Buying and Licensing Intellectual Property Assets from Troubled Companies-part I

• Publication year: 2004
• Pages: 101

33 Colo.Law. 11 Colorado Lawyer 2004.

2004, August, Pg. 101. Buying and Licensing Intellectual Property Assets from Troubled Companies-Part I

Vol. 33, No. 8, Pg. 11

The Colorado Lawyer
August 2004
Vol. 33, No. 8 [Page 101]

Specialty Law Columns
Intellectual Property and Technology Law
Buying and Licensing Intellectual Property Assets from Troubled Companies - Part I
by Gary H. Moore

This column is prepared by the CBA Technology Law and Policy Section. 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

Gary H. Moore

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 Gary H. Moore, Palo Alto, California. He is a partner in Cooley Godward LLP's Technology Transactions Group - (650) 843-5438, gmoore@ cooley.com.

This two-part article discusses, from the buyer's perspective, the purchase of intellectual property assets from a financially troubled seller. Part I addresses liability issues, bankruptcy, fraudulent transfers, and successor liability. Part II will focus on due diligence, practical matters involving acquisition, and bankruptcy effects on intellectual property licenses.

The turmoil in the high-technology industry over the past several years continues to offer opportunities for stronger companies to acquire intellectual property ("IP") assets from weakened or failing players. Lean times and difficulties in raising funding have forced numerous companies, including some with promising technology or products, to shut down operations and sell off their IP assets. Even established companies have elected to shed non-strategic technology and assets to focus on their core businesses.

Stronger players may be in a position to acquire patent portfolios and other IP that otherwise would not be available for purchase, and potentially do so at favorable prices. The buyer may wish to acquire such patents or other IP for offensive reasons or to build a portfolio for cross-licensing purposes. In some cases, the acquisition of IP may be part of a larger acquisition of assets from troubled companies.

Sometimes, the buyer's interest may be primarily defensive. For example, the buyer may be concerned that it might infringe the troubled company's patents now or in the future, and may not want the patent portfolio to fall into the wrong hands. The buyer also may want to hire key employees of the troubled company without risk of potential infringement claims by the troubled company or its successors.

Acquiring IP rights from financially troubled companies offers opportunities, but it also involves special issues and risks.1 When structuring the transaction, the prospective buyer should consider and take into account issues such as the: (1) problems attendant to dealing with an insolvent seller; (2) risks of post-closing challenges to the transaction or claims seeking to impose liability on the buyer; (3) limited value of post-closing indemnification and other contractual assurances from the seller; (4) increased importance (and potential difficulties) of pre-closing due diligence and obtaining good title at closing; (5) loss of employees important to the value of the acquired IP assets; and (6) impact of bankruptcy on IP licenses.

These issues will be covered in two parts. Part I focuses on the general risk of buying assets from an insolvent seller. It addresses the pros and cons for the buyer of purchasing the assets out of bankruptcy, fraudulent transfer issues, and successor company liability. Part II of this article, which will appear in this column in September 2004, will focus on due diligence, specific practical issues in securing ownership of acquired assets and putting the deal together, and the impact of bankruptcy on IP licenses.

Bankruptcy: Pros and Cons

A troubled company may be insolvent or headed toward insolvency. It already may be in bankruptcy proceedings or may file for bankruptcy protection before or after the transaction closes. From the buyer's perspective, acquiring IP in bankruptcy proceedings has both advantages and disadvantages, as compared to acquiring assets from an insolvent or potentially insolvent seller without bankruptcy proceedings.

If the seller is in bankruptcy, or if creditors of the seller file an involuntary bankruptcy petition against the seller before the acquisition is consummated, the buyer will have no choice whether the transaction will be concluded under the auspices of the bankruptcy court. However, if the seller is not yet in bankruptcy, and the matter remains in the seller's control, the buyer may have some say in the decision of whether to proceed with the transaction without a bankruptcy filing or only proceed with the acquisition in the context of a bankruptcy filing by the seller.

Advantages for Buyer

Bankruptcy offers a host of benefits for a troubled company (the seller), including an automatic stay on creditor actions and the ability to reject executory contracts. Purchasing assets from a troubled company in bankruptcy also has some of the following advantages for the buyer of IP assets.

Acquisition with the approval of the bankruptcy court substantially reduces the risk of later challenge to the transaction, including challenges by creditors under the fraudulent transfer laws, as discussed later in this article.

The bankruptcy trustee - or debtor-in-possession in a Chapter 11 reorganization - has the power to sell IP assets with bankruptcy court approval despite objections of shareholders.2 (For purposes of this article, the term "trustee" will be used to refer to the trustee or the debtor-in-possession.)

The trustee also may convey assets free and clear of many third-party interests.3 The trustee has the power to cherry-pick among the seller's executory agreements and reject those that it does not wish to retain. In the IP context, however, there is a major exception to this power to reject. As will be discussed in Part II of this article in more detail, under Bankruptcy Code § 365(n), if the trustee rejects a contract under which the debtor is a licensor of IP, the licensee has the right to retain its license rights under the contract (including its exclusivity rights).4 Thus, even when acquiring IP assets in bankruptcy, the buyer may be forced to take the assets subject to existing licenses.

Nonetheless, there may be other agreements that the seller would be able to reject in bankruptcy. These might include development agreements, support agreements, and distribution arrangements not constituting licenses.

Disadvantages for Buyer

On the other hand, bankruptcy proceedings also present certain disadvantages from the perspective of a prospective buyer. For starters, a sale in bankruptcy is a public auction. The bankruptcy court generally will approve a sale if it determines that the trustee is exercising reasonable business judgment. However, because the principal purpose of the bankruptcy proceeding is to maximize the seller's estate, bankruptcy sales are subject to "higher and better" offers presented by other bidders. The seller normally would be required to sell to the highest bidder, unless there were sound business reasons for accepting a lower bid.

Thus, the buyer runs the risk of being a "stalking horse" bidder, by establishing a base price that the seller will use to solicit higher or better bids. To provide some protection, the prospective buyer may insist on a break-up fee as part of the transaction, so that it will receive some benefit from being (and have some incentive to be) the first bidder. A buyer also may be reluctant to invest the substantial expense involved in due diligence unless it has some assurance that it will be reimbursed for those expenses if the sale is not completed due to a higher offer.5

A buyer also faces delays and publicity in bankruptcy proceedings and the approval process, which could lead to the loss of key employees. Retaining such personnel may be necessary for the buyer to realize the full potential value of some of the IP assets.

Disadvantages for Seller

There also are certain disadvantages to bankruptcy proceedings from the seller's perspective, and the seller may prefer to avoid a bankruptcy filing, if it can do so. For example:

Bankruptcy adds costs. Even if the seller is liquidating the company, more value ultimately may be available to the creditors (and perhaps the shareholders) if the liquidation can be achieved without a bankruptcy filing.

With the bankruptcy filing, current management and the board of directors will lose control of the process. In a Chapter 7 proceeding, the disposition of the assets will be in the hands of the bankruptcy trustee. Even in a Chapter 11 reorganization, in which the debtor remains in possession its actions may become subject to approval by a creditors committee and will become subject to bankruptcy court scrutiny and...