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Business Bankruptcy Issues Recent Developments

Patent Law Collides With Bankruptcy: Federal Circuit Denies Bankruptcy Liquidation Trust Standing To Sue For Patent Infringement

The United States Court of Appeals for the Federal Circuit has jurisdiction over, among other areas, patent appeals, so it’s not every day that a Federal Circuit decision appears on this business bankruptcy blog. (Actually, it’s been about a year since this post discussing another Federal Circuit decision.) However, a September 19, 2007 opinion (available here) of the Federal Circuit rested largely on the intersection of patent law and the terms of a Chapter 11 plan of reorganization. Since the decision denied a trust created under the plan standing to bring the debtor’s patent infringement claims, it’s a significant one for debtors and creditors alike. After discussing the court’s decision I’ll conclude with my suggested take-away from the case.

The At Home Corporation Plan And Liquidation Trusts. The litigation arose in the At Home Corporation Chapter 11 bankruptcy case, which was filed in September 2001. As part of the confirmed plan of liquidation, a general unsecured creditor liquidation trust (called GUCLT) was created to pursue various claims for the benefit of creditors, including certain patent infringement claims against Microsoft Corporation. A separate liquidation trust (called AHLT) received ownership of the At Home patent at issue in the litigation, among other assets. GUCLT was not granted a license to the patent.

The Patent Litigation And Federal Circuit Decision. The patent litigation reached the Federal Circuit in 2006. Although the plan and related documents granted GUCLT the express right to pursue the patent litigation claims at issue, the Federal Circuit found that to be insufficient to confer standing. It held that the patent statutes provide protection to the party with a right to exclude, not the party with a right to sue. Because the right to exclude others from practicing the patent (part of AHLT’s rights) had been separated from the right to sue for infringement (GUCLT’s rights), GUCLT was not protected under the patent statutes. The Federal Circuit summed up the situation this way:

The problem for GUCLT and AHLT is that the exclusionary rights have been separated from the right to sue for infringement. The liquidation plan contractually separated the right to sue from the underlying legally protected interests created by the patent statutes—the right to exclude. For any suit that GUCLT brings, its grievance is that the exclusionary interests held by AHLT are being violated. GUCLT is not the party to which the statutes grant judicial relief. See Warth, 422 U.S. at 500. GUCLT suffers no legal injury in fact to the patent’s exclusionary rights. As the Supreme Court stated in Independent Wireless, the right to bring an infringement suit is “to obtain damages for the injury to his exclusive right by an infringer.” 269 U.S. at 469; see also Sicom, 222 F.3d at 1381 (“Standing to sue for infringement depends entirely on the putative plaintiff’s proprietary interest in the patent, not on any contractual arrangements among the parties regarding who may sue…”); Ortho, 52 F.3d at 1034 (“[A] right to sue clause cannot negate the requirement that, for co-plaintiff standing, a licensee must have beneficial ownership of some of the patentee’s proprietary rights.”).

Since GUCLT had the right to sue but not the right to exclude others from practicing the patent, and since AHLT had the right to exclude others but not the right to sue for infringement, neither liquidating trust could sue for the infringement alleged in the GUCLT’s underlying lawsuit. The Federal Circuit ruled that the problem could not be solved by the typical practice of joining the legal title holder, here AHLT, to the patent litigation as a party. Although such joinder solves prudential standing requirements, the court held that it does not solve the constitutional standing requirement of actual legal injury. GUCLT did not suffer legal injury because it had no right to exclude others from practicing the patent.

The Federal Circuit’s majority opinion prompted an interesting dissent, which ended with the following:

While I do not read any precedent as directly governing the peculiar circumstances of this case, I also do not read any as precluding co-plaintiff standing for GUCLT. I believe that, in denying all possibility for enforcing the patent, the majority opinion extends limitations on co-plaintiff standing without a reasoned basis. Accordingly, while neither GUCLT nor AHLT individually may pursue infringement litigation, I would not deprive the patent of all value. Because I would allow GUCLT and AHLT, as co-plaintiffs, standing to sue Microsoft, I respectfully dissent.

The View From IP Bloggers. Dennis Crouch of the Patently-O patent law blog has an interesting post on the case, and he gets special thanks for first reporting on the decision. For another view, you may find this post from the Patry Copyright Blog published by William Patry, Google’s Senior Copyright Counsel, of interest.

Important Lessons. On his patent law blog, Dennis Crouch gives the practice pointer that he believes patent lawyers should learn from the decision: "A non-title-holder must be granted an exclusive license as well as full litigation rights in order to have standing to sue for patent infringement." That is helpful advice for patent lawyers, but I have a suggestion of my own.

  • When intellectual property such as patents, copyrights, or trademarks is involved in a bankruptcy case, get expert advice from IP counsel, in addition to bankruptcy advice. The problem may be separating exclusionary rights from the right to sue for patent infringement one day and transferring a trademark without its goodwill the next.
  • This suggestion applies when dealing with, for example, the transfer of IP in a bankruptcy case, whether by liquidation trusts, Section 363 asset sales, or something else, or assessing the risk of continuing patent infringement when purchasing IP assets.
  • As the Federal Circuit’s decision shows, the interplay between IP issues and bankruptcy cases can be complex and the possible outcomes surprising. Getting expert advice can help you avoid these and other traps for the unwary.
Business Bankruptcy Issues Recent Developments

Another Court Follows The Footstar Decision On Assumption Of IP Licenses In Bankruptcy

Intellectual property licenses continue to be significant to companies across a wide range of industries. This fact makes their treatment in business bankruptcy cases a topic of keen interest. 

Can A Debtor Licensee Retain IP License Rights? When the debtor in possession is a licensee under a patent, copyright, or trademark license, a key question arises: Can the license be assumed (bankruptcy-speak for kept) or will the bankruptcy filing put the licensor in a position to force rejection of the license — resulting in the ultimate termination of the debtor’s right to use the licensed IP?  A new case, discussed below, recently sided with the debtor in possession.

One Statute, Three Tests. This issue has led to a significant split of authority among bankruptcy courts and courts of appeal around the country, stemming from different interpretations of the language in Section 365(c)(1) of the Bankruptcy Code. That section provides as follows:

(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.

Some courts, including the U.S. Court of Appeals for the Ninth Circuit, have sided with the licensor and interpret Section 365(c)(1) to prohibit both assignment and assumption. Other courts, including the First Circuit, have permitted such licenses to be assumed.

  • Despite the split, most courts agree that Section 365(c)(1) prohibits assignment of executory contracts without the non-debtor contracting party’s consent if "applicable law" requires such consent because that would require the non-debtor party to accept performance from a new party. 
  • A number of courts have held that when the "applicable law" is federal patent, copyright, or trademark law, such consent is required.
  • Courts diverge, however, on whether the statute’s language should be read to prohibit a debtor in possession from assuming such executory contracts or only from assigning them.

Rather than cover that ground here, if this topic is new to you I suggest reading an earlier post entitled "Assumption Of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?" It discusses in detail how different courts have interpreted Section 365(c)(1), leading to the licensor-favorable "hypothetical test," the debtor-favorable "actual test," and the newer, debtor-favorable Footstar analysis. 

A Word On Footstar. Before moving on to the new decision, a brief word about the Footstar case may be helpful. In In re Footstar, Inc,, 323 B.R. 566 (Bankr. S.D.N.Y. 2005), Judge Adlai Hardin of the U.S. Bankruptcy Court for the Southern District of New York took a somewhat different approach in analyzing the statute. He concluded that Section 365(c)(1)’s use of the word "trustee" does not (as other courts had taken for granted) include the debtor or debtor in possession when assumption is sought because assumption does not require the non-debtor party to accept performance from a new party other than the debtor or debtor in possession. A trustee is a new party and the statute logically provides that a trustee may not "assume or assign" such an executory contract.

A Common Scenario. How does this issue come up in Chapter 11 cases? Well, here’s a typical situation. The debtor is the licensee under a prepetition patent license. The patent licensor files a motion to compel the debtor in possession to reject the patent license agreement or alternatively to have the automatic stay lifted to permit the licensor to cancel the agreement. The licensor argues that under the "hypothetical test" interpretation of Section 365(c)(1), the debtor in possession cannot assign the license and, as a result, cannot assume the license either. With neither option open, the licensor argues, the debtor in possession should be compelled to reject the license.

The Aerobox Decision. This was the situation that recently played out in the In re Aerobox Composite Structures, LLC Chapter 11 bankruptcy case. Ruling on just such a motion by a patent licensor, on July 27, 2007, Judge Mark B. McFeeley of the U.S. Bankruptcy Court for the District of New Mexico issued an 11-page decision holding that the actual test, and Judge Hardin’s analysis in Footstar, was the correct interpretation of Section 365(c)(1). As such, he denied the licensor’s motion and held that the debtor in possession was not barred by Section 365(c)(1) of the Bankruptcy Code from assuming the prepetition patent license at issue in that case. The Bankruptcy Court summed up its holding as follows:

Similarly, the bankruptcy court in Footstar reasons that it makes perfect sense for the statute, which uses the term, “trustee,” to prohibit the trustee from assuming or assigning a contract, because the trustee is an “entity other than the debtor in possession” but it makes no sense to read “trustee” to mean “debtor in possession.” Footstar, 323 B.R. at 573. Doing so

would render the provision a virtual oxymoron, since mere assumption [by the debtor in possession] (without assignment) would not compel the counterparty to accept performance from or render it to “an entity other than” the debtor.

Id.

This Court agrees.

Thus, where the debtor-in-possession seeks to assume, or, as is the situation in the instant case, where the debtor-in-possession has neither sought to assume nor reject the executory contract but simply continues to operate post-petition under its terms, 11 U.S.C. § 365(c)(1) does not prohibit assumption of the contract by the debtor-in-possession and cannot operate to allow the non-debtor party to the executory contract to compel the Debtor to reject the contract. In reaching this conclusion, the Court finds that the “actual test” articulated in Cambridge Biotech, and the reasoning of the court in Footstar, is the better approach to § 365(c)(1) when determining whether a debtor-in-possession is precluded from assuming an executory contract.

Venue Still Matters. The decision is interesting because it represents another bankruptcy court, this time outside of the Southern District of New York, endorsing the analysis in the Footstar decision. That said, Judge McFeeley wrote on something of a clean slate because the Tenth Circuit has not yet taken a view on whether the hypothetical test, the actual test, or the Footstar analysis controls. As this circuit-by-circuit chart of Section 365(c)(1) decisions shows (last updated in March 2007), many other circuits have staked out a position on the issue. Absent a Supreme Court decision or new legislation resolving the circuit split, where a debtor files bankruptcy will continue to make a big difference in the relative rights of licensors and debtors over intellectual property licenses in Chapter 11 cases.

Business Bankruptcy Issues Recent Developments

Assumption Of Intellectual Property Licenses In Bankruptcy: Are Recent Cases Tilting Toward Debtors?

Executory contracts present a host of interesting issues in bankruptcy cases. This is especially true when the executory contract involves a license of intellectual property (or "IP"). In the past I’ve devoted several posts to the topic, including how IP licenses are treated in bankruptcy and the unique issues presented when a trademark licensee or trademark licensor files bankruptcy. 

In this post, I’ll drill down a bit deeper into the question of how courts have analyzed whether a Chapter 11 debtor can assume or assign an IP license to a third party over the IP licensor’s objection. If you’re new to the topic, be forewarned: the courts are all over the map on the issue. For those who’d like a scorecard, you’ll find a link to a circuit-by-circuit chart in the "Where Does Your Court Stand?" section toward the end of this post.

Assumption And Assignment. 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.

The Key Bankruptcy Code Section. Since Section 365(c)(1) is so important to this debate, 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.

What’s "Applicable Law?" Collectively, a number of courts have interpreted the phrase "applicable law" to mean patent, copyright, and trademark law, holding that these federal intellectual property laws excuse a non-debtor party to an IP license from accepting performance from or rendering performance to an entity other than the debtor in bankruptcy. As a result, these courts have held that an IP licensor who does not consent can successfully block a debtor from assigning a patent, copyright, or trademark license to a third party during a bankruptcy case. This rule applies with greatest force to non-exclusive IP licenses but may also apply to certain exclusive licenses too. For more on this subject, read Professor Menell’s article on the bankruptcy treatment of IP assets, which I discussed last month.

What Constitutes Consent? Consent to assumption or assignment of an IP license can come in three ways. First, the licensor can affirmatively consent in writing after a bankruptcy case has been filed. Second, a licensor that fails to object after a motion has been filed seeking to assume, or to assume and assign, a license agreement will likely be deemed to have consented. Third, a number of license agreements expressly permit assignment under certain circumstances and many, but not all, courts will treat such provisions as providing the consent required under Section 365(c)(1)(B). A provision sometimes found in license agreements allows assignment in conjunction with a sale of all or substantially all of the assets of the licensee. Warren Agin of the Tech Bankruptcy blog wrote about a recent Massachusetts case (in which I represented the buyer) enforcing a similar provision.

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 three circuits have adopted the hypothetical test. The Ninth Circuit (covering California, 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.
  • The leading hypothetical test decision is from the Ninth Circuit in In re Catapult Entertainment, Inc.,165 F.3d 747 (9th Cir. 1999). In Catapult, the court built on an earlier decision holding that a non-exclusive patent license could not be assigned without the patent holder’s consent and, adopting the hypothetical test, held that such a patent license also could not be assumed over the patent holder’s objection.
  • Leading the charge for the actual test is the First Circuit’s decision in Institut Pasteur, et al. v. Cambridge Biotech Corporation, 104 F.3d 489 (1st Cir. 1997). That circuit includes Massachusetts, among other states.

A Third Test From New York. Despite this predominantly licensor-favorable backdrop, in several recent decisions courts have sided with Chapter 11 debtors. This emerging trend is noteworthy because two of those decisions come from the Southern District of New York. That’s where many of the largest Chapter 11 bankruptcy cases tend to be filed, such as Enron, WorldCom, Delphi Corporation, Dana Corporation, Northwest Airlines, and Delta Airlines, to name a few, making it perhaps the most important bankruptcy court in the country.

The New York Cases: Footstar And Adelphia. In a 2005 decision in In re Footstar, Inc., 323 B.R. 566 (Bankr. S.D.N.Y. 2005), the Bankruptcy Court for the Southern District of New York broke new ground. Although it did not involve intellectual property licenses, the case put Section 365(c)(1)’s language front and center and came up with a third way of analyzing this critical section. Judge Adlai Hardin adopted a new "literal" reading of section 365(c)(1), one that he found was "entirely harmonious with both the objective sought to be obtained in Section 365(c)(1) and the overall objectives of the Bankruptcy Code, without construing ‘or’ to mean ‘and.’" His approach? Section 365(c)(1)’s use of the word "trustee" does not (as other courts had taken for granted) include the debtor or debtor in possession. As such, the right of the non-debtor party to object to assignment does not by itself affect the right of the debtor in possession (as opposed to a trustee) to assume an executory contract.

In January 2007, Judge Robert Gerber, also of the Bankruptcy Court for the Southern District of New York, faced the same issue in the Adelphia Communications Chapter 11 case. In his decision on the Section 365(c)(1) issue, Judge Gerber expressly rejected the cases following the "hypothetical" test as "incorrectly decided," and instead embraced Judge Hardin’s Footstar decision, describing it as "consistent in outcome with the decisions of" those courts following the "actual" theory. In a footnote, Judge Gerber stated: "[W]here there is no Second Circuit authority, [the Bankruptcy Court for the Southern District of New York] follows the decisions of other bankruptcy judges in this district in the absence of clear error. But to say that the Footstar decisions should be followed under that standard would be faint praise here. In this Court’s view, Judge Hardin’s analysis in those decisions was plainly correct." This suggests that other judges in the Southern District of New York may follow suit, at least unless the Second Circuit were to rule otherwise.

For a detailed analysis of the Footstar decision, be sure to read the article by Cooley Godward Kronish partners Jay Indyke and Richard Kanowitz, and associate Brent Weisenberg, who were directly involved in the case, which appears in the April 2007 issue of the Journal of Bankruptcy Law and Practice. It’s called “Ending the Hypothetical’ vs.‘Actual’ Test Debate: A New Way to Read Section 365(c)(1),” 16 J. BANKR. L. & PRAC. 2 Art. 2 (2007).

Another Circuit Follows The Actual Test. The Fifth Circuit (covering Texas, Louisiana, and Mississippi) also jumped into the fray, albeit interpreting a different but related section, Section 365(e), with its February 2006 decision in Bonneville Power Administration v. Mirant Corp., 440 F.3d 238 (5th Cir. 2006). Upon the Chapter 11 bankruptcy of Mirant Corporation, the Bonneville Power Administration (BPA) attempted to terminate its executory contract with Mirant based on an ipso facto clause, a provision that makes a bankruptcy filing a breach of contract. While these provisions generally are not enforced, the BPA relied on Section 365(e)(2)(A), which closely mirrors the language of Section 365(c)(1)(A), and argued that it could terminate the contract because applicable law — the federal Anti-Assignment Act, 41 U.S.C. Section 15 — excused it from accepting performance from or rendering performance to an entity other than the debtor or debtor in possession. After a lengthy analysis, the Fifth Circuit joined the First Circuit (rejecting the position of the Third, Fourth and Ninth Circuits) and expressly adopted the "actual" test. The Fifth Circuit held that the ipso facto clause was null and void under Section 365(e)(1) because Mirant, the debtor in possession, was not actually planning to assign the contract. For a more detailed discussion of the case, be sure to check out Steve Jakubowski’s excellent post over at the Bankruptcy Litigation Blog.

Where Does Your Court Stand? With courts coming out on different sides of the hypothetical versus actual test issue, and with the Footstar and Adelphia courts advancing yet another view of Section 365(c)(1), you might be looking for a chart to keep up with all the decisions. Well, as part of a presentation I made last month to the Commercial Law and Bankruptcy Section of the Bar Association of San Francisco (and with a big assist from Brian Byun, an associate in the Bankruptcy & Restructuring Group at my firm who also contributed to this blog post), we put together just such a circuit-by-circuit chart of the various decisions. You may find this circuit map useful when reviewing the chart. 

How Often Does This Come Up? The answer is frequently. Most corporate debtors have critical in-licenses of intellectual property and either need to assume them or, as part of a Section 363 asset sale, assume and assign them to the buyer. IP licensors are understandably protective of their intellectual property. Still, even when they have the right to object to assumption or assignments, in my experience many IP licensors will agree to allow debtors to assume, and sometimes even to assign to a buyer, important licenses. There may be an added cost, either in the form of a fee or the imposition of conditions to protect the licensor’s rights. That said, not all licensors will consent to assumption or assignment. In hypothetical test jurisdictions, debtor licensees may end up losing their license rights.

Location, Location, Location. This phrase is most often associated with real estate, but it could just as well apply to the venue of a bankruptcy case when assumption of an IP license is at issue. A debtor’s ability to assume an IP license over the objection of the licensor can be radically different depending upon where the bankruptcy case is pending. Perhaps the developing circuit split over Section 365(c)(1) will lead the U.S. Supreme Court to agree to take up the issue. Until that happens, or Congress amends the law, what a debtor can do with its IP licenses will continue to depend, in no small part, on where it files bankruptcy. 

Business Bankruptcy Issues

New Article Examines Interplay Between Bankruptcy and Intellectual Property Law

Peter S. Menell, a Professor of Law at the University of California, Berkeley, School of Law (Boalt Hall) and the Director of the Berkeley Center for Law and Technology, is a highly regarded expert on intellectual property law. I wanted to let you know that he’s just posted a very interesting and comprehensive article on the Social Science Research Network (known as SSRN) reviewing how intellectual property assets are affected by bankruptcy. Having served on a panel with Professor Menell a few years ago, I can attest to his deep knowledge of these issues.

Entitled "Bankruptcy Treatment of Intellectual Property Assets: an Economic Analysis," the article begins with an extensive discussion of patent, copyright, and trademark law and then analyzes the complex interplay between IP and bankruptcy law. Covering a broad range of topics, the article discusses Section 365(n) of the Bankruptcy Code, how assumption and assignment of exclusive and non-exclusive licenses have been treated by the courts, and the issues surrounding the perfection of security interests in intellectual property.

If you’re familiar with bankruptcy, you’ll find the article’s overview of intellectual property law particularly helpful. If you’re familiar with IP law, you’ll benefit from the article’s discussion of how bankruptcy impacts IP rights. If you’re new to both, the article will give you a serious introduction to these legal issues. I recommend the article to anyone looking for a top-flight review and analysis of what happens when intellectual property finds its way into bankruptcy court.

Business Bankruptcy Issues Recent Developments

Copyrights And Bankruptcy Sales: The Importance Of Protecting Your Rights

I’ve posted in the past about bankruptcy asset sales and how parties with executory contracts need to keep track of bankruptcy cases to protect their rights. Steve Jakubowski of The Bankruptcy Litigation Blog has an entertaining and informative post about a recent Court of Appeals decision involving rappers, recording companies, copyrights, and bankruptcy that raises some similar issues.

It’s a cautionary tale about the importance of monitoring bankruptcy cases and acting to protect rights when copyrights are involved. (So you don’t get complacent, the same message applies for patents, trademarks, and other intellectual property, and especially when licenses are involved.) After describing the case briefly, I discuss some points to keep in mind when IP crosses the bankruptcy court’s door.

Setting The Stage. Some background on the facts of the case will help put things in perspective.

  • Act One: In 1989, Jeffrey Thompkins, a rap artist known as JT Money, entered into an exclusive recording agreement with the debtor (a recording company). In the agreement, Thompkins sold his sound recording copyrights in various songs in exchange for the debtor’s agreement to pay royalties on the records released. (A later agreement made the debtor a half owner in the musical composition copyrights as well.)
  • Act Two: Six years later, the debtor ended up in Chapter 11 bankruptcy. The copyrights were sold "free and clear" to another recording company for $800,000 as part of the debtor’s plan of reorganization, which the bankruptcy court confirmed. The recording agreement was ultimately rejected as an executory contract. Apparently, Tompkins neither objected to the sale nor defended his claim for damages after the recording agreement was rejected.

The Curtain Falls. Almost six years after the bankruptcy sale, Tompkins sued the purchaser of the copyrights in federal court, alleging copyright infringement and other claims. The district court granted the purchaser’s motion for summary judgment and the decision was affirmed on appeal. The Court of Appeals for the Eleventh Circuit held that even though the debtor had rejected the original recording agreement, under bankruptcy law that rejection acted only as a breach and not as a rescission of the contract. Quoting from earlier decisions, the Court of Appeals commented that rejection does not "vaporize" a debtor’s rights under a rejected contract. Here the debtor retained ownership of the copyrights transferred under the recording agreement even though it breached the obligation to pay royalties. Because the purchaser was the actual owner of the copyrights, the infringement claim failed.

Encore: Lessons For The Audience. What can intellectual property owners and debtors learn from this decision?

  • A transfer of IP under an executory contract will not be rescinded if the buyer later files bankruptcy and rejects the agreement.
  • An IP owner looking for more control over its IP should consider granting a license instead of making an outright sale subject only to a royalty obligation. In some industries this may not be a realistic alternative, but when possible it can give IP owners more control. 
  • In many jurisdictions, IP owners who have granted only non-exclusive licenses prohibiting assignment will have the equivalent of a veto right in bankruptcy over proposed assignments of the license. This is generally true for copyrights, patents, and possibly trademarks, and can have a big impact on a debtor’s ability to transfer license rights.
  • When a licensee or other debtor with rights related to IP files bankruptcy, it’s critical for IP owners to monitor the bankruptcy case and be prepared to take action to defend their rights. Among the issues that can come up: asset sales involving a sale of the IP or an assignment of license rights, breaches of license terms, and infringement issues.
  • Likewise, debtors and creditors committees need to understand what IP rights the debtor has, what consents may be required to assign or transfer those rights, and how the rights of third party licensors and other IP owners may impact asset sales and reorganization prospects.

Conclusion. The intersection between intellectual property and bankruptcy law can be complex. Whether you are an IP owner, a debtor, or a committee, getting good legal advice before and after a bankruptcy is filed can be critical in protecting your rights.

Business Bankruptcy Issues

Trademark Licensor In Bankruptcy: Special Risk For Licensees

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

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

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

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

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

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

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

Business Bankruptcy Issues

Infringement Claims: Is Bankruptcy The End Of The Line?

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

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

Continuing Infringement

What if a corporate debtor continues to infringe?

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

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

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

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

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

Past Infringement

What about claims for past infringement? 

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

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

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

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

Does the answer depend on the type of IP infringed?

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

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

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

Impact Of Asset Sale

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

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

A Final Note

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

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