Your intellectual property provider is bankrupt. What now?

A guide to bankruptcy and intellectual property license agreements

Bankruptcy can affect your license agreements for intellectual property (IP). Generally, license agreements are “executory contracts.” A contract is executory if performance remains outstanding on both sides of the agreement. When a party to an executory contract becomes a debtor in bankruptcy, it may either reject or assume the contract. However, the Bankruptcy Code provides some protections to non-debtor parties (or counterparties), especially when the contract is an IP license agreement.

Rejection relieves the debtor of performance, and the counterparty keeps a claim for damages. Although rejection claims often provide little value in bankruptcy, assumption can be worse. Assumption requires the parties to continue performance. The debtor also may be able to assign the contract to a third party—even if the contract prohibits such assignment. As a result, you may find yourself managing IP with someone you don’t know or trust.

You are the licensor and your license agreement is rejected.

If you license IP to a licensee that becomes a debtor in bankruptcy, the debtor licensee can reject the license agreement. As the licensor, you may welcome the opportunity to sever your relationship with an insolvent licensee. Although your rejection claim may have little value, as the licensor, you should be able to retrieve and secure your IP. It is important for the licensor to monitor the bankruptcy case. You may want to force an early decision to reject the license agreement or ask the bankruptcy court to terminate the license — but you cannot terminate without permission. In any event, as the licensor, you should consider filing a claim for damages with the bankruptcy court.

You are the licensee and your license agreement is rejected.

If you license IP from a licensor that files bankruptcy, you may wish to keep your rights in the IP. Congress recognizes that it would be unfair if licensors could terminate a license by filing bankruptcy. Section 365(n) of the Bankruptcy Code says that if the licensor rejects an IP license agreement, the licensee has two options: (1) it may treat the license as terminated, return the IP, and file a claim for damages; or (2) it may waive its claim for damages and retain the right to use the IP for the duration of the license for the stated royalties or other payments required by the license agreement.

Section 365(n) protection of a licensee’s rights is not perfect. For example, as licensee, you can enforce exclusivity provisions, but not maintenance, support, or other provisions. Some courts may characterize certain non-royalty payments as royalties, forcing payment to retain the use of the IP. Licensees should carefully draft the payment provisions in a license agreement to specify payments that are royalties, and if other payments are due, the purpose and consideration for those payments as distinguished from royalty payments. The licensee must monitor the case and move promptly to exercise its rights when the licensor debtor seeks rejection to prevent the licensor from using bankruptcy to rescind the right to use IP.

Trademark issues.

The special treatment of IP licenses in Section 365(n) is limited to patents, copyrights, and trade secrets. The Bankruptcy Code’s definition of intellectual property does not include trademarks. Most courts have concluded that trademark licensees do not have the option to retain their rights if the debtor licensor rejects. Others say the bankruptcy court has the power to grant these rights to a trademark licensee. The rules for licensing trademarks may depend on the location of the licensor’s bankruptcy case.

Assumption of your license agreement.

To assume a contract, the debtor must protect the counterparty’s interests. First, the debtor must cure all defaults, including paying all amounts due. Second, the debtor must compensate the counterparty for any actual losses as a result of default. Third, the debtor must provide adequate assurance that it has the financial, technical, and operational ability to continue to perform the contract.

If the debtor seeks to assume your license agreement, you should move quickly to review the debtor’s finances and business plan to ensure that the debtor will be able to cure all defaults and perform the license agreement after the assumption. In some jurisdictions if a debtor cannot assign an IP license, then it also cannot assume the license in the first place. Your rights may vary depending on where the bankruptcy case is filed.

Assignment of your license agreement.

A debtor in bankruptcy may assign most contracts even if the contract says that it is not assignable. The debtor first must assume the contract. Accordingly, before assignment, the counterparty is entitled to have all defaults cured and damages paid. In addition, the debtor must prove the assignee can provide the adequate assurance of performance. The proposed assignee must have at least the financial and operational capacity that the debtor had when it entered the license.

Moreover, IP licenses enjoy special protections in bankruptcy. Although non-assignment clauses generally are not enforceable in bankruptcy, bankruptcy law respects non-bankruptcy laws that say an agreement cannot be assigned. Many courts have held that federal law prevents the assignment of copyright, patent, and trademark licenses without the licensor’s consent. For example, franchise agreements may include licenses to use the franchisor’s IP, such as trademarks, trade names, trade secrets, or patents. These licenses may not be assignable under applicable non-bankruptcy law. Whether applicable non-bankruptcy law protects your license agreement from assignment must be determined case-by-case and may be affected by the location of the bankruptcy case.

Republished with permission. This article first appeared in Inside Counsel on June 30, 2015.