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).
With more bankruptcies on the horizon, especially in the dot-com sector, what rights do you have if one of your licensors files for bankruptcy?
Under certain conditions, 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 trade dress, 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.
The 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, review your agreement to determine if it is actually an executory contract subject to rejection in the bankruptcy. Then determine whether the code would permit you to legally continue to exploit the intellectual property if the bankruptcy estate rejects the license agreement.
Is the 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 it is not, it is generally not subject to rejection by the bankruptcy trustee.
While the title of the agreement indicates 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 nonexecutory. In determining if the licensee has acquired a property interest, courts look for the three bundle of rights — the right of exclusivity; the right to transfer; and the right to sue infringers
If these three rights have been transferred, 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.
Regardless of how the agreement is titled, it’s important to review the practical effects of the license agreement to determine if it is subject to rejection.
Rights retained if the IP license is rejected
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, the code 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 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 nonpassive rights provided by the licensor, such as maintenance, upgrades, support or modifications.
Under the code, the licensee is entitled to maintain its use of the intellectual property for the duration of the agreement, plus any extensions or renewals.
While not a comprehensive checklist, there are additional considerations 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 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: 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, the licensee may not have the ability to stop infringers or competitors from (legally or illegally) exploiting the patent. Joshua Marks ([email protected]) 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 multidisciplinary group of attorneys which focuses its practice on entrepreneurs, Internet, e-commerce and emerging growth companies. Joshua can be reached at (216) 696-4689. For additional information about the E-Group and to read SBN “Matter of Law” reprints, please visit http://www.arterhadden.com/egroup.
