IP License Agreements in Bankruptcy

IP License Agreements in Bankruptcy May 8, 2012 Presented by: Sean J. Grygiel

SUMMARY (1) Bankruptcy Terminology (2) IP Licenses in Bankruptcy (3) Dra=ing ConsideraLons 2

BANKRUPTCY TERMINOLOGY See Bankruptcy Code- Title 11 U.S.C. Intellectual Property DefiniMon in 11 U.S.C. 101(35A) of Bankruptcy Code 3

TERMINOLOGY INTELLECTUAL PROPERTY INCLUDES: (1) Trade Secrets (2) InvenMons Covered Under 35 U.S.C., Processes, Designs, Patents (3) Patent ApplicaMons (4) Copyrights (5) Plant VarieMes (6) Mask Works (Title 17, Chapter 9) 4

TERMINOLOGY BUT INTELLECTUAL PROPERTY DOESN T INCLUDE: (1) Trademarks / Trade Names (2) Service Marks (3) Overseas IP not within treames between U.S. and country of origin of work that provide reciprocal protecmon or are otherwise protected under 35 U.S.C. or 17 U.S.C. 5

TERMINOLOGY Why Aren t Trademarks Considered IP for Bankruptcy Purposes? Congress; Trademarks Depend to a large extent on control of quality and service, so decided to Allow the development of equitable treatment of this situamon by bankruptcy courts. (Sen. Report 100-505, 100 th Congress, 2d Sess. (1988)) In some circumstances (where protecmon similar to patent and copyright law needed), trademark may be treated like other IP assets, e.g., prevent unauthorized use of TM; preserve value of business name and/or product. 6

TERMINOLOGY Executory Contract Surprising!! Not defined in Bankruptcy Code Widely adopted definimon by Prof. Vern Countryman (Harvard Law School), specialist in commercial law and debtors rights 7

TERMINOLOGY Executory Contract Countryman DefiniMon for an Executory Contract Contract under which obligamon of bankrupt and other party to contract are so far unperformed that failure of either to complete performance would consmtute a material breach excusing performance of the other (Countryman, Executory Contracts in Bankruptcy, Part I (7 Minn Law Review 439, 460 (1973)) *SomeMmes referred to as Material Breach Test 8

TERMINOLOGY Countryman Material Breach Test Test Used by Most Courts (Minority Approach) Functional Test - Contract executory if determination permits debtor to reject contract as burdensome or unenforceable. Decided based on impact on bankruptcy case See, In re La Electronica, Inc., 995 F.2d 320, 322 n.3 (1st Cir. 1993) See, In re Bradlees Stores, Inc., 2001 WL 1112308 at *6 (S.D.N.Y. Sept. 20, 2001) 9

TERMINOLOGY Bankruptcy Proceedings - 2 major formats CHAPTER 7 - LiquidaLon (11 USC 701-784) Most common form LiquidaMon Proceeding Debtor s non- exempt assets sold by Chapter 7 Trustee PROCEDURE Trustee takes control of non- exempt assets, sells them and pays creditors whatever proceeds sales permit 10

TERMINOLOGY CHAPTER 11 ReorganizaLon (11 USC 1101-1174) ReorganizaMon proceeding Debtor usually remains in possession of its assets (DIP) DIP conmnues to operate business with oversight by Court and Creditors CommiOee DIP Fiduciary duty to maximize value for creditors of the Bankruptcy enmty Debtor proposed reorganizamon plan Confirmed by Court, if accepted by majority of creditors 11

TERMINOLOGY SecLon 365 of Bankruptcy Code Trustee s Authority to Assume, Assign or Reject (11 U.S.C. 365) Grants bankruptcy trustee (or debtor in possession) authority to assume, assign, or reject executory contracts to which debtor is a party. TEST: Is acmon in best interest of debtor? Trustee s Decision rejected only if manifestly unreasonable 12

IP LICENSES Are IP Licenses Executory Contracts? Q - A - Q - A - Do IP licenses fall under definition of executory contracts? Probably almost all do. Why? Unperformed obligations by both parties make IP license executory. (Countryman definition) 13

IP LICENSES Unperformed ObligaLons ObligaMon to pay royalmes usually not enough to cause contract to be declared executory (See Lubrizol Enters., Inc. v. Richmond Metal Finishers, 756 F.2d 1043, 1045 (4th Cir. 1945) General rule: Provisions that are more like condilons, than affirmalve dules or performance; sufficiently material to establish agreement as an executory contract 14

IP LICENSES Provisions Held to Establish Executory ObligaLons Licensor Covenant not to sue for infringement Duty to maintain IP Licensee Territorial restricmons ReporMng obligamons 15

IP LICENSES BOTTOM LINE Almost any obligamon, besides obligamon to pay, enough to establish IP license as executory contract under bankruptcy law test. See, In re Access Beyond Techs., Inc., 237 B.R. 32, 43 D. Del. 1999); Everex Sys., Inc. v. Cadtrak Corp., 89 F.3d 673 (9th Cir. 1996) See also, In re Gencor Indus. Inc., 298 B.R. 902, 907 (Bankr. M.D. Fla 2003) Holding that most favored namons and patent defense were condimons of payment, not conmnuing material obligamons 16

IP LICENSES While 365(a) gives trustee or debtor in possession authority to (1) assume or (2) reject executory contracts. Trustee must assume or reject enmre contract; no piecemeal assumpmons See, Stewart Title Guaranty Co. v. Old Rep. NaConal Title Insurance Company, 83 F.3d 735, 741 (5th Cir. 1996) 17

IP LICENSES Decision is maoer of debtor/trustees business judgment Orion Pictures Corp. v. ShowCme Networks, 4 F.3d 1095 (2d Cir. 1993) Factors in Decision (a) Benefit to bankrupt s estate (b) DiluMon to other creditors (c) Liability as administramve claim if assumed contract subsequently rejected 18

IP LICENSES Decision is maoer of debtor/trustees business judgment Orion Pictures Corp. v. ShowCme Networks, 4 F.3d 1095 (2d Cir. 1993) Factors in Decision (a) Benefit to bankrupt s estate (b) DiluMon to other creditors (c) Liability as administramve claim if assumed contract subsequently rejected 19

IP LICENSES Time Limit on Acceptance/RejecLon 365(d) sets Mme in which trustee/debtor must decide whether to accept/reject (1) In Chapter 7 proceeding - Within 60 days of bankruptcy pemmon (2) In Chapter 11 proceeding - Any Mme before confirmamon of reorganizamon plan 20

IP LICENSES Acceptance/RejecLon What happens if Chapter 11 debtor doesn t accept or reject license? Termed Ride Through No requirement in bankruptcy code that Chapter 11 debtor must assume or reject License is property of debtor a>er confirmamon 1st, 2nd, 3rd, 4th, 5th and 9th Circuits recognize Ride Through doctrine 21

Triggered by bankruptcy filing AUTOMATIC STAY 11 U.S.C. 362(a)(3) Protects bankruptcy estate from any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate Patents, TM s & Copyrights are property of the estate InjuncMon against conmnuance of any acmon, by any creditor against debtor (11 USC 362) 22

AUTOMATIC STAY ParMes can seek stay relief to terminate IP license for cause e.g. worried that debtor can t maintain quality control or cure defaults See Ford Motor Co. v. Claremont AcquisiCon Corp, Inc., 186 B.R. 977 (C.D. Calif 1995) Stay remains in effect unml (1) Judge li>s stay (2) Debtor gets discharge (3) Item is no longer property of the estate 23

AUTOMATIC STAY Replaced by permanent injuncmon when debtor receives discharge P.I. Prohibits creditors from all acmons that automamc stay prohibited While stay in effect, non- debtor can t unilaterally terminate IP license (11 U.S.C. 362(a)) AOempts to terminate - can be contempt of court 24

IP LICENSES - DEBTOR AS LICENSEE Tension Between Bankruptcy and IP Law 365(a) authorizes debtor to assume or reject any executory contract 365(d) authorizes debtor to assign executory contract, despite existence of provision in contract barring assignment - - - - - - - - - - - - - - - - - Conflict between IP Law (concepts of monopoly and non- assignability) And Bankruptcy Law (based on maximizing value for all parles) 25

IP LICENSES AssumpLon by Debtor Licensee 365(b)(1) - condimons of assumpmon are (1) defaults must be cured and (2) assuming party must provide adequate assurance of future performance ( 365(b) (1)) Examples of Future Performance in IP Licenses: (1) Pay royalmes (2) Maintain quality (3) ConMnued sales 26

IPSO FACTO CLAUSES 365(e)(1) and 541(c) - clause that automamcally terminates contract upon insolvency, financial condimon, or filing of bankruptcy Unenforceable once bankruptcy case has been filed But could be important (if debtor rejects license) to determine if contract has been/can be terminated under contract law See, One South, Inc. v. Hollowell, 963 So. 2nd 1156 (Miss. 2007) 27

IP LICENSES LimitaLons on Assignment 365(c) - Trustee can t assume/assign executory contract if (a) Applicable Law excuses a party, other than debtor from accepmng/ rendering performance to enmty other than debtor, whether or not contract restricts assignment of rights, and (b) Party does not consent to such assumpmon or assignment Applicable Law = PAT, TM, Copyright laws: Can prevent DIP from assigning or assuming contract Extraordinary - read literally, affords patent licensor ability to decline honoring executed license with bankrupt licensee Well- established principle under Federal Common Law, unless otherwise provided by terms of agreement, non- exclusive license is personal and not freely assignable 28

IP LICENSES LimitaLons on Assignment (1) In most jurisdicmons, non- exclusive licenses generally not assignable over licensor s objecmon (unless permioed by License) See Everex Systems v. Cadtrak, 89F.3d 673 (9 th Cir. 1996)); (2) Exclusive licenses assignable over objecmon of Licensor See Leicester v. Warner Bros. Corp., 232 F. 3d 1212 (9 th Cir. 2000) What s the RaLonale Here?? Exclusive licensee acquires actual property rights and may freely transfer them and licensor can t transfer them to someone else 29

365(c) InterpretaLon Courts differ in how 365(c)(1) should be interpreted 365(c) (Condensed version) Trustee may not assume or assign executory contract, whether or not contract prohibits or restricts assignment of rights, if (1) applicable law excuses a party (other than debtor) to the contract from accepmng performance from or rendering performance to, an enmty other than the DIP or debtor, whether or not such contract or lease prohibits or restricts assignment of rights or delegamon of dumes, and (2) such party does not consent to such assumpmon or assignment. 30

365(c) Query? Does OR mean AND also? I.e., what happens when bankrupt party wants only to keep (assume) a licensee? Does 365(c) mean debtor can neither assign or assume? Or just that debtor can t assign? Can debtor hypothemcally assign the license even though it doesn t want to ( hypothemcal test ) or what is debtor actually proposing to do ( actual test )? 31

365(c) SUMMARY ProblemaLc Split Among Courts Most courts agree 365(c)(1) bars assignment of executory contracts absent non- debtor s consent, if applicable law ( 365(c) requires such consent Otherwise, non- debtor must accept performance from a new party Courts split on whether language of 365(c) prohibits DIP (Trustee) (1) from assuming executory contracts or (2) only from assigning them Circuits don t agree: Apply different tests 32

Tests for Determining Applicability of 365(c) Circuits don t agree: Apply different tests 1) Actual Test - 1st Circuit (favors licensee) If DIP has no intent to assign executory contract to 3rd party, contract can be assumed if DIP meets requirements of 365 (Defaults cured and can provide assurance of future performance) See InsCtut Pasteur v. Cambridge Biotech, 104 F.3d 489 (1 st Cir 1997) 33

Tests for Determining Applicability of 365(c) 2) HypotheLcal Test - 3rd, 4th, 9th and 11th Circuits (favors licensor) Precludes assumpmon, or assumpmon + assignment, of IP license without consent of licensor, if license not assignable under non-bankruptcy law without consent of licensor See, In re West Electronics, 852 F.2d 79 (3rd Cir. 1988); In re Catapult Entertainment Inc., 165 F3d 747 (9 th Cir. 1999); N.C.P. MarkeCng Group v. BG Star Products, 279 Fed. Appx 561 (9 th Cir. 2008), Cert denied 129 S. CT 1577 (2009) * Rights of licensee can be taken away * PotenMal windfall to licensee 34

Tests for Determining Applicability of 365(c) 3) Footstar Test (New approach to 365(c) dilemma) Term Trustee in 365(c) should not include debtor- in- possession ProhibiMon against assignment + assumpmon under 365(c) is limited to condimons where Trustee, not debtor in possession, wants to assume executory contract See, In re Footstar Inc., 323 B.R. 566, 573 (Bankruptcy S.D.N.Y. 2005) 35

Tests for Determining Applicability of 365(c) Footstar Test (SomeMmes The New York Test") SoluMon for courts seeking to avoid negamve consequences of debtor/licensee that enters bankruptcy, but wants to assume, not assign its IP licenses 36

FOOTSTAR Footstar not involve IP license Adopted literal reading of 365(c)(1) Meant to be harmonious with objecmve of 365(c) and overall objecmve of bankruptcy code No construcmon of what or means Use of word Trustee not include debtor or DIP 37

FOOTSTAR Accordingly right of non- debtor party to object to assignment doesn t affect right of DIP or debtor (as contrasted with right of trustee) to assume an executory contract Followed by SDNY in Adelphia CommunicaMons (Adelphia 2007 WL 64728 at *3 N. 13) 38

FOOTSTAR Adelphia Court Footstar consistent in outcome with the decisions of courts following the actual test Notable because many large bankruptcy filings made in SDNY, e.g., Delphi, Enron, Worldcom, Delta Airlines 39

See, In re Footstar, 323 B.R. 566, 570-72 (Bankr. S.D.N.Y. 2005) Judge Adlai Hardin Great majority of lower courts have taken the view that courts should apply an actual test to permit assumpmon where debtor in possession does not intend to assign the contract. 40

TYPICAL SITUATION ADDRESSED BY FOOTSTAR (1) Debtor is patent licensee (2) License signed before bankruptcy filing (3) Licensor moves to force DIP to reject license agreement or to li> automamc stay so licensor can cancel agreement (4) Licensor argues DIP can t assign license & under hypothemcal test, can t assume agreement (5) Licensor argues DIP should be forced to reject license 41

Recent decision in Aerobox Composite Structures, LLC bankruptcy filing 373 B.R. 135, 138, 140-42 (Bankr. M.D. NM) Found Footstar was proper interpretamon of 365- n Denied licensor s momon DIP not barred by 365(c)(1) from assuming pre- pemmon license 42

BOTTOM LINE OF 365(c) Venue may decide outcome SDNY follows Footstar 1st Circuit follows actual test 3 rd, 4 th, 9 th, & 11 th Circuits follow hypothemcal test 6 th, 7 th, & 10 th Circuits unseoled on which test to follow 43

365(n) DEBTOR AS LICENSOR 1988 Intellectual Property Licenses in Bankruptcy Act (IPLBA) Pub. Law 100-506 365(n) rights of IP licensee when trustee rejects executory contract where debtor is licensor If executory contract is rejected, licensee can (1) treat contract as terminated by reason of rejecmon seek damages for breach or terminamon, or (2) retain its rights under license, including exclusivity, for duramon of agreement Doesn t protect exclusive licensee against failure to record and applicable non- bankruptcy law requires license recordamon Doesn t apply to trademarks: TM licensees must rely on interpretamon of 365(c)(1) 44

365(n) DEBTOR AS LICENSOR Only deals with (1) rejecmon by licensor, not by licensee, and (2) whether license may be (i) assumed or (ii) assumed and assigned by bankruptcy trustee 45

365(n) DEBTOR AS LICENSOR Protects rights to embodiments of IP to which licensee enmtled under applicable underlying contracts (see S. Rep. No. 100-505 at 9 (1988) Licensee has no rights in IP developed a>er bankruptcy filing even when rejected license agreement gave rights to use improvements (Szombathy v. Controlled Shredders Inc. No. 97 c 481, 1997 WL 183914 (N.D. IL 1997) 46

365- n TIMING OF ELECTION When does licensee exercise its right of elecmon under 365- n? 365(n)(1)(b) allows licensee to elect to retain its rights Right arises only on rejecmon of license by bankrupt and not before See, Dynamic Changes Hypnosis Center, Inc. v. PCH Holding LLC, 306 B.R. 800, 809 (E.D. VA 2004) 47

SOME THOUGHTS ON LICENSE DRAFTING What circuit laws may be applicable on bankruptcy of other party to agreement Ipso Facto Clauses unenforceable but could be valuable to permit terminamon a>er rejecmon of contract Right to terminate for conduct likely to occur before bankruptcy; poor financial results, performance delays Change of control gives right to terminate (avoid Ipso Facto problems 48

SOME THOUGHTS ON LICENSE DRAFTING Try to structure license as non- executory Only obligamon is to pay royalty; Put other obligamons in separate executory agreement, e.g. patent maintenance 49

SOME THOUGHTS ON LICENSE DRAFTING If licensee retains rights, must conmnue to make royalty payments Define triggering event for deposimng source code; escrow over which DIP has no control; not property of estate 50

SOME THOUGHTS ON LICENSE DRAFTING Try to obtain security interest in underlying IP as security for performance of debtors obligamons (strengthen rights of non- debtor party) 51

Thank you! Sean J. Grygiel Principal Fish and Richardson PC New York grygiel@fr.com Peter Ludwig Principal Fish and Richardson PC New York ludwig@fr.com 52