Bankruptcy and COVID-19: Issues for Licensees

In light of the current COVID-19 pandemic and its adverse impacts on the worldwide economy, many licensors have been forced to consider all options, including restructuring options. Bankruptcy provisions in IP licenses have always been important, but their importance will significantly increase as licensees identify and adjust to a "new normal" for their activities (and the activities of their strategic partners). Accordingly, it is becoming increasingly important to understand how a bankruptcy filing by an IP licensor can affect the licensee. For example, if a licensor declares bankruptcy, does the licensee no longer have access to the IP? Will the licensee be able to terminate the license and shift those rights to a more productive context? We take a brief look at some of these issues below.

How does the Bankruptcy Code apply to IP?
The filing by a debtor licensor for bankruptcy under Chapter 11 of the Bankruptcy Code ("Code") creates a bankruptcy estate that includes all of the debtor licensor's interests in its property, such as IP. The Code broadly defines intellectual property to include trade secrets, inventions, patents, patent applications, copyrights, plant varieties and mask works. Trademarks, trade names, and service marks are notably absent in the foregoing list. Those IP forms, along with international IP not covered by treaties between the U.S. and country of origin of work, are not expressly included in the definition. Congress has permitted bankruptcy courts, however, to develop equitable treatment of marks since such marks depend to a large degree on the control of associated service and quality. The Supreme Court recently addressed this issue, holding that trademark licenses are covered by the Code. See Mission Product Holdings Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019) (a debtor's rejection of an executory contract in bankruptcy has the same effect as a breach outside bankruptcy, even as to a trademark license).

What constitutes an executory contract?

The Bankruptcy Code does not specifically define executory contracts. An executory contract is understood, however, to mean a contract between a debtor and a third party under which both sides still have important ongoing performance obligations.

Are IP licenses considered executory contracts?
Yes, in most cases. Under the Code, an IP license can be considered an executory contract. An IP license generally creates ongoing obligations for a licensee, such as payment of royalties. Not all agreements including an IP license, however, are executory contracts. One example is an agreement to sell or assign IP (where at least one party does not have any ongoing obligations). Thus, a fully paid-up IP license (without other ongoing responsibilities by the licensee) would not be considered an executory contract.

What actions can a debtor licensor take with an executory contract?

The designation of an IP license as an executory contract is important. Subject to court approval,[1] a debtor licensor has the option to assume (i.e., continue) or reject an executory contract. Indeed, a debtor licensor may even be allowed to assume the contract and assign it to another party (even in light of anti-assignment clauses in the agreement). If a debtor licensor elects to assume such contract, the Code requires the debtor licensor to cure any defaults under that contract. Common defaults for debtor licensors include the failure to maintain/protect the underlying IP. Upon such cure, the contract will continue in full force between the debtor licensor (or an assignee) and the non-debtor licensee.

If a contract is rejected: (1) the debtor licensor does not have to perform its obligations under the contract; (2) such rejection will be treated as a breach rather than a termination of the contract; and (3) such rejection will provide the non-debtor licensee a claim for damages, but such a claim will merely place the non-debtor licensee in line with all of the other unsecured creditors of the bankruptcy estate.

How do provisions in IP licenses addressing bankruptcy affect non-debtor licensees?
Whether looking at existing IP contracts or planning prospective ones, it is important to pay close attention to certain provisions in the contract because such provisions will help determine the effects of a bankruptcy filing on the underlying IP and the non-debtor licensee. While tempting to assume the presence of a "termination upon bankruptcy" clause will allow a non-debtor licensee to avoid these issues, it will not. As noted above, the rejection of an IP license results in a breach - not a termination - of the underlying contract. A licensee should therefore focus on provisions that provide the right to terminate for conduct likely to occur well ahead of any bankruptcy filing, such as poor financial results or performance delays. There is no one-size-fits-all licensing provision to address bankruptcy. Each licensing scenario requires its own in-depth analysis to develop provisions that adequately protect the licensee.

What benefits does the Bankruptcy Code provide for non-debtor licensees?
Section 365(n) of the Code was enacted to provide certain benefits to non-debtor licensees. If sufficiently provided for in the underlying IP contract, Section 365(n) can require that until a debtor-licensor rejects such an IP contract, that debtor-licensor must either continue to perform under the IP contract or provide the non-debtor licensee with access to the subject IP (e.g., via escrow). In other words, the debtor-licensor cannot interfere with the licensed rights granted in the IP contract until an election is made. If the debtor-licensor ultimately rejects the IP contract, the non-debtor licensee can either (1) treat the IP contract as terminated by the rejection (and assert a claim for damages); or (2) retain its rights under such IP contract for the remaining term of the IP contract (provided that the licensee continues to perform its obligations under that IP contract). If the non-debtor licensee retains its rights, it may continue to use only the existing IP as of the bankruptcy filing (i.e., no new or additional IP) even though the non-debtor licensee must continue the performance of its obligations (e.g., payment of fees), which may have been based upon an increasing scope of IP over time. Additionally, the debtor-licensor will not be required to take affirmative actions under the contract (e.g., providing maintenance, updates, support or even defend the IP) but will be required to respect any exclusivity provisions of the license and cannot to sue the licensee for infringement.

Can proactive measures be taken?
Yes. It is important that licensees understand the effects of bankruptcy on an IP contract. A non-exhaustive list of proactive measures a licensee can pursue in this context include: (1) determine which existing IP contracts are executory contracts; (2) review those IP contracts for the issues outlined above and the terms that will likely drive the treatment of IP in the event of bankruptcy; (3) look for opportunities in existing IP contract (e.g., requests for re-pricing; new statements of work; disputes) to renegotiate/add/supplement terms that may be unfavorable to the entity on these issues; (4) plan carefully for these issues in new IP contracts (e.g., include Section 365(n) provisions); and (5) consider alternative approaches to the use of IP rights that may avoid such issues - e.g., the purchase of IP versus the licensing of same, or taking a security interest in IP.

[1] Different bankruptcy courts treat executory contracts involving IP differently, so it is important to consider the various treatments.

More questions? Contact the authors or visitFish's Intellectual Property Law Essentials.