A.
Introduction
Many attorneys believe
intellectual property has little application to their
practice. Intellectual property, however, is very pervasive
in today's business society. A client's ability to carry
on its day-to-day business can be affected by the many
facets of intellectual property. One such facet involves
the treatment of intellectual property in a bankruptcy
proceeding. Due to the increase of bankruptcy filings
over the past few years, it is critical for any attorney
who has corporate clients, regardless of size, to understand
how intellectual property rights can be affected by
a bankruptcy filing.
One aspect of the United
States bankruptcy laws that affect intellectual property
rights include the rights of licensors and licensees.
This article reviews how a licensor or licensee's intellectual
property rights could be affected when the other party
files for bankruptcy protection.
B. Intellectual Property
Intellectual property
generally includes the following: (a) patent rights,
(b) trademark and service mark rights, (c) copyright
rights and (d) trade secrets.
Patent rights are created
and governed by U.S. federal law. Generally speaking,
patents cover inventions of new and useful machines,
processes and improvements thereof; e.g., medical implants,
business methods, etc. Patents encourage invention by
providing an owner/inventor with a temporary monopoly
(generally 20 years) on the invention, which allows
the inventor to control the usage and sale of the invention.
However, in order to receive that protection, the inventor
must apply for and diligently pursue the patent, or
else the patent rights could be forfeited.
Trademarks and service
marks arise under federal, state and common law. A trademark
protects a name, symbol, word or combination thereof
used by a person to identify and distinguish his or
her goods or services from those provided or manufactured
by others. The primary purposes of a trademark or service
mark are identifying the origin of the subject goods
or services and providing some measure of quality assurance.
A mark needs to be distinctive or recognizable in order
to serve as an identifier; e.g., Exxon, Wal-Mart, Tyson.
Copyrights are also created
and governed by federal law. Copyrights cover "original
works of authorship fixed in any tangible medium of
expression"; e.g., music, computer programs, books.
A copyright owner possesses the exclusive right to (a)
reproduce the work, (b) prepare derivative works from
the work, (c) distribute copies of the work to the public,
(d) publicly perform the work and (e) publicly display
the work. An author need not register his copyright
to get protection - the only requirements are originality
and fixation in a tangible expression. Nonetheless,
to enforce one's rights by bringing an action in Federal
Court, (and in order for a secured creditor to properly
perfect a security interest in a copyright), the author
must register the work with the Copyright Office.
Trade secrets are protected
under state law only. Trade secrets are given broad
protection; virtually any information qualifies for
trade secret protection if its limited availability
gives it economic value and it is reasonably guarded.
Examples of trade secrets are customer lists, prices,
costs, processes and formulae.
C. General Overview of Intellectual Property Licenses
in Bankruptcy
1. In General
When a party has licensed
intellectual property from a licensor who subsequently
becomes a debtor in a bankruptcy case, two immediate
questions arise: (a) Was the license considered an "executory
contract"? and (b) What is the effect of the "rejection"
of the debtor? Section 365 of the Bankruptcy Code1
generally provides that, subject to certain limitations
and qualifications, a trustee "may assume or reject
any executory contract or unexpired lease of the debtor."2
Executory contracts are those contracts where there
is such performance due from each party to the contract
that nonperformance by either party would be a material
breach of the contract.3
2. Exclusive Intellectual Property Licenses
As a general rule, exclusive
licenses of patents, copyrights and trademarks are treated
as "executory contracts" pursuant to the Bankruptcy
Code because the licensor has a continuing obligation
to refrain from licensing the intellectual property
to third parties, and the licensee has a continuing
obligation to pay royalties, account to the licensor,
etc.4 A bankruptcy trustee may reject an
executory contract, assume an executory contract or
assume and assign an executory contract.5
If the trustee rejects the executory contract, the contract
is breached (but generally not automatically terminated)
and the non-debtor party has a pre-petition claim for
that breach of contract.
If the trustee assumes
an executory contract, or assumes and assigns the executory
contract, the trustee must: (a) cure, or provide adequate
assurance of cure, of any default, (b) compensate the
non-debtor party, or provide adequate assurance of compensation,
for any actual pecuniary loss for any default, and (c)
provide adequate assurance of future performance under
the executory contract.6 Upon assumption
of the executory contract, all obligations under the
contract become post-petition obligations of the bankruptcy
estate. However, if the executory contract is assumed
and assigned, the bankruptcy estate is relieved of all
obligations accruing after the assignment.7
Depending on the type
of bankruptcy filing, the trustee may or may not be
required to render a decision to assume or reject an
executory contract within a specific time frame. In
a Chapter 7 liquidation, the trustee must assume or
reject executory contracts within 60 days of the bankruptcy
petition unless the Bankruptcy Court extends that deadline.
Otherwise, the executory contract will be deemed rejected.8
In a Chapter 11 reorganization, there is generally no
time limit prior to confirmation of a plan of reorganization
for the trustee to assume or reject an executory contract.
Yet, any party may seek to have the Bankruptcy Court
impose such a deadline or compel the assumption or rejection
of the executory contract.9
If the licensor rejects
the license, the rejection is generally treated as a
breach of the license as of the date of the bankruptcy
filing. Section 365(n) of the Bankruptcy Code provides
that if a trustee or debtor in possession rejects "an
executory contract under which the debtor is a licensor
of a right to intellectual property," the licensee
under the contract may elect to retain its rights to
the use of the intellectual property (including exclusivity
provisions) for the duration of the contract because
such rights existed immediately before the commencement
of the bankruptcy case.10 If the licensee
elects to retain its rights, the licensor (or trustee,
if one has been appointed) is required, to the extent
the license so requires, to provide the licensee with
any intellectual property in its possession and to allow
the licensee to exercise all of its rights under the
license for the duration of the license because such
rights existed as of the date of the bankruptcy filing
(including exclusivity rights, but specifically excluding
any other right to specific performance). To retain
its rights, the licensee is required to pay all royalties
due under the license, and the licensee must waive any
setoff rights it may have and any administrative claim
it may have in the licensor's bankruptcy case. If the
licensee elects to terminate the license, any claim
by the licensee for damages for breach of the contract
is treated as a nonpriority general unsecured claim.11
Section 365(n), however, has several limitations that
must be considered when dealing with agreements involving
the use of intellectual property.
First, "intellectual
property" as defined by the Bankruptcy Code does
not include trademarks. If a trademark license is rejected
by the licensor, the licensee will lose its rights to
use the trademarks under the license. If trademarks
are the relevant and important property licensed, then
the licensee will need to rely on other means to protect
its trademark license rights. The licensee could take
a security interest in the trademarks and associated
goodwill to secure the licensor's obligations under
the license. Then, if the licensor files for bankruptcy
and rejects the license, the licensee can try to obtain
relief from the automatic stay and foreclose on the
trademarks and goodwill. Second, the licensee can attempt
to structure its trademark license so that it is not
an executory contract; i.e., the licensor has no duty
yet to perform under the license. This latter method
would be very difficult to achieve, however, because
typically the licensor at least must maintain the trademark
and associated goodwill under the license, which would
render the license executory.
Even where the intellectual
property covered by the license is not related to trademarks
and Section 365(n) applies, there are still limitations
for the licensee. Under Section 365(n), the licensee
must continue to pay royalties in order to retain its
rights to a rejected license. Even though a license
may designate what the royalty payments are, a bankruptcy
court may subsequently review the license and determine
that other, additional payments due under the license
are also royalty payments and must be paid by the licensee
to retain its rights. Therefore, it is important when
negotiating the license to clearly specify what the
royalty payments are and, if other payments are due,
what those payments are in consideration for, such as
a manufacturing fee. That way there is less of a risk
that a bankruptcy court will subsequently recharacterize
such payments as royalties.
3. Nonexclusive Intellectual Property Licenses
When a debtor's rights
are derived from a nonexclusive license, however, the
Bankruptcy Code significantly restricts the debtor-licensee's
right to assume the license without the licensor's consent.
Section 365(c)(1) of the Bankruptcy Code provides that
a debtor may not assume an executory contract without
the non-debtor's consent if applicable law precludes
assignment of the contract to a third party. Since courts
in different jurisdictions interpret this section differently,
the forum in which a debtor chooses to file for bankruptcy
protection may significantly affect that debtor's ability
to realize value from a patent to which the debtor has
a nonexclusive license.12
An example of the different
treatment by the courts involves a nonexclusive patent
license. Most courts interpreting Section 365(c)(1)
in the context of a nonexclusive patent license apply
a "hypothetical test" for determining whether
assumption by a debtor may occur: Whether, under the
applicable law, the licensor could refuse performance
from "an entity other than the debtor or the debtor-in-possession."13
Thus, because federal patent law generally makes nonexclusive
patent licenses personal, most courts effectively preclude
a debtor-licensee from assuming a license without the
licensor's consent.14 A minority of jurisdictions,
however, apply a different rule, known as the "actual
test," which requires the court to conduct a "case-by-case
inquiry into whether the nondebtor [is] 'forced to accept
performance under its executory contract from someone
other than the debtor party with whom it actually contracted.'
"15
D. Perfection of Security Interests in Intellectual
Property
When counseling clients
on the procedures involving security interests, the
"file early, file often, file everywhere"
advice is usually given. When the collateral involves
intellectual property, however, such advice should still
be given but may not be all that accurate.
With respect to perfecting
a security interest in a patent or trademark, there
is no requirement in the Patent Act or the federal trademark
law16 that a security interest be filed in
the United States Patent and Trademark Office (PTO).
Section 261 of the Patent Act requires the recording
of a transfer of rights of ownership, not "mere
licenses," and a security interest in a patent
that does not involve a transfer of a right of ownership
is just a license.17 Nevertheless, it is
still a good idea to file a security interest with the
PTO. At least one district court found that while the
Patent Act did not expressly state that a creditor must
file with the PTO in order to perfect its security interest,
such a recording would protect the assignee against
the claim of a subsequent lien creditor.18
In contrast, the Copyright
Act does specifically provide for the filing of security
interests in the Copyright Office. Due to the fact that
registration of the copyright is not mandatory, a split
in authority has developed. This division centers on
the treatment of registered versus unregistered copyrights.
When dealing with a registered copyright, the courts
are fairly consistent in requiring that the perfection
of a security interest be dependant upon the filing
of such in the Copyright Office.19 When the
copyright is unregistered, most courts still hold that
the filing of a security interest in the Copyright Office
is a requirement for perfection. Some courts, however,
have held that a security interest in an unregistered
copyright need not be recorded in the Copyright Office.20
With the splits in authority
regarding whether to file a security interest in the
PTO or the Copyright Office, the best advice would be
to "file early, file often, file everywhere,"
even though such filing may not be necessary.
Conclusion
As society's dependence
on advanced technology grows, businesses are taking
greater care to secure their rights in new discoveries
or innovations, thus making it common for the principal
assets of any given company to consist of intellectual
property. The increased significance of intellectual
property assets in bankruptcy cases has started to generate
quite a great deal of case law. However, many scenarios
have not been explored in published opinions. Whether
representing licensors or licensees, lawyers are finding
new challenges in servicing their clients. Having a
firm grasp of the unique positions facing those parties
engaging in intellectual property agreements will aid
in accomplishing the ultimate goal: providing the best
possible protection for your clients.
Endnotes
1 Section
365 of Title 11 of the United States Code.
2 11 U.S.C.
§ 365(a).
3 Cinicola v.
Scharffenberger, 248 F.3d 110, 123 (3d Cir. 2001);
Kaler v. Craig(In re Craig), 144 F.3d 593, 596
(8th Cir. 1998); In re Helms Construction
& Development Co., Inc., 110 F.3d 1470, 1472
(9th Cir. 1997).
4 See Encino
Bus. Management, Inc. v. Prize Frize, Inc. (In re Prize
Frize, Inc.),
32 F.3d 426, 428 (9th Cir. 1994);
5 11 U.S.C.
§ 365.
6 11 U.S.C.
§ 365(b).
7 11 U.S.C.
§ 365(k).
8 11 U.S.C.
§ 365(d)(1); University of Connecticut Research
& Development Corp.
v. Germain (In re Biopolymers, Inc.), 136 B.R. 28-29
(Bankr. Conn. 1992)
(exclusive patent license 1 Throughout this Paper, the
term "trustee" will
also refer to the debtor-in-possession in a Chapter
11 reorganization unless
expressly stated otherwise. 2 473345v6 rejected by operation
of law upon
trustee's failure to seek to assume license within 60
days.).
9 11 U.S.C.
§ 365(d)(2).
10 11 U.S.C. § 365(n)(1)(B).
11 11 U.S.C. § 365(n)(2).
12 11 U.S.C. § 365(c)(1)
13 In re West Electronics
Inc., 852 F.2d 79, 82 (3d Cir. 1988) (emphasis in
original).
14 See In re Catapult
Entertainment Inc., 165 F.3d 747, 750 (9th Cir.
1999).
15 Institut Pasteur
v. Cambridge Biotech Corp., 104 F.3d 489, 493 (1st
Cir.), cert.
denied, 521 U.S. 1120 (1997).
16 Lanham Act, 15 U.S.C.
§ 1051, et. seq.,
17 See In re Cybernetic
Services, Inc., 252 F.3d 1039 (9th Cir. 2001).
18 See City Bank and
Trust Co. v. Otto Fabric, Inc., 83 B.R. 780, 782
(D.
Kan.1988).
19 See National Peregrine,
Inc. v. Capitol Federal Savings and Loan Ass'n (In
re
Peregrine Entertainment, Ltd.), 116 B.R. 194 (C.D.
Cal. 1990).
20 See Aerocon Engineering
Inc. v. Silicon Valley Bank (In re World Auxiliary
Power
Co.), 244 B.R. 149 (Bankr. N.D. Cal. 1999). |
