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Licensing Intellectual Property From An Israeli Company: What Happens If There’s A Bankruptcy?

Many technology companies are based in Israel and license intellectual property to companies in the United States and around the world. This raises an interesting question: what happens if the Israeli company, as licensor, goes into bankruptcy or liquidation in Israel? The latest edition of Cross Border Commentary, a publication by the International Business Practice of my firm, Cooley Godward Kronish LLP, has just addressed that very question.

The U.S. Law Answer.  Before turning to Israeli law, let’s look at how this issue plays out under the United States Bankruptcy Code. A licensor in bankruptcy or its bankruptcy trustee has the option of assuming (keeping) or rejecting (breaching) a 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.  Many licensees will not have a problem with assumption of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is the fear of losing their rights to the licensed IP, which often can be mission critical technology, if the license is rejected.

  • Special protections. Recognizing this concern, the United States Bankruptcy Code, in Section 365(n), provides licensees with 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 even a right to enforce an exclusivity provision. In return, the licensee must continue to make any required royalty payments. The licensee also can retain rights under any agreement supplementary to the license, which includes 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.
  • Watch out for trademarks. While many people would expect intellectual property to include trademarks, the Bankruptcy Code has its own limited definition of "intellectual property." The bankruptcy definition includes trade secrets, patents and patent applications, copyrights, and mask works.  Importantly, however, it does not include trademarks. This distinction means that trademark licensees enjoy none of Section 365(n)’s special protections and those licensees are at risk of losing their trademark rights in a bankruptcy. 

For more on these subjects, you may find these earlier posts, "Intellectual Property Licenses: What Happens In Bankruptcy?" and "Trademark Licensor In Bankruptcy: Special Risk For Licensees" of interest.

The Israeli Perspective. An article in Cooley’s Cross Border Commentary, prepared by Einat Meisel of the Israeli law firm of Gross, Kleinhendler, Hodak, Berkman and Co., discusses a Tel-Aviv District Court decision involving these issues. When an Israeli company known as Commodio Ltd. entered liquidation, two of its intellectual property licensees sought to retain rights under their license agreements with Commodio. In ruling on the effort, the Israeli court made several important holdings:

  • The licensees could continue to use the IP as long as they made required any royalty payments and complied with the terms of use in the agreements, with payments to be made to the liquidator.
  • The licensees could gain access to the underlying source code behind the object code covered by their licenses provided this did not impose substantial expense on the company in liquidation.
  • No transfer of ownership in the IP could occur due to the liquidation, as this would be contrary to Israeli bankruptcy law.
  • A right of first refusal covering certain of the intellectual property would be enforceable in the bankruptcy.

Comparison To A U.S. Bankruptcy. With a few key differences, the outcome in the Commodio case is similar to the treatment under U.S. law. Under Section 365(n)’s provisions, licensees would have the ability to retain their rights to the IP, with any royalty payments being made to the bankruptcy estate. If an agreement contained a source code license, the licensees could also access the source code under Section 365(n). However, absent a license grant to the source code, the outcome would likely be different in a U.S. bankruptcy.  Provisions purporting to transfer ownership of the IP upon a bankruptcy or liquidation would not be enforceable in a U.S. bankruptcy. Finally, the right of first refusal enforced in the Israeli case might not be enforced in a U.S. bankruptcy if the agreement were rejected but could if the license were assumed. 

Get Advice. Licensing intellectual property from a foreign corporation raises a number of issues, including what happens if the foreign licensor goes bankrupt or becomes insolvent. Potential licensees should be sure to get expert advice on the applicable foreign law, including the implications of bankruptcy, when licensing IP from a foreign company. Although licensees from Israeli companies can find some comfort in the Commodio decision, it remains important to get advice on Israeli law specific to your situation. 

The Financially Troubled Company

How Venture Capitalists View An Economic Downturn

Recent posts from two thought-leading venture capitalists give insights into how VCs approach the impact of a possible recession. The first is from Will Price, a managing director at venture capital firm Hummer Winblad. In his post, titled "Downturn – Now What?" (hat tip: Ask The VC blog), Will offers some very interesting observations, including this one:

If I take the last downturn as my guide, I can say with confidence that venture investors would be well suited to continue to invest right through the downturn – in 2002 and 2003 terrific companies were formed and funded at very reasonable valuations and with business models that reflected the demand for capital efficiency and economic viability.

The second post comes from Jason Mendelson who, together with fellow Foundry Group managing director Brad Feld, publish the Ask The VC blog. This new post, titled "What Is The Effect Of The ‘Pending’ Recession On Venture Capital Financings Of Private Companies?," examines similar issues. Jason makes a number of thoughtful comments, including:

Now how does this all affect VC financings?  Well, history would tell us that VCs will put less money into funding companies, converse cash and wait until the acquisition and public markets open up a bit.  With a lack of good exits, why would a VC want to invest in a company?  However, that’s never made much sense to me, especially if we limit investments to early-staged companies.  I’ve always thought the best time to invest in young startups is when things are choppy.  You usually can invest at lower prices, hire folks for less than you normally would, etc.  Also, I’d never expect an investment to exit in the near future (1-3 years, for sure) and therefore the company will be well positioned to exit at the end of the recession.  If you wait until the recession is over, you are already paying too much.

For anyone interested in how a recession could impact venture-backed companies, including insolvency professionals who work with the ones that fail, these new posts from two leading venture capitalists make for very informative reading.

Business Bankruptcy Issues Recent Developments

Two Ways To Get The Updated Bankruptcy Code Online For Free

Looking for a free, online and updated version of the entire Bankruptcy Code, reflecting the amendments made by the Bankruptcy Abuse Prevention and Consumer Protection Act ("BAPCPA")? Now there are two ways to access it.

These are handy resources for attorneys and others who need to find the up-to-date Bankruptcy Code online.

Business Bankruptcy Issues Recent Developments

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

Happy New Year to everyone. I’m back from a holiday blogging break with a report on the first appellate decision to address the question left open in last year’s U.S. Supreme Court 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. Although unrelated, this new decision also tackles the interesting question of whether a guarantor of a debt can become liable if the payment of the debt by the primary obligor later is returned in a preference settlement.

The Travelers Case. As a brief refresher, 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 (available here) in March 2007. 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, you may find this earlier post of interest.

A Developing Split. Since the Travelers decision, two bankruptcy courts issued decisions on the open issue, coming to different conclusions. 

  • In May 2007, in the In re Qmect, Inc. decision (available here), the U.S. Bankruptcy Court for the Northern District of California held that unsecured creditors could recover post-petition attorney’s fees. For more on that decision, see this earlier post on the case and its analysis. 
  • In July 2007, in the In re Electric Machinery Enterprises, Inc. case (available here), the U.S. Bankruptcy Court for the Middle District of Florida came to the opposite conclusion, following a majority of courts that had addressed this issue unrestrained by the Ninth Circuit’s Fobian decision. See this previous post for more on the Florida decision.
  • Commentators, including with the recent article written by the American Bankruptcy Institute‘s Scholar in Residence Professor Mark Scarberry, have joined the fray as well.

The SNTL Corp. Ruling. On December 19, 2007, the Ninth Circuit Bankruptcy Appellate Panel ("BAP") issued its decision in the In re SNTL Corp. case (available here). After carefully reviewing both the Qmect and Electric Machinery decisions, as well as pre-Travelers case law, the BAP chose to follow Qmect, holding that "claims for postpetition attorneys’ fees cannot be disallowed simply because the claim of the creditor is unsecured." Judge Dennis Montali, writing for the unanimous BAP panel, 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.

A Ninth Circuit Decision To Come? In the first quote above, you may have picked up the BAP’s reference to the Ninth Circuit having this issue before it in the Travelers case. That case, on remand from the Supreme Court, appears to have been fully briefed. Any decision from the Ninth Circuit itself on the issue would, of course, supersede this BAP decision and be controlling authority in the circuit, but it may be months before such a ruling comes down.

A Bonus Issue: Guarantor’s Liability Revived After A Preference Settlement. The facts of the SNTL Corp. case are complex, but the key facts are fairly straightforward. In short, one of the debtor’s insurance company subsidiaries owed money to the creditor and the debtor guaranteed the debt. Although the subsidiary paid the creditor, the subsidiary was later placed into state insolvency proceedings. The state insurance commissioner sued the creditor for return of the payment on preference grounds. The creditor settled the preference case and returned most of the payment ($110 million of a $163.4 million original payment). The creditor thereafter amended its proof of claim in the debtor’s Chapter 11 case, seeking recovery under the guaranty of the returned preference.

  • After first determining that the guaranty’s language permitted the creditor to assert a claim to the extent provided by law, the BAP next held, "[w]hile we located no Ninth Circuit or California case precisely on point, we agree that the return of a preferential payment by a creditor generally revives the liability of a guarantor."
  • The BAP cited to various case and restatement authority for the proposition that although a guarantor is discharged on payment of a debt, a preferential payment is deemed to be no payment at all.
  • The BAP also held that repayment of a preference in a settlement, following a preference lawsuit, is not a voluntary payment that would avoid the guarantor’s liability.
  • Given the risk of a preference recovery, the creditor’s revival claim under the guaranty was a contingent claim as of the petition date and became allowable once the contingency occurred following the petition. As a result, the creditor’s claim for the full $110 million of the preference settlement was an allowed claim.

An Important Decision. BAP decisions are not binding precedent in the Ninth Circuit, but this first appellate decision on the open, post-Travelers question may encourage 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.  We may see creditors begin to include such amounts in unsecured claims at an increasing pace, while we wait for the Ninth Circuit’s decision on this issue in the remanded Travelers case. The added bonus of the SNTL Corp. court’s guaranty analysis and holding makes this decision an even more interesting, and important, read.

Recent Developments

Morgan Stanley Now Predicts A Recession For U.S. Economy

Morgan Stanley has became the first major Wall Street firm to predict that the U.S. economy will fall into recession. In an article entitled "Recession Coming," Morgan Stanley economists Richard Berner and David Greenlaw forecast that the U.S. economy will suffer a mild recession in 2008:

We’re changing our calls for US growth and monetary policy.  Since the shock of tighter financial conditions surfaced in August, we’ve incrementally reduced our outlook for future growth.  But the time for incremental changes is over.  A mild recession is now likely: We expect domestic demand to contract by an average 1% annualized in each of the next three quarters, no growth in overall GDP for the year ending in the third quarter of 2008 and corporate earnings to contract by 5-10% over that longer period.  Three factors have tipped the balance to the downside: Financial conditions continue to tighten, domestic economic weakness is broadening into capital spending, and global growth — for us, long the key bulwark against a downturn — is slowing. 

Berner and Greenlaw likewise see the potential for a "perfect storm" for consumers brought on by the continuing housing downturn (they predict a 10% decline in home prices next year), a weakening job market, and higher energy and food costs. To avoid an even sharper downturn, they expect the Federal Reserve to cut interest rates by 100 basis points over the next seven to nine months, moves they believe will help keep the recession short and mild.

To date, most Wall Street economists have stopped short of predicting a recession. If the Morgan Stanley forecast comes true, it would almost certainly accelerate the predicted rise in corporate debt defaults, especially on high-yield debt. That would very likely bring about an even bigger increase in Chapter 11 bankruptcy filings than has already been predicted. 

Business Bankruptcy Issues

Chapter 11 Plan Ballots: A New Resource Goes Online

The Altman Group, one of a number of companies that provides bankruptcy claims and balloting services, has just launched a new Bankruptcy Ballot Archive. The Archive makes available a range of different types of ballots, which are used for voting on Chapter 11 bankruptcy plans of reorganization. The ten ballot categories on the Archive include the following:

  • Asbestos/Mass Tort Cases
  • Bondholder Ballots
  • Contested Plan Solicitations
  • Convenience Class Election
  • Equity Holder Ballots
  • Pre-Packaged and Pre-Negotiated Plan Ballots
  • Ballots with Releases

For debtors and restructuring professionals looking for a broad spectrum of sample ballot forms to consider for a particular Chapter 11 plan, this new archive is a good place to start. 

Business Bankruptcy Issues Recent Developments

Delaware Bankruptcy Court Opts Out Of Newly Amended Rule 3007’s Procedures For Omnibus Claim Objections

As described in a post earlier this week, one of the major changes made by the new amendments to the Federal Rules of Bankruptcy Procedure that took effect on December 1, 2007 was the inclusion of limits on the use of omnibus claim objections. Newly revised Rule 3007 restricts omnibus objections to certain situations and imposes formatting standards on the motions that can be filed. 

When describing the amended rule, I commented that the Delaware Bankruptcy Court, through Local Rule 3007-1, has had its own omnibus objection procedures for some time and that they seemed to be in conflict with the new national rule. Well, taking advantage of the "unless otherwise ordered by the court" language in amended Rule 3007(c), Chief Judge Mary F. Walrath of the Delaware Bankruptcy Court issued this General Order noting the conflict but directing that the amended Rule 3007(c) "shall not be applicable to omnibus objections that are filed in accordance with Local Rule 3007-1." As a result, barring an individual judge choosing to apply the national Rule 3007 procedure in a particular situation, omnibus objections in Delaware cases will continue to be governed by Delaware’s own local procedures.

Special thanks to Chuck Kunz of MorrisJames, publishers of the Delaware Business Bankruptcy Report, for alerting me to Delaware’s new General Order.