IP Licenses and U.S. Insolvency Law:

1. IP Licenses and U.S. Insolvency Law: The Sexiest Intersection on Bankruptcy Boulevard

2. 1 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

3. 2 The Clash of Bankruptcy Law and Patent Law Bankruptcy Law: Free assignability of contracts is fundamental to a business’s successful reorganization and re-emergence from bankruptcy. Patent Law: Non-exclusive patents are not freely assignable; fundamental to patent law is the patent holder’s right to exclude others from using the patent.

4. 3 U.S. Bankruptcy Code Key Provisions Bankruptcy’s Goal: relieve honest debtors of debts and provide them with a fresh start Section 541 - The Bankruptcy Estate Sweeping, inclusive definition of debtor’s 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 company’s bankruptcy

5. 4 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

6. 5 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.

7. 6 Debtor as Licensor May the debtor-licensor reject the license? Section 365(n) enacted in response to Fourth Circuit’s 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.

8. 7 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

9. 8 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 licensor’s consent to keep its patent license.

10. 9 Debtor as Licensee (cont’d) 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 licensor’s consent, the debtor-licensee could not assume the license.

11. 10 Debtor as Licensee (cont’d) 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 licensor’s 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).

12. 11 Debtor as Licensee (cont’d) 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

13. 12 Debtor as Licensee (cont’d) 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.

14. 13 Debtor as Licensee (cont’d) 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 licensor’s consent) is applicable non-bankruptcy law. Which means: debtor cannot assign its non-exclusive patent licenses without licensor’s 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 licensor’s consent, even if it does not intend to assign that license.

15. 14 Debtor as Licensee (cont’d) 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.

16. 15 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 software’s developers).

17. 16 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.

18. 17 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 Nextwave’s licenses, declaring they were cancelled upon Nextwave’s 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 FCC’s revocation of its licenses under the arbitrary and capricious standard.

19. 18 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.

20. 19 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 government’s ability to hide behind a regulatory flag. Market predictability is redeemed. Bankruptcy priority is restored.

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