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Article: March 2020: Bankruptcy and Restructuring Litigation Update

Business Litigation Reports

Protecting Intellectual Property in Bankruptcy

In the modern economy, intellectual property is often a business’s most valuable asset. The treatment of intellectual property under Title 11 of the United States Code (the “Bankruptcy Code”), therefore, has a significant impact on the value of a corporate debtor and the assets that are available to the company’s creditors. The Bankruptcy Code balances the rights of debtors, license counterparties, and other creditors, to establish whether a debtor can monetize its intellectual property or retain its intellectual property rights. 

Here are the general rules that govern the treatment of intellectual property rights held by a debtor:

  • Where the debtor is a licensee under an exclusive IP license:  The debtor holds freely alienable property rights in the IP.
  • Where the debtor is a licensee under a non-exclusive IP license:  The debtor may be able to retain the IP rights but almost certainly cannot sell those rights to others.
  • Where the debtor is a licensor under an exclusive IP license:  Absent an avoidable transfer, the debtor cannot rescind the license; therefore, the debtor cannot grant other parties licenses to use the same IP.
  • Where the debtor is a licensor under a non-exclusive IP license:  Absent an avoidable transfer, the debtor cannot rescind the license, but the non-exclusive license does not prohibit the debtor from granting other parties licenses to use the same IP.

 

The Debtor as Licensee: Selling Licenses

Federal copyright and patent laws prohibit a licensee from assigning non-exclusive intellectual property rights to a third party. Bankruptcy courts abide by this restriction. See, e.g., In re Golden Books Family Entertainment, Inc., 269 B.R. 300 (Bankr. D. Del. 2001) (non-exclusive licenses cannot be assigned under federal copyright law); Perlman v. Catapult Entertainment, Inc. (In re Catapult Entertainment, Inc.), 165 F.3d 747 (9th Cir. 1999) (assignment of non-exclusive patent license is prohibited by federal patent law). Similarly, the court in In re Trump Entm’t Resorts, Inc. held that “trademark licenses are not assignable in the absence of some express authorization from the licensor, such as a clause in the license agreement itself.” 526 B.R. 116, 123 (Bankr. D. Del. 2015) (citing In re XMH Corp., 647 F.3d 690, 695 (7th Cir. 2011) (“as far as we’ve been able to determine, the universal rule is that trademark licenses are not assignable in the absence of a clause expressly authorizing assignment”); see also Miller v. Glenn Miller Prods., Inc., 454 F.3d 975, 988, 992-93 (9th Cir. 2006); 3 McCarthy on Trademarks § 18:43 (4th ed. 2010)). Given the alienability restrictions on non-exclusive intellectual property, a debtor seeking to sell such assets must generally obtain the consent of the licensor. In some instances, however, the license itself may permit a sale or assignment of the licensed rights. See Murray v. Franke-Misal Technologies Group, LLC (In re Supernatural Foods, LLC), 268 B.R. 759 (Bankr. M.D. La. 2001) (license permitting assignment in connection with sale of substantially all assets amounted to requisite consent to transfer). 

In contrast to non-exclusive licenses, federal law permits a licensee to freely transfer exclusive patent and copyright licenses. Bankruptcy courts follow this rule. See In re Golden Books Family Entertainment, Inc., 269 B.R. 311 (Bankr. D. Del. 2001) (exclusive copyright license assignable under copyright law) (citing In re Patient Educ. Media, Inc., 210 B.R. 237 (Bankr. S.D.N.Y. 1997)). Trademark licenses stand as the lone exception to the free alienability of an exclusive license. “The general prohibition against the assignment of trademark licenses absent the licensor’s consent is equally applicable to both exclusive and non-exclusive trademark licenses.” Trump Entm’t, 526 B.R. at 127.

The Debtor as Licensee: Retaining Licenses

While a non-exclusive license cannot be assigned, it is an open question whether a reorganized debtor nevertheless retains its intellectual property. See 11 U.S.C. § 365(a) (permitting debtors to assume executory contracts). Some jurisdictions, such as the Third and Ninth Circuits, do not permit reorganized debtors to retain their licenses. Others, including the First, Fourth, and Fifth Circuits, permit debtors to assume their pre-petition intellectual property licenses.

The Third Circuit pioneered the “hypothetical” test under which the bankruptcy court must replace the debtor (whether or not reorganized) with a hypothetical third party to determine whether the third party would be able to acquire the license. If the hypothetical third party could not acquire the license, then the debtor cannot retain it. See In re West Elecs., Inc., 852 F.2d 79, 83 (3d Cir. 1988). Unfortunately, the “hypothetical” test yields value-decimating results. See, e.g., In Re Access Beyond Technologies, Inc., 237 B.R. 32 (Bankr. D. Del. 1999) (on a motion to sell assets, the court determined that non-exclusive patent license was non-assumable and nonassignable); see also In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999) (the plain language of section 365(c)(1) precluded the debtor from assuming the intellectual property licenses because federal patent law renders patent licenses personal and nondelegable). 

Under the “actual” test applied in other circuits, courts allow a debtor to retain a license, reasoning that the retention and use of the license is not an assignment of the license. As long as the debtor does not assign the license, courts applying the “actual” test hold that there is no reason to analyze whether the debtor can compel the licensor to accept performance from a third party. See, e.g., Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489, 493 (1st Cir. 1997). The Fourth Circuit and Fifth Circuit have adopted the “actual” test.  See RCI Tech. Corp. v. Sunterra Corp. (In re Sunterra Corp). 361 F.3d 257 (4th Cir. 2004); In re Mirant Corp., 230 B.R. 693, 705 (5th Cir. 1999).  And although the Second Circuit has not ruled on this issue, bankruptcy courts within the Second Circuit have adopted the “actual” test. See, e.g., In re Adelphia Communications Corp., 359 B.R. 65 (Bankr. S.D.N.Y. 2007).

Consequences and Conclusions

Generally, the Bankruptcy Code’s treatment of intellectual property follows applicable non-bankruptcy law. In a bankruptcy proceeding, a rejection of a license (equivalent to breach) has the same consequences as a breach outside the bankruptcy context. Similarly, the Bankruptcy Code neither expands nor contracts a debtor’s ability to sell its intellectual property. 

There are, however, some areas where the Bankruptcy Code departs from applicable non-bankruptcy law.  In those areas, the determination of rights to intellectual property therefore depends on the debtor’s jurisdiction and the non-bankruptcy law applicable to intellectual property.  Careful planning can mitigate the effect of these exceptions.  Using the “hypothetical” test as an example: Negotiating a plan of reorganization prior to filing a petition for bankruptcy relief may help a company obtain the consent of its intellectual property licensors, thereby permitting the company to retain its intellectual property during the company’s bankruptcy proceeding. Alternatively, a company with substantial holdings of intellectual property may elect to file for bankruptcy in a jurisdiction that uses the “actual” test under which the debtor may be able to retain the license and reorganize under a bankruptcy plan.