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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

Bankruptcy Asset Sales: What Parties With Contracts Should Watch For

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

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

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

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

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

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

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

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

Business Bankruptcy Issues

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 Recent Developments

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

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

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

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

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

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

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

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

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

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

Business Bankruptcy Issues

Intellectual Property Licenses: What Happens In Bankruptcy?

The major role intellectual property, or "IP," plays in our economy makes intellectual property licenses an especially significant type of executory contract.  Whether you are a licensor or licensee, it’s important to know what can happen to IP licenses when a bankruptcy is filed.

Licensor in bankruptcy.  A licensor in bankruptcy (or its bankruptcy trustee) has the option of assuming or rejecting 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 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.

Licensee in bankruptcy.  The law is different when an IP licensee files bankruptcy.  The Bankruptcy Code, in Section 365(c)(1), contains an exception to the general rule that executory contracts can be assumed and assigned to third parties if defaults are cured and adequate assurance of future performance is demonstrated. The exception kicks in when "applicable law" precludes such an assignment absent consent of the nondebtor party. 

  • Restrictions on assignment. Case law from several United States Courts of Appeals holds that "applicable law" — here patent and copyright law (and perhaps trademark law) — in fact precludes an assignment of rights under an intellectual property license unless the IP owner has consented.  These courts have ruled that non-exclusive patent and copyright licenses are personal and nonassignable. As a result, a patent or copyright holder can prevent a debtor licensee from assuming and assigning a non-exclusive license to a third party without the licensor’s consent. 
  • License at risk. In the Ninth Circuit, which includes California, a licensor not only can stop a debtor from assigning the license to a third party, it can even prevent a debtor from keeping the license for itself.  Although the reason is technical, stemming from how the Ninth Circuit has interpreted Section 365(c)(1) of the Bankruptcy Code, the impact can be very real. For those interested, the landmark Ninth Circuit decision on this point is In re Catapult Entertainment, Inc.,165 F.3d 747 (9th Cir. 1999). 

Get advice. The interplay between bankruptcy and intellectual property law is complex.  Whether you are a licensor or licensee, you should get legal advice about your specific license agreement and the ways you may be able to protect your rights if a bankruptcy is filed.  Likewise, companies that anticipate having to file bankruptcy should pay careful attention to their IP licenses before they file.

Business Bankruptcy Issues

Executory Contracts — What Are They And Why Do They Matter In Bankruptcy?

If you start talking to a bankruptcy lawyer, before long you’ll probably hear them use the term “executory contract.” Often they’ll act as though people use the term everyday.  The truth is that bankruptcy lawyers are just about the only lawyers – much less business people — who ever talk about executory contracts.  (I confess I do it too, but there’s a really good reason.)

So what is an executory contract? The concept is fairly simple. It’s a contract between a debtor and another party under which both sides still have important performance remaining.  Put another way, if either side stopped performing the contract it would be an actual breach of contract. 

Examples of executory contracts (and some common reasons why they might be executory) include:

  • Real estate leases (tenant has to pay rent/landlord has to provide space)
  • Equipment leases (lessee has to pay rent/lessor has to provide equipment)
  • Development contracts (development work required/payment required on milestones), and
  • Licenses to intellectual property (licensee can use only within scope of license/licensor must refrain from suing for licensed uses).

Having cleared up the definition, the next question is why executory contracts seem to matter so much in bankruptcy.  (The debtor even has to list them separately in its bankruptcy schedules.)

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