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Examining the Different Treatment in Bankruptcy for Exclusive vs. Non-Exclusive License Agreements

January 2010

Wolff & Samson IP/Bankruptcy Law Alert

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

The filing of a corporate bankruptcy is often a last-ditch effort to preserve value, primarily for lenders with liens on assets, but also for unsecured creditors and equity shareholders. While every company’s preference is to realize going-concern values, the reality in the last several years is that bankruptcy has become a forum in which companies are often sold on the cheap or assets are sold piecemeal for cents on the dollar.

Generally, a company in bankruptcy has the right, subject to the bankruptcy court’s approval, to maximize the value of its executory contracts - - those for which both parties continue to have performance obligations. These contracts include intellectual property licenses, the value of which may be maximized by selling them to third-parties. A debtor has three options: the debtor may assume the license and continue using it in its reorganized business; a debtor also may assume and then assign the license to a third-party buyer for valuable consideration; or a debtor may reject the license, walk away from its contractual obligations, and leave the other party holding an unsecured damage claim in the bankruptcy. This right is an integral and valuable part of the bankruptcy process -- a process designed to facilitate the debtor’s restructuring, minimize its economic losses, and maximize the value of assets for the benefit of creditor and equity constituents.

A non-exclusive IP license is one in which multiple parties have been granted, by a licensor, certain rights and use privileges regarding an IP asset. Most non-exclusive license agreements are subject to the debtor’s assumption, assignment or rejection powers, each of which will have different legal and practical implications if the debtor in bankruptcy is a licensor or licensee. For example, if the debtor is the licensor and rejects or terminates the license agreement, the licensee normally would be prohibited from continuing to use the licensed intellectual property; depending on the nature of the licensee’s business, this may have serious financial implications. Section 363 of the Bankruptcy Code, however, allows the licensee of a rejected license to “elect” to retain its rights under the license, upon certain conditions such as continuing to pay license royalties. While the Bankruptcy Code grants these statutory protections for copyright and patent licensees whose contracts have been rejected, trademark and service mark licensees share no such protection and must seek relief under equitable grounds.

Exclusive license agreements are different. An exclusive license grants rights and privileges to a single entity, which sometimes has re-licensing privileges. Accordingly, an exclusive license agreement, without any on-going obligations to perform by the licensor other than to collect royalties, may be deemed by a court to be an outright sale rather than a license. In that case, the section 365 protections discussed above may not apply to the licensee and, if it is a debtor in bankruptcy, it will be free to transfer the asset without the licensor’s consent. The battle over whether the exclusive license is executory or an outright sale therefore may become paramount.

Accordingly, depending in part upon whether the rights to use the IP asset are exclusive or non-exclusive, a licensee that is the debtor may find itself in a competitive position vis-à-vis the licensor of its IP license. Generally, a licensee of intellectual property must meet certain criteria before assuming and/or assigning its license. An “assumed” license allows the debtor to cure any defaults and continue to use the license in bankruptcy and upon emerging from bankruptcy. An “assigned” license allows a third-party to use the license, with consideration for that use flowing to the licensee, not the licensor. Typically, a licensor must consent to the licensee’s assumption or assignment, but there is a split in the current state of the law, with the majority of courts holding that if a licensor can prohibit, hypothetically under non-bankruptcy law, its license from being assigned to another party, then the licensor may withhold its consent from the licensee either assigning or even assuming the license. The practical effect of these decisions is that licensees filing for bankruptcy could lose their licenses at the licensor’s discretion, unless certain precautions are taken when the license agreement is entered into. For this reason, the licensee may want to consider whether it can “forum shop”, i.e., seek a bankruptcy venue which follows the minority rule on this issue; this rule permits a licensor to withhold its consent from the licensee’s assumption or assignment of a license agreement only if the licensee intends in fact to assign its license to a third party. In the latter case, the licensor could prevent a sale of the license to a third party buyer, but could not prevent the licensee from using the license in its reorganization or upon its emergence from bankruptcy. Creative counsel may therefore structure the deal as a stock purchase, rather than an asset sale to a third-party, if the transfer of the IP is the critical aspect of the deal.

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