Intellectual Property Considerations in Times of Financial Distress

• Publication year: 2013
• Citation: Vol. 17 No. 02

Intellectual Property Considerations in Times of Financial Distress

by Johnathan G. Bolton and Martin S. Loui

Intellectual property ("IP") is increasingly a valuable asset and is a critical component for almost any business in today's marketplace. A company's rights in an IP asset are typically embodied in licenses that grant the company's use of IP by contract. Within this framework, enter the context of troubled economy, where distressed companies facing foreclosure, insolvency or the inability to refinance might find themselves at the cross-roads of survival, facing the possibility of a bankruptcy filing, shutting their doors or handing over the keys to their lenders. In choosing the former option — specifica lly a chapter 11 case filed in order to reorganize and gain a fresh start or, at least, maximize the company's liquidity value — the distressed company will be confronted with the sometimes complex interplay between IP and bankruptcy laws. The continued right to use licensed IP assets in a bankruptcy case not only affects the distressed company but also all parties engaged in a licensing arrangement with the financially-troubled licensor or licensee. Navigating these laws can be a complicated and complex exercise, often with a harsh economic impact on one or both parties in an IP licensing arrangement.

This article will discuss how IP rights can be affected by the U.S. bankruptcy laws. It explores several different situations where either a licensor or licensee files a chapter 11 bankruptcy case (i.e., the "debtor-in-possession"), and the impact and risk that occurs with respect to the contractual counter-party which impact and risk can be substantial. This article emphasizes that it is critical for both parties in a license agreement concerning IP, during the initial structuring and negotiation stages, to be cognizant of how a bankruptcy filing may affect their respective IP rights down the road and how certain relief granted to a debtor-in-possession in a chapter 11 bankruptcy case trumps the rights otherwise afforded to the counterparties under IP laws. Additionally, precautionary steps are suggested to help minimize the damage that might be caused to affected businesses.

Background Leading to Bankruptcy

Many issues arise when a company enters into the so-called "zone of insolvency" (i.e., the point when the value of its debts exceeds the value of its assets), including issues that can affect the extent and value of the company's IP portfolio. At this juncture, officers and directors must be mindful of their fiduciary duties.¹ Furthermore, at the point of insolvency, the company must decide whether it will realistically be able to continue as a going concern or whether it should liquidate its assets in a commercially reasonable manner in order to generate the highest and best price for the assets for the benefit of all stakeholders.

If the company does not act quickly after choosing its course of action, it is possible that creditors will begin to dismember the company by obtaining judgments, recording liens, and executing on the company's assets, including its IP assets. The valuation of IP assets can be the subject of a separate article, but what can be said here is that there are normally dramatic differences in the value of IP depending on whether the company owns its patents, trademarks, copyrights, trade secrets, etc. or if the company is simply an exclusive or non-exclusive licensee of IP rights. Furthermore, the market value of a company's IP can be affected by its current financial circumstances.

Most IP license agreements contain provisions that allow licensors to terminate the IP licenses if certain financial covenants are breached by the licensee, including the non-payment of royalties due. For example, a common provision in an IP license states that it is an "Event of Default" if the company "becomes insolvent or admits its inability to pay its debts generally as they become due or if it becomes subject, voluntarily or involuntarily, to any proceeding under bankruptcy or insolvency law." Furthermore, IP licenses also normally provide that the license "is not assignable without the consent of the licensor." Often, a purported assignment to a third party of the license without the consent of the licensor is void.

For a company that owns its own IP assets and has entered the zone of insolvency, one way the business can attempt to raise money to pay off existing debt is to sell, assign or license the company-owned IP In those contexts where companies own their own patents, licensing the use of patented technology can be an excellent way to generate additional cash flow Similarly, selling a valuable IP asset can be a way to generate cash to reduce existing debt. In one recent situation, Hostess Brands, Inc. ("Hostess") filed a chapter 11 bankruptcy petition on January 11, 2012.² After negotiations to modify its existing collective bargaining agreement ("GBA") failed, and with no hope that a true "reorganization" would be successful, Hostess asked the U.S. Bankruptcy Court for, and was granted, approval to conduct an orderly liquidation sale of its assets so as to maximize the value of such assets, pursuant to a Bankruptcy Court-approved "wind-down process."³

In scenarios where a licensor wrongfully attempts to terminate a license of IP, a bankruptcy filing by the licensee can prevent an improper termination of the license by imposition of the automatic stay, which prevents the licensor from taking any actions to terminate the licensee's valuable property rights in the license.⁴ The automatic stay also prohibits the taking of actions to obtain possession of the licensed IP rights, which is the property of the bankruptcy "estate" of the debtor-in-possession upon institution of the chapter 11 case, as well as taking action to collect or recover a claim against the debtor that could have been brought before the bankruptcy petition was filed. Violations of the automatic stay, including actions attempting to terminate contractual rights, ought to be on the radar screen of contractual counterparties because the Bankruptcy Court is authorized to award damages for violations of the automatic stay.⁵

If a troubled company is ultimately forced to file a chapter 11 bankruptcy case because of a dispute with its licensor, or for any other reason, the Bankruptcy Code provides some protections for licensees of certain kinds of IP, but not necessarily for others. For example, although patents, patent applications, plant varieties, mask works, copyrights and trade secrets are included within the Bankruptcy Code's definition of "intellectual property," trademarks are not included that definition.⁶ Therefore, the protections given to licensees of certain types of intellectual property rights may not apply to holders of trademark licenses, as discussed below.⁷ There is also a question regarding whether copyrights and patents gained under foreign...