How does Chapter 11 Bankruptcy affect Intellectual Property?

Intellectual Property during a Chapter 11 Bankruptcy

Many of you would recognize the name CBGB from t-shirts and slogans, all without knowing that the name originated from a legendary music venue in Manhattan. Even more interesting, the club has been closed since 2006. Yet, the investors who purchased it bought it for the naming rights, not the club. These rights, called intellectual property rights, are now in the midst of a Chapter 11 Bankruptcy filed on behalf of the investors. So the question is, what happens to those intellectual property rights during a Chapter 11 Bankruptcy?

In a typical Chapter 11 Bankruptcy, the case is administered in the following way: 1) rejection or assumption of executory contracts; (2) sale of assets; (3) claims adjudication; (4) litigation. For this article, we are only concerned with the first issue, the executory contract. A contract is considered to be executory if there is still an outstanding obligation by one or both parties to the contract, of which the terms were the consideration for entering into the contract. Bankruptcy Courts have found that non-exclusive licenses of intellectual property can not be assumed and assigned unless there is consent. Everett Systems, Inc. v. Cadtrack Corp, 89 F.3d (9th Cir. 1996).

Stepping back for a moment, let's put ourselves in the shoes of the person who has licensed intellectual property from a licensor who subsequently becomes bankrupt. In this scenario, when the license is an exclusive one, then it is treated as an executory contract. The licensor cannot sell those rights to anyone else, no more than the licensee can stop paying royalties. See Encino Bus. Management, Inc. v. Prize Frize, Inc. In those cases where the license is non-exclusive, Section 365(n) of the Chapter 11 Bankruptcy Code states that if the trustee or the Chapter 11 Debtor rejects "an executory contract under which the debtor is a licensor of a right to intellectual property", the licensee under the contract may:

1) treat the license as terminated and assert a claim for breach of contract; or

2) elect to retain its rights to the use of the intellectual property as such rights existed immediately before the commencement of the bankruptcy case, or the duration of the contract. 11 U.S.C. 365(n)(1)(B)

Thus, no matter what they choose the the licensee must be allowed to exercise either of its rights, and it must continue to make payments for the rights it is licensing for the duration of the contract.

It is important to note though that Section 365(n) does not apply to ALL contracts which contemplate or involve intellectual property. Rather, the contract must be one which the debtor is a "licensor of a right to intellectual property".

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