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Business Bankruptcy Issues Recent Developments The Financially Troubled Company

The Monetization Of Intellectual Property In Bankruptcy And Restructuring

ABI Panel. Last month I had the honor of speaking on a panel at the American Bankruptcy Institute’s 2022 Annual Spring Meeting in Washington, D.C. The topic of our panel was the Monetization of Intellectual Property in Bankruptcy and Restructuring.

  • I was joined by four distinguished panelists, Leslie Zmugg, General Counsel of Gordon Brothers (who was our moderator); Arthur Daemmrich, the Jerome and Dorothy Lemelson Director at the Lemelson Center for the Study of Invention and Innovation at the Smithsonian Institution; Bradley Limpert at Limpert & Associates; and Joshua Pichinson, Managing Director at Sherwood Partners, Inc./agencyIP.
  • The panel covered a range of issues, including an historical perspective on intellectual property and the way business failures impacted technological development, the impact of licenses on IP sales in bankruptcy, due diligence issues in distressed IP sale transactions, and cross-border implications in certain intellectual property transactions.

Video Available. The American Bankruptcy Institute has now made the the video of the panel discussion available for your viewing pleasure — just follow the link in this sentence to watch it.

I hope you find it helpful.

 

 

Image Courtesy of Flickr by Alejandroxwq

Business Bankruptcy Issues Recent Developments

A Beam Of Sun For Trademark Licensees: Another Appellate Court Holds Rejection Does Not Terminate A Trademark Licensee’s Rights

The In re Tempnology LLC bankruptcy case in New Hampshire has produced yet another important decision involving trademarks and Section 365(n) of the Bankruptcy Code. This time the decision is from the United States Bankruptcy Appellate Panel for the First Circuit (“BAP”). Although the BAP’s Section 365(n) discussion is interesting, even more significant is its holding on the impact of rejection of a trademark license. The decision is also further evidence of the continuing trend of courts seeking ways to protect trademark licensees in bankruptcy.

Before we get ahead of ourselves, let’s take a quick look back at the Bankruptcy Court’s decision.

The Bankruptcy Court’s Decision. Just about a year ago the New Hampshire Bankruptcy Court issued a decision involving the effects of rejection by the debtor, Tempnology LLC, of a Co-Marketing and Distribution Agreement (“Agreement”). In re Tempnology, LLC, 541 B.R. 1 (Bankr. D.N.H. 2015). In the Agreement, Tempnology had granted Mission Product Holdings, Inc. (“Mission”) (1) a non-exclusive license to certain of Tempnology’s copyrights, patents, and trade secrets, (2) an exclusive right to distribute certain cooling material products that Tempnology manufactured, and (3) an associated trademark license. With one of its first motions in the bankruptcy case, Tempnology rejected the Agreement.

  • The Bankruptcy Court held that the non-exclusive license to Tempnology’s copyright, patent, and trade secret rights was a license of “intellectual property” as defined in Section 101(35A) of the Bankruptcy Code, and that Mission’s rights to continue to use that IP was protected under Section 365(n). However, the exclusive distribution rights were not “intellectual property” under Section 101(35A) and the Bankruptcy Court held Mission’s distribution rights were not protected under Section 365(n).
  • The Bankruptcy Court also held that because trademarks were not included in Section 101(35A)’s definition of intellectual property, Mission’s trademark license rights were not protected by Section 365(n).
  • In considering the impact of rejection, the Bankruptcy Court followed the 1985 decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). The Bankruptcy Court held that due to the rejection of the Agreement, Mission lost both the exclusive distribution rights and the trademark license rights.
  • You can get the details on the Bankruptcy Court’s decision at this prior post, entitled “A Reminder Of The Limits Of Section 365(n)’s Licensee Protection.”

Why No Mention Of The Seventh Circuit’s Sunbeam Decision? In that earlier post, I noted that given Circuit level decisions over the last few years involving trademarks and bankruptcy, it was interesting that the Bankruptcy Court’s decision did not mention 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 discussion of the Sunbeam decision). In contrast to Lubrizol, the Sunbeam court held that rejection is a breach by the debtor and does not terminate the agreement or the rights of the non-breaching party.
  • As a result, the Seventh Circuit allowed the non-debtor trademark licensee to continue using the licensed trademarks despite rejection of the trademark license.

At the time I speculated that if the Bankruptcy Court in the Tempnology case had applied the Sunbeam decision, the result might have been different.

The Bankruptcy Appellate Panel Decision. Mission appealed the Bankruptcy Court’s decision to the BAP. On November 18, 2016, the BAP issued its decision, affirming in part and reversing in part the Bankruptcy Court’s decision. Follow this link for a copy of the BAP’s November 18, 2016 decision.

  • The BAP affirmed the Bankruptcy Court’s holding that the exclusive distribution rights in the Agreement were not intellectual property as defined in the Bankruptcy Code and were not protected by Section 365(n).
  • The BAP also affirmed the Bankruptcy Court’s decision that Section 365(n) did not protect Mission’s rights as a trademark licensee, ruling that the Bankruptcy Court had corrected held that Section 101(35A)’s definition of “intellectual property” excludes trademarks.
  • On the trademark point, Mission urged the BAP to follow the equitable approach that Judge Ambro had suggested in his concurring opinion in the Third Circuit’s decision in In re Exide Techs., 607 F.3d 957 (3d Cir. 2010), which would let bankruptcy courts fashion equitable protections for trademark licensees. The BAP declined to follow either that approach or the one taken by the New Jersey Bankruptcy Court in In re Crumbs Bake Shop, 522 B.R. 766 (Bankr. D.N.J. 2014), which had effectively applied Section 365(n) to trademarks.
  • For more on the Crumbs Bake Shop and Exide Techs. decisions, take a look at this earlier post.

The BAP Discusses, And Then Follows, Sunbeam. Had the BAP stopped there, it would have affirmed the Bankruptcy Court’s holding. The BAP, however, did not stop there. Instead, it considered the Sunbeam decision and ultimately followed its analysis on the effect of rejection on a trademark license agreement. In so doing, the BAP became the first appellate court outside the Seventh Circuit to adopt the Sunbeam decision’s rejection analysis.

The BAP turned to the Lubrizol decision first:

We must part company with the bankruptcy court, however, on the effect the Debtor’s rejection of the Agreement had on Mission’s licensee rights in the Debtor’s trademark and logo. The bankruptcy court ruled that, because the Debtor’s trademark and logo were not protected by Mission’s election under § 365(n), Mission did “not retain rights to the Debtor’s trademarks and logos post-rejection.” This conclusion endorses Lubrizol’s approach to the rejection of executory contracts, namely that rejection terminates the contract. Lubrizol, however, is not binding precedent in this circuit and, like the many others who have criticized its reasoning [footnote omitted], we do not believe it articulates correctly the consequences of rejection of an executory contract under § 365(g). We adopt Sunbeam’s interpretation of the effect of rejection of an executory contract under § 365 involving a trademark license.

The BAP went on with its analysis:

Applying Sunbeam’s rationale, we conclude that, while the Debtor’s trademark and logo were not encompassed in the categories of intellectual property entitled to special protections under § 365(n), the Debtor’s rejection of the Agreement did not vaporize Mission’s trademark rights under the Agreement. Whatever post-rejection rights Mission retained in the Debtor’s trademark and logo are governed by the terms of the Agreement and applicable non-bankruptcy law.

Thus, we conclude that the bankruptcy court did not err in ruling that Mission’s § 365(n) election failed to protect its rights under the Agreement as licensee of the Debtor’s trademark and logo, but it erred in ruling that Mission’s rights in the Debtor’s trademark and logo as set forth in the Agreement terminated upon the Debtor’s rejection of the Agreement.

Sunbeam, Now Joined By Tempnology, Raises A Number Of Questions. If followed by other courts, the Sunbeam and Tempnology decisions raise a variety of issues. These include the following:

  • Aside from the right to use the licensed trademarks, does the licensee keep other rights under the trademark license, such as exclusivity if applicable?
  • Does the licensee have rights to use the trademarks for the full term of the license agreement plus any extensions, or some shorter period?
  • If payment of royalties is required under a trademark license, must the trademark licensee continue to pay them post-rejection to use the licensed trademarks, as an IP licensee covered by Section 365(n) is required to do?
  • Can the trademark licensee instead argue that rejection is a material breach by the debtor and excuses the obligation to pay royalties?
  • Under Sunbeam and Tempnology, if rejection does not terminate trademark license rights, is the same true for intellectual property licenses other than trademarks, such as patents and copyrights, covered by Section 365(n)?
  • Is the Section 365(g) analysis of Sunbeam and Tempnology just limited to trademark license rights? Can a non-debtor party to an executory contract argue that other of its contract rights are also preserved, as long as they don’t impose affirmative performance obligations on the debtor? If so, in Tempnology, would that extend to Mission’s exclusive distribution rights?
  • Are licensees of patents, copyrights, or trade secrets, otherwise protected by Section 365(n), required to follow Section 365(n)’s statutory scheme to retain their rights, or can they rely on the analysis in Sunbeam and Tempnology as a complete alternative?
  • How will purchasers of trademarks and other assets react to the potential continued use of trademarks by licensees under rejected trademark licenses?

Conclusion. The BAP’s Tempnology decision marks the first time an appellate court other than the Seventh Circuit has applied the Sunbeam analysis to a trademark license.

  • It remains to be seen if other courts will start to follow suit or, alternatively, if the Lubrizol decision’s approach to the consequences of rejection will continue to hold sway.
  • If many courts followed the Sunbeam/Tempnology approach and rejected Lubrizol, the omission of trademarks from Section 365(n) protection could matter less than in the past. In addition, the license agreement’s provisions governing the licensee’s rights upon the licensor’s breach could become much more significant.

Given the broad implications of the Lubrizol/Sunbeam split on rejection of executory contracts, and especially on trademark licenses, be sure to stay tuned.

 

Image Courtesy of Flickr by discutant

Business Bankruptcy Issues Recent Developments

Seventh Circuit Bankruptcy Ruling Is Big Win For Trademark Licensees

On July 9, 2012, the U.S. Court of Appeals for the Seventh Circuit issued its decision in Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, and in doing so handed a major victory to trademark licensees whose licenses are rejected in bankruptcy by trademark owners. A copy of the opinion is available through this link. However, before discussing the details of the opinion, it’s important to put it in context first. And for that, we need to journey back to the 1980s.

A History Of Rejection. Back in 1985, the U.S. Court of Appeals for the Fourth Circuit issued a decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). The Fourth Circuit held that Lubrizol, a nonexclusive patent licensee whose patent license was rejected as an executory contract in the bankruptcy case of Lubrizol’s licensor, debtor Richmond Metal Finishers, could not "rely on provisions within its agreement with [the debtor] for continued use of the technology."  According to the Lubrizol court, when Congress enacted Section 365(g) of the Bankruptcy Code, governing the effect of rejection of an executory contract, "the legislative history of § 365(g) makes clear that the purpose of the provision is to provide only a damages remedy for the non-bankrupt party," and no specific performance remedy. The Fourth Circuit held that, as a result, when the debtor rejected the contract, Lubrizol, as the patent licensee, lost its rights under the license.

Congress Protects Certain IP Licensees. In reaction to the Lubrizol decision and the concerns of the decision’s potential impact on patent and other technology licensees, in 1988 Congress added Section 365(n) to the Bankruptcy Code, expressly permitting licensees of intellectual property to elect to retain their rights to the intellectual property. However, Congress also added to the Bankruptcy Code its own definition of "intellectual property" for Section 365(n) purposes, and decided not to include trademarks in Section 101(35A)’s definition. As a result, trademark licensees have none of the protections of Section 365(n). Follow the link for more on Section 365(n) and its protections for licensees.

Back To The Future. With that history in mind, it’s time to come back to the future, or at least the present. Lubrizol’s decision that a licensee cannot rely on the provisions of its license agreement for continued use of the intellectual property, together with the fact that Section 365(n)’s protections do not extend to trademark licenses, has for years left trademark licensees at great risk of losing all trademark rights if the license is rejected. That is, it seemed that way until just the past couple of years.

  • A 2010 decision from the U.S. Court of Appeals for the Third Circuit in the In re: Exide Technologies case held that when a trademark license was provided in connection with the sale of a business, and that sale had been substantially performed, the trademark license was no longer executory, could not be rejected, and the licensee could continue to use the trademarks.
  • In a concurring opinion in Exide Technologies, Judge Ambro went further, concluding that rejection of a trademark license should not deprive the licensee of all rights. In enacting Section 365(n) but leaving trademarks outside the definition of "intellectual property," Congress did not intend that Lubrizol’s result apply to trademark licenses and instead courts should use equitable powers to protect licensees.
  • Last year, in the case that led to the Seventh Circuit’s decision here, the bankruptcy court in In re Lakewood Engineering & Manufacturing Co., Inc, 459 B.R. 306 (Bankr. N.D. Ill. 2011), decided to "step into the breach," follow Judge Ambro’s reasoning, and begin the "development of equitable treatment" of trademark licensees that it concluded Congress had anticipated would occur. In so doing, it held that despite rejection of a manufacturing and supply agreement that included a trademark license, the licensee could continue to sell trademarked goods as it had been licensed to do.

The Seventh Circuit’s Decision. The bankruptcy court’s decision was taken up on appeal to the Seventh Circuit. In its July 9, 2012 opinion, written by Chief Judge Frank H. Easterbrook, the Seventh Circuit disagreed with the bankruptcy court’s analysis but ultimately affirmed its decision. In its opinion, however, the Seventh Circuit took aim directly at the Lubrizol decision and reasoning.

The facts of the Sunbeam case are fairly straightforward. Lakewood Engineering & Manufacturing Co. made various consumer products, including box fans, which were covered by its patents and trademarks. Lakewood contracted with Chicago American Manufacturing ("CAM") to make its fans for 2009, granting CAM a license to the relevant patents and trademarks. In recognition of both the investment CAM would have to make to manufacture the fans and Lakewood’s own distressed financial condition, the agreement authorized CAM to sell directly any of the 2009 production of box fans that Lakewood did not purchase. A few months after the agreement was signed, Lakewood was forced into involuntary bankruptcy and a trustee was appointed. The trustee sold Lakewood’s assets, including the patents and trademarks, to Sunbeam Consumer Products, which wanted to sell its own fans and not have to compete with CAM’s sales. The trustee rejected the CAM agreement and, when CAM continued to sell the remaining fans, Sunbeam sued CAM for infringement.

The issue on appeal was the effect of the trustee’s rejection of the CAM agreement, and specifically the trademark license, on CAM’s ability to sell the fans. The Seventh Circuit’s focus on the Lubrizol decision was apparent:

Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), holds that, when an intellectual-property license is rejected in bankruptcy, the licensee loses the ability to use any licensed copyrights, trademarks, and patents. Three years after Lubrizol, Congress added §365(n) to the Bankruptcy Code. It allows licensees to continue using the intellectual property after rejection, provided they meet certain conditions. The bankruptcy judge held that §365(n) allowed CAM to practice Lakewood’s patents when making box fans for the 2009 season. That ruling is no longer contested. But “intellectual property” is a defined term in the Bankruptcy Code: 11 U.S.C. §101(35A) provides that “intellectual property” includes patents, copyrights, and trade secrets. It does not mention trademarks. Some bankruptcy judges have inferred from the omission that Congress codified Lubrizol with respect to trademarks, but an omission is just an omission. The limited definition in §101(35A) means that §365(n) does not affect trademarks one way or the other. According to the Senate committee report on the bill that included §365(n), the omission was designed to allow more time for study, not to approve Lubrizol. See S. Rep. No. 100–505, 100th Cong., 2d Sess. 5 (1988). See also In re Exide Technologies, 607 F.3d 957, 966–67 (3d Cir. 2010) (Ambro, J., concurring) (concluding that §365(n) neither codifies nor disapproves Lubrizol as applied to trademarks). The subject seems to have fallen off the legislative agenda, but this does not change the effect of what Congress did in 1988.

Chief Judge Easterbrook’s opinion noted that the bankruptcy court had permitted CAM to continue using the trademarks on equitable grounds, but rejected that approach as going beyond what the Bankruptcy Code permits. The Seventh Circuit then directly addressed the Lubrizol decision:

Although the bankruptcy judge’s ground of decision is untenable, that does not necessarily require reversal. We need to determine whether Lubrizol correctly understood §365(g), which specifies the consequences of a rejection under §365(a). No other court of appeals has agreed with Lubrizol—or for that matter disagreed with it. Exide, the only other appellate case in which the subject came up, was resolved on the ground that the contract was not executory and therefore could not be rejected. (Lubrizol has been cited in other appellate opinions, none of which concerns the effect of rejection on intellectual-property licenses.) Judge Ambro, who filed a concurring opinion in Exide, concluded that, had the contract been eligible for rejection under §365(a), the licensee could have continued using the trademarks. 607 F.3d at 964–68. Like Judge Ambro, we too think Lubrizol mistaken.

After observing that outside of bankruptcy a licensor’s breach does not terminate a licensee’s right to use intellectual property, and Section 365(g) provides that rejection is breach, the Seventh Circuit turned to the impact of Section 365(g) and rejection in bankruptcy:

What §365(g) does by classifying rejection as breach is establish that in bankruptcy, as outside of it, the other party’s rights remain in place. After rejecting a contract, a debtor is not subject to an order of specific performance. See NLRB v. Bildisco & Bildisco, 465 U.S. 513, 531 (1984); Midway Motor Lodge of Elk Grove v. Innkeepers’ Telemanagement & Equipment Corp., 54 F.3d 406, 407 (7th Cir. 1995). The debtor’s unfulfilled obligations are converted to damages; when a debtor does not assume the contract before rejecting it, these damages are treated as a pre-petition obligation, which may be written down in common with other debts of the same class. But nothing about this process implies that any rights of the other contracting party have been vaporized. Consider how rejection works for leases. A lessee that enters bankruptcy may reject the lease and pay damages for abandoning the premises, but rejection does not abrogate the lease (which would absolve the debtor of the need to pay damages). Similarly a lessor that enters bankruptcy could not, by rejecting the lease, end the tenant’s right to possession and thus re-acquire premises that might be rented out for a higher price. The bankrupt lessor might substitute damages for an obligation to make repairs, but not rescind the lease altogether.

The Court then distinguished rejection from avoidance powers, which might lead to rescission or termination of an agreement, observing that "rejection is not ‘the functional equivalent of a rescission, rendering void the contract and requiring that the parties be put back in the positions they occupied before the contract was formed.” Thompkins v. Lil’ Joe Records, Inc., 476 F.3d 1294, 1306 (11th Cir. 2007). It ‘merely frees the estate from the obligation to perform’ and ‘has absolutely no effect upon the contract’s continued existence’. Ibid. (internal citations omitted)." Follow the link for more background on the Thompkins decision.

The Seventh Circuit referenced scholarly criticism of the Lubrizol decision before turning back to the Fourth Circuit’s opinion: 

Lubrizol itself devoted scant attention to the question whether rejection cancels a contract, worrying instead about the right way to identify executory contracts to which the rejection power applies.

Lubrizol does not persuade us. This opinion, which creates a conflict among the circuits, was circulated to all active judges under Circuit Rule 40(e). No judge favored a hearing en banc. Because the trustee’s rejection of Lakewood’s contract with CAM did not abrogate CAM’s contractual rights, this adversary proceeding properly ended with a judgment in CAM’s favor.

A Significant Decision. The Seventh Circuit’s opinion in the Sunbeam case not only creates a circuit split that could potentially lead the Supreme Court to address the issue, but more significantly represents the first court of appeals decision in 27 years to challenge Lubrizol’s view of how rejection impacts an intellectual property license. Although binding only in the Seventh Circuit (much like, in theory, Lubrizol was binding only in the Fourth Circuit), the Sunbeam decision has the potential to impact licensee rights in cases across the country. Licensees, and especially trademark licensees, will be arguing that rejection does not terminate their license rights. Debtors and purchasers of trademarks may well argue otherwise. If followed by other courts, the Sunbeam decision and its potential interplay with Section 365(n) raises a number of questions, including:

  • Aside from the right to use the licensed trademarks, does the licensee keep other rights under its agreement, such as exclusivity if applicable?
  • How long does the right to the trademarks continue, the full term of the license agreement plus any extensions, or some shorter period?
  • If royalties are required under a trademark license, must the trademark licensee continue to pay them post-rejection to use the licensed trademarks, as an IP licensee covered by Section 365(n) is required to do, or can the trademark licensee argue that rejection is a material breach excusing that performance?
  • Since under Sunbeam rejection does not terminate trademark license rights, does the same analysis apply to intellectual property other than trademarks, including those covered by Section 365(n)?
  • Are licensees of patents, copyrights, or trade secrets, otherwise protected by Section 365(n), required to follow Section 365(n)’s statutory scheme to retain their rights, or can they rely on the Sunbeam decision’s analysis of the effect of rejection as an alternative approach? 
  • How will purchasers of trademarks and other assets react to the potential continued use of the marks by licensees under rejected trademark licenses?

Conclusion. As these questions suggest, the full impact of the Seventh Circuit’s Sunbeam decision is yet to be determined. It remains to be seen how other circuits — and bankruptcy courts in important venues such as Delaware and the Southern District of New York — will react. Given the circuit split now created, it’s possible the Supreme Court could address the issue, either in Sunbeam or a later case. In the meantime, however, a long-standing and often accepted view of the impact of rejection on intellectual property licenses, and especially on trademark licenses, has been upended. It will likely take courts, licensors, and licensees some time to sort through how the new, post-Sunbeam state of the law will play out. This could get interesting — stay tuned.

Business Bankruptcy Issues Recent Developments

When Worlds Collide: Do Section 365(n) IP Licensee Rights Work In A Chapter 15 Cross-Border Bankruptcy?

Section 365(n) And Licensee Rights. I have discussed in the past how Section 365(n) was added to the Bankruptcy Code to protect licensees of intellectual property in the event the licensor files bankruptcy.

  • Under Section 365(n), if the debtor or trustee rejects a license, 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.
  • To read more about Section 365(n)’s benefits and protections, follow the link in this sentence.

Limits Of Section 365(n). These protections, however, have their limits. One limitation comes from the fact that the Bankruptcy Code’s special definition of "intellectual property" excludes trademarks from the scope of Section 365(n)’s protections. Another major limitation is that since Section 365(n) is a U.S. Bankruptcy Code provision, it only applies in a U.S. bankruptcy case.

What Happens To Section 365(n) In Chapter 15 Cases? One issue that was less clear was what would happen if a foreign licensor were the subject of a case under Chapter 15 of the U.S. Bankruptcy Code. Would Section 365(n) apply to protect licensees in a Chapter 15 proceeding?

  • Chapter 15 allows an entity’s foreign representative to obtain U.S. bankruptcy protection for assets and interests in the United States. It was was added to the Bankruptcy Code a few years ago to implement certain cross-border insolvency procedures when corporations had assets and interests in more than one country. To read more on Chapter 15 bankruptcy, follow the link in this sentence. 
  • Section 365(n) and Chapter 15 recently collided in the Chapter 15 case of Qimonda AG, and led to a decision by Judge Robert G. Mayer of the United States Bankruptcy Court for the Eastern District of Virginia on that very issue. 
  • The Bankruptcy Court’s decision, discussed below, is available by following the link in this sentence.

The Qimonda Chapter 15 Case. In the Qimonda AG Chapter 15 case, the Bankruptcy Court had previously recognized the pending German insolvency proceeding as a "foreign main proceeding" under Chapter 15 of the U.S. Bankruptcy Code. As part of the Chapter 15 proceeding, the Bankruptcy Court had entered a supplemental order providing, among other things, that Section 365 of the U.S. Bankruptcy Code would apply to the Chapter 15 case.

U.S. Licensees Invoke Section 365(n). Following the Bankruptcy Court’s supplemental order, certain U.S. licensees asserted Section 365(n) rights in an attempt to retain their rights to intellectual property that Qimonda AG had licensed them.

The Bankruptcy Court’s Decision. After considering the motion and opposition, Judge Mayer issued a decision agreeing with Qimonda AG’s foreign representative and he modified the prior supplemental order to exclude the effect of Section 365(n) by providing that it would apply only if the foreign representative "rejects an executory contract pursuant to Section 365 (rather than simply exercising the rights granted to the Foreign Representative pursuant to the German Insolvency Code)." In reaching this decision, the Bankruptcy Court considered the effect of its recognition of the German insolvency proceeding given the purpose of Chapter 15:

The principal idea behind chapter 15 is that the bankruptcy proceeding be governed in accordance with the bankruptcy laws of the nation in which the main case is pending. In this case, that would be the German Insolvency Code. Ancillary proceedings such as the chapter 15 proceeding pending in this court should supplement, but not supplant, the German proceeding.

That objective is particularly relevant in this case where there are many international patents.  The patents themselves are issued under the laws of various nations. While there may be multiple international patents, the multiple international patents protect the same idea, process or invention in the country that issued the patent. If the patents and patent licenses are dealt with in accordance with the bankruptcy laws of the various nations in which the licensees or licensors may be located or operating, there will be many inconsistent results. In fact, the same idea, process or invention may be dealt with differently depending on which country the particular ancillary proceeding is brought. Rather than having a coherent resolution to Qimonda’s patent portfolio, the portfolio may be shattered into many pieces that can never be reconstructed. In this case, Qimonda licensed its patents to companies that are operating in various nations. It is clear that the patent rights are not being exploited solely, and even possibly principally, in the United States. In fact, they are being utilized throughout the world. If the laws of the various nations in which the patents are being used would be applicable, there will be many different treatments of the patents that have been licensed by Qimonda AG and many different and inconsistent results throughout the world. This is detrimental to a systematic bankruptcy proceeding and detrimental to the resolution of the German bankruptcy proceeding itself. It diminishes the value of these assets. It results in an inefficient insolvency administration. It may well be detrimental to parties who are or wish to license the patents. It is not difficult to envision that if the patent portfolio is splintered without overall administration or control, some parties may be left with incomplete patent protection. Holding an American patent without holding a patent enforceable in the Europe may significantly restrict its use and utility. This is at odds with the Congressionally stated purposes in §1501.

                                          *       *        *

All the patents should be treated the same. There should not be disparate results simply because of the location of a factory or research facility or corporate office. This would be the result if the supplemental order were left in place. It is clear that the inclusion of §365 in the supplemental order was improvident. It had unintended consequences that significantly and adversely affect the main proceeding in Germany.

Conclusion. The Qimonda AG decision underscores that although Section 365(n) of the Bankruptcy Code offers significant protection to licensees, its benefits frequently stop at the water’s edge. When the licensor is based outside of the United States, Section 365(n) will be of little help, even if the license covers U.S. issued patents and the foreign licensor obtains protection for its U.S. assets and interests under Chapter 15 of the Bankruptcy Code. Licensees must continue to keep the limits of Section 365(n) in mind when negotiating licenses of intellectual property from foreign licensors.

Business Bankruptcy Issues

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

U.S. Supreme Court Shows Interest In Deciding Whether The Hypothetical Test Or The Actual Test Should Be Used To Determine If IP Licenses Can Be Assumed In Bankruptcy

It looks like the U.S. Supreme Court, or at least two of the Justices, is interested in deciding whether the "hypothetical test" or the "actual test" should be used in determining whether an intellectual property license can be assumed by a debtor in possession under Section 365(c)(1) of the Bankruptcy Code. That was the clear message from the somewhat unusual statement by Justice Kennedy, with whom Justice Breyer joined, issued on March 23, 2009, in connection with the Supreme Court’s denial of a writ of certiorari in the N.C.P. Marketing Group, Inc. case. You can read a copy of the entire statement by following the link in the prior sentence.

The N.C.P. Marketing Case. As a refresher, in 2005, the U.S. District Court for the District of Nevada issued its first of a kind decision, In re: N.C.P. Marketing Group, Inc., 337 B.R. 230 (D.Nev. 2005), holding that trademark licenses are personal and nonassignable in bankruptcy absent a provision in the trademark license to the contrary. Click here for a copy of the N.C.P Marketing Group decision and here, here, and here to read earlier posts on the case. Last May, the Ninth Circuit affirmed the District Court’s judgment "for the reasons provided by that court" in an order designed as "not for publication."

Assumption And Assignment. A key basis for the District Court’s decision in the N.C.P. Marketing Group case was the way the Ninth Circuit has interpreted Section 365(c)(1), specifically on the question of whether a debtor in possession can assume an intellectual property license. In bankruptcy parlance, assumption means that the debtor gets to keep the license. Usually, debtors are allowed to exercise their business judgment when deciding whether to assume or reject (read: breach and stop performing) an executory contract, as well as to assume and assign one to a third party. However, Section 365(c)(1) of the Bankruptcy Code puts a limit on a debtor’s ability to assign executory contracts, and perhaps even to assume them, when "applicable law" gives the non-debtor party to the contract the right to refuse to deal with someone else. In the N.C.P. Marketing Group decision, the District Court held that federal trademark law under the Lanham Act was such "applicable law" and rendered non-exclusive trademark licenses nonassignable.

The Key Bankruptcy Code Section. Section 365(c)(1) is so important to this debate that it bears careful review. Here’s what it says:

(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.

Hypothetical Versus Actual Test. If a debtor cannot assign an IP license without consent of the licensor, can it at least assume the license? That question has led courts to examine ever so closely the first seven words of Section 365(c): "The trustee may not assume or assign…"

  • When the statute says that the trustee may not assume or assign an IP license, does the word "or" really mean "and" too?
  • Put differently, what happens when a debtor is only trying to assume (keep) an IP license and is not actually trying to assign it? Does the Bankruptcy Code language mean that it can neither assume nor assign the license or does it only mean that the debtor cannot assign the license?
  • That, in a nutshell, is the difference between the so-called "hypothetical test" (which reads Section 365(c)(1)’s language as asking whether the debtor hypothetically could assign the license even if it’s only proposing to assume it) and the "actual test" (which interprets the statute’s language as asking only what the debtor is actually proposing to do).
  • The U.S. Courts of Appeals for at least three circuits have adopted the hypothetical test. The Ninth Circuit (covering California, Nevada, Arizona, and a number of other Western states), the Third Circuit (which includes Delaware, the venue of many Chapter 11 cases), and the Fourth Circuit (covering Virginia, West Virginia, Maryland, and North and South Carolina), have held that Section 365(c)(1) gives most IP licensors a veto right over proposals by a Chapter 11 debtor to assign — and even to assume — IP licenses.
  • For a more complete discussion of these issues, take a look at this earlier post, entitled "Assumption of Intellectual Property Licenses in Bankruptcy: Are Recent Cases Tilting Toward Debtors?"

Justice Kennedy’s Statement. N.C.P. Marketing Group petitioned the U.S. Supreme Court for a writ of certiorari, seeking review of the decision denying it the ability to assume the trademark license. Although also voting to deny review, Justice Kennedy issued a three-page statement on that decision to express his view, joined in by Justice Breyer, that the Supreme Court should considering granting certiorari in a future case on the "significant question" of whether the hypothetical test or the actual test should be applied in interpreting Section 365(c)(1) of the Bankruptcy Code. Justice Kennedy summed up his analysis this way:

The division in the courts over the meaning of §365(c)(1) is an important one to resolve for Bankruptcy Courts and for businesses that seek reorganization. This petition for certiorari, however, is not the most suitable case for our resolution of the conflict. Addressing the issue here might first require us to resolve issues that may turn on the correct interpretation of antecedent questions under state law and trademark-protection principles. For those and other reasons, I reluctantly agree with the Court’s decision to deny certiorari. In a different case the Court should consider granting certiorari on this significant question.

Justice Kennedy’s discussion of the two tests suggests that he (and perhaps Justice Breyer) may be leaning toward the actual test. Although noting that the actual test "may present problems of its own," including that it aligns Section 365 "with sound bankruptcy policy only at the cost of departing from at least one interpretation of the plain text of the law," Justice Kennedy aimed most of his criticism in the statement at the hypothetical test.

  • Specifically, Justice Kennedy commented that one "arguable criticism of the hypothetical approach is that it purchases fidelity to the Bankruptcy Code’s text by sacrificing sound bankruptcy policy." He stated that the hypothetical test "may prevent debtors-in-possession from continuing to exercise their rights under nonassignable contracts, such as patent and copyright licenses." Continuing, he noted that without these licenses, "some debtors-in-possession may be unable to effect the successful reorganization that Chapter 11 was designed to promote."
  • He also remarked on what he perceived as a "windfall" to nondebtor parties to valuable executory contracts. While outside of bankruptcy the nondebtor cannot renege on its agreement, if the debtor files bankruptcy "then the nondebtor obtains the power to reclaim–and resell at the prevailing, potentially higher market rate–the rights it sold to the debtor." Although most non-exclusive licenses are not treated as a sale of intellectual property, Justice Kennedy appears to view the potential loss of IP license rights due to a bankruptcy filing as an unfair result.

Conclusion. In denying review in the N.C.P. Marketing Group case, the Supreme Court has let stand the decision of the courts below that, where the hypothetical test applies as it does in the Ninth Circuit, a non-exclusive trademark license cannot be assumed by a debtor in possession. However, given the detailed statement issued by Justice Kennedy, and joined in by Justice Breyer, it appears that the chances of the Supreme Court granting certiorari in a future IP license assumption case have increased. If such a case reaches the Supreme Court, the current split in the circuits on this important intersection between bankruptcy and intellectual property law may finally be resolved.

Business Bankruptcy Issues The Financially Troubled Company

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.