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Protecting IP Rights From A Licensor’s Bankruptcy: What You Need To Know About Section 365(n)

Many companies rely on in-bound licenses of intellectual property, especially those involving patents or trade secrets, and spend millions of dollars on research, development, and ultimately commercialization of drugs or products incorporating the licensed IP. With so much at stake, licensees frequently ask a critical question: Can our license rights be terminated if the licensor files bankruptcy?

Assumption Or Rejection. A license is typically held to be an executory contract. This means that a licensor in bankruptcy (or its bankruptcy trustee) has the option of assuming or rejecting the license. Generally, a debtor licensor can assume a license if it meets the same tests (cures defaults and provides adequate assurance of future performance) required to assume other executory contracts.  Most licensees will not object to the assumption of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is whether they risk losing their rights to the licensed IP if the license is rejected.

Bankruptcy Code Section 365(n). To address this concern, in 1988 Congress added Section 365(n) to the Bankruptcy Code to give licensees special protections.  If the debtor or trustee rejects a license, under Section 365(n) a licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payment. The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements.  Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.

Some Important Limitations. If the license is rejected, however, the licensor will no longer have to perform under the license. This means the licensor will not have to update or continue to develop the IP, and will not have to make available any updates later developed. In addition, Section 365(n) only applies in a U.S. bankruptcy case. It generally will not be of any help in a bankruptcy or insolvency of a non-U.S. licensor under applicable foreign law.

No Protection For Trademark Licensees. Many people expect intellectual property to include trademarks, but when Section 365(n) was enacted a special, limited definition of "intellectual property" was also added to the Bankruptcy Code. The bankruptcy definition includes trade secrets, U.S. patents and patent applications (less clear as to foreign patents), copyrights, and mask works, but it does not include trademarks. This distinction means that a trademark licensee enjoys none of Section 365(n)’s special protections and is at risk of losing its trademark license rights if the licensor files bankruptcy. For more on the special bankruptcy risk facing trademark licensees, follow the link in this sentence.

Getting The Most Out Of Section 365(n). Although Section 365(n) gives licensees significant comfort within limits, there are a number of approaches a licensee can take to maximize the statute’s benefits while avoiding its pitfalls. Here are a few to consider:

  • Make sure you actually have a granted license. Section 365(n) only applies to actual license rights as they existed at the time the bankruptcy case was commenced. This means that an agreement by the licensor to grant a license to IP at some later date, including a springing license grant on a bankruptcy filing, will likely be unenforceable if a bankruptcy is filed. Get a present grant of a license to any important IP or risk not having a license to it at all.
  • Consider a technology escrow. Licensees sometimes forget that Section 365(n) is not self-executing. This means that Section 365(n) doesn’t require the licensor to deliver the embodiment of the licensed intellectual property to the licensee unless the license or an agreement supplementary to the license expressly provides for such a right. One solution is to include this delivery provision in the license itself. Another common approach is to establish a technology (often a source code) escrow into which the embodiment and updated versions of the embodiment are in fact deposited, to be released to the licensee on specified conditions.
  • Refer to Section 365(n) in the license. Section 365(n) applies to licenses of bankruptcy-defined intellectual property whether it is mentioned in the license or not. That said, including an express reference that the license involves such IP, as the old saying goes, "wouldn’t hurt." A provision in the license that the agreement involves IP covered by Section 365(n), although not binding on the bankruptcy court, may be helpful in persuading a bankruptcy trustee — or the bankruptcy judge — that the IP involved is indeed subject to Section 365(n)’s protections.
  • Save the election until later. If you do include a Section 365(n) reference in the license, it’s usually better to state that no Section 365(n) election is then being made. Things change, and there is always a chance that the IP will turn out to be less important in future years, meaning you might elect to treat a rejected license as terminated.
  • Get bankruptcy advice before you sign the license. As the points above illustrate, even with Section 365(n), protecting your IP license can be tricky if a bankruptcy is later filed. Be sure to seek advice from bankruptcy counsel knowledgeable about IP licenses when the license is being drafted, not just after the licensor gets in financial trouble.

Conclusion. Section 365(n) of the Bankruptcy Code can provide valuable protections for licensees of intellectual property, but those protections have their limitations. Taking steps to maximize your rights when the license is being drafted can make a big difference if the licensor later files bankruptcy.

Business Bankruptcy Issues Recent Developments

First Court Of Appeals Decision Addresses Question Left Open In The Supreme Court’s Travelers Opinion: Can Unsecured Creditors Recover Post-Petition Attorney’s Fees?

On June 23, 2009, the U.S. Court of Appeals for the Ninth Circuit became the first Court of Appeals to answer the question left open in the U.S. Supreme Court’s March 2007 decision in Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. — whether post-petition attorney’s fees can be added to unsecured claims.

The Travelers Case. Before turning to the SNTL Corp. case itself, let’s look back at the Supreme Court’s decision. In March 2007, the U.S. Supreme Court overruled the Ninth Circuit’s so-called Fobian rule in the Travelers Casualty & Surety Co. of America v. Pacific Gas & Electric Co. decision. However, it did not decide whether unsecured creditors could recover, as part of their unsecured claims, post-petition attorney’s fees incurred during the course of the bankruptcy case. For more on the Travelers decision, follow the link in this sentence.

The SNTL Corp. BAP Decision. In the December 2007 BAP decision, Bankruptcy Judge Dennis Montali, writing for the unanimous BAP panel, held that that "claims for postpetition attorneys’ fees cannot be disallowed simply because the claim of the creditor is unsecured." On the unrelated issue, the BAP held that a guarantor’s liability was revived after a preference settlement.

The Ninth Circuit Rules In The SNTL Corp. Case. On June 23, 2009, the Ninth Circuit decided the appeal, issuing a brief, per curiam decision, stating as follows:

The Bankruptcy Appellate Panel decision is AFFIRMED for the reasons stated in its opinion in this case sub nom. We adopt the BAP opinion, In re SNTL Corp., 380 B.R. 204 (B.A.P. 9th Cir. 2007), as our own and attach it as an appendix to this opinion. See Appendix, infra.

A Second Look At The BAP’s Decision. Given that the Ninth Circuit affirmed and adopted as its own the BAP opinion in its entirety, further review of the BAP’s analysis is merited. In reaching its decision, the BAP carefully reviewed two earlier decisions by bankruptcy courts that had taken up the open "Travelers" issue, In re Qmect, Inc. (see earlier post on the Qmect decision) and In re Electric Machinery Enterprises, Inc. (see prior post on the Electric Machinery decision), as well as pre-Travelers law, and first explained its analysis of the interplay between Sections 502 and 506(b):

We are not persuaded by the approach of the Electric Machinery court and, like Qmect, we reject the argument that section 506(b) preempts postpetition attorneys’ fees for all except oversecured creditors. While we cannot predict how the Ninth Circuit will decide this issue in Travelers, we do find a clue in Joseph F. Sanson Inv. Co. v. 268 Ltd. (In re 268 Ltd.), 789 F.2d 674, 678 (9th Cir. 1986), where the Ninth Circuit observed that section 506(b) defines secured claims and does not limit unsecured claims:

When read literally, subsection (b) arguably limits the fees available to the oversecured creditor. When read in conjunction with § 506(a), however, it may be understood to define the portion of the fees which shall be afforded secured status. We adopt the latter reading.

268 Ltd., 789 F.2d at 678.

Next, the BAP discussed Section 502(b)(1)’s requirement that the court determine the amount of an unsecured claim as of the petition date:

The Electric Machinery court, like the bankruptcy court here and many of the pre-Travelers majority courts, disallowed the postpetition fees of an unsecured creditor because section 502(b)(1) provides that a bankruptcy court “shall determine the amount of such claim . . . as of the date of the filing of the petition” and the postpetition fees did not exist as of that date. Elec. Mach., 371 B.R. at 551; Pride Cos., 285 B.R. at 373. Because the amount of fees incurred postpetition cannot be determined or calculated as of the petition date, section 502(b) purportedly precludes their allowance. Id. We disagree with this approach, as it is inconsistent with the Bankruptcy Code’s broad definition of “claim,” which — as discussed previously — includes any right to payment, whether or not that right is contingent and unliquidated. See 11 U.S.C. § 101(5)(A); Qmect, 368 B.R. at 884.

The BAP then held that the Supreme Court’s 1988 Timbers decision did not apply:

We believe that Electric Machinery’s reliance on Timbers is misplaced. Timbers provided that an undersecured creditor could not receive postpetition interest on the unsecured portion of its debt. Timbers, 484 U.S. at 380. This holding is consistent with section 502(b)(2), which specifically disallows claims for unmatured interest. Inasmuch as section 502(b) does not contain a similar prohibition against attorneys’ fees, the comparison between the current issue and that presented in Timbers is not persuasive.

Finally, the BAP held that it was unnecessary to reconcile the competing public policy considerations advanced by the Electric Machinery and Qmect decisions:

Because we find that the Bankruptcy Code itself provides the answer to this issue (by not specifically disallowing postpetition fees), we do not attempt to reconcile these policy concerns. In the end, it is the province of Congress to correct statutory dysfunctions and to resolve difficult policy questions embedded in the statute.

For more on this decision, as well as the BAP’s discussion (now adopted by the Ninth Circuit) on the revival of a guarantor’s liability after a preference settlement, this earlier post on the BAP’s In re SNTL Corp. decision may be of interest.

On Remand From The Supreme Court’s Travelers Decision. One interesting side note involves the BAP’s December 2007 comment in the In re SNTL Corp. decision about being unable to predict how the Ninth Circuit would decide this issue in the Travelers case on remand from the U.S. Supreme Court. Months later, in May 2008, the Ninth Circuit issued this brief order in the Travelers case, effectively remanding the case for "consideration of the bankruptcy court in the first instance." The bankruptcy judge to whom the decision was remanded? Bankruptcy Judge Dennis Montali, who wrote the BAP opinion in In re SNTL Corp.

Impact On Unsecured Creditors? As the first ruling by a U.S. Court of Appeals on this open issue, the Ninth Circuit’s decision may lead unsecured creditors to include post-petition attorney’s fees as part of their allowed unsecured claims when their contracts or a statute provides for them outside of bankruptcy. It will be interesting to see whether the decision has a significant impact on how unsecured creditors in the Ninth Circuit and other jurisdictions pursue claims in bankruptcy cases, and how bankruptcy estates react to such claims for post-petition attorney’s fees.

Business Bankruptcy Issues The Financially Troubled Company

Section 363 Sales And Beyond: An M&A Lawyer’s Perspective On Purchasing Assets From Distressed Companies

With the economy suffering through the longest recession since the 1930s, it’s little wonder that much of the merger and acquisition ("M&A") activity these days has been focused on distressed companies. The Chrysler and General Motors cases may be the best-known examples, but Chapter 11 bankruptcy is frequently used by companies large and small to sell assets through Section 363 sales. The important intersection between bankruptcy and M&A deals in today’s business climate was recently made the focus of an article in the Wall Street Journal, aptly called "Barbarians in Bankruptcy Court."

Although Section 363 sales are quite common, some distressed companies are able to complete an asset sale outside of bankruptcy. The sale may be made directly by the company, or the seller may actually be a lender foreclosing on its collateral under the Uniform Commercial Code. In still other situations, the seller may be an assignee acting through a general assignment for the benefit of creditors under state law.

Regardless of the path chosen, the landscape of distressed asset purchases can be significantly different from that traversed by many traditional M&A lawyers and, most importantly, their clients. Fortunately, one of my M&A partners at Cooley Godward Kronish LLP with significant experience in distressed acquisitions, Jennifer Fonner DiNucci, has recently written an insightful article on the subject. Entitled "Balancing the Risks and Benefits of Transactions Involving Distressed Companies," the article discusses the unique challenges — and opportunities — posed by distressed asset acquisitions. It also highlights some of the major issues that potential asset buyers encounter when dealing with a distressed seller, and points out key differences between distressed transactions and more traditional M&A deals with solvent companies.

The article makes for interesting — and timely — reading for anyone considering a purchase of assets from a distressed company.

Business Bankruptcy Issues Recent Developments

General Motors Files Chapter 11 Bankruptcy In New York

General Motors Corp. filed for Chapter 11 bankruptcy protection this morning in the U.S. Bankruptcy Court for the Southern District of New York. Judge Robert E. Gerber has been assigned to preside over the case.

A copy of GM’s bankruptcy petition is available here. The petition listed approximately $82 billion in assets and $172 billion in liabilities. A copy of GM’s press release regarding its bankruptcy can be found at the link in this sentence. GM has also created a restructuring website where additional information for customers, suppliers, and others can be found.

Business Bankruptcy Issues Recent Developments

Spring 2009 Edition Of Bankruptcy Resource Is Now Available

The Spring 2009 edition of the Absolute Priority newsletter, published by the Cooley Godward Kronish LLP Bankruptcy & Restructuring group, of which I am a member, has just been released. The newsletter gives updates on current developments and trends in the bankruptcy and workout area. Follow the links in this sentence to access a copy of the newsletter or to register to receive future editions. You can also subscribe to the blog to learn when future editions of the Absolute Priority newsletter are published, as well as to get updates on other bankruptcy topics.

The latest edition of Absolute Priority covers a range of cutting edge topics, including:

  • Claim issues involving the Madoff SIPA proceeding;
  • How new Bankruptcy Code provisions involving swap agreements and swap participants are being interpreted;
  • The importance of the mutuality requirement in setoffs;
  • Post-petition rent and Section 503(b)(9) "20 day goods" claims; and
  • The use of a trademark after a bankruptcy petition is filed.

This edition also reports on some of our recent representations of official committees of unsecured creditors in Chapter 11 bankruptcy cases involving major retailers. These include Mervyn’s, Boscov’s, Gottschalk’s, Lenox Sales, Goody’s, KB Toys, BTWW Retail, and Innovative Luggage, among others. In addition, a note from my colleague, Jeffrey Cohen, the editor of Absolute Priority, discusses the current economic climate and the impact it continues to have on how debtors and creditors have been approaching bankruptcies and restructurings.

I hope you find this latest edition of Absolute Priority to be a helpful resource.

Business Bankruptcy Issues Recent Developments

Text Of Legislation To Repeal Certain Of BAPCPA’s Business Bankruptcy Changes Affecting Retailers Now Available

As reported in a post on the blog earlier this week, on April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." At that time the official text of the legislation was not available.

The bill would repeal changes made by BAPCPA relating to (1) the deadline to assume or reject non-residential real property leases, (2) utility deposits, (3) the Section 503(b)(9) administrative claim, and (4) reclamation. These BAPCPA provisions are among those that have had a significant impact on retailers. For a discussion of the bill’s provisions, you can read this blog’s earlier post on the legislation or the explanation of the bill by the NACM. It will be interesting to follow the bill as it makes its way through the legislative process in Congress.

Business Bankruptcy Issues Recent Developments

Legislation Introduced To Repeal Certain Business Bankruptcy Changes Made By BAPCPA’s 2005 Amendments

On April 2, 2009, Representative Jerrold Nadler (D-NY) introduced a bill entitled the "Business Reorganization and Job Protection Act of 2009." The bill has been co-sponsored by Representative Steve Cohen (D-TN), the Chairman of the Subcommittee on Commercial and Administrative Law of the United States House of Representatives Committee on the Judiciary. As of the date of this post, the bill’s official text has not been printed but the National Association of Credit Management has made available on its website what appears to be a final or near-final draft of the legislation, which you can access by clicking here. I plan to provide an update on the blog once the official version of the bill as introduced becomes available.

Introduction of the bill follows testimony before the Subcommittee on Commercial and Administrative Law by a number of bankruptcy professionals and law professors, including my partner and the Chair of Cooley Godward Kronish LLP‘s Bankruptcy & Restructuring Group, Lawrence Gottlieb. Click here for a prior post about his September 26, 2008 testimony, which focused on the disappearance of reorganizations of retailers since the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (known as "BAPCPA"). A link to Representative Nadler’s press release on the bill’s introduction can be found here.

The Legislation’s Proposed Changes. The Business Reorganization and Job Protection Act of 2009, introduced as H.R. 1942, would make several major amendments to the Bankruptcy Code. The common theme is that the proposed bill would repeal certain changes made by BAPCPA and restore the statutory language that was in place before BAPCPA was enacted in 2005. The four principal changes are as follows:

  • Real Estate Leases. The bill would change Section 365(d)(4) of the Bankruptcy Code by repealing the maximum 210-day period within which debtors could assume or reject non-residential real property leases. Instead of the current 120-day initial period and up to a 90-day extension, the statute would revert back to the initial 60-day period under the prior law but, more importantly, would allow the bankruptcy court, for cause, to grant further extensions without any time limit.
  • Utilities. Similarly, the bill would repeal Section 366(c) of the Bankruptcy Code, which now requires a deposit of cash or certain cash equivalents to provide adequate assurance of payment to utilities. If enacted, the bill would allow debtors to establish adequate assurance of payment with something short of a monetary deposit, as had been the case under the pre-BAPCPA law.
  • 20-Day Goods Administrative Claim. The bill would also make changes to the law relating to shipments by vendors prior to a bankruptcy filing. It would repeal Section 503(b)(9) of the Bankruptcy Code, added by BAPCPA, which gives an administrative claim to vendors for the value of goods received by a debtor in the ordinary course of business during the 20 days before the bankruptcy petition.
  • Reclamation. Another change the bill proposes to make is to go back to the pre-BAPCPA language in Section 546(c) of the Bankruptcy Code governing reclamation claims, specifically to repeal language that had expanded the potential reclamation claim for vendors to the 45 days before a bankruptcy petition. The bill would reinstate the pre-BAPCPA provisions restricting reclamation to that provided for under the Uniform Commercial Code (generally only a 10 day period) and permitting an administrative claim or secured claim to be provided to a reclaiming vendor in lieu of a return of the goods pursuant to a valid reclamation claim.
  • Effective Date. Finally, the bill proposes that its changes would apply to cases commenced on or after the date of its enactment, meaning it would apply to cases filed after the bill became law but not to cases filed before it became law.

Conclusion. If the Business Reorganization and Job Protection Act of 2009 were enacted, it could have a major impact on Chapter 11 bankruptcy cases, in particular those involving retailers. As explained in a recent article by several of my colleagues, the cumulative changes made by BAPCPA have had a profound impact on retail Chapter 11 cases. Repealing them could enable retailers the opportunity to emerge from Chapter 11 — the way they often did in the years before the BAPCPA amendments were adopted. Otherwise, we are likely to continue to see more retailers forced into going of out business sales in Chapter 11.