Virtually all companies, from high-tech ventures to traditional businesses, use intellectual property (IP) to drive their operations. Oftentimes, this IP did not originate with the company using it, but instead has been licensed. The variety of mission-critical, licensed IP is as broad as the economy itself: from key patented technology at the core of a company’s products to proprietary processes and techniques used in the manufacture of specific goods to copyrighted content to trademarks and trade names. Where licensed IP is a key component of a company’s business, the relationship with the licensor is critical. The filing of a bankruptcy petition by the licensor of key IP can pose a real dilemma to the non-bankrupt licensee.
For bankruptcy purposes, IP license agreements are typically executory contracts; that is, as of the date of the filing of the bankruptcy petition, there remain material unperformed obligations by both the licensor and licensee. If the agreement in question is an executory contract, the debtor, in our example the IP licensor, has the right, under Section 365 of the Bankruptcy Code, to assume, assign, or reject such agreement, subject of course to the terms of Section 365 and the caselaw interpreting that provision.
If the rejected license is not otherwise protected by the Bankruptcy Code, rejection by the licensor could be disastrous for the licensee who depends on the license for a product or technology central to its business. If an IP license were to be treated as a garden-variety executory contract, the effect of rejection by the licensor would be to extinguish the licensee’s right to use the license and leave the former licensee holding an unsecured, pre-petition claim for money damages resulting from the rejection. Although this claim may be large, it will likely be cold comfort to the former licensee. As any regular bankruptcy practitioner can attest, bankruptcy claims typically are worth pennies on the dollar, and are oftentimes completely valueless. Thus, the licensee’s loss of the right to use the license would likely be uncompensated.
In order to forestall this draconian result, Section 365(n) of the Bankruptcy Code affords important protections to “intellectual property” licensees. This section provides that when a debtor/licensor rejects an executory contract under which the debtor is a licensor of a right to “intellectual property,” the licensee has the option of either (a) treating the agreement as terminated by reason of the rejection and asserting an unsecured pre-petition claim for the damages associated with such termination; or (b) retaining its rights under the agreement as such rights existed immediately prior to the commencement of the bankruptcy case. If the licensee elects to retain its rights, those rights are retained for the duration of the agreement and any additional period for which the agreement may be extended by the licensee as of right under applicable non-bankruptcy law (e.g., any contractual extensions of the agreement). If the licensee elects to retain its rights under the agreement, it is obliged to continue to make any payments required under the agreement and the licensee is deemed to have waived any right to an administrative claim it may have against the debtor and any right of setoff the licensee might have under applicable non-bankruptcy law. This section requires also that the debtor/licensor not interfere with the licensee’s exercise of its rights under the rejected license agreement.
Intellectual property is in quotation marks in the prior paragraph because the meaning of that term for purposes of the Bankruptcy Code and Section 365(n) is somewhat narrower than is commonly understood. Section 101(35A) of the Bankruptcy Code defines intellectual property as (i) a trade secret; (ii) an invention, process, design, or plant protected under the U.S. Patent Act; (iii) a patent application; (iv) a plant variety; (v) a work of authorship protected under the U.S. Copyright Act; and (vi) a mask work protected under Chapter 9 of the U.S. Copyright Act (i.e., a semi-conductor mask work). The Bankruptcy Code includes neither trademarks nor trade names in its statutory definition of intellectual property. While the Bankruptcy Code includes important protections for many licensees of intellectual property, the rights of trademark and trade name licensees may be in danger from a rejection of the relevant license by the licensor debtor.
While the bankruptcy of a key licensor poses a dilemma to the non-bankrupt licensee, understanding the protections afforded to “intellectual property” licensees is an important step toward assisting the non-bankrupt licensee to thrive in the face of licensor bankruptcy. To avoid losing its license, the non-bankrupt licensee should take a proactive stance in the licensor’s bankruptcy case and file a paper clearly electing to retain its license.
David Lee Tayman is an attorney with the law firm of Dickstein Shapiro LLP in its Washington, D.C. office. He concentrates his practice on bankruptcy and creditors’ rights.