Chapter IP

The incredible growth we've seen in companies' intellectual property portfolios over the past decade, combined with the current economic situation, may increase the chance that licensees and licensors will face their ­debtor counterparts in federal bankruptcy court.

Unfortunately, the boilerplate contractual provisions that might seem to terminate a license when a party petitions for bankruptcy may not provide any real protection, as they are often found unenforceable by courts. As a result, whether you license your technology or you license from others, you should understand your options if a bankruptcy event occurs.

IP rights in bankruptcy frequently hinge on whether a license is considered an "executory" contract. Basically, under bankruptcy law, an executory contract is one that requires both parties to have ongoing material performance obligations. An example is where the licensor grants an ongoing nonexclusive license and the licensee is required to pay royalties. On the other hand, a nonexecutory contract may consist of a paid-up exclusive license with no
ongoing obligations.

If you've licensed technology to a company that declares bankruptcy and the bankruptcy judge decides the license is nonexecutory, then the license may be considered property of the bankruptcy estate and can be sold­ -- even to one of your competitors. On the other hand, if the judge determines the license is executory, then your licensee may assume (that is, continue) or reject the license. The question of whether an executory intellectual property license can be assumed or assigned is fraught with uncertainty. If the license is nonexclusive, then your licensee usually needs your consent (as licensor) to assume and assign. In some jurisdictions, however, a bankrupt licensee doesn't require the licensor's consent to assume a non-exclusive license, but must still get consent to assign it. If you've licensed gizmo patents, and your bankrupt licensee assumes the license, then the licensee can go on manufacturing gizmos covered by the patents. If the license is exclusive and assumed, then your licensee may be able to go on and assign the license to another company, outside your control.

If your technology is licensed from a company that goes bankrupt, and the bankruptcy judge decides your license is nonexecutory, then the arrangement continues as if the bankruptcy never occurred. So, in such a situation, you could go on using your licensed software even though your software vendor has declared bankruptcy.

But if the license is executory, the licensor's bankruptcy trustee may assume or reject the license. When the trustee assumes the license, then the arrangement continues as usual. Even when the trustee rejects, the U.S. Bankruptcy Code provides some assistance to you as licensee. First, you have the option to treat the license as breached and bring an unsecured claim for money damages arising out of the breach. Second, for patent and copyright licenses (but not trademark licenses), you can satisfy your obligations under the license in exchange for retaining your rights under the agreement. These special rights for licensees are provided under Section 365(n) of the Bankruptcy Code.

In many situations, this option means continuing to pay royalties in exchange for the ability to keep using the bankrupt licensor's patents or copyrights in your current business. In some cases, your rights may include the ability to enforce any exclusivity provision, like suing your competitors for making widgets covered by the patents you've licensed. But your rights would not include prospective grants, such as rights to make future modifications to the licensed widget technology.

It's a good idea to pull out your key licenses and determine (with help from a legal professional) how they are likely to be treated if the counterparty files for bankruptcy. If you need bet-the-company technology from another firm, check to see whether you can negotiate a paid-up license rather than an ongoing contract. Likewise, if you rely on licensing revenue for a big part of your income, try to recast your licenses so that the revenue stream stays constant but you won't lose control of your IP if either you or your licensees go into bankruptcy.

James Klaiber and Blake Reese are registered patent attorneys in the intellectual property group of the litigation department of Milbank, Tweed, Hadley & McCloy LLP.