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The Use of IP Rights to Control the Section 363 Sale Process in Bankruptcy

January 2010

This is the second in a series of five "IP/Bankruptcy Law Alerts."

Most bankruptcies filed recently are sales of assets. Section 363 of the Bankruptcy Code allows the sale of all or some assets of a company, free and clear of any third-party claims to those assets. This is done by auction process and may include the sale or transfer of IP licenses, but special rules apply to the transfer of IP licenses in bankruptcy.

Generally, a debtor in bankruptcy has the power, subject to bankruptcy court approval, to assume and assign its executory contracts – as part of a sale of other assets – during its bankruptcy proceedings, with certain exceptions. Executory contracts generally have some performance obligations outstanding by both parties to the contract. In many instances, IP licenses are executory contracts and, when sold by a debtor that is also the licensee of the IP, the debtor obviously seeks to retain the value received for the assigned license. That value normally would have inured to the benefit of the licensor, just like any other licensing of its IP. In the context of intellectual property licenses, the most important exception is that, absent a contractual provision to the contrary, the non-debtor licensor usually must consent to the assignment of its intellectual property license to a third-party. Thus, if a licensee/debtor in bankruptcy seeks to sell an IP license, pursuant to Section 363 of the Bankruptcy Code, it must first “assume” and then “assign” the license with the non-debtor licensor’s consent. Accordingly, licensors enjoy substantial leverage in bankruptcy proceedings where their intellectual property licenses are important assets, or components of assets, in the Section 363 sale process, since they wield veto power over the sale by their debtor licensees. That veto power is found in Section 363 itself, which effectively provides that a debtor cannot transfer its IP license if applicable non-bankruptcy law would prevent the transfer.

Licensees therefore must be fully informed of the limitations on their rights in the sale process. If they are negotiating a license agreement – almost always at a time when bankruptcy is a remote and distant concern – the inclusion of a valid and enforceable clause specifically waiving the need for the licensor’s consent to a subsequent assumption or assignment should be considered, even though in many cases a licensee may lack the bargaining power to alter standard licensing terms. Prior to filing for bankruptcy, the licensee also should carefully review all of its licenses to determine which require licensor consent for assignment. And, if the licensee actually proceeds to the sale process in bankruptcy and anticipates the need for the licensor’s consent to sell important licensed assets, gaining the licensor’s consent and cooperation should be a top consideration before the sale process even starts, so the licensor does not hold the sale process ransom to its demands upon the likely third-party buyer of the license.

The top priority for licensors, on the other hand, is to ensure that they enter into license agreements which clearly require their consent for an assignment. Once this is done, the licensor should be vigilant because it has the right to object to any bankruptcy plan or sale to assume and assign their license, provided an objection makes good business sense. One reason to object is to create leverage in negotiating – for the licensor – a more favorable termination or assignment of the license to a third-party.

If you have any questions or would like additional information about this series of Alerts or recent bankruptcy filings that may affect your business, please contact:

Bankruptcy and Creditors’ Rights Group:
Robert E. Nies ¦ Member of the Firm ¦ Phone (973) 530-2012 ¦ Email
Karen L. Gilman ¦ Member of the Firm ¦ Phone (973) 530-2006 ¦ Email
David N. Ravin ¦ Member of the Firm ¦ Phone (973) 530-2034 ¦ Email

Intellectual Property Group:
Peter E. Nussbaum ¦ Member of the Firm ¦ Phone (973) 530-2025 ¦ Email
Jeffrey M. Weinick ¦ Member of the Firm ¦ Phone (973) 530-2028 ¦ Email