IP Law Essentials

Bankruptcy and COVID-19: Issues for Licensors

The outbreak of the global COVID-19 pandemic has wreaked untold adverse impacts to the worldwide economy, leading licensees to consider all options, including restructuring options. While bankruptcy provisions in IP licenses have always been important, that importance will significantly increase as licensors identify and adjust to a "new normal" for their activities (and the activities of their strategic partners). It is important to understand how a bankruptcy filing by an IP licensee can affect the licensor. For example, if a licensee declares bankruptcy, will the licensor stop receiving royalty payments? Will the licensor be able to terminate the license and shift those rights to a more productive context? We take a brief look at some of these issues below.

What does the Bankruptcy Code say about IP?
The filing by a debtor licensee for bankruptcy under Chapter 11 of the Bankruptcy Code ("Code") creates a bankruptcy estate that includes all of the debtor licensee's interests in its property, including IP. Intellectual property is broadly defined in the Code to include trade secrets, inventions, patents, patent applications, copyrights, plant varieties and mask works. Trademarks, trade names, and service marks are notably absent in the foregoing list. Those IP forms, along with international IP not covered by treaties between the U.S. and country of origin of work, are not expressly included in the definition. Congress permitted bankruptcy courts, however, to develop equitable treatment of marks since marks depend to a large degree on control of associated quality and service. And the Supreme Court recently addressed this issue, holding that trademark licenses are covered by the Code. See Mission Product Holdings Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019) (a debtor's rejection of an executory contract in bankruptcy has the same effect as a breach outside bankruptcy, even as to a trademark license).

What is an executory contract?

While not specifically defined under the Code, an executory contract is understood to mean a contract between a debtor and a third party under which both sides still have important ongoing performance obligations.

Is an IP license just another executory contract?
Yes, in most cases. Under the Code, an IP license can be considered an executory contract. An IP license often creates ongoing obligations for a licensor, such as a duty to prosecute and maintain underlying IP. Not all agreements including an IP license, however, are executory contracts. For example, an agreement to sell or assign IP (where at least one party does not have any ongoing obligations). Accordingly, a fully paid-up IP license (without other ongoing responsibilities by the licensee) would not be considered an executory contract.

What option does a debtor licensee have with an executory contract?

The designation of an IP license as an executory contract is important. Subject to court approval,[1] a debtor licensee has the option to assume (i.e., continue) or reject an executory contract. A debtor licensee may even be allowed to assume the contract and assign it to another party (even with anti-assignment clauses in the agreement).[2] If a debtor licensee elects to assume such contract, the Code requires the debtor to cure any defaults under that contract. Common defaults for debtor licensees include the failure to pay amounts under the contract. Upon such cure, the contract will continue in full force between the debtor licensee (or an assignee) and the non-debtor licensor.

If a contract is rejected: (1) the debtor licensee is relieved of its obligations to perform under the contract; (2) such rejection will be treated as a breach (not a termination) of the contract; and (3) such rejection will provide the non-debtor licensor a claim against the debtor licensee for damages, but such a claim merely places the non-debtor licensor in line with all of the other unsecured creditors of the bankruptcy estate.

What is the effect of provisions in IP licenses addressing bankruptcy?
Whether looking at existing IP contracts or planning prospective ones, paying close attention to certain provisions in the contract will help determine the effects of a bankruptcy filing on the underlying IP and the non-debtor licensor. While tempting to assume the presence of a "termination upon bankruptcy" clause will allow a non-debtor licensor to avoid these issues, it will not. As noted above, the rejection of a contract including an IP license will result in a breach - not a termination - of the underlying contract. A licensor should therefore focus on provisions providing the right to terminate for conduct likely to occur well ahead of any bankruptcy filing - e.g., poor financial results or performance delays. There is no one-size-fits-all licensing provision that addresses bankruptcy. Each licensing scenario needs its own in-depth analysis to analyze/develop provisions that adequately protect the licensor.

What proactive measures can be taken?
It is important that licensors understand the effects of bankruptcy on an IP contract. A non-exhaustive list of proactive measures an entity can pursue in this context include: (1) determine which existing IP contracts are likely to be considered executory; (2) review such existing executory IP contracts for the issues outlined above and the terms that will likely drive the treatment of IP in the event of bankruptcy; (3) look for opportunities in existing IP contract (e.g., requests for re-pricing; new statements of work; disputes) to renegotiate/add/supplement terms that may be unfavorable to the entity on these issues; (4) plan carefully for these issues in new IP contracts; and (5) consider alternative approaches to the use of IP rights that may avoid such issues - e.g., the sale of IP versus the licensing of same.

[1] Different bankruptcy courts treat executory contracts involving IP differently, so it is important to consider the various treatments.

[2] Certain bankruptcy courts have required a licensor to consent to such an assignment.

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