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Bankruptcy

Vanishing Assets:
Debtors As Licensees of Intellectual Property

By
Robert W. Jones
H. Jefferson LeForce

Patton Boggs LLP
2001 Ross Avenue, Suite 3000
Dallas, TX 75201

©H. Jefferson LeForce and Robert W. Jones, 2005

In today's technology and knowledge oriented business world, almost all businesses are licensees of various types of intellectual property rights. Some licenses are very small cogs of a business that are easily replaceable (a license to use pc software) and others are the very underpinnings of a business that are virtually irreplaceable (a license for a key manufacturing process or the right to use a name or likeness on a product). In those bankruptcy cases in which the debtor's licenses are critical to the business, whether the debtor can assume or assume and assign those licenses likely will be critical to the success of the bankruptcy, /Footnote 1/ and ultimately the return to creditors.

Intellectual property licenses are almost always executory contracts. Moreover, federal common law often excuses an intellectual property licensor from accepting performance from a party other than the original licensee. As a result, debtors in possession (or trustees) often are unable to fully utilize valuable or key intellectual property licenses to reorganize or sell a business. Even in those jurisdictions in which a debtor may assume a license and reorganize, a debtor still may find itself unable to quickly realize the value of the license through a sale.

I. TYPES OF INTELLECTUAL PROPERTY

This article will discuss the three types of intellectual property most commonly at issue when licensing issues arise in a bankruptcy: patents, trademarks, and copyrights. Issues involving other types of intellectual property, such as trade secrets and domain names/URLs, have been less common in bankruptcy.

Patents

A patent for an invention is the grant of a property right to the inventor, issued by the United States Patent and Trademark Office. See generally 35 U.S.C. § 100 et seq. In the United States, a patent is issued to an inventor(s) (who must be an individual) for a period of twenty years from the date the application was filed or, in special cases, from the date an earlier related application was filed, subject to the payment of maintenance fees. The right conferred to the holder of the patent is the right to exclude others from making, using, offering for sale, selling or importing the invention. However, an inventor does not have an exclusive right until the patent is issued.

The issuance of a patent vests original ownership in the inventor or inventors. Those inventor(s) can only transfer ownership by actual assignment. Further, an employee has no common law or statutory obligation to assign a patent to an employer (though many employees may have a contractual obligation to do so).

Trademarks

Trademarks are distinctive word(s), design(s), symbol(s), or combinations thereof claimed by a person or entity to describe and distinguish one's goods or services from others, and to indicate the source of goods. See generally 15 U.S.C. § 105 et seq. Trademark rights are derived from the use of the mark in commerce. It gives the person the right to prevent others from using a confusingly similar mark in commerce, but not to prevent others from making the same goods or from selling the same goods or services under a clearly different mark. Unlike patents, a federal registration is not required, but does provide additional protections if the trademark is used in interstate commerce.

Ownership of a trademark initially vests in the original user (whether an individual or entity). Ownership may be transferred only through an assignment, but in order for a valid transfer to occur the goodwill of the business must be transferred as well. The transfer of a trademark without goodwill is considered an assignment in gross and is invalid.

Copyrights

A copyright gives an author the right to exclude others from using, copying, preparing derivative works from, publicly displaying or performing work created by the author. See generally 17 U.S.C. § 101 et seq. A copyright is created when the copyright is fixed to the tangible medium of expression and registration is not required. However, similar to trademarks, registration provides additional protections. A copyright is valid for the life of the author plus a term of years depending on when it was fixed to the medium and the nature of the author.

The copyright in the work of authorship immediately becomes the property of the author who created the work – only the author, or those deriving their rights through the author, can rightfully claim copyright in and to the work(s). Therefore, authorship in a copyright can vest in either in the name of an individual(s) author(s), or in the name of any entity (whether qualifying as a "work for hire" or otherwise deemed such under written agreement). The transfer of ownership of any material object that embodies a protected work, however, does not of itself convey any rights in the copyright. Like patents and trademarks, copyright ownership may only be transferred by assignment.

II. INTELLECTUAL PROPERTY LICENSES

The primary benefit provided to the owners of patents, trademarks, and copyrights, therefore, is the right to exclude or prevent others from using the intellectual property. At its most basic level, an intellectual property license provides a non-owner the right to use the intellectual property without the risk of being sued for infringement. This license right to use another's intellectual property is personal in nature.

Intellectual property licenses have long been viewed as personal rights that are not freely transferable. Troy Iron and Nail Factory v. Corning, 55 U.S. 193, 216 (1852)("A mere license to a party, without having his assigns or equivalent words to them, showing that it was meant to be assignable, is only the grant of a personal power to the licensees, and is not transferable by him to another."); Gardner v. Nike, 279 F.3d 774 (9th Cir. 2002)(copyright licenses are not transferable as a matter of law); In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999)(patent licenses are personal and non-assignable absent consent); and Matter of Travelot Co., 286 B.R. 447 (Bankr. S.D.Ga. 2002)(federal trademark law prevents assignment of non-exclusive license). Consequently, federal common law will generally prevent the transfer of almost all intellectual property licenses that are executory contracts, absent the consent of the licensor, pursuant to § 365(c)(1)(B).

III. INTELLECTUAL PROPERTY LICENSES AS EXECUTORY CONTRACTS

Courts have almost uniformly held that intellectual property licenses are executory contracts pursuant to 11 U.S.C. § 365(a). Most courts in making such a determination have applied the "Countryman Test" to determine if "obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other." In re Sunterra Corp., 361 F.3d 257 (4th Cir. 2004). Even though it was in the context of a debtor as licensor, one of the first analyses of whether an intellectual property license is executory -- Lubrizol Enterprises, inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985) -- remains a definitive case. In Lubrizol, the Fourth Circuit found that the executory nature of a licensing agreement was the established by the existence of both affirmative and negative duties, and ongoing contingent duties in the license. Lubrizol at 1046-47.

Consequently, virtually all intellectual property licensing agreements that have not been terminated will be executory contracts, because the parties will have ongoing duties and covenants. "Applying the Countryman definition of executory contracts, courts generally have found intellectual property licenses to be ‘executory' within the meaning of section 365(c) because each party to the license had the material duty of ‘refraining from suing the other for infringement of any of the [intellectual property] covered by the license.'" In re Golden Books Family Entertainment, Inc., 269 B.R. 311, 314 (Bankr.D.Del. 2001).

In very limited instances, an intellectual property license that is "exclusive" will have so completely transferred a set of intellectual property rights to the licensee that the license creates a property interest in the intellectual property. In such instances, the debtor may freely transfer an exclusive license as a property right (as opposed to a executory contract). See In re Valley Media, Inc., 279 B.R. 105 (Bankr.D.Del. 2002); In re Golden Books Family Entertainment, Inc., 269 BR. 311 (Bankr.D.Del. 2001). But, not all licenses labeled "exclusive" will receive this treatment. First, many licenses labeled "exclusive" are not truly exclusive licenses. Second, this theory has been adopted in only a handful of cases, by only a handful of courts. Third, the reported decisions only interpret copyright licenses. Fourth, it appears a trademark license could never be a truly exclusive license transferring a property interest, because without a transfer of goodwill any transfer would be an invalid transfer in gross. While parties should be aware of this potential exception, parties should also be equally aware that it might be an extremely narrow exception.

IV. ASSUMPTION AND ASSIGNMENT

The ultimate question, therefore, is whether a debtor in possession can assume an executory intellectual property license. Two different interpretations of 11 U.S.C. § 365 have created a split in the case law as to that issue. The genesis of the split is in the language of 11 U.S.C. § 365(c), which states:
(c) The trustee may not assume or assign any executory contract . . . of the debtor . . .if –

    (1)(A) applicable law excuses a party [the licensor] other than the debtor, to such contract . . . from accepting performance from or rendering performance to an entity other than the debtor or the debtor in possession . . .; and

    (B) such party does not consent to such assumption or assignment.
The specific language that has split the courts is whether "may not assume or assign" means that a debtor in possession cannot even assume an executory intellectual property license when applicable law would otherwise excuse the non-debtor from accepting performance from a third party. The courts that have read the text literally have adopted what has become known as the "Hypothetical Test." On the other hand, other courts have articulated what is referred to as an "Actual Test" of whether the non-debtor is being forced to accept performance from a party not originally a party to the contract.

The Hypothetical Test

Under the Hypothetical Test, the Debtor may not assume an executory contract if the contract could not be assigned to a hypothetical assignee under applicable non-bankruptcy law. Because of the disjunctive nature of the statute, a number of circuit courts have held that a debtor in possession cannot assume a license, once applicable law would prevent assignment. In re Sunterra Corp., 361 F.3d 257 (4th Cir. 2004); In re Catapult Entm't, Inc., 165 F.3d 747, 750 (9th Cir. 1999); In re James Cable Partners, 27 F.3d 534, 537 (11th Cir. 1994); In re West Electronics., Inc., 852 F.2d 79, 83 (3rd Cir. 1988). Because intellectual property licenses are executory and generally non-transferable, a debtor must obtain consent before it can assume or assign an intellectual property license in those circuits.

What type of consent is necessary? Typically one of two types of consent can be obtained: (1) consent as part of assumption or assignment or (2) pre-bankruptcy consent contained in a license. Either consent can authorize the assumption, or assumption then assignment. However, the effectiveness of pre-bankruptcy consent language can be illusory. Often, an intellectual property license will authorize assignment, transfer and/or sublicense to related entities or wholly owned companies, successors, etc. That type of language on its face might appear to satisfy the statutory consent required by 11 U.S.C. § 365(c)(1)(B).

However, assumption and assignment is a two-step process. Consequently, a licensor must consent to both steps– assumption and assignment. Consent to assignment does not equate to consent to assumption. Because assumption is always the first step, lack of consent to assumption likely will provide an impediment to previously authorized assignments. If a licensor has not consented to assumption, it may effectively block any previously consented to assignment. In re Sunterra Corp., 361 F.3d 257, 271 (4th Cir. 2004). But see In re Hernandez, 285 B.R. 435, 441 (Bankr.D.Ariz. 2002)(consent authorizing a transfer regardless of assignee's identity, effectively removed the requirements and protections of 365(c)(1)); In re Supernatural Foods, 268 B.R. 759 (Bankr.M.D.La. 2001).

The Actual Test

Under the "Actual Test", courts effectively ask if in a particular case the party assuming the contract will actually be the same as the party to the original intellectual property license. See Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489, 493 (1st Cir. 1997). While the weight of circuit court authority is with the Hypothetical Test, the majority of lower courts that are not bound by such court precedent tend to follow the Actual Test. See generally In re Catapult Entm't, Inc., 165 F.3d 747, 749-750 (9th Cir. 1999)(collecting lower court cases adopting the Actual Test, while ultimately adopting the Hypothetical Test). Therefore, those courts will undertake a case by case analysis, and may allow a debtor in possession to assume an intellectual property license.

Assignment

Neither the Hypothetical Test nor the Actual Test allow a debtor to assign an intellectual property license without the licensor's actual consent to the assignment. In a Hypothetical Test jurisdiction, a debtor will not be able to reorganize around nor assign as part of a going concern sale an intellectual property license. This limitation may severally impact the going concern value of a bankrupt business that relies on licenses. In an Actual Test jurisdiction, a debtor may be able to assume a valuable intellectual property license and reorganize around such a license, but will not be able to transfer the intellectual property license without consent.

V. CONCLUSION

A debtor may have very few options when dealing with intellectual property licenses and should be prepared to respond to objections to assumption and assignment. This problem is a long term planning problem that is most easily addressed when negotiating an intellectual property license. When negotiating a license, counsel should add assumption consent language to any assignment consent language. Moreover, debtor's counsel should be prepared to identify significant intellectual property licensing issues when considering choice of venue for a filing, if more than one venue option is available. Finally, debtor's counsel may be left hoping that either a licensor will not object to an assumption or assignment motion or will be willing to negotiate a settlement. In today's high tech and intellectual property driven world, all parties should understand their respective rights to intellectual property licenses to determine whether an intellectual property license may have vanished.






Footnote 1: 11 U.S.C. § 365(n) provides for the treatment of debtors as licensors of intellectual property (as defined by 11 U.S.C. § 101(35A), which excludes trademarks). This article will not address any 11 U.S.C. § 365(n) matters.


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