called In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), when the U.S. District Court in Nevada held that trademark licenses are personal and nonassignable, absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision. In reaching its conclusion, the court held that under the Lanham Act, the federal trademark statute, a trademark owner has a right and duty to control the quality of goods sold under the mark:

Because the owner of the trademark has an interest in the party to whom the trademark is assigned so that it can maintain the good will, quality, and value of its products and thereby its trademark, trademark rights are personal to the assignee and not freely assignable to a third party.  

The U.S. Court of Appeals for the Ninth Circuit (which includes Nevada, California, and other western states) had previously interpreted the key Bankruptcy Code provision involved, Section 365(c)(1), to prevent a debtor from assuming an agreement when it does not have the right to assign it. (For a discussion about how bankruptcy can affect intellectual property licenses, including the impact of this earlier Ninth Circuit case, you may want to read my earlier post on the topic.) 

Building on this Ninth Circuit law, the trademark owner in the N.C.P. Marketing Group case argued that under trademark law the debtor could neither assume nor assign the non-exclusive trademark license at issue. The district court agreed, holding that the bankruptcy court correctly granted the trademark owner’s motion to compel the debtor to reject the trademark license, forcing the debtor to give up its license rights. 

Good news for trademark owners.  The decision is good news for trademark owners. Many have have long worried that if a licensee files bankruptcy it might be able to use the Bankruptcy Code’s general power to assume and assign executory contracts to assign trademark licenses to third parties over the trademark owner’s objection. The N.C.P. Marketing Group decision extends to trademark owners protections already recognized by many courts for patent and copyright holders. The case does not address whether the same rule would apply to exclusive trademark licenses, but given the trademark owner’s similar rights and duties to control the quality of goods sold under a licensed mark, the result could be the same. 

Bad news for debtor licensees. The decision, of course, is bad news for trademark licensees that file bankruptcy.  If the decision is followed by other courts, trademark licensees in bankruptcy will be unable to assign their rights to third parties or even to keep those rights for themselves without the trademark owner’s consent.  The value of these debtors, and their ability to repay creditors, could suffer as well.

On appeal. The district court’s decision may not be the last word. The debtor has appealed to the Ninth Circuit, although a ruling could be a number of months away.  I will report on the Ninth Circuit’s decision when it comes down.  In the meantime, this is only one district court decision, applying Ninth Circuit law, so its full impact has yet to be determined.

Just for kicks. Finally, for those interested, the trademarks involve the Billy Blanks® Tae Bo® fitness program.  At least until the Ninth Circuit rules on appeal, the district court’s decision will give trademark owners like Billy Blanks a "leg up" in their efforts to control their marks.