Bankruptcy Protections For The Nonbankrupt Intellectual Property Licensee And Licensor

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Bankruptcy protections for the nonbankrupt intellectual property Licensee and licensor

Victory over Lemelson

Upcoming CAFC patent decisions

Prior to the enactment of certain protections under the Bankruptcy Code, nonbankrupt licensees of intellectual property (i.e., patents, computer software, etc.) who may have expended hundreds of thousands of dollars developing the product covered by the license, were left with a rejected license and a valueless unsecured claim. Further, nonbankrupt licensors of computer software embedded in equipment (i.e., telecommunications switching equipment or copiers) were unable to collect royalties if the bankrupt licensee sold the equipment without advising the licensor. In the bankruptcy arena, as a general rule, a trustee (or debtor-in-possession) may assume or reject an executory contract to which the debtor is a party.1 While intellectual property licenses, such as patent and computer software licenses, are executory contracts,2 certain protections exist in the context of intellectual property licenses that afford the nondebtor party certain exceptions to the general rule. As discussed below, both licensees and licensors of intellectual property licenses can turn to the Bankruptcy Code for protection if the other party to the license files a bankruptcy petition.

Debtor as the LicensoróSection 365(n) of the Bankruptcy Code

Pursuant to section 365(n) of the Bankruptcy Code, if the debtor-in-possession or trustee rejects an intellectual property contract, the licensee may elect to (a) treat the contract as terminated if the rejection "amounts to such a breach as would entitle the licensee to treat such contract as terminated by virtue of its own terms, applicable nonbankruptcy law, or an agreement made by the licensee with another entity"; or (b) "retain its rights (including a right to enforce any exclusivity provision of such contract, but excluding any other right under applicable nonbankruptcy law to specific performance of such contract) under such contract and any agreement supplementary to such contract, to such intellectual property (including any embodiment of such intellectual property to the extent protected by applicable nonbankruptcy law), as such rights existed immediately before the case commenced" for the duration of the contract and any period for which the contract may be extended by the licensee. 11 U.S.C. ß 365(n).

When enacted in 1988, section 365(n) "struck a fair balance between the interests of the bankrupt and the interests of a licensee of the bankrupt's intellectual property." In re Prize Frize, Inc., 32 F.3d 426 (9th Cir. 1994). Therefore, if the licensee chooses to retain its rights under the license, the licensee must continue making royalty payments to the licensor pursuant to the terms of the license agreement. 11 U.S.C. ß 365(n)(2). Furthermore, "license fees" paid for the use of technology, patent and proprietary rights are considered to be "royalty payments" and therefore must be paid if the licensee wishes to retain its rights under section 365(n). Prize Frize, 32 F.3d at 429.

Unfortunately, the licensee may not be entitled to updates or improvements to the intellectual property that are developed after the rejection of the license. The rights of the licensee, if the licensee chooses to retain them under section 365(n), are as they existed prior to the filing of the bankruptcy petition. See, e.g., In re Matusalem, 158 B.R. 514, 521 (Bankr. S.D. Fla. 1993). Pursuant to the terms of section 365(n)(1)(B), the rights retained by the licensee are limited to the passive obligations of the debtorlicensor óthe licensee has no right to specific performance of obligations under the license other than the exclusivity provisions. Accordingly, legal scholars have posited that the debtor-licensor has no obligation to improve or update the intellectual property at issue subsequent to the rejection of the license. See Madlyn Gleich Primoff and Erica G. Weinberger, E-Commerce and Dot-Com Bankruptcies: Assumption, Assignment and Rejection of Executory Contracts, Including Intellectual Property Agreements, and Related Issues under Sections 365(c), 365(e) and 365(n) of the Bankruptcy Code, 8 AM. BANKR. INST. L. REV. 307, 343 (Winter 2000). For example, a licensee acting under section 365(n) has no right to seek specific performance from the debtor-licensor regarding any post-rejection upgrades or patches on software that is subject to the license. In re Centura Software Corp., 281 B.R. 660, 669 (Bankr. N.D. Cal. 2002).

Exclusion of Trademarks from the Protection of the Bankruptcy Code

Trademarks are not included within the definition of "intellectual property" and, therefore, are not protected by Section 365(n). The Bankruptcy Code defines "intellectual property" to mean: "(a) trade secret; (b) invention, process, design, or plant protected under title 35; (c) patent application; (d) plant...