The recent economic slowdown has forced scores of businesses to shut down or file for protection under Title 11 of the United States Code (the "Bankruptcy Code"). Since more bankruptcies are forecasted, especially in the dot-com sector, the prudent licensee should understand certain rights available to it if one of its licensors enters bankruptcy. Under certain conditions, section 365(n) of the Bankruptcy Code permits a licensee to continue to use the intellectual property ("IP") that is the subject of a license agreement, even if such agreement is later rejected by the bankrupt estate. These special rights and protections do not apply to trademarks or tradedress, since these terms are absent in the Bankruptcy Code's definition of intellectual property. However, special rights and protections are provided for trade secrets, copyrights and patents.
Section 365 of the Bankruptcy Code authorizes a bankruptcy debtor or trustee to assume, assign or reject "executory contracts" in an effort to maximize the value of its bankruptcy estate. Executory contracts are those in which some portion of the agreement remains unperformed or ongoing by both parties. For example, a typical patent license agreement is generally executory since the licensee's duty to pay certain royalty fees is ongoing, as is the licensor's obligation not to sue the licensee for infringement. In essence, as long as certain criteria are met, the bankrupt estate is permitted to assume executory contracts it considers beneficial and to reject or terminate those it considers burdensome.
If faced with the possibility that one or more of your licensors may enter bankruptcy, you should: (1) review your agreement to determine if it is actually an executory contract subject to rejection in the bankruptcy; and (2) determine whether '365(n) would permit you to legally continue to exploit the intellectual property if the bankruptcy estate rejects the license agreement.
(1) Is The License Agreement Really An Executory Contract?
Before a court will permit a bankruptcy trustee to assume, assign or reject an IP agreement, it must first determine that the agreement is executory in nature. If the agreement is not executory, then it is generally not subject to rejection by the bankruptcy trustee.
While the title of the agreement is indicative of the parties' intent, courts examine the practical effect of the agreement to determine if any of the "essential rights" in the underlying intellectual property have transferred an ownership interest, thus rendering the agreement non-executory. In determining if the licensee has acquired a property interest, courts look for the three "bundle of rights": (1) the right of exclusivity; (2) the right to transfer; and (3) the right to sue infringers. If these three rights have been transferred, then the licensee is imputed to have "title" to the intellectual property and the license agreement is generally outside the scope of a bankruptcy debtor's rejection. If less than all three rights have been transferred, courts generally find the rights to be merely contractual, and thus executory. Accordingly, regardless of how the agreement is titled, it is important to review the practical effects of the license agreement to determine if it is subject to rejection.
(2) What Rights Can You Retain If The IP License Is Rejected In Bankruptcy?
Section 365(n) of the Bankruptcy Code provides certain rights when a trustee rejects an executory contract under which the debtor is a licensor of an intellectual property. In striking a balance between the interest of the bankrupt estate and the licensee, '365(n) permits the licensee to retain its rights to use the intellectual property in the same manner as it had prior to the filing of bankruptcy, as long as the licensee makes the royalty and/or other payments as required under the license agreement. If the licensee opts under '365(n) to continue to use the intellectual property, then the licensee retains the right to enforce any exclusivity provision of its contract, but loses the right to specific performance of other non-passive rights provided by the licensor, such as maintenance, upgrades, support, modifications, etc. Under 365(n), the licensee is entitled to maintain its use of the intellectual property for the duration of the agreement, plus any extensions or renewals.
This article provides a basic overview of two key principles to consider when your licensors face possible bankruptcy. While not a comprehensive checklist, the additional considerations listed below provide the licensee with factors to keep in mind when drafting or renewing license agreements. In some circumstances, it may be prudent to modify an ongoing license agreement to ensure that it complies with the following principles:
- Include specific rights detailing renewal options and term extensions as of right in the license agreement.
- If the licensor is willing, draft the license agreement to include territorial exclusivity provisions since courts may not find an exclusive field-of-use license sufficient to pass title or a property interest.
- Specify what rights the licensee has with respect to exclusivity, transfer, and bringing suit against infringers.
- Keep in mind a potential pitfall of '365(n): If a licensor elects to continue to exploit a patent or other intellectual property under an executory agreement that was rejected by the bankrupt licensor, then the licensee may not have the ability to stop infringers or competitors from (legally or illegally) exploiting the patent.
Joshua Marks is an attorney at Arter & Hadden LLP and is a member of the firm's Intellectual Property Group and the E-Group. The E-Group is a multi-disciplinary group of attorneys who focus their practice on entrepreneurs, Internet, e-commerce and emerging growth companies. Joshua can be reached at 216/696-4689 or jmarks@arterhadden.com. For additional information about the E-Group and to read SBN "Matter of Law" reprints, please visit our website at: http://www.arterhadden.com/egroup.
Reprinted with permission by SBN magazine