Intellectual property comprises some of the most valuable assets a business may hold – its brands, patents, know-how, and other intangible rights that make the business unique.  The intellectual property assets (IP) throughout the energy sector—upstream, midstream, downstream and service providers along the way—will be affected as more energy companies seek bankruptcy relief in the wake of both the oil price war and the Covid-19 pandemic. Even companies not considering bankruptcy for themselves are likely to be affected when their IP licensors or licensees file for bankruptcy.

There is no one-size-fits-all answer to IP or bankruptcy issues, much less when they collide in a licensor or licensee’s bankruptcy case. A creditor-licensor of intellectual property rights is in a vastly different position than a creditor-licensee who takes its rights from a newly bankrupt party. This article explains some of the rights and obligations of the non-debtor licensor and licensee of IP. It also provides a brief overview of how potential IP buyers can benefit from Section 363 of the Bankruptcy Code, which allows them to acquire a bankrupt entity’s IP assets free and clear of that entity’s liabilities.

1. Rights and restrictions by a licensor against the debtor-licensee.

When an IP licensee files bankruptcy (i.e., becomes the “debtor” in a bankruptcy case), the non-debtor licensor may be placed in a precarious position.  Debtors are debtors because they cannot (or will not) pay their debts. If the debtor-licensee was already behind on license payments, and then files bankruptcy, the non-debtor licensor’s first instinct may be to terminate the license. Once the bankruptcy is filed, however, the licensor cannot unilaterally terminate the license without bankruptcy court approval.  The filing of a bankruptcy petition triggers an “automatic stay,” which prevents creditors from taking any actions against the debtor and its estate due to pre-bankruptcy debts. Violations of the automatic stay can carry hefty fines or worse; therefore, it is imperative to tread carefully and seek advice of counsel before taking any actions against a bankrupt debtor. Moreover, many courts have found that the “automatic termination” clauses that trigger upon a filing of bankruptcy are unenforceable. Thus, before terminating the license, the non-debtor licensor must obtain permission to do so from the bankruptcy court.

A bankruptcy filing gives the debtor-licensee great latitude in how to treat what is termed an “executory” IP license. The classification of a license as “executory” is an important distinction because a debtor-licensee may elect to reject (terminate), assume (keep the license as-is), or assign (effectively, sell or otherwise transfer)[1] an executory license. See 11 U.S.C. §365. While the bankruptcy statute does not define the term, a contract is generally considered “executory” if each party has ongoing obligations to perform in some way, and courts have been overly accommodating in finding contracts to be executory. For example, some courts have determined that a licensor’s continued obligation not to sue its licensee for infringement caused the license to be executory. Obligations as simple as a licensee’s requirement to maintain confidentiality, appropriately mark a patented product, or provide accounting of sales have been found to satisfy the “continued obligation” requirement.

A licensee’s ability to assume or assign a license may raise great alarm to a licensor concerned that its rights could fall into the hands of an ineffective licensee or a competitor.  Luckily, the power to assign or assume a license is not absolute. Section 365(c)(1) of the Bankruptcy Code prevents a debtor-licensee from assigning or assuming an executory contract when (a) the licensor does not consent to the assumption/assignment and (b) applicable law otherwise excuses the licensor from accepting performance or rendering performance to another party. While an anti-assignment clause in the license will be disregarded for these purposes, a clause that specifically allows assignment under certain circumstances may be used to provide the requisite consent. A non-debtor licensor should insert itself into negotiations about a possible sale and assignment of a license to ensure that its rights are protected, and it should be prepared to file an objection to the assignment with the bankruptcy court when necessary to protect and preserve its rights.

Depending on the circumstances, a licensor may urge the bankruptcy court to treat license payments that accrue while a bankruptcy case is pending as an administrative claim. If accepted, the claim would be entitled to priority over some other claims against the estate and paid during the course of bankruptcy. If unsuccessful, however, this action may be detrimental to the licensor’s rights.

2. Rights and restrictions of the licensee against a debtor-licensor.

When a licensor files bankruptcy, a licensee will logically fear that it will lose the rights to continue using a critical piece of technology. After all, the same statutes that allow a bankrupt licensee to reject, assign, or assume an executory contract also apply to the licensor. Importantly, Section 365(n) of the Bankruptcy Code protects a licensee’s ability to continue business as usual in some regards. Notably, even if a bankrupt licensor rejects an IP license, the licensee can elect to either (1) accept the termination and assert a breach of contract claim or (2) continue to act on the license as it existed on the day the bankruptcy petition was filed. In effect, as long as the licensee continues to uphold its end of the license (e.g., pay royalties, appropriately mark and account for product sold, etc.), the licensee will be entitled to continue using the technology or other licensed IP as it existed when the bankruptcy petition was filed. One important caveat is that the licensee’s rights will often not extend to any improvement to the technology made after the petition is filed. Moreover, the licensee is on its own if an infringement claim is made against it. A licensor who has rejected a license will not be required to perform any obligations under the license, such as defending its licensee from infringement claims, other than to refrain from suing the licensee for infringement.

It is important to note that the particular provisions of Section 365(n) only apply to copyright, patent and trade secret/know-how licenses; they do not apply to trademark licenses.  For information on a recent Supreme Court ruling concerning trademarks and bankruptcy, see our article at https://www.louisianalawblog.com/business-and-corporate/recent-united-states-supreme-court-decision-tackles-question-of-what-happens-when-bankruptcy-meets-intellectual-property/.

3. Issues and benefits of acquisitions through bankruptcy – the 363 sale.

Sales of a bankrupt company’s assets through Section 363 of the Bankruptcy Code offer a great opportunity for a solvent company to expand its patent portfolio, acquire desirable IP licenses, and otherwise expand its IP.  Bankruptcy sales are a specialized form of asset acquisition; a potential buyer should engage experienced counsel to guide it through the process and avoid potential landmines.  One particularly attractive aspect of “363 Sales,” as they are often called, is that purchasers of estate assets can usually obtain those assets free and clear of any liens and encumbrances.[2]  The buyer can often take the assets free of any unknown liabilities, such as infringement claims that pre-date the sale.

As with any asset purchase, due diligence will need to be performed on the assets (IP) to be acquired. Unlike typical deals, however, sales through the bankruptcy are often subject to a relatively short timeline. Due diligence of the bankrupt assets is typically compressed and may have to be performed without substantial assistance from the bankrupt seller, who often lacks the necessary funds or infrastructure to assist. Diligence is particularly important because the seller may cease to exist as a going concern soon after the sale closes.  Post-closing indemnities are rare, and trying to enforce one may be practically impossible.  This risk is typically factored into the purchase price for the assets.

Moreover, portfolios are often acquired in less than pristine shape. It costs money to maintain IP rights: both U.S. and foreign patent and trademark registrations require the payment of maintenance fees to remain in force, and many foreign countries require these payments annually. The failure to pay these fees at any time may result in the abandonment of the rights. As such, the potential purchaser needs to ascertain the status of all significant intellectual property rights and develop a plan during the due diligence to take over and cure[3] any issues or defects that may exist. Likewise, to the extent that pending applications are acquired, the purchaser needs to be ready to take over these applications in whatever state they exist and take immediate action to perfect these rights. Kean Miller maintains relationships with foreign IP attorneys who are ready to assist our clients in the protection of their rights across the globe.

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[1] Perhaps the biggest concern is that a debtor-licensee may assign its license to a competitor of the licensor.

[2] Chapter 11 Bankruptcy permits licensees of the estate’s IP to petition the Court to protect their interest by insuring that the licensees be permitted to continue using the technology.

[3] Some jurisdictions allow for the revival of IP rights upon the payment of the owed annuity and a surcharge, while others require the owner to file a petition explaining why the payment was missed. Depending on the circumstances, forfeited rights may not be able to be revived.

 

This article first appeared on the Louisiana Law Blog here