Understanding how intellectual property (IP) and bankruptcy laws intersect has never been more essential. Whether you are a debtor in Chapter 11 or a company with critical licensing agreements, the treatment of IP rights in bankruptcy can have a significant impact on the future of your business.
What Is Intellectual Property, Anyway?
Christopher Wick, a partner at Hahn Loeser & Parks LLP, breaks down the key types of IP:
- Patents: These protect inventions and discoveries. Governed by the Patent Act and managed by the USPTO, patents offer a 20-year exclusionary right to inventors. Wick notes that the law now uses a ‘first to file’ system instead of ‘first to invent.’
- Copyrights: These cover original works fixed in a tangible medium — think music, writing, and art. Copyrights can be exclusive or non-exclusive and are regulated by the US Copyright Office.
- Trademarks: Defined under the Lanham Act, trademarks distinguish goods in the marketplace. They must be used in commerce to be valid, and while federal registration isn’t required, it brings real advantages like nationwide presumptions of ownership.
- Trade Secrets: These include formulas, methods, or processes not generally known. Most states follow the Uniform Trade Secrets Act.
- Domain Names: Though not traditionally licensed, domain names often relate to trademarks and can be valuable digital property.
What the Bankruptcy Code Covers and What It Doesn’t
James Sullivan of Seyfarth Shaw LLP explains that while the Bankruptcy Code defines ‘intellectual property,’ excluding trademarks and foreign IP, bankruptcy courts often defer to non-bankruptcy law (like state or federal IP law) to determine rights. This matters because the protections under the Code, like the ability to assume or reject a license, depend on what is ultimately defined as IP.
As Sullivan further explains, conflicts can arise between the Code and IP law due to their distinct priorities and foci. While the Code is designed to give the debtor a fresh start and to maximize value for creditors, IP law is focused on protecting creators and enforcing exclusivity, meaning that licensees will expect to retain their rights even if the licensor files for bankruptcy.
Understanding IP Licenses in the Context of Bankruptcy
Wick explains that most IP licenses are considered executory contracts, meaning both sides will have ongoing obligations. This is key because Section 365 of the Bankruptcy Code gives debtors the right to:
- Assume (continue honoring the contract),
- Reject (treat the contract as breached), or
- Assign (transfer the contract to someone else).
But not all IP contracts are created equal. For example, exclusive licenses may be considered assignments and thus not executory, whereas non-exclusive licenses are more likely to be executory because they only grant permission, not ownership.
Protections for Licensees: Section 365(n)
Section 365(n) was Congress’s way of protecting licensees after the Lubrizol decision, which had allowed debtors to revoke IP licenses by rejecting them.
This provision gives licensees a choice to treat the license as terminated and file a claim or keep using the IP (if it qualifies under the Code) and continue paying royalties. This protection doesn’t extend to trademarks or foreign IP.
Sullivan urges licensees to be proactive and pay close attention to how their licenses are drafted and recorded.
When a Rejection Isn’t Really a Rejection
The Supreme Court’s 2019 decision in Mission Product Holdings v. Tempnology clarified that rejection of a license is a breach, not a rescission.
As Wick puts it, even if the debtor rejects the contract, the licensee can still use the IP under the terms of the agreement. This is particularly important for non-exclusive trademark licenses, which had been left in legal limbo before Tempnology.
Assignment and Assumption: More Than a Formality
If a debtor wants to assign an IP license to a third party, they may hit roadblocks. Sullivan noted that Section 365(c) restricts assignment when ‘applicable law’ bars performance by anyone other than the original party, especially in personal service contracts like IP licenses.
Three different approaches have emerged in the courts:
- Hypothetical Test (majority rule): If the contract couldn’t be assigned under non-bankruptcy law, it can’t be assumed either.
- Actual Test: Focuses on whether the debtor actually intends to assign the contract.
- Footstar Approach: A minority view holding that a debtor-in-possession is not the same as a ‘trustee,’ and therefore can assume even unassignable contracts.
Protecting IP in Section 363 Sales
When debtors sell assets in bankruptcy, they often include IP rights. But Wick warns that there are risks, including valuation challenges, especially when it’s unclear how widely an IP asset is used, and confidentiality breaches, particularly if NDAs or licensing terms are disclosed improperly.
Liens on IP: What Lenders Should Know
Lenders need to take care when securing liens on IP assets. Sullivan stresses that the perfection of security interests in IP can vary depending on whether the asset is a patent, trademark, or copyright. For example, patents and trademarks must be recorded with the USPTO, and copyrights must be recorded with the US Copyright Office. Trade secrets, however, are governed by state law and don’t usually require registration, making them trickier to lien against.
Final Takeaways
For those navigating bankruptcy and IP, it is critical to:
- Draft licenses carefully, with bankruptcy scenarios in mind.
- Understand the status of each IP type under the Code.
- Be prepared to assert or defend 365(n) rights in the event of rejection.
- Monitor the debtor’s intentions with respect to assumption and assignment.
To learn more about this topic view Bankruptcy Intersections: Intellectual Property. The quoted remarks referenced in this article were made either during this webinar or shortly thereafter during post-webinar interviews with the panelists. Readers may also be interested to read other articles about intellectual property.
This article was originally published here.
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