Dealing With a Licensor’s Bankruptcy

In January, we explained how a licensee’s bankruptcy looks from a licensor’s point of view.

What about a licensor’s bankruptcy from a licensee’s point of view?

The landscape is quite similar, except that in the first scenario, the main concern of the licensor is usually whether it will be paid by the bankrupt licensee, while in the second scenario, the main concern of the licensee is usually whether it will continue to receive the benefit of the license from the bankrupt licensor.

Thanks to a revision of the Bankruptcy Code, the licensee can usually continue to receive most of the benefits of the license even against the wishes of the licensor, except if it is a trademark license.

A bankrupt licensor gets to make the same choices about an executory license agreement as does a bankrupt licensee– to assume it, to assume and assign (sell) it, or to reject it.

Assumption is usually good for the licensee because it retains the benefit of the license. The licensor will elect to assume if it thinks that the license is a revenue producer that is beneficial to its Chapter 11 reorganization efforts, or if it decides to sell the license to a third party as part of a Chapter 7 or Chapter 11 asset sale.

The licensor’s decision to reject is normally bad for the licensee, unless the licensor’s performance had become so erratic that the licensee wanted to end the relationship anyway.

However, the licensor’s decision to reject does not need to be the end of the story. The licensee can either: 1) accept the rejection and file a claim for damages caused by termination of the license (and probably receive no more than the proverbial ten cents on the dollar); or 2) elect to continue receiving the benefits of the license under Section 365(n) of the Bankruptcy Code, the so-called Intellectual Property Bankruptcy Act of 1988 that was enacted to prevent hardship to licensees when a license is a core part of their business.

If the licensee chooses to retain its rights under Section 365(n), then it can continue to use the licensed intellectual property as it existed on the filing date of the licensor’s bankruptcy for the remainder of the license term and any renewals, however it cannot force the licensor to provide new or affirmative performance. For example, a licensee of software can continue using the software as it existed on the bankruptcy filing date, but cannot compel the licensor to provide updates, maintenance, or indemnification against third party claims, even if required per the license terms.

The licensee’s election of Section 365(n) comes at a cost. It must continue to pay royalties per the original terms of the license with no offsets for the licensor’s non-performance of its affirmative obligations.

But as mentioned above, there is a big loophole in Section 365(n)’s protection of licensees. It only applies to licenses of “intellectual property” as defined in the Bankruptcy Code, which includes trade secrets, patents, copyrights, and mask works, but NOT trademarks. The reasons are somewhat murky, but it appears that since licensor quality control is an indispensable requirement for trademark licenses, Congress was concerned that trademark licenses were inherently incompatible with the “no affirmative obligations” concept of Section 365(n), so excepted them from that section’s shield. But the legislative history also hints that bankruptcy judges should have discretion to shield trademark licenses from rejection in the interests of justice. Also, where the trademark license is inseparable from associated copyright or patent licenses to a particular technology, the licensee might be able to retain its trademark license. But otherwise, the licensee of a rejected trademark license is probably out of luck.

A final note. A licensee that wants to terminate the license relationship cannot invoke the licensor’s bankruptcy, even if the license agreement stipulates that the licensor’s bankruptcy is a default that justifies termination. Bankruptcy law overrides such “ipso facto” provisions, and requires licensees to continue performing (including paying royalties) under the license agreement in the interim between the licensor’s filing for bankruptcy and its election to assume or reject, except if the licensee makes a motion and gets a court order terminating the license.

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