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10/12/2009: Bankruptcy Filing May Affect Intellectual Property Holdings

Category: Law

In these challenging economic times, protecting intellectual property is paramount. This is especially true as bankruptcy filings continue to soar. For businesses, it is important to understand how intellectual property is treated under bankruptcy law.

Business bankruptcy filings totaled 55,021 for the 12-month period ending June 30, up a whopping 63 percent from the 33,822 filings for the 12-month period ending June 30, 2008, according to statistics released in August by the Administrative Office of the U.S. Courts.

Bankruptcy gives the debtor company broad authority to cancel contracts with other companies.  For example, Chrysler used this power, given under Section 365 of the Bankruptcy Code, to terminate more than 700 dealer franchise agreements.

An amendment that was enacted in 1988 limits the ability of bankrupt companies that have licensed their intellectual property to others to terminate the licensee’s rights over the objection of the licensee. However, the amendment does not extend this protection to all kinds of intellectual property. Frank Perch, a bankruptcy attorney at the Savannah law firm of HunterMaclean, said Congress defined intellectual property in Section 365 to include trade secrets, copyrights, patents and patent applications, but did not include trademarks.

As a result, for businesses that incorporate another entity’s trademarks into their product, the licensor’s bankruptcy filing could have dire consequences. For example, consider a Hewlett-Packard computer with an Intel processor. Hewlett-Packard has a license to use Intel’s copyrighted material and the associated trademark. If Intel were to file for bankruptcy, Hewlett-Packard would still be able to use the Intel processor, but the use of the trademark could be in jeopardy.

Rachel Young, who specializes in intellectual property law at HunterMaclean, said trademarks are different from other intellectual property in that they exist perpetually as long as they are in continuous use and have not become generic. On the contrary, patents and copyrights are granted for a limited time.

This difference adds more negotiable value to the trademark, Perch said, citing the recent liquidations of retailers such as Circuit City, Linens & Things and Montgomery Ward. Even after the stores were liquidated, the trademarks were sold for substantial sums that were distributed among the creditors. The former retailers’ trademarks are now being used to operate online stores under different ownership.

“There are a lot of situations where trademarks are deemed to have value in bankruptcy,” Perch explained, “Even when the company has been liquidated.”
Young said a trademark owner such as Intel may still choose to license its trademark to the current business partner, but because the trademark license is not protected by Section 365, the licensor may renegotiate for better terms. The licensor also could sell the trademark to a competitor for a higher price.

“The trustee might be willing to continue to license the trademark, but they’re going to want to negotiate for more favorable terms,” Young said. “If the trademark adds substantial value to the licensee's product ,the trustee is going to have much greater leverage to negotiate the terms of the license.”

To protect one’s business interests, Young and Perch recommend a few ways that a licensee could avoid the pitfalls of Section 365. First, a licensee could negotiate for ownership of the trademark, which could possibly be coupled with a license back to the now-former trademark owner. Notably, while ownership would ensure protection, trademark owners are not likely to sell their interests without a sizeable offer.

Another strategy would be to take a security interest in the licensor’s other assets, Young said. “A security interest could compensate the licensee for loss of the use of the mark,” she explained. “But it’s also a way for the licensee to gain leverage to keep the licensing agreement.”
If a company fails to negotiate for either of the previous trademark deals, Perch and Young recommend seeking counsel as soon as a bankruptcy is filed to challenge the decision to reject the trademark license.

An attorney could argue that the decision to reject is an inappropriate exercise of the debtor’s business judgment.

Because of the trademark license’s special circumstances, Young recommends separating trademark agreements from other types of intellectual property contracts.  Section 365 allows trade secret, patent and copyright licensees to retain their rights to use the intellectual property, but in return the licensee must continue to pay royalties.  Thus, with a bundled payment, a licensee could face paying for a rejected trademark license in order to keep using the other types of intellectual property.

Perch and Young also stressed that the protection given by Section 365 is limited.  A licensor may still reject the patent, trade secret or copyright license. If the license is rejected, Section 365 grants the licensee the ability to use the intellectual property and enforce exclusivity provisions, but the licensor is no longer responsible for updating or continuing to develop the intellectual property.

Also, Section 365 only applies to actual license rights before bankruptcy and does not apply to an agreement to grant a license at some later date. To ensure that these and any other possible problems are addressed, consider having an attorney present when drafting any contract, Perch said.

“As in most cases, it is better to have an attorney review these issues at the start of the contract rather than later,” Perch added. “A little forethought now can save you a big headache later.”

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