It isn't law yet, but on December 5, 2013, the U.S. House of Representatives passed a significant patent reform bill known as the "Innovation Act." Although the focus of the legislation is on patent infringement litigation and other patent law revisions, the Innovation Act, H.R. 3309, would also make major changes to Section 365(n) of the Bankruptcy Code. Follow the link in the prior sentence for a copy of the Innovation Act in the form passed by the House and received in the Senate last week. It would also address the interplay between Section 365(n) and Chapter 15 cross-border bankruptcy cases, the subject of my last post, on the Qimonda AG decision from the U.S. Court of Appeals for the Fourth Circuit.

Licensee Protections Under The Current Version Of Section 365(n). Section 365(n) was added to the Bankruptcy Code in 1988 to protect licensees of intellectual property in the event the licensor files bankruptcy.

  • Under Section 365(n) as it now exists, if a debtor or trustee rejects a license, the licensee can elect to retain its rights to the licensed intellectual property, including a right to enforce an exclusivity provision.
  • In return, the licensee must continue to make any required royalty payments.
  • The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements.
  • Taken together, these provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.
  • To read more about the current version of Section 365(n)'s benefits and its protections, follow the link in this sentence.

Limits Of The Current Section 365(n). These existing protections have several significant limitations. First, the Bankruptcy Code's special definition of "intellectual property" excludes trademarks from the scope of Section 365(n)'s protections (although a recent Seventh Circuit decision may have opened an alternative path for trademark licensees to retain their rights). Another is that Section 365(n) is in the U.S. Bankruptcy Code and applies only in a U.S. bankruptcy case. Most other countries do not have protections similar to Section 365(n).

Proposed Changes In The House-Passed Innovation Act. The Innovation Act would make four major changes to Section 365(n)'s protections for licensees.

  • First, it would extend Section 365(n)'s protections, including through an amendment to Section 101(35A) of the Bankruptcy Code's definition of intellectual property, to licenses of trademarks, service marks, and trade names.
  • Second, rejection of a trademark, service mark, or trade name license would not relieve the trustee (or presumably a debtor in possession in a Chapter 11 case) of the debtor's contractual obligations to monitor and control the quality of a licensed product or service.
  • Third, it would expand the payments that a licensee would have to continue to make to the estate, if it elected to retain its license rights, to include not only "royalty" payments but also "other" payments under the license.
  • Fourth, it would amend Section 1522 of the Bankruptcy Code to make Section 365(n) directly applicable to Chapter 15 cases, providing that if a foreign representative rejects or repudiates an IP license, the licensee would be entitled to elect to retain its IP rights under Section 365(n).

If enacted and signed by the President, the Innovation Act's revisions would apply as of the date of enactment to pending and future cases.

Will The Innovation Act Become Law? I'm a bankruptcy lawyer, not a political analyst, but it's fair to say we shouldn't get too excited about these potential legislative changes just yet. The Innovation Act has passed only the House and has been referred to the Senate Committee on the Judiciary, where the bill meets an uncertain fate. Even if the Innovation Act passes the Senate, the Section 365(n) provisions could be amended or the legislation could otherwise stall. However, the Innovation Act is not a one-party bill: it passed the House with a large bipartisan majority on a 325-91 vote. That suggests it has the potential for support in the Senate.

Potential Impact Of Innovation Act's Changes To Section 365(n). If the changes to Section 365(n) do become law, they would be the most significant revisions since its enactment in 1988.

  • The biggest changes would be the extension of Section 365(n)'s protections to trademarks, service marks, and trade names, together with the monitoring obligations on a trustee. In the 25 years since Section 365(n) was enacted, trademark licensees have lived under the specter of losing trademark license rights in bankruptcy. These revisions would be a sea change in the trademark area.
  • In addition, the Innovation Act provides that the trustee or debtor in possession would not be relieved of a contractual obligation to continue to monitor the quality of goods or services using a mark, in effect limiting the benefits of rejection to an estate for the protection of consumers. However, it's unclear how a trustee would be able to meet such an obligation, particularly if an estate had no assets, and how a trustee could meet a long-term obligation to monitor quality given that the Chapter 7 case would eventually be closed. These were some of the difficult issues that led Congress to leave trademarks out of Section 365(n) originally.
  • Another significant change is the requirement that a licensee that elects to retain its IP rights under Section 365(n) essentially continue to make all payments under the license agreement and not simply those determined to be "royalty" payments. If this provision becomes law, drafters of license agreements will need to consider how rejection and the non-performance of the licensor's obligations would impact payments otherwise required under the license agreement.
  • As a timely anticipation of the Fourth Circuit's Qimonda AG decision, the Innovation Act would apply Section 365(n) in all Chapter 15 cases through an amendment to Section 1522. The language used -- applying when a foreign representative rejects or "repudiates" a license agreement -- suggests that the House intended this to cover not only rejection under Section 365 of the Bankruptcy Code but also equivalent foreign law powers to repudiate or disclaim contracts. By placing the Section 365(n) reference in a new, separate subsection of Section 1522 governing protection of creditors and other interested persons, it seems that Section 365(n) would apply in all Chapter 15 cases, regardless of whether the foreign representative sought preliminary or discretionary relief under Sections 1519 or 1521.

Conclusion. If it becomes law in its current form, the Innovation Act would bring the most sweeping changes to Section 365(n) since its enactment in 1988. Although there's a long way to go before that actually happens, the breadth of the proposed changes and their impact on bankruptcy and IP law makes this piece of legislation one to watch. Stay tuned.