The intersection where IP law meets bankruptcy law poses special challenges to licensees and licensors. Imagine the patent licensor whose debtor licensee intends to assign the licensed patent rights to the licensor's chief competitor. Or consider the trademark licensee whose debtor licensor wants to end the license and sell the trademark to a rival. The resolution of these IP issues may prove vitally important to the parties involved.

Executory Contracts in Bankruptcy

The Bankruptcy Code gives a debtor special protections in dealing with "executory contracts" - contracts where material obligations are yet to be performed by each of the parties. The Bankruptcy Code allows the debtor to "assume," "assign" or "reject" an executory contract, oftentimes notwithstanding any provisions in the contract that limit assignment without consent of the nondebtor party. When the debtor "assumes" the contract, it formally agrees to cure any defaults (prepetition and postpetition) and be bound by the obligations of the contract. The debtor may continue as a party to the assumed contract (i.e., keep the contract for itself) or may assign the assumed contract to a third party. Typically assumption and assignment occur as part of one transaction. If an executory contract is burdensome or undesirable, the debtor may "reject" the contract, and formally opt not to perform its obligations. Rejection is a material breach of the contract that frees the other party from performance but leaves it with only an unsecured damages claim against the debtor.

The ability to assume and assign a contract without the other party's consent is one of the "superpowers" given to debtors under the Bankruptcy Code, and often a key motivation for a bankruptcy filing. That superpower, however, has important limits: If "applicable law" excuses the nondebtor party from accepting performance from or rendering performance to a party other than the debtor, the Bankruptcy Code expressly prohibits assignment without consent of the nondebtor.

Factoring in IP Law

IP law comes into play in two important ways. First, is a license of IP an executory contract? For nonexclusive IP licenses, whether the subject is patent, copyright, trade secret or trademark, the answer is usually yes. Exclusive IP licenses are another story. Courts will analyze an exclusive license to determine if it transfers so much control of the IP that it constitutes a disguised sale. If so, the agreement will not be deemed an executory contract. In effect, the asset can just be "sold," rather than having the licensed rights "assigned."

Second, for those licenses that are executory contracts, does "applicable law" preclude assignment without consent of the nondebtor party? To answer that question, bankruptcy courts will look to federal common law concerning IP (rather than state contract law). When it comes to patents and copyrights, federal common law precludes a licensee from assigning a license agreement without the consent of the licensor. Courts have looked to the basic principles of patent and copyright law and determined that the covenant not to sue in every license agreement is personal in nature and limited to the named licensee. Other courts have also pointed out that a licensee who could license freely without licensor's consent is in a position to compete directly with the licensor, which undermines the limited monopoly granted to inventors and authors under copyright and patent law. Thus, when no consent to assignment can be found in the agreement itself, it must be obtained from the licensor.

Under trademark law, certain recent cases have reached the same outcome based on a different rationale. These courts, following leading trademark commentators, concluded that a trademark licensee may not assign the license absent licensor's consent because the licensor's right and duty to exert quality control over use of the mark makes a trademark license personal in nature. Certain older cases, on the other hand, have allowed assignment of trademark licenses without licensor's consent, either without discussion of applicable law to the contrary, or after distinguishing the purpose of trademark law, protecting consumers from confusion, from the purpose of patent and copyright law, encouraging creativity in the sciences and arts. "Applicable law" for trademarks continues to evolve, so nondebtor parties to trademark licenses must be vigilant in protecting their rights.

Thus, if the debtor is a licensee of patents or copyrights, consent of the licensor is needed for any assignment of the agreement, and a trend to require consent for trademark licenses may be developing as well. In some jurisdictions, this federal policy requiring licensor's consent to assignment has also been held to prevent assumption of the agreement by a debtor-in-possession, even where there is only a hypothetical possibility that the contract might be assigned after assumption. In these jurisdictions, a debtor may be prevented from even keeping the IP license for itself without consent.

Special Bankruptcy Protections for Nondebtor Licensees

Section 365(n) of the Bankruptcy Code contains special protections for nondebtor licensees of certain intellectual property in the event a debtor licensor files for bankruptcy and then seeks to reject a license. Generally, a licensee of "intellectual property" whose license is rejected by a debtor licensor can elect to retain its rights under the license so long as it continues to pay any applicable royalty (although the licensor would be freed from the burdens). In this instance, "intellectual property" is a defined term in the Bankruptcy Code that expressly includes patents and copyrights, but does not include trademarks. Licensees of patents and copyrights can therefore invoke section 365(n) to protect themselves from the harsh results of rejection by the debtor. Trademark licensees, on the other hand, must object and attempt to preserve their rights by appealing to the court's equitable powers and developing case law.

The Most Important Step to Avoid Danger

If you find yourself and your IP rights embroiled in a bankruptcy case, you must carefully monitor the proposed treatment of those rights by the bankrupt entity to ensure that they are preserved and protected, and if not, you must speak up. Even though federal law and the Bankruptcy Code offer specific protections and rights to nondebtor parties to IP licenses, your silence after notice of a proposed treatment may be deemed to be your consent. If you want to protect your ability to restrict a debtor licensee's proposed assignment of your license, or you want to continue to use a debtor's IP under a license, you must take action and object to any proposed action or treatment that interferes with those rights.