The Treatment of Intellectual Property Under Bankruptcy Law

Patents are government-issued grants of the right to exclude others from making, using or selling an invention. A patent is awarded in the United States to the first person to invent, not the first to file a claim, as is true in almost all other countries. The subject matter of an invention may include products, processes, compositions of matter and improvements. Excluded from patent protection are laws of nature, natural phenomena, and abstract ideas. In addition, the invention must be useful, novel and non-obvious. Novelty means that the invention as compared with what has gone before must be new. For the purposes of patent law, the universe of “what has gone before” is known as “prior art” and includes prior inventions, as well publications anywhere in the world that disclose the prior invention. If the claimed invention is identical to subject matter disclosed or embodied in the prior art reference, the invention or a particular claim (the portion of the patent defining the invention) is “anticipated” and invalid for lack of novelty. Finally, the invention must be non-obvious. Unlike novelty, non-obviousness does not require that the claimed invention be identical to the prior art, rather, the test for obviousness focuses on the differences between the claim and the prior art, and asks whether a “person of ordinary skill in the art” at the time of the invention was made might have come up with the invention.

The Law of Copyright

The law of copyright, in general, protects “original works of authorship,” which is broadly defined by statute to include almost all works of creative expression so long as they have some modicum of originality and are “fixed in a tangible medium of expression.” Copyright protects, however, only a work's expression, it does not protect the underlying ideas. This is perhaps the most critical distinction in copyright law. It also should be emphasized that authors and artists are not required to register a work to obtain copyright protection since under United States law, copyright protection attaches as soon as the work is fixed in a tangible medium of expression.

The basis for trademark law is fundamentally different from patent and copyright law. Rather than encouraging invention or creation, the goals of trademark law are to prevent consumer confusion and unfair competition and to encourage the creation of good will in a mark. In particular, a trademark is any symbol, word, name, device or any combination of these used to identify products, services, or their producers in the marketplace and may include fragrances, the distinctive features of items and the trade dress of both the packaging of a product and nonfunctional features of the appearance of a product. Trademarks are protected from third party use if such use would confuse or mislead the consumers as to the origin of the trademarked product or service. The owner of a trademark can register it with the federal government and thereby qualify for more robust remedies. Trademarks are also accorded limited protection under state law.

Adjudicating Intellectual Property Rights in Bankruptcy Court

Section 365 of the Bankruptcy Code gives the bankruptcy trustee or debtor-in bankruptcy (“DIB”) the authority to “assume,” “assign” or “reject” a debtor's “executory contracts” based on whether the action is in the best interests of the debtor, notwithstanding any contrary provisions appearing in such agreements, and subject to certain other limitations as described below. The bankruptcy court will only reject a decision by the trustee if it is “manifestly unreasonable.” Upon the court's approval of the debtor's assumption of an executory contract, the pre-petition contract is reinstated and becomes fully binding.

Courts almost always find that IP licenses meet the Countryman test for an executory contract because most IP licenses have ongoing material obligations such as obligations by the licensee to account for and to pay royalties for the life of the agreement. Other material ongoing IP licensee obligations include sharing technology with the licensor, reporting on problems with the technology and marking all products sold under the license with the proper statutory patent notice. On the licensor's side, courts have held that contractual obligations to provide a non exclusive licensee with notice of any patent infringement suit or any other use or licensing of the process, to refrain from licensing the technology to anyone else at a lower royalty rate, to approve grants of sublicenses under reasonable standards, to indemnify licensees for losses and to defend claims of infringement are considerations in determining whether the agreement is executory. Several courts recognize the licensor's implicit or explicit duty to forbear from suing the licensee for infringement as, inherently, a material ongoing performance obligation that makes the agreement executory. See e.g., In re Access Beyond Techs., Inc., 237 B.R. 32, 43 (Bankr. D. Del. 1999).

Regardless of whether a license is executor, the Bankruptcy Code expressly prohibits the assignment of a license, without the consent of the non-debtor party, if “applicable law” excuses such non-debtor party from accepting performance from or rendering performance to an entity or person other than the debtor. In general, the federal policy designed to protect the limited monopoly of IP owners and restrict unauthorized use constitutes “applicable law.”

Patent Licenses

Whether patent licenses are assignable depends on whether they are non-exclusive or exclusive. Federal law has long held that non-exclusive patent license agreements are personal to the licensor and are not assignable unless expressly made so in the agreement. See e.g., PPG Indus., Inc. v. Guardian Indus. Corp. 597, F.2d 1090, 1093 (6th Cir. 1979). Accordingly, courts have unanimously applied ' 365(c) to prohibit the assignability of non-exclusive patent licenses absent consent of the non-debtor licensor.

In contrast, because patent law specifically regards exclusive licenses as conferring property and not merely personal rights, ' 365(c) generally has been held not to preclude assumption and assignment of an exclusive patent license by the debtor-licensee. However, at least one court has barred the licensee from assigning its interest under an exclusive patent license. In re Hernandez, 285 B.R. 435 (Bankr. D. Ariz. 2002).

Copyright Licenses

Section 101 of the Copyright Act specifically identifies an exclusive license as a transfer of copyright ownership. By contrast, the nonexclusive license does not transfer any rights of ownership [and] ownership remains with the licensor and the licensor still retains the exclusive right to use or authorize the use of the copyrighted work. Therefore, as in patent law, a non exclusive copyright license is personal to the licensee and cannot be assigned without the consent of the licensor. Section 365(c) prohibits a debtor licensee from assigning a non-exclusive copyright license without the consent of the non-debtor licensor.

Courts are split, however, on the assignability of exclusive licenses where the contract is silent on the issue of assignability. The Ninth Circuit has held that the Copyright Act does not allow a copyright licensee to transfer its rights under an exclusive license without the consent of the original licensor. Nike v. Gardner, 279 F.3d 774, 780-81 (9th Cir. 2002). On the other hand, other courts have taken the position that the holder of an exclusive license is entitled to all the rights and protections of the copyright owner to the extent of the license and the right to transfer such rights and, accordingly, an exclusive licensee may freely transfer his rights. According to these rationale, therefore, ' 365(c) does not prohibit a debtor-licensee from assigning an exclusive copyright license. See, e.g., I.A.E. v. Shaver, 74 F.3d 768, 775 (7th Cir. 1996).

Trademark Licenses

Although it is generally not in the interest of the trademark owner to have the license transferred to a third party without consent, ' 365(c) will not necessarily excuse a trademark holder, in the absence of a contract provision barring assignment of the trademark, from accepting performance from or rendering performance to a party other than the debtor in accordance with the terms of a license. However, at least one court has held that because of the significant interest in a trademark owner's need to protect its mark's good will, value and distinctiveness, “trademarks are personal and non-assignable without the consent of the licensor.” In re N.C.P. Mkt'g Grp 337 B.R. 230, 236 (D. Nev. 2005).

Rights of a Non-Debtor Licensee Upon Rejection

Prior to the passage of the Intellectual Property Bankruptcy Protection Act of 1988 (“IPBPA”), which amended ' 365 of the Bankruptcy Code, IP licensees faced the real possibility that where the debtor-licensor rejected an IP license, the licensee would lose their right to continue to use that IP and would be left with only a pre-petition claim for contract damages, even where the licensee may have built a business or product line upon use of the licensor's IP. Section 365(n) addressed this issue by providing a non-debtor IP or technology licensee with two options in the event that a licensor seeks to reject a license falling within the bankruptcy's definition of “intellectual property.” First, the licensee can treat the rejection as a breach, giving rise to a potential claim for money damages under ' 365(g). Alternatively, the licensee can elect to retain the rights to the intellectual property covered by the license. In return, the licensee must continue to pay royalties due under the licensing agreement and must waive all rights to set off or any claim for administrative expenses.

Section 365(n) permits the licensee to enforce only the “passive” obligations of the licensor such as adhering to confidentiality agreements and, in the case of an exclusive license, not licensing the technology to others, which are necessary for the licensee to enjoy the continued use and exploitation of licensed IP. In other words, by rejecting the licensing agreement, the debtor is relieved from performing any affirmative duties under the contract. Thus, while the Code permits a licensee to retain its rights to IP that existed prepetition, it does not permit post rejection enforcement of the debtor-licensor's on-going obligations to update or improve such intellectual property.

Section 365(n) specifically includes licenses to patents, copyrights, and trade secrets, but does not encompass trademark licenses. Thus, the rejection by a debtor-licensor of a trademark license extinguishes the licensee's right to use the mark and leaves the licensee with only a claim for breach of contract. Indeed, one court confirmed the rejection by the debtor-licensor of a trademark license agreement over the objections of the licensee that rejection would result in damages of $67 million. In re Exide Techs., 340 B.R. 222, 249-50 (Bankr. D. Del. 2006).

An Unresolved Question

An important unresolved question is how to treat licenses which bundle trademark rights along with other IP such as copyrights. According to one court, the answer may depend on whether the licensee raised the issue prior to court approval of a rejection of the license agreement. In re Centura Software Corp., 281 B.R. 660, 671-73 (Bankr. N.D. Cal. 2002).

Finally, companies must act expeditiously in protecting their rights. Indeed, the failure to do so may result in a licensee losing its IP rights.

Conclusion

The treatment of IP assets in bankruptcy presents real challenges to both IP and bankruptcy lawyers. The potential problems are exacerbated because under bankruptcy law, the parties often cannot simply address the issues through contract. While Congress has enacted amendments to the Bankruptcy Code, such as ' 365(n), that have clarified certain areas and provided increased protection to licensees and licensors in the event of a bankruptcy, several areas remain open to questions. Accordingly, it is important for bankruptcy attorneys to have a basic understanding of IP law, or at a minimum to know when they should be consulting with their IP colleagues about a bankruptcy estate that includes a large amount of IP.

Peter J. Toren is a partner in the New York Office of Kasowitz, Benson, Torres & Friedman LLP specializing in IP litigation. He regularly consults with the firm's bankruptcy counsel.

As the worldwide economy expanded over the past decade, intellectual property (“IP”) assets have increased greatly in value and become an ever increasing share of a company's balance sheet. Now, as the economy contracts and many companies are facing bankruptcy, a key question concerns the status of the IP that may have been assigned, transferred, sold or licensed if one of the parties to the transaction declares bankruptcy. The answer may depend on whether the IP in question can be classified as a patent, copyright or trademark and the outcome of this inquiry may be critically important to any company that is in danger of losing its rights to manufacture a licensed product because the licensor declared bankruptcy, as well as to any licensor who may be faced with a totally new competitive landscape because the debtor-licensee sold its rights to the licensor's primary competitor. Accordingly, it is important for attorneys who specialize in bankruptcy law to be able to spot whether a particular type of intellectual property is a patent, copyright or trademark.

Overview of Federal and State Intellectual Property Rights

The United States Constitution authorizes Congress “[t]o promote the progress of Science and useful Arts, by securing for limiting Times to Authors and Inventors the exclusive right to their respective Writing and Discoveries.” U.S. Const. art. I, ' 8, cl. 7. The framers of the Constitution believed that in order to promote the creation and dissemination of knowledge, authors and inventors must be compensated for their efforts. Without being compensated authors and innovators would not willing to devote their time and effort to develop new works if others can simply copy or infringe their works for free. Thus, the framers of the Constitution gave Congress the authority to enact laws to protect patents and copyrights for limited times.

Patents are government-issued grants of the right to exclude others from making, using or selling an invention. A patent is awarded in the United States to the first person to invent, not the first to file a claim, as is true in almost all other countries. The subject matter of an invention may include products, processes, compositions of matter and improvements. Excluded from patent protection are laws of nature, natural phenomena, and abstract ideas. In addition, the invention must be useful, novel and non-obvious. Novelty means that the invention as compared with what has gone before must be new. For the purposes of patent law, the universe of “what has gone before” is known as “prior art” and includes prior inventions, as well publications anywhere in the world that disclose the prior invention. If the claimed invention is identical to subject matter disclosed or embodied in the prior art reference, the invention or a particular claim (the portion of the patent defining the invention) is “anticipated” and invalid for lack of novelty. Finally, the invention must be non-obvious. Unlike novelty, non-obviousness does not require that the claimed invention be identical to the prior art, rather, the test for obviousness focuses on the differences between the claim and the prior art, and asks whether a “person of ordinary skill in the art” at the time of the invention was made might have come up with the invention.

The Law of Copyright

The law of copyright, in general, protects “original works of authorship,” which is broadly defined by statute to include almost all works of creative expression so long as they have some modicum of originality and are “fixed in a tangible medium of expression.” Copyright protects, however, only a work's expression, it does not protect the underlying ideas. This is perhaps the most critical distinction in copyright law. It also should be emphasized that authors and artists are not required to register a work to obtain copyright protection since under United States law, copyright protection attaches as soon as the work is fixed in a tangible medium of expression.

The basis for trademark law is fundamentally different from patent and copyright law. Rather than encouraging invention or creation, the goals of trademark law are to prevent consumer confusion and unfair competition and to encourage the creation of good will in a mark. In particular, a trademark is any symbol, word, name, device or any combination of these used to identify products, services, or their producers in the marketplace and may include fragrances, the distinctive features of items and the trade dress of both the packaging of a product and nonfunctional features of the appearance of a product. Trademarks are protected from third party use if such use would confuse or mislead the consumers as to the origin of the trademarked product or service. The owner of a trademark can register it with the federal government and thereby qualify for more robust remedies. Trademarks are also accorded limited protection under state law.

Adjudicating Intellectual Property Rights in Bankruptcy Court

Section 365 of the Bankruptcy Code gives the bankruptcy trustee or debtor-in bankruptcy (“DIB”) the authority to “assume,” “assign” or “reject” a debtor's “executory contracts” based on whether the action is in the best interests of the debtor, notwithstanding any contrary provisions appearing in such agreements, and subject to certain other limitations as described below. The bankruptcy court will only reject a decision by the trustee if it is “manifestly unreasonable.” Upon the court's approval of the debtor's assumption of an executory contract, the pre-petition contract is reinstated and becomes fully binding.

Courts almost always find that IP licenses meet the Countryman test for an executory contract because most IP licenses have ongoing material obligations such as obligations by the licensee to account for and to pay royalties for the life of the agreement. Other material ongoing IP licensee obligations include sharing technology with the licensor, reporting on problems with the technology and marking all products sold under the license with the proper statutory patent notice. On the licensor's side, courts have held that contractual obligations to provide a non exclusive licensee with notice of any patent infringement suit or any other use or licensing of the process, to refrain from licensing the technology to anyone else at a lower royalty rate, to approve grants of sublicenses under reasonable standards, to indemnify licensees for losses and to defend claims of infringement are considerations in determining whether the agreement is executory. Several courts recognize the licensor's implicit or explicit duty to forbear from suing the licensee for infringement as, inherently, a material ongoing performance obligation that makes the agreement executory. See e.g., In re Access Beyond Techs., Inc., 237 B.R. 32, 43 (Bankr. D. Del. 1999).

Regardless of whether a license is executor, the Bankruptcy Code expressly prohibits the assignment of a license, without the consent of the non-debtor party, if “applicable law” excuses such non-debtor party from accepting performance from or rendering performance to an entity or person other than the debtor. In general, the federal policy designed to protect the limited monopoly of IP owners and restrict unauthorized use constitutes “applicable law.”

Patent Licenses

Whether patent licenses are assignable depends on whether they are non-exclusive or exclusive. Federal law has long held that non-exclusive patent license agreements are personal to the licensor and are not assignable unless expressly made so in the agreement. See e.g., PPG Indus., Inc. v. Guardian Indus. Corp. 597, F.2d 1090, 1093 (6th Cir. 1979). Accordingly, courts have unanimously applied ' 365(c) to prohibit the assignability of non-exclusive patent licenses absent consent of the non-debtor licensor.

In contrast, because patent law specifically regards exclusive licenses as conferring property and not merely personal rights, ' 365(c) generally has been held not to preclude assumption and assignment of an exclusive patent license by the debtor-licensee. However, at least one court has barred the licensee from assigning its interest under an exclusive patent license. In re Hernandez, 285 B.R. 435 (Bankr. D. Ariz. 2002).

Copyright Licenses

Section 101 of the Copyright Act specifically identifies an exclusive license as a transfer of copyright ownership. By contrast, the nonexclusive license does not transfer any rights of ownership [and] ownership remains with the licensor and the licensor still retains the exclusive right to use or authorize the use of the copyrighted work. Therefore, as in patent law, a non exclusive copyright license is personal to the licensee and cannot be assigned without the consent of the licensor. Section 365(c) prohibits a debtor licensee from assigning a non-exclusive copyright license without the consent of the non-debtor licensor.

Courts are split, however, on the assignability of exclusive licenses where the contract is silent on the issue of assignability. The Ninth Circuit has held that the Copyright Act does not allow a copyright licensee to transfer its rights under an exclusive license without the consent of the original licensor. Nike v. Gardner , 279 F.3d 774, 780-81 (9th Cir. 2002). On the other hand, other courts have taken the position that the holder of an exclusive license is entitled to all the rights and protections of the copyright owner to the extent of the license and the right to transfer such rights and, accordingly, an exclusive licensee may freely transfer his rights. According to these rationale, therefore, ' 365(c) does not prohibit a debtor-licensee from assigning an exclusive copyright license. See, e.g., I.A.E. v. Shaver , 74 F.3d 768, 775 (7th Cir. 1996).

Trademark Licenses

Although it is generally not in the interest of the trademark owner to have the license transferred to a third party without consent, ' 365(c) will not necessarily excuse a trademark holder, in the absence of a contract provision barring assignment of the trademark, from accepting performance from or rendering performance to a party other than the debtor in accordance with the terms of a license. However, at least one court has held that because of the significant interest in a trademark owner's need to protect its mark's good will, value and distinctiveness, “trademarks are personal and non-assignable without the consent of the licensor.” In re N.C.P. Mkt'g Grp 337 B.R. 230, 236 (D. Nev. 2005).

Rights of a Non-Debtor Licensee Upon Rejection

Prior to the passage of the Intellectual Property Bankruptcy Protection Act of 1988 (“IPBPA”), which amended ' 365 of the Bankruptcy Code, IP licensees faced the real possibility that where the debtor-licensor rejected an IP license, the licensee would lose their right to continue to use that IP and would be left with only a pre-petition claim for contract damages, even where the licensee may have built a business or product line upon use of the licensor's IP. Section 365(n) addressed this issue by providing a non-debtor IP or technology licensee with two options in the event that a licensor seeks to reject a license falling within the bankruptcy's definition of “intellectual property.” First, the licensee can treat the rejection as a breach, giving rise to a potential claim for money damages under ' 365(g). Alternatively, the licensee can elect to retain the rights to the intellectual property covered by the license. In return, the licensee must continue to pay royalties due under the licensing agreement and must waive all rights to set off or any claim for administrative expenses.

Section 365(n) permits the licensee to enforce only the “passive” obligations of the licensor such as adhering to confidentiality agreements and, in the case of an exclusive license, not licensing the technology to others, which are necessary for the licensee to enjoy the continued use and exploitation of licensed IP. In other words, by rejecting the licensing agreement, the debtor is relieved from performing any affirmative duties under the contract. Thus, while the Code permits a licensee to retain its rights to IP that existed prepetition, it does not permit post rejection enforcement of the debtor-licensor's on-going obligations to update or improve such intellectual property.

Section 365(n) specifically includes licenses to patents, copyrights, and trade secrets, but does not encompass trademark licenses. Thus, the rejection by a debtor-licensor of a trademark license extinguishes the licensee's right to use the mark and leaves the licensee with only a claim for breach of contract. Indeed, one court confirmed the rejection by the debtor-licensor of a trademark license agreement over the objections of the licensee that rejection would result in damages of $67 million. In re Exide Techs., 340 B.R. 222, 249-50 (Bankr. D. Del. 2006).

An Unresolved Question

An important unresolved question is how to treat licenses which bundle trademark rights along with other IP such as copyrights. According to one court, the answer may depend on whether the licensee raised the issue prior to court approval of a rejection of the license agreement. In re Centura Software Corp., 281 B.R. 660, 671-73 (Bankr. N.D. Cal. 2002).

Finally, companies must act expeditiously in protecting their rights. Indeed, the failure to do so may result in a licensee losing its IP rights.

Conclusion

The treatment of IP assets in bankruptcy presents real challenges to both IP and bankruptcy lawyers. The potential problems are exacerbated because under bankruptcy law, the parties often cannot simply address the issues through contract. While Congress has enacted amendments to the Bankruptcy Code, such as ' 365(n), that have clarified certain areas and provided increased protection to licensees and licensors in the event of a bankruptcy, several areas remain open to questions. Accordingly, it is important for bankruptcy attorneys to have a basic understanding of IP law, or at a minimum to know when they should be consulting with their IP colleagues about a bankruptcy estate that includes a large amount of IP.

Peter J. Toren is a partner in the New York Office of Kasowitz, Benson, Torres & Friedman LLP specializing in IP litigation. He regularly consults with the firm's bankruptcy counsel.