In 1888 – yes 1888 – Kodak coined the slogan: “You press the button, we do the rest.” The company, which was immortalized in Paul Simon’s song “Kodachrome1”, sold its assets – at apparent fire-sale prices – in bankruptcy court in New York. The Kodak case brought into sharp focus the treatment of intellectual property (IP) rights in bankruptcy. That is because Kodak has an extensive patent portfolio — way back in 1975, for example, Kodak built one of the first digital cameras. The sale of the patent portfolio 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.
It would be a mistake to think, however, that this scenario is unlikely to be repeated. Many debtor companies are licensors of intellectual property (although perhaps not on the same scale as Kodak), including obvious ones like Nortel and less obvious ones like GM and Chrysler. When IP licensors file bankruptcy, holders of IP licenses from the debtor should be vigilant and take certain steps to protect themselves. This article discusses, at a high level of generality, issues important to in-house counsel and executives at companies that depend upon licenses from IP licensors.
The Bankruptcy Code defines intellectual property to include trade secrets, patents, and copyrights. Trademarks, trade names, service marks, and certain foreign IP are not included in that definition. The rationale for that distinction is that the Code gives the greatest protection to authors and inventors. 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 intellectual property 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 protection of trademarks is not needed in the bankruptcy environment.
[Editor’s note: For more information on Intellectual Property, please see Intellectual Property and the U.S. Constitution.]
For many parties, their IP rights will be embodied in a license agreement. Most IP licenses are likely to be considered “executory contracts,” which is a classification with powerful consequences in bankruptcy. To be an executory contract, an IP license must contain mutual unperformed obligations. Those unperformed obligations can be fairly soft. From the IP licensor perspective, they include the covenant not to sue, duty to maintain IP, and 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.
Executory contract status is important in bankruptcy. By motion, debtors can reject (breach) or assume (agree to perform) executory contracts in their business judgment (an easy standard to meet). Historically, that put 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 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.
[Editor’s note: For more information on executory contracts, please see Battling Bankrupt Bargains — A Non-Debtor Perspective on Executory Contracts.]
But 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 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 agreement, they have to be paid.
[Editor’s note: For more information, please see The Intersection of Bankruptcy and … Intellectual Property Law.]
The licensee, however, should make this key decision in writing promptly after the debtor- IP licensor files its motion to reject. Don’t dally. Licensees in big debtor cases, like those of Kodak, GM, and Chrysler, should be on a careful look-out for the debtor’s treatment of their license. It might lie buried in a lengthy omnibus motion to reject that affects hundreds of licenses. If you miss the motion and don’t make an election, the debtor will argue you waived the right to do so.
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 is a licensee to 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. It is good practice to make those written requests at the beginning of the bankruptcy case. They help to keep the debtor honest.
The last big ticket item to consider for creditor-licensees in bankruptcy cases (we don’t have the space to sweat the small stuff – which alas can get pretty big) 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 is needed to protect a third party’s interest. One form of protection you might seek 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.
[Editor’s Note: This is an update of an article originally published in May 2013]
Jonathan Guy has extensive experience as lead counsel in complex commercial and bankruptcy litigation matters in trial and appellate courts throughout the United States. He has represented clients in numerous industries, including commodity trading, energy, real estate, telecommunications, manufacturing and healthcare. Mr. Guy has most recently been ranked in Chambers USA 2012 as a leading…
LLC Membership Interests in Chapter 11 – Can They be Sold Over Other Members’ Objections?
When Your Tenant Files for Bankruptcy
Battling Bankrupt Bargains – A Non-Debtor Perspective on Executory Contracts
Dealing With Distress For Fun & Profit – Installment #5 – A Peek Into Some Basic Chapter 11 Concepts
90 Second Lesson: What is a “UCC Article 9” Sale?
What to Do In the Event of a Customer Bankruptcy
Subscribe to Our FREE Newsletter - DailyDAC Weekly!
Get updated with the latest bankruptcy articles and opportunistic deals.