Intellectual Property Licenses and Bankruptcy

• Publication year: 2003
• Pages: 63

32 Colo.Law. 63 Colorado Lawyer 2003.

2003, August, Pg. 63. Intellectual Property Licenses And Bankruptcy

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63

Vol. 32, No. 8, Pg. 63

The Colorado Lawyer
August 2003
Vol. 32, No. 8 [Page 63]

Specialty Law Columns
Intellectual Property and Technology Law
Intellectual Property Licenses And Bankruptcy
by Celia F. Rankin

This column is prepared by the CBA Technology Law and Policy Forum Committee. The column provides information of interest to intellectual property attorneys and other attorneys who counsel technology companies, by focusing on developing law applicable to technology businesses

Column Editors:
Nathaniel T. Trelease, WebCredenza, Inc., Denver - (720) 937-9930, ntrelease@webcredenza.com; Jim Brogan, Cooley Godward, LLP, Broomfield - (720) 566-4190, jbrogan@cooley.com

About The Author:
This month's article was written by Celia F. Rankin Boulder, a partner at Faegre & Benson - (303) 546-1352 crankin@ faegre.com. The author thanks Ben Fernandez, a third-year law student at the University of Colorado School of Law and summer associate at Faegre & Benson, for his assistance in the legal research of this article.

This article discusses the treatment of intellectual property licenses when one of the parties to the license agreement files for bankruptcy. The article also provides suggestions for protecting the interests of the licensor and licensee.

In today's economic climate, the viability of companies, both large and small, is a concern. The technology area has seen especially turbulent times. Yet, the use of technology often pervades a company's infrastructure, products, and service offerings. When contemplating entering into an intellectual property ("IP") license, companies frequently are raising two issues: (1) what will happen if the other party files for bankruptcy; and (2) what can be done to protect a company's interests as a licensor or licensee. This article analyzes these two issues and provides strategies for protecting the licensor and licensee.

The Impact of a Bankruptcy Filing

Most bankruptcies commence voluntarily when the bankrupt company ("Debtor") files a petition with a bankruptcy court. Such filing results in two immediate effects: (1) the creation of a bankruptcy estate; and (2) the imposition of the automatic stay.1 The Debtor's bankruptcy estate will consist of all of the Debtor's interests in property at the moment of filing the petition, including proceeds from such property and additional interests in property the Debtor may acquire later.2

The automatic stay acts as a "time-out" in favor of the Debtor. It stops all actions and activities that seek to collect money from the Debtor, execute on the Debtor's assets, or terminate the Debtor's rights in property.3 To resume such actions or activities against the Debtor, a party first must obtain approval from the bankruptcy court.

IP licenses will become part of the Debtor's bankruptcy estate. Thus, after the filing date, a party to the IP license cannot take any action with respect to the IP license (such as terminating the license) without first getting bankruptcy court approval.

Executory Contracts And IP Licenses

If an agreement is deemed by the bankruptcy court to be an "executory contract," the Debtor may, subject to bankruptcy court approval, reject, assume, or assume and assign that contract.4 The Bankruptcy Code ("Code") does not define "executory contracts," although the definition has been addressed abundantly in case law and legal analyses.5 Executory contracts basically are those in which: (1) "performance remains due to some extent on both sides";6 and (2) "the obligations of both parties are so far unperformed that the failure of either party to complete performance would constitute a material breach and thus excuse the performance of the other."7

Treatment of Executory Contracts

A rejection of an executory contract is deemed to be a pre-petition breach by the Debtor, giving rise to a pre-petition claim for breach of contract damages.8 Specific performance is not an available remedy even if the terms of the executory contract or the applicable non-bankruptcy law would allow it.9 If the bankruptcy court allows the damage claim, it will be treated as a general unsecured claim; thus, the party to the executory contract will become a member of the general creditor body. Ordinarily, this relegates the party to a fate of, at best, recovering ten cents on the dollar on the amount of the allowed damage claim.

An assumption of an executory contract by the Debtor requires the Debtor to: (1) cure outstanding defaults under the executory contract or "provide adequate assurance" that it will do so;10 and (2) "provide adequate assurance of future performance."11 Assumption results in the executory contract becoming a contractual obligation of the bankruptcy estate. In the event of breach of the executory contract after the assumption date, damages likely would be treated as a first priority administrative claim,12 which usually would be paid at 100 cents on the dollar. The Debtor also may choose to assume and assign the executory contract by: (1) providing adequate assurance that the proposed assignee can perform; and (2) showing that there is no prohibition against assignment by applicable non-bankruptcy law (such as law governing personal services contracts and certain IP licenses).13

Relying solely on a contractual provision in the executory contract prohibiting or limiting assignment may not be enough to prevent the Debtor from assigning the executory contract.14 The applicable non-bankruptcy law should be checked to determine whether it prohibits assignment without consent from the other contracting party. Given the Debtor's options for handling executory contracts, the issue of whether an IP license will be deemed an executory contract becomes pivotal. As noted above, the Code does not define executory contracts, although an abundance of case law defines them.15

Characterization of IP Licenses

Most IP licenses will be deemed executory contracts because there likely will be material continuing obligations on the parts of both parties. For example, the Ninth Circuit Court of Appeals held that "[a] nonexclusive patent license is, in essence 'a mere waiver of the right to sue' the licensee for infringement."16 This promise by a licensor to forbear from suit constitutes sufficient performance due to make the contract executory.17 Likewise, a patent licensee's duty to mark products with the proper statutory patent notice is performance due.18

Regarding the obligation to make payments under an agreement, for the agreement to be deemed executory, courts have required more than just an obligation of continuing payments. Installment payments without additional duties are not sufficient. For example, in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.,19 the Fourth Circuit Court of Appeals noted:

. . . the promise to account for and pay royalties required that [the licensee] deliver written quarterly sales reports and keep books of account subject to inspection by an independent Certified Public Accountant. This promise goes beyond a mere debt, or promise to pay money, and was at the critical time executory.20

An interesting case finding that a particular license was not executory given the payment scheme used by the licensor is Microsoft Corp. v. DAK Industries, Inc.,21 which concerned a license to sell Microsoft Word. The contract provided for a payment schedule with associated rights to sell a certain number of copies; additional copies were to be charged a royalty. Prior to filing bankruptcy, DAK did not produce more copies than it was obligated to pay for under the payment schedule. As a result, all debt obligations were incurred pre-petition and the royalty obligation was not triggered. Microsoft provided no post-petition consideration. The court concluded that the contract was more similar to a sale than a license to use IP.22

Assignment of IP Licenses

Code § 365(c)(1) prevents a trustee or debtor-in-possession from assigning an executory contract without the permission of the non-Debtor party, if applicable law so provides. With regard to IP licenses, federal IP law qualifies as applicable law, which generally preempts state contract law.23 Following is a discussion of how IP license assignments are treated in the
areas of patent, copyright, and trademark law.

Patents: The federal patent policy...