How To Protect Your IP Rights When Your Licensor Files for Bankruptcy

What Companies Can Do To Protect Their IP Rights in Bankruptcy

The Kodak case brought into sharp focus the treatment of intellectual property rights in bankruptcy. Inventor of the roll-film hand camera in 1888 and maker of the first digital camera, the iconic company licensed thousands of patents in its extensive patent portfolio, estimated at $4.5 billion. In 2012, Kodak filed bankruptcy and sold its assets — at apparent fire-sale prices — in bankruptcy court in New York. The sale of a patent portfolio of that size affects the rights of hundreds, if not thousands, of licensees to use Kodak’s patents, foreign and domestic, past and present. The names of the interested parties adorn the shelves of every big box electronics store, including Apple, Nikon, Samsung, Nintendo, and Canon.

However, it would be a mistake to think that this scenario is unlikely to be repeated. Many debtor companies are licensors of intellectual property (IP), including obvious ones like Nortel and less obvious ones like GM and Chrysler. When IP licensors file for bankruptcy, holders of IP licenses from the debtor should be vigilant and take specific steps to protect themselves. This article discusses general issues important to in-house counsel and executives at companies that depend on IP licenses.

How Does the Bankruptcy Code Define Intellectual Property?

The Bankruptcy Code defines IP to include:

• Trade secrets
• Patents
• Copyrights

The Bankruptcy Code does not include:

• Trademarks
• Trade names
• Service marks
• Certain foreign IP

The rationale for that distinction is that the Code protects authors and inventors most. Congress has deemed it prudent in the Copyright Act and the Patent Act to grant monopolies to authors and inventors, thereby encouraging innovation. The Code’s definition of IP is consistent with that theme.

Trademark law, by contrast, is designed to protect the value of identifying symbols by preventing confusion. So, arguably, the Code embodies the view that heightened trademark protection is not needed in the bankruptcy environment, but more on this later.

IP License Agreements Are Executory Contracts

Many parties’ IP rights will be embodied in a license agreement. Most IP licenses are likely to be considered ‘executory contracts,’ a classification with powerful consequences in bankruptcy. An IP license must contain mutual unperformed obligations to be an executory contract. Those unperformed obligations can be pretty soft. From the IP licensor perspective, they include the covenant not to sue, the duty to maintain IP, and the duty to protect against infringement. For the licensee, they include the agreement to use IP only in a certain way, territorial restrictions, and reporting obligations. Even fully paid-up license agreements can be executory contracts.

Executory contract status is essential in bankruptcy. By motion, debtors can reject (breach) or assume (agree to perform) executory contracts in their business judgment, which has been an easy standard to meet historically but puts creditor-licensees of fully paid-up license agreements in an untenable position. The debtor could reject the license, but the creditor-licensee could not require performance from the debtor. For licensees that relied on the use of IP for the operation of their business, that was an ugly prospect, which manifested itself in an infamous bankruptcy/IP case called Lubrizol.

In Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., the Fourth Circuit held that the debtor-licensor’s rejection of an IP license in bankruptcy removed the licensee’s patent rights.

Enacting § 365(n) to Preserve Licensee IP Rights

However, Congress fixed this problem in 1988, at least for IP, that falls under the Code’s definition of IP. Now, if a debtor-IP licensor rejects an IP license, the licensee, under 365(n)(1) of the Bankruptcy Code, can choose between deeming the license terminated (and moving on without the use of the IP) or retaining its rights as they existed before the bankruptcy case. Under the 1988 fix, the licensee can continue to use the IP provided under the license agreement. Of course, the licensee has to perform its side of the bargain. If royalty payments are due for the remainder of the contract, they must be paid.

The licensee, however, should make this critical decision in writing promptly after the debtor-IP licensor files its motion to reject. Don’t dally. Licensees in significant debtor cases, like those of Kodak, GM, and Chrysler, should carefully look out for the debtor’s treatment of their IP license in bankruptcy. It might lie buried in a lengthy omnibus motion to reject, affecting hundreds of permits. If you miss the motion and don’t make an election, the debtor will argue you waived the right to do so.

Protecting Trademark Rights in Mission Products Holdings, Inc. v. Tempnology, LLC

Though the Bankruptcy Code does not include trademarks in its IP definition, a 2019 Supreme Court case, Mission Products Holdings, Inc. v. Tempnology, LLC, held that a debtor-licensor’s rejection of a trademark license agreement does not strip the creditor-licensee’s right to use the trademark.

The court stated that under § 365(g), the bankruptcy estate “cannot possess anything more than the debtor itself did outside bankruptcy.” Therefore, the bankruptcy does not expand a debtor-licensor’s rights. The court also argued that rejecting a contract in bankruptcy constitutes a breach, and by tradition, the licensee continues to hold the rights under the agreement.

The decision may have more significant implications for other protections of IP rights in bankruptcy in the future.

Don’t Wait! Be Proactive About Your IP Licenses in Bankruptcy

What if the debtor does not immediately reject an agreement? Alternatively, the debtor may just sit on your license and decline to make a decision. A license that is neither rejected nor assumed may even ‘pass through’ the bankruptcy. So, what does a licensee do in the meantime? The Bankruptcy Code has an answer, though it is not often used. Section 365(n)(4) says that unless and until the debtor-IP licensor rejects the license, where a licensee makes a written request, the debtor shall perform under the license and not interfere with the licensee’s rights. Making those written requests at the beginning of the bankruptcy case is good practice. They help to keep the debtor honest.

I Object! Don’t Let Your IP License Get Sold Out From Under You

The last big ticket item to consider for creditor licensees in bankruptcy cases is what happens if the debtor-IP licensor decides to sell its IP. Section 363 of the Bankruptcy Code allows a debtor to sell its assets “free and clear” of the interests of others if certain conditions are met. In an IP sale, absent an objection, the licensee might find itself stripped of its interests. So, object! Section 363(e) allows the bankruptcy court, on request, to condition a sale as needed to protect a third party’s interest. One form of protection is an order subjecting the sale to the licensee’s rights, including the licensee’s section 365(n) rights. So again, a licensee’s vigilance may be rewarded.

The Bankruptcy Code provides IP creditor licensees with peculiar protections for their prepetition contract rights. Still, if you snooze, you can lose.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Valuation Series
2. Business Law Review Series
3. Restructuring, Insolvency & Troubled Companies Series 

This article was originally published on April 23, 2018, and previously updated on January 27, 2021 and August 22, 2022. This article was most recently updated by the DailyDAC Editors.]

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