Counsel Should Draft IP Agreements With Bankruptcy in Mind

Unlike in the 20th century, today’s intellectual property portfolios are likely to be the most valuable assets to fuel restructuring or discharge debt. Distressed companies can effectively safeguard and monetize that IP to protect and maximize assets, raise capital, or divest from non-core product lines or service sectors.

Given the US Bankruptcy Code’s varying treatment of IP assets, in-house counsel must audit and analyze portfolios closely to preserve value most effectively and prepare for looming economic storms. The Bankruptcy Code specifically addresses patents, copyrights, trade secrets, and mask works—but not trademarks, which makes a robust portfolio audit crucial.

No company deliberately heads toward financial distress, but it’s never too early for an analysis to identify the most valuable IP so it can be safeguarded. Counsel can strategize to minimize IP-related risks both in and on the way to insolvency and maximize value well before experiencing choppy waters.

Even on a sunny day, counsel should take an informed approach to IP agreements. They should draft agreements with the possibility of market-driven bankruptcy conditions in mind to protect the IP holders’ rights. Periodic analysis and documentation should be undertaken to guard against future economic storms.

The Bankruptcy Code’s Section 365(n) explicitly gives options for patent, copyright, and trade secret agreements if a debtor-licensor rejects related agreements: Treat the license as terminated or continue using the licensed IP under the pre-rejection terms.

If choosing the latter, the licensee must continue paying royalties to the licensor-debtor, and its rights can’t be expanded or extended beyond the term of the underlying agreement. This makes it imperative to draft licensing terms that account for the possibility of bankruptcy when relying on other parties’ IP.

Although trademarks, trade names, and service marks aren’t included in the Bankruptcy Code’s definition of IP—meaning this election provision doesn’t apply—the US Supreme Court came to the rescue of licensees of rejected trademark licenses.

In Mission Product Holdings, Inc. v. Tempnology, LLC, the Supreme Court held that a debtor’s rejection of a contract in bankruptcy equates to a breach of contract, not a termination. Accordingly, a trademark licensee may still have the right to use the licensed trademark—even after a debtor-licensor’s rejection—like it would if the licensor had breached the agreement outside of bankruptcy.

But when proceeding after license rejection, trademark licensees must rely on judicial precedent rather than Bankruptcy Code protection. Trademark licensees also may have to overcome the unique risk of trademark abandonment if the debtor-licensor fails to maintain quality control after rejection.

Understanding and documenting how existing IP licenses are treated in bankruptcy requires assessing the potential for assumption, assumption and assignment, or rejection of licenses. Early analysis of licenses’ relative value enables counsel to negotiate with debtors regarding any assumption, assumption and assignment, or rejection during bankruptcy.

Such practices also help ensure all requisite formalities that should be consistently performed to protect ownership rights are in place for employees and licensing and development partners.

To avoid any ownership gaps, for example, documents evidencing transfer of ownership should be properly executed and timely recorded. Employee terminations can complicate communication regarding ownership, value, and duration of IP rights unless documentation has been generated and maintained prior to a reduction in force.

Additionally, as first mates leave the sinking ship, standard processes for non-competition and non-disclosure agreements often falter because no one is there to implement them; as a result, protected trade secrets disembark with those leaving for safer shores.

To ensure potential purchasers or lenders positively perceive the value of the company’s IP, it is crucial to maintain a proper inventory and analysis of the complete portfolio. Perceived disorganization or mismanagement of a company’s portfolio can tarnish the appearance of value to potential buyers or lenders who are considering IP as collateral.

Analysis should include a determination of what IP to maintain—as well as what IP to abandon and what to sell or exclusively license to others for revenue generation. Independent portfolio analysis usually provides recommendations on patent lapse and licensing.

One of the quickest ways to identify patents worth culling (or lapsing) is to review technologies reaching the end of their shelf lives. A validation exercise using Cooperative Patent Classification codes and abandonment of your portfolios and competitors’ portfolios also may aid the exercise. Licensing recommendations typically include lists of target companies in adjacent markets that may allow revenue generation without loss of competitive advantage in the primary market.

Some of this can be used to entertain stalking-horse offers at a bankruptcy’s start or in earlier, less formal debt remedies, such as workouts or assignments for the benefit of creditors. Automating this analysis is equally valuable for managing renewal budgets. The decision whether to jettison cargo or put it in the lifeboats essentially requires recognizing and documenting value using objective, data-driven analysis.

In this way, IP counsel can prepare to navigate bankruptcy’s complex framework while maximizing value. Licensors should carefully review their agreements to understand the implications of their own bankruptcies and be prepared to assert their rights.

Licensees must be ready to make key decisions, in writing, promptly after the debtor’s motion or notice to reject a license. This enables bankruptcy counsel to make requests at a bankruptcy’s start and object to the sale of key IP to offset debt.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Christine McCarthy is a partner at Barnes & Thornburg who focuses her practice on electrical, telecommunications and computer software implemented technologies. She advises global clients on strategic IP portfolio management, standards essential patents, and patent licensing.

Molly Sigler is a partner at Barnes & Thornburg who focuses on insolvency matters, representing creditors in bankruptcies and receivers in receiverships nationwide, and efficiently advancing complex, multilayered cases toward resolution.

Gurpreet Kaur is vice president of intellectual property at UnitedLex, where she leads patent, trademark, and litigation teams and advises clients on IP strategy and operations.

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