C.A.G. Insights

Terms of an Intellectual Property License May Dictate IP Rights of Parties in Bankruptcy

As a result of the debilitating effects from COVID-19, businesses have been forced, or will be forced, to permanently close their doors.  Consequently, some of these businesses will seek relief from their outstanding debts, in bankruptcy, which may cause potential issues with intellectual property agreements.

Generally, companies that file for bankruptcy use Chapter 11, which provides for the “reorganization” of the entity and usually allows the companies’ managers to remain in control of the company.  The primary goal of bankruptcy proceedings is to maximize the recoveries of the creditors by increasing the value of the assets owned by the company (i.e., bankruptcy estate) through various mechanisms afforded by Congress in the Bankruptcy Code.  One particular mechanism – rejection of executory contracts – enables companies to get rid of unfavorable contracts with minimal repercussions.

Intellectual Property and Executory Contracts

Executory contracts are generally defined as contracts where both parties owe substantial performance, and a failure by one of the parties to perform would constitute a material breach and excuse the other party’s continuing performance.  In most situations, intellectual property licenses qualify as executory contracts and enable debtor-companies (i.e., licensors) to get out of licensing their intellectual property.

However, the licensees to these intellectual property licenses are not left completely empty-handed in the event that the licensors reject the licenses.  Congress has afforded some protection to licensees of “covered” intellectual property, such as patents and copyrights.  In these situations, Congress allows the licensees to continue using the covered intellectual property for the agreed upon duration, as long as the licensee continues to fulfill their obligations.

Curiously, trademarks were not explicitly named as covered intellectual property by Congress; they are treated slightly different from their covered counterparts.  In 2019, the Supreme Court resolved the ambiguity around the rejection of trademark licensing agreements; the Supreme Court  held that trademark licensees may similarly continue to use the trademark under the agreed upon terms but with a couple of caveats: (1) the bankruptcy court must find that the licensee’s rights would survive this breach under non-bankruptcy law; and (2) the statutory limitations on a licensee’s post-rejection rights do not apply.

Consequently, a licensee’s right to continue to use a trademark post-rejection hinges on the terms of the licensing agreements and the state law governing the agreements.  Additionally, because the statutory limitations on trademark licensees do not apply, trademark licensees may be able to receive more expansive rights than licensees of covered intellectual property.  Thus, it is imperative for both parties to carefully craft these intellectual property agreements with a potential bankruptcy filing in mind.

Takeaways for Parties to an Intellectual Property License Subject to Bankruptcy

Bankruptcy filings enable debtors the ability to get out of certain unfavorable agreements, such as intellectual property licenses.

Licensees of rejected “covered” intellectual property agreements retain the ability to continue using the covered intellectual property under the agreed upon terms.

Licensing terms and state law will dictate whether licensees may continue to use the trademark under the agreed upon terms.

Without careful consideration of licensing terms, trademark licensees may be able to receive more expansive post-rejection rights compared to licensees of covered intellectual property.