In law, the term “intellectual property” is used to define intangible rights protecting commercially valuable products.[1] Mostly comprised of trademarks, copyrights, and patents, but also includes trade secrets, rights of publicity, moral rights, and rights against unfair competition.[2] People have become more familiar with these types of assets with the explosion of the Internet and the creation of internet tokens, the metaverse, as well as traditional forms of protections for invention, artistic works, and logos. This type of property is different than tangible assets like cars, homes, or even money. This post will look at how bankruptcy impacts intellectual property assets both from the debtor’s and creditor’s perspective.
Bankruptcy is an extraordinarily complex area of the law and should not be entered into without careful contemplation, usually after consulting with an attorney. There are various types of bankruptcy, but two of the most common are Chapter 7 and Chapter 11. To provide a simple overview, when a company or an individual files for Chapter 7 any nonexempt assets belonging to the debtor will be sold off and the profits will be distributed amongst the creditors. The debts will then be discharged. This is different than a Chapter 11 filing. In Chapter 11 bankruptcy, the debtor works with the creditors to reduce the debts. Once the debts are reduced, the debtor only owes the renegotiated debts and still functions as a person or an entity. There are specific requirements for any kind of bankruptcy; if you’re considering filing for bankruptcy, we strongly suggest that you consult a bankruptcy attorney for advice on how to proceed, as this article will focus on the intellectual property element. For creditors, it is especially important to note that whenever a debtor files for bankruptcy, there is an automatic stay order for any collection attempts. Do not attempt to collect a debt when there is an automatic stay in place; instead, contact the trustee of the bankruptcy to ensure your debt is listed with them.
Copyrights and bankruptcy can be approached from two viewpoints. The first is from the perspective of the person who owns the intellectual property (the “rights holder”) declares bankruptcy. The other way is when a person who licenses intellectual property (a “Licensee”), learns that a rightsholder of the intellectual property has declared bankruptcy.
If a rights holder declares bankruptcy, then the intellectual property is treated just like any other asset. An example of this can be found in the Death Row Records case. In 2006, the record label Death Row Records filed for bankruptcy. Death Row Records had to auction of the record label’s copyrights in the music it produced. This is the simplest way in which the distribution of assets can occur. The reason these assets were auctioned off was to determine the fair market value of the property. After the rights are transferred to the new owner, that new owner can use the intellectual property as they see fit. To pull from the previous example, this meant that the new owner of Death Row Records’ Intellectual Property could re-release songs, remix tracks, and distribute material without any regard to Death Row Records after the bankruptcy proceedings concluded.
Whenever rights holder has declared bankruptcy, licensees are left in a very precarious position. The actual ownership of the Intellectual Property may change as such, licensees do not know if they need to continue honoring the licensing agreement with the rightsholder or wait until the new owner obtains the property. If the Intellectual Property is transferred to a new owner, there is no promise that the new owner will maintain the previous license. To provide some stability Congress passed a specific provision to assist Licensees. Bankruptcy Code § 365(n) was enacted to provide certain protections to licensees of a “right to intellectual property.” This Bankruptcy Code (the “Code”) section was made to try and ensure that licensees of intellectual property receive something when the rights holder declares bankruptcy. The Bankruptcy Code has a specific definition of “intellectual property,” which includes trade secrets, patents, patent applications, plant varieties, copyrights, and mask works.[3] The Code does not address copyright registrations because registration is not a prerequisite for the existence of those rights.[4] Of note, this definition does not include trademarks or foreign patents.
There are two options for a licensee of intellectual property, as defined by the Code, when a rights holder declares bankruptcy. Option one is to treat the bankruptcy as a material breach and terminate the licensing agreement.[5] If a licensee does this, then they no longer have a license to use the intellectual property and they get an unsecured claim for money in the amount of the damages. Option two is to modify the licensing agreement.[6] There are specific limitations on the modifications that can be done; under the Code, only the rights that are retained at the time that the debtor declares bankruptcy are allowed to continue. Depending on the requirements set out in the licensing agreement, the rights holder may not have to maintain the intellectual property during the bankruptcy. The Licensee will still need to provide any royalty payments to the debtor that are part of the license; Courts have defined royalties very broadly.[7] Also, the Licensee must waive any right of setoff for damages and any administrative priority claims under Code 503(b) related to the performance under the modified license.
As noted earlier, trademarks are not considered Intellectual Property under the Code. If you are the licensee of a trademark and the rights holder declares bankruptcy, you cannot declare a material breach or modify the licensing agreement, unless the license provides otherwise. Instead, Courts will treat the licensing agreement as it would prior to the bankruptcy declaration.[8] If the debtor or licensee attempts to cancel the contract, they will be found to be in material breach.[9]This means that there is not any specific relief set out by the Code for trademark licenses.
This article is a brief overview into the complex situation surrounding intellectual property and bankruptcy; as such not every factor or scenario was explained. It is advisable to speak with an attorney that specializes in these matters. Please reach out to me if you want to set up a complementary one hour consult to discuss your intellectual property needs.
[1] Black’s Legal Dictionary
[2] Ibid
[3] Bankruptcy Code § 101(35A)
[4] 17 U.S.C. § 201(a)
[5] Bankruptcy Code § 365(n)(1)(A)
[6] Bankruptcy Code § 365(n)(1)(B)
[7] See In re Prize Frize, Inc., 32 F.3d 426 (9th Cir. 1994) (determining that licensing fees are royalties).
[8] Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019) (The Court rejected an attempt by a licensor to terminate a trademark licensing agreement using standard bankruptcy processes.)
[9] Ibid