The plain meaning of section 365(c): the tension between bankruptcy and patent law in patent licensing.

• Author: Ying, Jennifer

INTRODUCTION I. EXECUTORY CONTRACTS IN BANKRUPTCY LAW A. Contracts as Property of the Bankruptcy Estate B. Patent Licenses as Executory Contracts 1. Rejection of an Executory Contract 2. Assumption of an Executory Contract 3. Assignment of an Executory Contract II. BASIC PRINCIPLES OF PATENT LAW A. The Balance Between Exclusivity and Disclosure B. Two Types of Patent Interests: Assignments and Licenses C. Exclusive Versus Nonexclusive Patent Licenses D. Patent Law's Strong Protection of Owners' Rights III. THE LEGAL SYSTEM'S APPROACH TO THE TENSION BETWEEN BANKRUPTCY AND PATENT LAW A. Transferability of Patent Licenses and the Federal Common Law Principle B. Inconsistent Case Law 1. Development and Adoption of the Hypothetical Test 2. Development and Adoption of the Actual Test C. Recent Case Law Trends in Interpretation IV. INTERPRETING SECTION 365 (C): IS THE "OR" REALLY AN "AND"? A. The "or" as a Disjunctive "or" B. The "or" as a Conjunctive "and" 1. Does the Literal Reading Create Inconsistencies? a. Section 365(c)'s Interaction with Section 365(f) (1) b. Section 365(c)'s Interaction with Section 365(e) 2. The Legislative History of Section 365 3. The Literal Reading and General Bankruptcy Policies V. THE LITERAL READING AS A CREDITOR-PROTECTION MEASURE A. Patents Are a Property Right B. Patent Law's Injunctive Relief Against Infringers CONCLUSION INTRODUCTION

This Comment examines the underlying tension between bankruptcy law and intellectual property law in the context of nonexclusive patent licenses. The tension arises when a patent owner (i.e., a licensor) (1) grants a license for its patent and the licensee" files for bankruptcy under Chapter 11 of the United States Bankruptcy Codes while the license is still in effect, In a traditional Chapter 11 filing, the debtor-licensee assumes an asset (here, the patent license) by becoming a debtor-in-possession (4) and is then free to assign the asset to another entity in order to facilitate its restructuring and reorganization plan. (5) From the licensor's perspective, however, the debtor-licensee is not free to assign the license because it is nontransferable. Furthermore, patent law's fundamental "fight to exclude" principle allows the patent owner to sue for patent infringement in the absence of a license agreement. (6) Thus, the question becomes whether a debtor-licensee should be allowed to continue operating under its license once it files for bankruptcy, or if a conflict in bankruptcy and patent law should prevent the debtor-licensee from assuming and using the license. If the debtor-licensee's ability to use an essential asset is subject to conflicting law, then neither the licensor nor the licensee can be sure of its fights.

With technology at the forefront of today's economy, many companies increasingly rely on technology licenses in order to conduct their businesses. Unsurprisingly, the fight to continue using intellectual property licenses--in particular, patent licenses--is critical to the survival of a distressed debtor. Most importantly, the debtor-licensee's assured ability to assume and assign the license will determine whether it will be able to successfully obtain financing or even continue operations after undergoing a Chapter 11 filing.

Part I of this Comment outlines the considerations of Chapter 11 bankruptcy law relating to patent licenses and a debtor-licensee's interests. Part II identifies the competing interests of patent law. Part III explores the various approaches courts have taken to address the conflict between bankruptcy and patent law, focusing on the development of the two main tests that courts have adopted to resolve the conflict. In addition, Part III examines the recent case law trends in some bankruptcy courts. Part IV investigates the statutory interpretation and legislative history of section 365 (c) of the Bankruptcy Code and focuses on why the literal reading of the statute should prevail. Part V discusses how the literal reading of section 365 (c) enables patent rights to be a form of creditor protection against the competing interests of a strong bankruptcy policy.

1. EXECUTORY CONTRACTS IN BANKRUPTCY LAW

   1. Contracts as Property of the Bankruptcy Estate

      Bankruptcy law relies on the concept of freely assignable rights of property in order to facilitate the restructuring and reorganization of the debtor. (7) In particular, Chapter 11 of the Bankruptcy Code tries to preserve the ongoing value of the business and maximize the economic return to all constituents of the business. (8) At its heart, a business is no more than a series of contracts enabling the development, production, or sale of a good or service. Putting aside a company's physical assets (e.g., land, buildings, equipment, inventory), the majority of a company's value comes from its contracts with its creditors, distributors, suppliers, customers, and the like.

      Section 541 of the Bankruptcy Code provides that a bankruptcy estate is created upon the filing of a bankruptcy petition. (9) The bankruptcy estate is considered to have a separate legal existence than that of the debtor who filed the case. (10) The Bankruptcy Code defines "property of the estate" as all of the debtor's legal and equitable interests in property as of the bankruptcy petition's filing date. (11) Courts have interpreted a debtor's bankruptcy estate to include the debtor's contractual rights. (12) In the case of a debtor business filing for Chapter 11, the bankruptcy estate includes the debtor's physical assets as well as the debtor's contracts with any creditors, distributors, suppliers, customers, and the like. (13)

   2. Patent Licenses as Executory Contracts

      The conflict between intellectual property and bankruptcy law arises from the Bankruptcy Code's treatment of a special type of contract, known as an "executory contract," under section 365. (14) Any contracts that require, at the time of the bankruptcy petition filing, further performance from each party are considered executory. (15) In particular, nonexclusive licenses, such as those commonly found in patent licenses, are considered executory contracts within the meaning of the Code. (16) This is because both parties have continuing obligations--in the case of a nonexclusive patent license, the licensor has a continuing obligation not to sue the licensee for infringement of its patent, and the licensee has a continuing obligation to commercialize the licensed invention. (17)

      With executory contracts, a debtor has three options: (1) rejection of the contract, (2) assumption of the contractual obligations, or (3) assignment (i.e., transfer) of the contract. (18) The ability to freely choose and exercise these three options is fundamental to a debtor's ability to maximize the value of its assets during reorganization or restructuring.

      1. Rejection of an Executory Contract

         The first option, rejection, is relatively straightforward. The debtor simply rejects the contracts it deems to be of low value or highly cumbersome to operate. (19) Under section 365(g) of the Bankruptcy Code, the debtor's trustee, (20) with the approval of the bankruptcy court, may reject an executory contract. (21) This rejection constitutes a breach of the contract, effective immediately prior to the debtor's bankruptcy filing. (22) In technology licensing cases, section 365(n) of the Bankruptcy Code provides a remedy for breach of contract if the debtor party is the licensor--in these cases, the nondebtor party may treat the license as terminated. (23) Similarly, if the debtor party is the licensee, rejection of the license allows the nondebtor party to treat the license as terminated. (24) Thus, regardless of whether the debtor is the patent licensor or licensee, if the debtor chooses to reject the license, the license will be deemed terminated. (25)

      2. Assumption of an Executory Contract

         The situation becomes more complex if the debtor party wishes to assume and assign the license as a patent licensee, due to bankruptcy's protections of a debtor's interests and estate. In Chapter 11 filings, the assumption and assignment of an executory contract fundamentally affects the debtor's ability to restructure. (26) The debtor will want to assume the contracts it deems to be valuable and, upon assumption, retain the contracts as part of its reorganization. (27) Since a patent license authorizes the debtor-licensee to operate under the terms of the license, the debtor-licensee will likely assume the license in order to continue its business operations during bankruptcy. For example, a debtor may be in the business of manufacturing widgets and has licensed a patent enabling it to produce the widget. After filing for bankruptcy, if the debtor wishes to be able to continue its business operations and (hopefully) make a profit, it must assume the patent license in order to continue manufacturing the widgets legally, or risk being sued for patent infringement by the patent owner.

         The specific requirements for assuming a contract are governed by section 365 (b) of the Bankruptcy Code. The main conditions are that the debtor must assure the court of its "ability to cure past defaults and meet future obligations." (28) These two conditions are intended to ensure that the nondebtor party, who is forced to continue performance, receives the full benefit of its bargain. (29) In the case of a patent license, because the licensor is foregoing its right to sue the licensee for conduct that "but for the license, would be an infringement," (30) the licensor must be assured that the debtor-licensee is in a position to fulfill the commercialization terms of the patent license. (31)

         When a debtor assumes a contract, the debtor's estate becomes obligated to take on the contract in its entirety. (32) The debtor cannot pick and choose parts of the contract it wishes to assume. (33) Furthermore, upon assumption of the contract, the nondebtor party is given priority-claimant...