the impact of bankruptcy on intellectual property licenses · 2014-04-16 · •key issue: can...

The Impact of Bankruptcy on Intellectual Property Licenses Presented by: Felton E. Parrish, Partner Charlotte +1 (704) 350-7820 [email protected]

© 2014 Winston & Strawn LLP

• Automatic Stay

• Filing of bankruptcy case imposes an automatic stay (11 U.S.C. § 362). • Precludes unilateral termination of contract by non-debtor party

• Must obtain relief from automatic stay from bankruptcy court before taking any enforcement action

• Ipso Facto Clauses

• Contract clause providing for automatic termination or event of default upon filing for bankruptcy is typically unenforceable

• Executory Contracts

• IP licenses are typically treated as executory contracts for bankruptcy purposes.

• Under section 365, debtors in possession may assume, assign or reject executory contracts (11 U.S.C. § 365)

Bankruptcy Basics

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• Basics of Executory Contracts:

• Assumption: debtor must cure all defaults and provide adequate assurance of future performance

• Assignment: debtor must assume the contract and the proposed assignee must provide adequate assurance of future performance

• Key Point: Subject to limited exceptions, Bankruptcy Code allows for assignment of contracts even if contract contains an anti-assignment clause.

• Rejection: treated as a pre-petition breach of the contract and non-debtor party has a general unsecured claim for damages

Bankruptcy Basics

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Bankruptcy issues depend on whether debtor is licensee or licensor

Key issues arising if debtor is licensor:

• What happens to licensee if the debtor rejects the license?

• Can non-debtor continue using IP?

• Can debtor sell IP free and clear of licensee’s rights?

Key issues arising if debtor is licensee:

• Can debtor assume IP license over objection of licensor?

• Can debtor assign IP license over objection of licensor?

Summary of Executory Contract Issues

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Issues Arising When Debtor Is Licensor


•Key Issue: What happens to licensee if licensor rejects the license?

• Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, 756 F.2d 1043 (4th Cir. 1985) – court held that patent licensee lost rights to use patent after debtor/licensor rejected the license agreement

• In response to Lubrizol, Congress enacted section 365(n)

• Under 365(n), licensee of “intellectual property” can elect to retain rights to intellectual property (including right to exclusivity)

• Licensee will be required to make future royalty payments

• Licensor is excused of further performance (other than allowing licensee’s continued use) See In re Quad Systems Corp. 2001 WL 1843379, at *14 (E.D. Pa. 2001) (citing legislative history to state: “The debtor/trustee will essentially have no obligation to the licensee after rejection other than to turn over existing technology and permit the licensee to use the technology.”).

Debtor As Licensor

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•Section 365(n) only applies to “intellectual property” as defined by the Bankruptcy Code

• Section 101(35A) defines intellectual property as (a) trade secret, (b) invention, process, design or plant protected under title 35, (c) patent application, (d) plant variety, (e) work of authorship protected under title 17, or (f) mask work protected under title 35

• Key Point: Trademarks are NOT included in definition

• Patents and copyrights are entitled to 365(n) protections but not trademarks

Debtor As Licensor

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•Additional issues under section 365(n) • Application to non-U.S. IP is unclear

• covers trade secrets, patent applications, and plant varieties without limit on geographic scope

• only covers patents and copyrights granted under U.S. law

• In re EI Intern., 123 B.R. 64, 65 (Bankr. D. Idaho 1991) (without explanation, court allowed continued use of software license in Canada pursuant to 365(n)).

• Only allows use of intellectual property as it existed before commencement of bankruptcy case

• licensee not entitled to use any post-petition improvements

• Licensee must continue to make royalty payments

• royalty payments must continue even though may be receiving fewer services than contemplated under original license because licensor excused from performance going forward

• licensee cannot use damages caused by licensor’s non-performance as an offset to royalty payments

Debtor As Licensor

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•Potential arguments for trademark licensee to retain use of license • Argue that trademark license is not an executory contract that can be rejected

• In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010)

• non-debtor licensee acquired assets related to industrial battery business for $135 million

• assets acquired along with perpetual, exclusive, royalty free license to use the “Exide” trademark in the industrial battery business

• 11 years after acquisition, seller/licensor filed for bankruptcy and sought to reject the license so that it could regain “Exide” marks for use in the industrial battery business

• Bankruptcy Court allowed license to be rejected

• Third Circuit overturned bankruptcy court and concluded that license was not executory because licensee had substantially performed all obligations at time of purchase

• But See In re Interstate Bakeries Corp., 690 F.3d 1069 (8th Cir. 2012)

• Eighth Circuit declined to follow Exide

Debtor As Licensor

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•Argue that trademark license is integral to other intellectual property entitled to 365(n) protection • In re Matusalem, 158 B.R. 514 (Bankr. S.D. Fl. 1993) (court suggested that upon

rejection of single license for trade secrets and trademarks, licensee would be able to continue use of trademark)

• But See In re Centura Software, 281 B.R. 660 (Bankr. N.D. Cal. 2002) (court held that even though licensee entitled to 365(n) protection for patents/copyrights, protection would not extend to related trademark licenses).

• Argue that Lubrizol was wrongly decided and rejection of license does not mean that licensee loses right to use trademark

• Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, 686 F.3d 372 (7th Cir. 2012)

• rejects reasoning of Lubrizol and concludes that rejection does not terminate licensee’s rights

Debtor As Licensor

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•Debtor may be able to sell license free and clear of licensee’s rights • Under section 363(f), upon satisfaction of certain conditions, debtor can sell assets

free and clear of all interests

• This potentially allows licensor to assign license “free and clear” of a licensee’s rights under section 365(n).

• Precision Industries, Inc. v. Qualitech Steel SBQ, LLC, 327 F.3d 537 (7th Cir. 2003) (363(f) allowed sale of property free and clear of lessee’s rights under section 365(h), provision analogous to 365(n)); Compak Cos. v. Johnson, 415 B.R. 334 (N.D. Ill. 2009) (citing Precision Industries for proposition that rights under intellectual property license can be terminated by a sale under 363(f)); In re Dynamic Tooling Systems, Inc., 349 B.R. 847 (Bankr. D. Kan. 2006) (noting that some cases allow 363(f) to extinguish rights under 365(n)).

Debtor As Licensor

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Summary:

•Debtor may reject license

•Patent and copyright licenses entitled to limited protection of 365(n)

•Trademark licensees may lose right to use trademark, but recent Sunbeam decision is favorable.

•Debtor may assign license free and clear of licensee’s rights (including rights under 365(n)).

Debtor As Licensor

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Ways for Licensee to Mitigate Risk:

• Obtain security interest in the IP

• Have licensor convey IP to bankruptcy remote entity so that license is granted by bankruptcy remote entity.

• Expressly state in license that 365(n) is applicable.

• Delineate between payments for license and payments made for services.

• Monitor bankruptcy case closely to prevent loss of rights in a 363 sale.

Debtor As Licensor

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Issues Arising When Debtor Is Licensee


•Key Issue: Can Debtor assume and/or assign an IP license over the objection of the licensor?

•Debtor’s right to assume and/or assign executory contracts is governed by Bankruptcy Code section 365.

• Section 365(f): anti-assignment provisions are generally rendered unenforceable.

• Section 365(c), contract may not be assumed or assigned if assignment is prohibited by applicable law.

•Even if contract contains anti-assignment provision, it can be assigned unless assignment is prohibited as a matter of law (without reference to anti-assignment provision).

Debtor As Licensee

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•Two key issues in IP context:

1. Does applicable non-bankruptcy law prohibit assignment of intellectual property licenses?

• If non-bankruptcy law prohibits assignment, then debtor in bankruptcy will not be able to assign the license.

2. If license cannot be assigned to third party, can debtor assume the license for its own future use?

•Opinions are split.

Debtor As Licensee

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•Does applicable non-bankruptcy law prohibit assignment of intellectual property licenses? • Patents

• Non-exclusive patent license is not assignable.

• Cases are mixed on assignability of exclusive licenses.

• Copyrights

• Courts generally hold that non-exclusive copyright licenses are not assignable.

• Cases are split on whether exclusive copyright licenses are assignable.

• Trademarks

• Courts generally hold that trademark licenses are not assignable absent a provision in the license to the contrary.

*See Appendix to Materials for Citations to Cases*

Debtor As Licensee

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• If license cannot be assigned, can a debtor-in-possession assume the license for its own use?

• Language of 365(c) appears to prohibit assumption by debtor even if debtor does not want to assign the license.

• Statute provides: “The trustee may not assume or assign any executory contract” if contract may not be assigned under applicable non-bankruptcy law. 11 U.S.C. § 365(c) (emphasis added).

Debtor As Licensee

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• Hypothetical Test:

• Court considers whether hypothetical assignment would be permitted; if not, then license cannot be assumed.

• Adopted in 4 circuits: Third, Fourth, Ninth, and Eleventh

• Cinicola v. Scharffenberger, 248 F.2d 110, 121 (3d Cir. 2001);

• In re Sunterra Corp., 361 F.3d 257 (4th Cir. 2004)(non-exclusive copyright license);

• In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999)(non-exclusive patent license; reserves decision as to exclusive patent license);

• In re James Cable Partners, L.P., 27 F.3d 534 (11th Cir. 1994).

Debtor As Licensee

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• Actual Test:

• license may be assumed unless the debtor actually seeks to assign the license.

• Adopted in First and Fifth Circuits

• Institute Pasteur et al. v. Cambridge Biotech Corp, 104 F. 3d 489 (1st Cir. 1997) ; In re Mirant Corp., 440 F.3d 238 (5th Cir. 2006)

• Also followed by bankruptcy courts in S.D.N.Y.

• In re Footstar, 323 B.R. 566, 570-72 (Bankr. S.D.N.Y. 2005) (use of word “trustee” in 365(c) does not include debtor or debtor-in-possession); In re Adelphia Communications Corp., 359 B.R. 65, 2007 WL 64128 at *3 (Bankr. S.D.N.Y. 2005)

Debtor As Licensee

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Summary:

• If non-bankruptcy law prohibits assignment, the license cannot be assigned.

• Non-exclusive licenses generally unassignable

• Trademark licenses generally unassignable

• Cases mixed for exclusive patent or copyright licenses

• If license cannot be assigned, then debtor may not be able to assume the license for its own use.

• Gives licensor leverage in restructuring negotiations

Debtor As Licensee

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Practice Points for Licensees:

• Negotiate a provision allowing for assignment of license at least in the context of a merger, sale of substantially all assets, or other change of control event.

• Carefully consider bankruptcy venue

• If IP licenses are important for debtor’s business, then all other things equal, would be better to file in a jurisdiction that follows the “actual test” if at all possible.

Practice Point for Licensor:

• Monitor bankruptcy case closely • Bid procedures in connection with a sale may provide that failure to object to the

sale constitutes approval of proposed assignment.

Debtor As Licensee

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the impact of bankruptcy on intellectual property licenses · 2014-04-16 · •key issue: can...

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