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Intellectual Property in Bankruptcy: An Overview

| Bridget L. Welborn

At first blush, you might think that the goals of intellectual property law would not be affected by bankruptcy law.  The foundation of intellectual property law is to protect certain exclusive rights afforded to original works of creative expression and innovation and to prevent consumer confusion.  Generally, intellectual property includes copyrights, patents, trademarks, and trade secrets.  Federal bankruptcy law, in particular Chapter 11 of the Bankruptcy Code, generally focuses on the reorganization of the financial affairs of the debtor while minimizing financial losses to the debtor's creditors

However, your first impression can be misleading.  The interplay between intellectual property law and bankruptcy law has increased over the past couple of years as more companies utilize intellectual property and, unfortunately, more businesses have elected to take advantage of bankruptcy protection.  This article provides an overview on how a bankruptcy filing, specifically a Chapter 11 filing, may affect your intellectual property rights.

Bankruptcy Code Section 362 – The Automatic Stay

The "automatic stay" is a fundamental protection provided to a debtor in bankruptcy.  When a bankruptcy petition is filed, the automatic stay prohibits pre-petition creditors from attempting to collect debts, enforce liens, execute on judgments, or take other actions against the debtor or against the debtor's property which is now the property of the bankruptcy estate.  There are instances in which the bankruptcy court will grant relief from the automatic stay to allow actions against the debtor or property of the estate but, in general, the automatic stay applies broadly and bars such actions.

Consider the implications of the automatic stay on your intellectual property rights.  For example, take the scenario where you contend that several businesses have infringed a patent belonging to you.  After the suspected infringement occurs, but before you bring an infringement claim, one of the businesses files bankruptcy.  If that business is one of many potential defendants in your contemplated patent infringement case, the automatic stay prohibits you from including the bankrupt business in your suit.  However, it is possible your case may yet be brought against the other defendants even though it is stayed as to the debtor.  On the other hand, if it is impossible for you to pursue your case without the debtor because all defendants are intertwined, then your entire patent infringement case may be stayed by bankruptcy law even though only one defendant has filed bankruptcy. 

Contrast the effect of the automatic stay on the patent infringement example above with the effect it has if the suspected infringement of your patent occurs after the bankruptcy petition is filed.  The automatic stay prevents actions or claims against the debtor that could have been brought before the filing of the bankruptcy petition, as those claims will typically be addressed within the bankruptcy reorganization process itself.  However, a patent infringement case against a debtor for actions of the debtor after the bankruptcy filing may proceed against the debtor because the automatic stay does not generally apply to post-petition causes of action.

Also, while the automatic stay will prevent litigation against the debtor relating to pre-petition obligations, it generally has no effect on post-petition litigation initiated by the debtor or a bankruptcy trustee on behalf of the debtor.  After filing bankruptcy, the debtor, or its trustee, can bring a patent infringement suit against another party, and the automatic stay will not apply (although any benefit of the claims by the debtor or the trustee may constitute property of the bankruptcy estate). 

Bankruptcy Code Section 363 – Sale of Property

The Bankruptcy Code generally provides that a Chapter 11 debtor allowed to continue to operate its business may enter into enforceable contracts in the ordinary course of its business without court approval.  Thus, a contract for the sale or license to you of the debtor's intellectual property in the ordinary course of the debtor's business may not require court approval.

On the other end of the buy/sell or licensor/licensee spectrum, Section 363 of the Bankruptcy Code provides that the debtor's property may be sold free and clear of any interest of the debtor or its creditors in the property, provided certain conditions are met such as (i) applicable non-bankruptcy law permits the sale free and clear of any interest, (ii) everyone with an interest in the property consents, or (iii) the interest in the property is a lien and the sale price of the property is greater than the aggregate value of all liens on the property. 

If the debtor is an intellectual property licensor ("debtor-licensor"), then its ability to sell its intellectual property free and clear of any interest may be appealing to it.  However, this ability may create complex issues for you as a licensee of the debtor if you want to retain the right to use the debtor's intellectual property.  If the debtor-licensor is permitted to sell its intellectual property free and clear of all liens and interests, then the sale would be free and clear of your right to use the intellectual property under your pre-bankruptcy license from the debtor-licensor.

While there are mechanisms in place that can provide protection for you as the licensee in these situations, it generally requires your active involvement.  Thus, licensees should remain active throughout the bankruptcy proceedings in which a debtor-licensor may seek to sell its intellectual property. 

Bankruptcy Code Section 365 – Executory Contracts

The Bankruptcy Code provides that a debtor, with the court's approval, may assume (continue to perform or assign) or reject (cease to perform) any of its executory contracts.  An executory contract is one that still has performance obligations owed by each party to the other.  Often the terms of an intellectual property license have the effect of creating an executory contract.  Generally, problems do not occur with the assumption of a license so long as the debtor can actually continue to perform, but there can be big problems for you if the debtor opts to reject your license contract with it.

If the debtor is permitted, without your consent, to freely reject an intellectual property contract licensing you to use the debtor's intellectual property, then the debtor-licensor can unilaterally cease performing its obligations under your license.  This could result in huge setbacks for you if you are relying on your license to use the debtor's intellectual property to operate your business.  Fortunately, the Bankruptcy Code provides certain protections that afford you a continuing right to use the licensed intellectual property for a period of time so long as you continue to perform your obligations under the license.  

The application of bankruptcy law operates differently for a debtor-licensee.  A debtor-licensee is generally afforded the same opportunity to assume, reject, or assume and assign its intellectual property licenses just as it does any other executory contract.  If your debtor-licensee rejects a license to use your intellectual property, then it would cease to have the right to use your intellectual property, and you would lose your right to be paid for that use.  On the other hand, a debtor-licensee's ability to assume your contract and assign the license to use your intellectual property to another party varies depending on the type of license and the type of intellectual property at issue.  For instance, federal patent law generally prohibits the assignment of non-exclusive patent licenses without the consent of the licensor, meaning that they are not assumable by a debtor-licensee.  Of course, if the debtor wants to continue to license your intellectual property, you are free to negotiate a new contract with the debtor.

Conclusion

Whether you are a licensor or licensee of intellectual property, you should give special attention to your intellectual property licenses in order to understand and protect your intellectual property rights during a bankruptcy proceeding.

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© 2014 Ward and Smith, P.A. For further information regarding the issues described above, please contact Bridget L. Welborn.

This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.

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