Section 365(n) of the Bankruptcy Code provides offers substantial protection for licensees when a licensor files for bankruptcy. In a bankruptcy proceeding, a licensor/executor has the option of either accepting and continuing an intellectual property license agreement, or rejecting the license. If an intellectual property license is rejected, a licensee is afforded beneficial options under the Code. The Bankruptcy Code defines “intellectual property” in Section 101 (35A) as a-

  1. trade secret;
  2. invention, process, design or plant protected under title 35 [this is the patent statute];
  3. patent application;
  4. plant variety;
  5. work of authorship protected under title 17 [this is the copyright act]; or
  6. mask work protected under chapter 9 of title 17; to the extent protected by applicable nonbankruptcy law; …

Noticeably absent from the definition of “intellectual property” is trademarks. The exclusion of trademarks from the definition of intellectual property is likely stems from a unique characteristic of trademark licenses. These licenses can potentially put the value of the mark is at risk. Thus, the owner of the mark has a legitimate interest in assuring that the licensee maintains the qualitative standards expected from the licensee. If the licensee is permitted to use the mark without control by the holder (e.g. in bankruptcy under Section 365(n)), that right is lost.

In the case where a bankrupt licensor/trustee rejects an intellectual property license involving intellectual property as defined above, a licensee then has two choices. It can elect to retain the rights in the license, pay what is due under the terms of the license, and waive any claims against the licensor in the bankruptcy proceeding, or it can extinguish its rights in the license and file a claim against the debtor-licensor in the bankruptcy proceeding. If the licensee elects to continue the license, the licensor (and trustee) may not interfere with the licensee’s rights under the license, even though it has rejected the license.

Although a licensee has a right to continue the license during and after a licensor’s bankruptcy proceeding, even adversely (against the licensor’s will), the licensee’s ability to assign rights under the license may be limited. Courts have ruled that an assignment of rights under an intellectual property license is invalid unless the intellectual property owner has consented. Some of these courts have reasoned that non-exclusive patent and copyright licenses are personal, making the “adverse” licenses under Section 365(n) not assignable. Conversely, an intellectual property licensor may also prevent a debtor-licensee from assuming and assigning a non-exclusive license to a third party without the licensor’s consent.

The potential harsh effects on intellectual property licenses in bankruptcy, however, may be overcome with careful drafting of the license agreement from the start. Obtaining the prior and express consent of the licensor for assignments by the licensee could minimize or eliminate the uncertainty of future assignability. Further, including termination provisions within the license agreement based upon bankruptcy-triggering events (as opposed to termination based upon bankruptcy itself, which is an unenforceable provision) may be desirable for a licensor wishing to maintain greater control over its intellectual property. Also, taking a security interest in the underlying intellectual property can aid a licensee who elects to discontinue a rejected license and file a claim.

In an age where a company’s intellectual property may be its most important, or only, asset, and where license agreements are the vehicle to facilitate the business enterprise, it is critical to took to the future in the drafting of the agreement. Although the issues in bankruptcy are often complex, careful planning and full understanding of the rights of the licensor and licensee in both pre-and post-bankruptcy can not only create more certainty for the parties, but can potentially increase the value of the license itself.