Solving insolvencies

Attorneys Beni Surpin, Victor Vilaplana and Marshall Hogan of law firm Foley & Lardner outline five insolvency-related issues to keep in mind while transacting for and in connection with intellectual property across borders

Brexit. Donald Trump. The year 2016 can be characterised as one of unpredicted results and impending uncertainty.

In June, the UK electorate voted to leave the EU and in November, a tumultuous presidential campaign in the US ended in a stunning win for Trump. Businesses throughout the world sought not only to understand the possible implications of these and other major events, but also to take strategic advantage of them.

As we move in to 2017, both domestic and international companies are looking beyond their borders to protect against risks and capitalise on strategic opportunities across a changing international business landscape. As a result, many companies are re-evaluating their intellectual property agreements and assessing the risks of cross-border licensing. International insolvency law can add another layer of complexity to such transactions.

Here are five insolvency-related issues to keep in mind while transacting for and in connection with intellectual property across borders.

US bankruptcy law is far more protective of the rights of IP licensees than other legal regimes

Companies seeking to license IP to or from entities in other countries should be aware that licensees are not likely to be given the same protections as they are afforded in the US in the event their licensor enters insolvency proceedings. In the US and in most countries around the world, the bankruptcy trustee or administrator has the right to reject certain pre-petition contracts of the debtor.

However, the US Bankruptcy Code contains a special protection for licensees of IP against such rejection powers in Section 365(n). Its provisions protect licensees from being stripped of their rights under a licence agreement and allow them to retain rights (subject to making all royalty payments due, pursuant to related Section 365(n)(2)), including rights to exclusivity.

Other countries, such as Germany, do not afford special protections to IP contracts and they are treated the same as other executory contracts. Companies within the US should be mindful of this difference when contemplating entering into licence agreements with entities outside of the US. Companies outside of the US may want to consider this benefit of licensing IP from US-based companies.

Companies should also be aware of the limits of Section 365(n). While it clearly applies to patents and copyright, its application to trademarks has been the subject of litigation. Some recent cases, such as Re Crumbs Bake Shop of 2014 and Sunbeam Products v Chicago American Manufacturing of 2012, have afforded the protections of 365(n) to trademark licensees. In addition, there is some debate as to whether ‘intellectual property’ includes foreign copyright or trademarks, as the US Bankruptcy Code defines the term to include patents and copyright entitled to protection under the US federal law.

A foreign debtor can obtain the protections of the US Bankruptcy Code through Chapter 15

US-based companies transacting with foreign parties with regard to US-based assets and IP should also be aware of Chapter 15 of the Bankruptcy Code. By filing Chapter 15 bankruptcy proceedings in the US and obtaining recognition of a foreign main proceeding, a foreign debtor (through its “foreign representative”) can obtain the assistance of the US bankruptcy courts in protecting US-based assets of the foreign debtor.

For instance, after recognition of a foreign proceeding as a foreign main proceeding under Chapter 15, a foreign debtor immediately obtains the protection of the automatic stay, which is a very broad protection prohibiting any attempt by a creditor to enforce a pre-petition debt or foreclose on an interest in property. In addition, US bankruptcy courts can bind creditors and other parties to rulings of the foreign debtor’s foreign bankruptcy proceedings, even if such rulings are at odds with the US Bankruptcy Code.

For example, Section 365 and its subsection (n) are not automatically applicable in a Chapter 15 bankruptcy case. However, bankruptcy courts are authorised to order that it is applicable, as the bankruptcy court did in 2013’s Jaffe v Samsung Electronics, which concerned approximately 4,000 US patents owned by Qimondo.

US licensees of IP may face challenges when seeking to benefit from the protections of Section 365(n) in cross-border insolvency proceedings

When a foreign licensor of US IP goes bankrupt, will its US-based licensees be entitled to the protections of Section 365(n)? A recent case suggests that US courts may be inclined to answer positively.

In Jaffe v Samsung, a foreign licensor of US patents filed for bankruptcy protection in Germany. The bankruptcy administrator also petitioned the US Bankruptcy Court in Virginia under Chapter 15 for recognition of the German bankruptcy proceeding as a foreign main proceeding. The US Bankruptcy Court granted the petition and provided, on its own, that Section 365 would apply (as mentioned above, it does not automatically apply in Chapter 15 cases).

As part of liquidating the foreign debtor’s assets, the German bankruptcy administrator determined that several licence agreements for US patents were no longer favourable to the debtor. The German administrator rejected the licences in the foreign proceeding and filed a motion with the US Bankruptcy Court to determine (contrary to the court’s earlier order) that Section 365(n) would not apply. Over the opposition of many licensees, the US Bankruptcy Court effectively granted the German administrator’s motion, holding that 365(n) did not apply unless the German administrator was seeking to reject a contract pursuant specifically to Section 365 (rather than pursuant to German law).

On appeal, the district court remanded and ordered that the Bankruptcy Court consider whether the interests of the creditors and other interested entities, including the debtor, were sufficiently protected pursuant to section 1522(a) of the Bankruptcy Code. Section 1522(a) states that the court may recognise a foreign proceeding “only if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected”. On remand, the Bankruptcy Court determined that, after balancing the interests of the creditors and the foreign debtor, 365(n) should apply. The Court of Appeals for the Fourth Circuit affirmed this holding.

The Jaffe v Samsung decision is an important tool for licensees of IP owned by a foreign entity, but its holding appears somewhat limited to its facts. For instance, the Fourth Circuit declined to impose a broad, across-the-board prohibition on rejecting licence agreements without applying Section 365(n). As a result, some uncertainty remains as to whether US-based licensees of a foreign debtor can count on obtaining the protections of 365(n)’s protections in the context of a Chapter 15.

Various strategies can help licensees protect their IP rights against risks of insolvency of foreign debtors

Licensees transacting with foreign licensors have a range of options for protecting against the risk that the licence will be rejected in a foreign bankruptcy. These options include:

  • Requiring that the licensor deposit the technology to a bankruptcy-remote special purpose entity (SPE) in the US;

  • Obtaining a lien on the IP to secure performance on the licence; and

  • Including provisions in the licence to improve the licensee’s position in litigation should it become embroiled in a Jaffe v Samsung-type situation, including provisions expressly recognising the Section 365(n) protections, the materiality of the 365(n)-type obligation, and the importance of the licence.

US bankruptcy law can also more robustly protect the rights of IP licensors than foreign law

Licensors’ rights can also be put at risk by the bankruptcies of their licence counterparties. Section 365(f)(1) of the Bankruptcy Code generally empowers a debtor or trustee in bankruptcy to assume and assign executory contract rights to third parties notwithstanding non-assignment provisions. However, Section 365(c) of the Bankruptcy Code creates a narrow exception to this general rule, excusing the non-bankrupt party from accepting performance from a party other than the debtor.

This exception is generally held to apply to non-exclusive licenses of US patents and copyright because applicable non-bankruptcy US law favours the ability of owners of such IP rights to control the identity of their licensees. However, where a licence is governed by foreign law, the result may differ from US law. As a result, in assessing risk, IP licensors should be mindful of this potential difference when contracting for a licence governed by non-US law.

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