Restructuring

Contributed by Katherine Doorley
Yesterday, we posted the first part of our coverage of the June 4, 2013 field hearing of the American Bankruptcy Institute’s Commission to Study the Reform of Chapter 11.  After a thorough discussion of leases of non-residential real property, the ABI Commission turned to its second panel of the day, which discussed potential reforms to the provisions of section 365 of the Bankruptcy Code governing licenses of intellectual property. Robert L. Eisenbach, III, a partner at Cooley LLP, and Lisa Hill Fenning, a partner at Arnold & Porter LLP, presented testimony.
Eisenbach’s testimony, which is available here, focused on what he perceived to be the three main problems facing licensors and licensees in a bankruptcy context: (i) the circuit split over the interpretation of section 365(c)(1) of the Bankruptcy Code, when a debtor, who is also a licensee, seeks to assume, but not assign, an intellectual property license, and the circuit split over the application of section 365(g) when an intellectual-property license is rejected by a debtor, who is also a licensor; (ii) the need for further clarification that consent to the assignment of a license in a prepetition license agreement constitutes consent for the purposes of section 365(c)(1)(B); and (iii) the need for amendments to section 365(n) to remove ambiguity created by the Bankruptcy Code’s definition of intellectual property.  Eisenbach first discussed the circuit split on whether a trustee or debtor in possession may assume “in bound” intellectual property licenses, (i.e., licenses where the debtor is the licensee and is obtaining the rights to use intellectual property).  The two main tests used by courts in determining whether the debtor may assume such licenses are the “hypothetical test” and the “actual test.”  Under the hypothetical test, the court interprets section 365(c)(1) to consider whether a debtor may hypothetically assign an intellectual property license, even if the debtor is merely proposing to assume the license.  Under this test, if the debtor may not assign the license in question, the debtor will not be permitted to assume the license.  By contrast, the actual test considers only what the debtor actually proposes to do with the license.  Under the actual test, a debtor would be allowed to assume an intellectual property license so long as the debtor only intends to assume, and not assign, the license.  Eisenbach proposed that the actual test be adopted to allow debtors to freely assume intellectual property licenses.
The second circuit split over section 365(c)(1) discussed by Eisenbach was the split between courts that follow the decision in Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., in which the United States Court of Appeals for the Fourth Circuit held that non-debtor Lubrizol, a nonexclusive patent licensee whose license was rejected by the debtor/licensor, could not continue to use the technology provided under the license despite certain provisions in the license agreement and the United States Court of Appeals for the Seventh Circuit’s decision in Sunbeam Prods., Inc. v. Chicago Am. Mfg., LLC, which held that rejection of a trademark license did not abrogate the licensee’s contractual rights, and the licensee was still entitled to utilize its licensed trademarks.  Eisenbach proposed that the ABI Commission draft a clarifying amendment for section 365(g) of the Bankruptcy Code expressly adopting Lubrizol, which would leave section 365(n) of the Bankruptcy Code as the “sole protective provision for licensees whose licensors reject the license in bankruptcy.” Section 365(g) provides that the rejection of an executory contract constitutes a breach of said contract.  Section 365(n) provides certain protections for licensees of intellectual property whose agreements are rejected by a trustee or debtor in possession, including the option to elect to retain the rights to the licensed intellectual property.  Eisenbach noted that Lubrizol has been considered good law for almost 27 years and that the Sunbeam decision has created uncertainty in an area of the law where there had been relative certainty on all sides.
Eisenbach then briefly discussed the issue of consent with respect to licenses. Under section 365(c)(1)(B), a non-debtor party to a license is excused from accepting performance from, and is not required to provide performance to, any entity other than the debtor, without the non-debtor’s consent.  Certain license agreements, however, permit assignments.  Several courts view prepetition consent sufficient for the purposes of section 365(c)(1)(B), but courts are not unanimous on this issue.  Eisenbach has recommended that the ABI Commission propose amendments to section 365(c)(1)(B) clarifying that prepetition consent in a license agreement would constitute consent for the purposes of the Bankruptcy Code.
Finally, Eisenbach turned to the definition of “intellectual property” under section 101(35A) of the Bankruptcy Code.  Only “intellectual property” as defined in the Bankruptcy Code receives protection under section 365(n).  While the definitions under section 101(35A) include United States patents, as Eisenbach noted, it is unclear whether the protections of section 365(n) extend to foreign patents, because foreign patents are not included in the definition of “intellectual property.”  The uncertainty as to whether foreign patents are protected under section 365(n) has increased transactional costs as parties insist on complex agreements to protect their rights.  Eisenbach recommended that section 101(35A) be amended to provide express coverage for foreign patents and patent applications.
Fenning largely agreed with Eisenbach on the three major issues facing licensors and licensees of intellectual property.  Specifically, Fenning’s written testimony and her presentation to the Commissioners focused broadly on three main issues: (i) whether the assumption or assignment of intellectual property licenses requires consent; (ii) the scope and effect of the Bankruptcy Code on the rights of licensees in cases where the debtor was not a direct party to a pre-existing license; and (iii) amendments to section 365(n) of the Bankruptcy code.
Like Eisenbach, Fenning stated that debtors should be allowed to assume intellectual property licenses, but she argued that adoption of the actual test was problematic.  She noted that, often, the entity emerging from bankruptcy bears little to no relationship to the prepetition license holder, particularly given the prevalence of sales under section 363 of the Bankruptcy Code.  Fenning expressed concern that adopting the actual test could go too far, particularly in the case of licensors who are vigilant about the quality and reputation of their brands.  Rather than adopting the actual test, Fenning suggested creating a separate test for assumability of intellectual property licenses by a reorganized debtor.  Specifically, she recommended that intellectual property licenses be freely assumable by a reorganized debtor unless a change in control provision requires express consent.
Like Eisenbach, Fenning expressed concern that section 365(n) fails to protect trademarks, foreign patents and various “penumbras” of intellectual property rights.  Fenning suggested revisions to section 365(n), including an expanded definition of intellectual property under section 101(35A).  In particular, Fenning asserted that section 365(n) is under-inclusive because it does not cover intellectual property obtained from a debtor’s predecessors.  Fenning argued for the adoption of amendments that would protect all prior licenses of a debtor and that a debtor should not be able to refuse to comply with section 365(n) simply because the license was granted to a predecessor of the debtor.
The questions of the Commissioners focused primarily on the issue of assumption.  In particular, the Commissioners focused on Fenning’s concerns regarding change in control and whether it was possible to draft language that would not ultimately result in a change in control provision becoming an ipso facto clause.  They also asked whether it was even possible to adopt a bright-line change in control test with regard to the assumption of intellectual property licenses.  The Commissioners and the panelists also discussed several other nuanced aspects of the interplay between intellectual property law, current industry practices and the Bankruptcy Code.  We encourage you to watch the hearing video and review the written testimony of the panelists, all of which is available here.  Future field hearings of the ABI Commission will be held on November 1, 2013 in Atlanta at the annual meeting of the National Conference of Bankruptcy Judges and on November 22, 2013 in Austin at the Jay L. Westbrook Bankruptcy Conference.