Posts Tagged ‘Bankruptcy’

Handling Trademark Licensees in Bankruptcy

Tuesday, May 31st, 2011

Don’t panic, trademark licensors with financially shaky licensees. In case it has already sold out at your local newsstand, here is a copy of Handling Trademark Licensees in Bankruptcy, Part 1, from the June issue of Royaltie$ magazine, written with our friend and former Beanstalk colleague, Oliver Herzfeld.

Part 2 will be out in August.

Licensor Recovery of Attorneys’ Fees in Bankruptcy

Thursday, November 18th, 2010

Photo Courtesy tristam sparks under the cc 2.0 license

The only thing worse for a licensor than losing money when its licensee files for bankruptcy is paying attorneys’ fees on top of that to stop the bleeding.

Two of the most common bankruptcy proceedings that licensor creditors get involved in are: 1) hearings related to the licensee’s attempt to assume an executory license agreement; and 2) lawsuits against the licensor to recover so-called preferential transfer payments from the licensee.

But can a clever licensor recover attorneys’ fees incurred in post-petition bankruptcy proceedings, if it had the foresight to include a well-drafted attorneys’ fee provision in its boilerplate license agreement?

Since a 2007 Supreme Court decision, the answer has been “maybe,” which was a big improvement over the previous answer of “almost never.”

Until 2007, there were two hurdles against a licensor creditor recovering its attorneys’ fees in a bankruptcy proceeding. The first was that many courts invalidated attorneys’ fee provisions to the extent that they applied to bankruptcy proceedings, arguing that the Bankruptcy Code had a general policy to invalidate contractual clauses that were triggered by bankruptcy. The second was that some courts interpreted the Bankruptcy Code to prohibit recovery of attorneys’ fees by unsecured creditors under any circumstances.

In 2007, the US Supreme Court removed the first hurdle in Travelers Casualty & Surety Co. v. Pacific Gas & Electric Co., which held that the Bankruptcy Code did not contain a blanket prohibition on recovery of attorneys’ fees for bankruptcy related proceedings, as long as the attorneys’ fees provision is valid under state law.

But the Travelers case did not address the second hurdle, and there is currently a split among various courts whether unsecured creditors can recover attorneys’ fees even pursuant to a contractual provision valid under state law. So far, the Second Circuit, Ninth Circuit, and Sixth Circuit federal appeals courts have permitted such recovery, while the First Circuit and Eighth Circuit (in pre-Travelers opinions) have not.

Sigh, so confusing. What is a licensor to do? Well of course, put attorneys’ fee recovery language in your boilerplate license agreement. The worst that can happen is the court says no.

A starter attorneys’ fee provision might read as follows:

“If any legal action, arbitration, or other proceeding is brought under or in relation to this Agreement, including but not limited to any legal action, arbitration, or proceeding under the U.S. Bankruptcy Code, then in addition to any other relief to which the Licensor is entitled, if the Licensor is the successful or prevailing party, then the Licensor is also entitled to recover, and the Licensee shall pay, all: (a) reasonable attorneys’ fees of the Licensor; (b) court costs; and (c) expenses, even if not recoverable by law as court costs (including, without limitation, all fees, taxes, costs and expenses incident to arbitration, appellate, bankruptcy and post-judgment proceedings); incurred in that action, arbitration, or proceeding and all appellate proceedings. For purposes of this Section, the term ‘attorneys’ fees’ includes, without limitation, paralegal fees, investigative fees, expert witness fees, administrative costs, disbursements, and all other charges billed by the attorney to the Licensor.”

Adjust the above to be valid under the state law that governs the license agreement. Check whether that state law makes the provision reciprocal, by deeming that if an agreement grants one party the right to recover attorneys’ fees, then the other party is automatically entitled to recover its attorneys’ fees under like circumstances. Then cross your fingers.

Dealing With a Licensor’s Bankruptcy

Monday, June 21st, 2010

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.

Dealing With a Licensee’s Bankruptcy

Saturday, January 2nd, 2010

The envelope arrives from the bankruptcy court.  You open it and realize with a shock that your licensee has filed for bankruptcy, and listed you as a creditor.  Over the last year, it has become an increasingly common event.

But from a licensor’s point of view, a licensee bankruptcy is not automatically the disaster it might appear to be.  There is a Very Good Scenario as well as a Very Bad Scenario for licensors dealing with a licensee’s bankruptcy.

First, some background on bankruptcy law.  Bankruptcy is a process for adjusting the debts of a debtor as set forth in the federal Bankruptcy Code.

The two main categories of business bankruptcy are Chapter 7 and Chapter 11.  Chapter 7 is a so-called liquidation bankruptcy, in which the debtor is carved up, its assets sold, and the proceeds distributed to creditors according to a formula contained in the Bankruptcy Code.  Chapter 11 is a so-called reorganization bankruptcy, in which the debtor survives, and pays off creditors a portion of what it owes them, usually from a combination of loans, selected asset sales, and current revenues.

The Chapter 11 is carried out according to a plan that must be voted on and approved by the creditors.  Chapter 11s sometimes fail, and convert to Chapter 7 liquidations.

The important thing to know about licenses in bankruptcy is that they are normally treated as a kind of asset called an “executory contract,” which is fancy way of saying that the contract is still active.

When licensees go bankrupt, the Bankruptcy Code requires them to choose whether to “assume” the license (accept it in full according to its original terms) or “reject” it (just what the name implies).

As a licensor, normally you would want the licensee to assume—this is the Very Good Scenario.  The reason is that in order to assume, the Bankruptcy Code requires the licensee to promptly come current on royalties and all other contractual obligations, and prove it has the means to stay current in the future.  Which means that if the licensee is in arrears – which bankrupt licensees always are – it will need to quickly come current and stay current, and follow all other terms of the license as originally drafted, just like your very best licensee.  If your license is drafted correctly, you can even require the assuming licensee to pay your bankruptcy court attorney’s fees as part of the assumption process.  Nice!

Why would a licensee decide to assume?  The licensee may have determined that the license is a revenue producer that is critical to its Chapter 11 reorganization efforts, or may have decided to sell that license to a third party as part of either a Chapter 11 or Chapter 7 asset sale.

But what if you do not want the licensee to assume, or assume and assign (sell) the license, despite the obvious financial benefits? You may be able to veto the licensee’s attempt to assume and/or assign, but the answer can vary widely depending on the kind of license and the court that decides the issue, so it is important to consult with a bankruptcy attorney on this issue.

On the other hand, if the licensee decides to reject the license, that is the Very Bad Scenario, and you the licensor will be lucky to get the proverbial ten cents on the dollar, often many months or years later.  In fact, you will normally need to file a claim with the bankruptcy court to receive even the ten cents.

There is one more layer to the bankruptcy cake, which is that the assumption/rejection rules only apply to the licensee’s debts as of the date of the bankruptcy filing.  There is a whole different set of rules that governs payments of royalties on sales made after the date of the bankruptcy filing—and yes, absent a bankruptcy court order, the licensee is normally allowed to continue exercising the license after the bankruptcy filing, even if the license says that it automatically terminates upon the licensee’s filing for bankruptcy.  Such so-called “ipso facto” clauses are automatically invalid under bankruptcy law.  A Chapter 11 licensee may pay you the full royalties on the regular schedule for post-filing use of the license, or you may need to have your attorney file a motion with the bankruptcy court for an “administrative expense claim,” which normally gets paid at more than ten cents on the dollar, but with no guarantee of a hundred cents on the dollar.

So, licensors, after the initial shock of the licensee’s bankruptcy wears off, remember that so far from being an automatic disaster, a licensee bankruptcy may put you in an even better position than you were before.  But whether you stand to realize ten cents or a hundred cents on the dollar, in order to maximize your recovery, make sure you have an attorney knowledgeable about bankruptcy law to guide you through an arcane and specialized process.