Magazine article Business Credit

Dumbing Down Intellectual Property: Chapter 11 Impact on IP License Agreements

Magazine article Business Credit

Dumbing Down Intellectual Property: Chapter 11 Impact on IP License Agreements

Article excerpt

Innovation and creativity are essential for competitive advantage and success in a global economy. The attendant intellectual property (IP) assets are the product of substantial capital investment, and companies should carefully manage risks associated with such assets.

A company may be a LICENSOR or a LICENSEE of intellectual property assets, where it invests significant capital in research and development or in production and distribution capabilities of licensed intellectual property. A risk to such investment is the Chapter 11 filing of a counterparty to a license agreement relating to patents and trademarks, which can jeopardize the contract and cause substantial financial loss.

On Jan. 12, 2018, the U.S. First Circuit Court of Appeals issued a significant ruling that a company-licensee of a trademark lost its rights under the license when the Chapter 11 debtor-licensor rejected the contract. For perspective on this ruling, this article addresses the Chapter 11 impact on companies as both licensors and licensees of intellectual property.

Company as Licensor

As a LICENSOR, a company must ensure its assets are protected and that the insolvent counterparty can continue to perform, often paying royalties, or the company-licensor can retract and recover the intellectual property assets. The Bankruptcy Code provides the debtor the right to (1) assume, (2) assume and assign, or (3) reject "executory contracts" including license agreements. If the debtor seeks to assume, or assume and assign (a frequent occurrence in Section 363 sales) a license agreement, it must "cure" or pay pre-petition arrearages, including unpaid royalties.

Practical tip: a well-drafted license agreement should be "cross-defaulted" with related sales or supply agreements such that "cure" is defined to include unpaid invoices for products.

In addition, to assume a license agreement, a debtor must provide the company "adequate assurances of future performance," which should include evidence of capitalization and liquidity to perform and pay obligations incurred, including royalties and invoices for the sale of goods. A well-drafted assignment provision can add protections for the company.

However, the Bankruptcy Code restricts a debtor's right to assume and assign a contract if applicable non-bankruptcy law prohibits assignment. Courts have held that patent licenses and nonexclusive trademark licenses are not assignable. Also, Uniform Commercial Code Section 2-210(2), regarding contracts for the sale of goods, prohibits assignment where it would materially increase the burden or risk. A company-licensor concerned about a proposed assumption and assignment should consider asserting this restriction.

A rejection in bankruptcy of the license agreement by the debtor is deemed a pre-petition breach of contract, meaning the company would have a pre-petition general unsecured claim, which often has little or no value. However, the company would be relieved of its ongoing performance obligations.

In sum, as a licensor, a company should be able to obtain ongoing performance from a debtor-licensee under its license, or recover its intellectual property assets, possibly sustaining a write-off for unpaid royalties or invoices, but not losing the underlying intellectual property assets.

Company as Licensee

By contrast, if a company is a LICENSEE, it may have invested substantial capital in plants, people and infrastructure to support manufacturing products utilizing the licensed patents or trademarks.

If the debtor-licensor assumes the license agreement (a successful reorganization) or assumes and assigns the license (a Section 363 sale), it must "cure" pre-petition arrearages and provide adequate assurances of future performance. As such, the impact on the company may be minimal as the company will continue to utilize the rights granted in the license agreement. …

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