IP Licenses and U.S. Insolvency Law:

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IP Licenses and U.S. Insolvency Law

• The Sexiest Intersection on Bankruptcy Boulevard

William F. Gray, Jr., Es q. Zachary D.
Silbersher, Esq.
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OVERVIEW

• I. U.S. Bankruptcy Code Key Provisions
• II. The debtor as licensor
• III.The debtor as licensee
• IV.Source Code Escrow Agreements Are they worth
  it?
• V. The Nextwave case Where the government is the
  licensor

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The Clash of Bankruptcy Law and Patent Law

• Bankruptcy Law Free assignability of contracts
  is fundamental to a businesss successful
  reorganization and re-emergence from bankruptcy.
• Patent Law Non-exclusive patents are not freely
  assignable fundamental to patent law is the
  patent holders right to exclude others from
  using the patent.

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U.S. Bankruptcy Code Key Provisions

• Bankruptcys Goal relieve honest debtors of
  debts and provide them with a fresh start
• Section 541 - The Bankruptcy Estate
• Sweeping, inclusive definition of debtors
  property
• Consists of all legal and equitable interests of
  the debtor at the time of filing the petition.
• Property of the Estate includes contract rights
  (In re Computer Communications, Inc., 824 F.2d
  725 (9th Cir. 1987))
• Section 525 - Protection Against Discrimination
• prevents government discrimination on the basis
  of companys bankruptcy

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U.S. Bankruptcy Code Key Provisions

• Section 365(c) - Assumption
• invalidates provisions restricting assignment
  unless applicable non-bankruptcy law excuses the
  other party from accepting performance from an
  entity other than the debtor
• Section 365(f) - Assignment
• invalidates provisions restricting assignment
• subject to 365(c)
• Section 365(e) - Voids Ipso Facto Clauses
• invalidates provisions that terminate a license
  upon insolvency or bankruptcy.
• Nevertheless, non-assignment provisions and ipso
  facto clauses should always be placed in
  contracts even though they may be invalidated in
  bankruptcy

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IP Licenses are Executory Contracts

• Section 365 allows the trustee or
  debtor-in-possession to reject, assume or assign
  executory contracts.
• Executory contract a contract where neither
  party has yet to fully perform and failure to
  perform by either party would constitute a
  material breach.

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Debtor as Licensor

• May the debtor-licensor reject the license?
• Section 365(n) enacted in response to Fourth
  Circuits decision in Lubrizol Enterprises, Inc.
  v. Richmond Metal Finishers, Inc., 756 F.2d 1043
  (4th Cir. 1985).
• Without Section 365(n), debtor-licensors could
  reject their licenses and sell them to other
  parties for a greater benefit, hanging the
  original licensee out to dry.

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Debtor as Licensor

• Under Section 365(n), EVEN IF a debtor-licensor
  rejects a license, then the licensee may
• 1) treat the rejection as a breach and file a
  claim,
• the claim will be treated as pre-petition breach
• the licensee cannot continue using the license
• OR
• 2) keep its rights under the license for its
  remaining term and continue to make royalty
  payments.
• licensee waives any right to setoff
• licensee waives any right to an administrative
  expense claim

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Debtor as Licensee

• Remember Section 365(n)? It protects licensees
  when the debtor is the licensor. If the
  debtor-licensor rejects the license, the licensee
  can keep using it.
• Section 365 enables a debtor-licensee to assume
  or reject IP license as it chooses.
• Except, when the debtor is a patent licensee, it
  needs the licensors consent to keep its patent
  license.

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Debtor as Licensee (contd)

• In re Catapult Entertainment, Inc., 165 F.3d 747
  (9th Cir. 1999)
• Debtor-licensee wanted to assume its patent
  license in a reorganization plan.
• Licensor argued that since US federal patent law
  barred assignment without the licensors consent,
  the debtor-licensee could not assume the license.

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Debtor as Licensee (contd)

• In re Catapult Entertainment, Inc., 165 F.3d 747
  (9th Cir. 1999)
• Section 365(c) prevents a trustee or
  debtor-in-possession from assuming or assigning
  contracts if applicable non-bankruptcy law would
  hold that the non-debtor party is excused from
  accepting performance form anyone other than the
  debtor.
• If only Section 365(f) applied, then the U.S.
  federal patent statute (which prevents
  assignments of patent licenses without the
  licensors consent) would be applicable
  non-bankruptcy law, and would not be enforced.
• But, Section 365(f) states that it is subject to
  Section 365(c).

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Debtor as Licensee (contd)

• In re Catapult Entertainment, Inc., 165 F.3d 747
  (9th Cir. 1999)
• Under the language of Section 365(c),
  non-bankruptcy applicable law can prevent a
  trustee or debtor-in-possession from assuming or
  assigning executory contracts.
• The majority of courts interpret this language to
  make it difficult for insolvent technology
  companies to use their patents to reorganize.
• Two tests have emerged
• 1) Hypothetical Test
• 2) Actual Test

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Debtor as Licensee (contd)

• In re Catapult Entertainment, Inc., 165 F.3d 747
  (9th Cir. 1999)
• Hypothetical Test (Majority)
• The Hypothetical Test will not let a technology
  company assume a license if, hypothetically,
  applicable law would prevent it from assigning
  that license.

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Debtor as Licensee (contd)

• Three reasons the Hypothetical Test is bad for
  technology companies trying to reorganize
• 1. Section 365(c) controls instead of Section
  365(f).
• Which means applicable non-bankruptcy law that
  restricts assignment of licenses will apply.
• 2. The US federal patent statute (restricting
  assignment without licensors consent) is
  applicable non-bankruptcy law.
• Which means debtor cannot assign its
  non-exclusive patent licenses without licensors
  consent.
• 3. Following a literal reading of a Section
  365(c), non-assignability under applicable
  non-bankruptcy law also extends to the right to
  assume licenses.
• Which means a debtor-in-possession may not even
  assume a patent license without the licensors
  consent, even if it does not intend to assign
  that license.

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Debtor as Licensee (contd)

• Actual Test (Minority)
• Will the licensor have to accept performance from
  someone other than who it contracted?
• Therefore, a technology company in bankruptcy can
  assume its licenses, provided they will not be
  assigned.
• Which means the company can keep operations
  going in order to successfully reorganize.
• The First Circuit follows the Actual Test.
• Recently, a District Court in the Fourth Circuit
  followed the Actual Test.

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Source Code Escrow Agreements (SCEA)in
Bankruptcy Are they worth it?

• A licensee does not need an SCEA if Section
  365(n)(1)(B) and (n)(3) applies.
• Under those sections, a vendor can access source
  code over objections of the trustee, if
• the license is executory, due to continuing
  obligations of the vendor, and
• the license explicitly requires the vendor
  release the source code upon default.
• Practical Tip Source code is not helpful
  without expert consultants (i.e. programmers or
  the softwares developers).

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The Nextwave case Where the government is the
licensor

• F.C.C. v. Nextwave Personal Communications, Inc.,
  is a recent Supreme Court decision that will have
  broad implications for government licensing
  issues.
• Nextwave addresses whether a governmental agency
  can discriminate against a company in
  bankruptcy.

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The Nextwave case Where the government is the
licensor)

• The FCC used auctions to award broadband
  licenses. Two of the six auction blocks (C-Block
  and F-Block) were restricted to small businesses.
• The FCC revoked Nextwaves licenses, declaring
  they were cancelled upon Nextwaves breach of the
  payment obligations. Again the Second Circuit
  denied Nextwave relief. It reasoned that the FCC
  was acting as a regulator and not a creditor.
  Thus Nextwave could only challenge the FCCs
  revocation of its licenses under the arbitrary
  and capricious standard.

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The Nextwave case Where the government is the
licensor)

• The Supreme Court reversed and held for Nextwave.
  It held that the FCC violated Section 525 of the
  Bankruptcy Code which prevents government
  agencies from revoking licenses from debtors who
  are in bankruptcy for failure to pay a
  dischargeable debt.

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The Nextwave case Where the government is the
licensor

• By its holding, the Supreme Court realigned the
  priority of the Bankruptcy Code with respect to
  government issued licenses. Nextwave foreclosed
  the governments ability to hide behind a
  regulatory flag.
• Market predictability is redeemed.
• Bankruptcy priority is restored.

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