Intellectual Property Rights and Strategies in Bankruptcy

Transcription

1 Intellectual Property Rights and Strategies in April Morrison & Foerster LLP All Rights Reserved

2 I. Market Overview II. The Rise and Importance of Intellectual Property Rights III. Strategies for Acquiring Intellectual Property in

3 Market Overview

4 Based on the bankruptcy filings and restructurings in the past year alone, the deepening financial crisis and tightening credit markets have affected virtually every industry and investor. In the US, the 29,960 business bankruptcies recorded during the first three quarters of 2008 (Jan. 1 Sept. 30) eclipsed the full year 2007 (Jan. 1- Dec. 31) business filing total of 28,137. In 2008, there were 140 bankruptcy filings of public companies with assets of $100 million or more. Chapter 11 business filings spiked to 2,485 during the third quarter of 2008, an increase of 76 percent over the 1,410 filings during the similar period in 2007.

5 According to data.com, major US company filings reached 231 in By comparison, 289 major bankruptcies were filed in 2000 and 383 in 2001 (during the dotcom bust). The number of major bankruptcies in 2009 could well exceed 400 assuming predicted rates of default and bankruptcy filings trend together. See NYU s Altman Sees 2009 Default Rate Doubling Multiple industries likely to be impacted those affected by increased fuel costs and decreased consumer spending (such as retail, transportation, food and beverage, and manufacturing) capital-intensive businesses those that rely on commercial paper, or seasonal or other regular financing.

6 The Rise and Importance of Intellectual Property Rights

7 Ability to exploit and transfer rights to intellectual property is a critical feature of an integrated global economy. Increase in value of intellectual property to companies. Intellectual property rights are critical to the operation of many businesses. often provides unique opportunities to obtain high quality and useful IP technology.

8 B. Right to Assume or Reject Executory Contracts Debtor in possession (or the bankruptcy trustee) has the exclusive right to assume (accept) or reject (disavow) an executory contract in existence at the commencement of the bankruptcy case. In certain circumstances, the debtor in possession (or the bankruptcy trustee), can assume and assign (sell) executory contracts. Debtor s decision to assume or reject an executory contract is subject to court approval. Court applies a business judgment standard.

9 B. Right to Assume or Reject Executory Contracts (Cont.) Contract provisions automatically terminating the contract upon a bankruptcy filing (ipso facto clauses) generally are unenforceable. In a Chapter 11 case the debtor in possession must seek approval to assume or reject executory contracts by the time its plan of reorganization is confirmed. In a Chapter 7 case the trustee has 60 days to assume executory contracts. If the trustee fails to assume the contract within that period, the contract is deemed rejected. Under certain circumstances, the trustee may extend the 60 day period for cause.

10 B. Right to Assume or Reject Executory Contracts (Cont.) Contract continues in existence, as is, until debtor either assumes or rejects the contract. During the pendency of the bankruptcy case, non-debtor counter-party to the contract has the right to request that the court compel the debtor to assume or reject the contract. Debtor must assume or reject the entire contract.

11 C. Requirements of Assumption Under Section 365(b) and (c) of the US Code ASSUMPTION requires the debtor to: (1) cure, or provide adequate assurance that it will cure, all monetary and non-monetary defaults capable of being cured; (2) compensate, or provide adequate assurance that it will compensate, the non-debtor party for any actual pecuniary loss resulting from such defaults; and (3) provide adequate assurance of future performance under such contract.

12 C. Requirements of Assumption 365(b) and (c) (Cont.) Debtor may not assume (or assign) any executory contract, irrespective of whether the contract prohibits or restricts assignment if: (1)applicable non-bankruptcy law excuses the non-debtor party accepting performance from, or rendering performance to, party other than the debtor; and (2)the non-debtor party does not consent to such assumption or assignment; or (3)such contract is (a) (b) (c) a contract for personal services; to loan money; to issue securities; or from any (d) a lease of non-residential real property that was terminated prior to the petition date.

13 D. Definition of Executory Contract Countryman definition: A contract under which the obligations of both the bankrupt and the other party to the contract are so far unperformed that failure of either to complete performance would constitute a material breach excusing performance of the other. Functional analysis: Whether the debtor has unperformed duties that the trustee may elect to perform or breach, depending upon which will result in the best value for the estate

14 II. License Agreement A. Determination Whether a License Agreement is an Executory Contract Generally, license agreements are considered to be executory contracts. Potential material continuing obligations which could support a determination that the license agreement is an executory contract include: Obligation to refrain from licensing property to others; Continuing duty to account for and pay royalties; Indemnification obligations; Duty to defend licensee from infringement claims; Obligations related to reporting, labeling, service, maintenance, training and support obligations.

15 B. Special Rights Granted to Licensees of Intellectual Property Section 365(n) of the Code governs the rights of an intellectual property license where (1) debtor is licensor and (2) license is one for intellectual property. If a debtor/licensor rejects an executory license, section 365(n) provides the licensee with the option of treating the license as terminated by virtue of the rejection and asserting damages for breach, or retaining its rights under the license for its duration and any applicable extensions. Section 365(n) of the Code applies to license agreements executed prepetition (even if term of license did not commence before petition date).

16 C.Definition of Intellectual Property Pursuant to Section 101(35A) of the Code Intellectual property means a: (A) trade secret; (B) invention, process, design, or plant protected under Title 35 [of the United States Code] (e.g., patents); (C) patent application; (D) plant variety; (E) work of authorship protected under Title 17 [of the United States Code] (e.g., copyrights); or (F) mask work protected under Chapter 9 of Title 17 [of the United States Code]; to the extent protected by applicable nonbankruptcy law.

17 D. Excluded from Definition of Intellectual Property With respect to (1) invention, process, designs, or plant protected under Title 35; (2) work of authorship protected under Title 17; and (3) mask work protected under Chapter 9 of Title 17, are categories that apparently apply only to items protected under U.S. law (not foreign law).

18 D. Excluded from Definition of Intellectual Property (Cont.) Definition of intellectual property does not include: Trademarks Trade Names Service Marks Drafting tip: Parties may, however, specify in license agreement that if the agreement is determined to be executory, the parties intend license to be license of intellectual property protected by Section 365(n) of the Code. Drafting tip: Licensee may wish to separate licenses between (1) those eligible for Section 365(n) protection (i.e., US patents, US copyrights, and trade secrets); and (2) those that are not protected (i.e., trademarks, non-us patents, and non-us copyrights).

19 E. Licensee s Options Following Debtor s Rejection of Intellectual Property License (Section 365(n)) If the debtor-licensor elects to REJECT a license of intellectual property, the non-debtor licensee may: treat the license agreements as terminated; or retain its rights under the license agreement to the intellectual property, as such rights existed immediately before the commencement of the bankruptcy case for (1) the duration of the contract and (2) any period for which the contract may be lawfully extended (post-petition enhancements and modifications are likely not covered). Licensee also has the right to enforce the exclusivity of the license against third parties in order to prevent patent infringement.

20 1. Election to Treat License Agreement as Terminated Drafting tip: To make it clear that the debtor s rejection of the license entitles the non-debtor licensee to treat the agreement as terminated, the license should clearly provide that the following constitute an event of default entitling the non-debtor licensee to terminate the agreement: the licensor s rejection of the agreement under Section 365 of the Code; and the licensor s breach or failure to perform or observe any of its obligations or covenants under the terms of the agreement.

21 1. Election to Treat License Agreement as Terminated (Cont.) Licensee will forfeit any and all of its rights to continue to use intellectual property. The licensee s damages claim will be treated as a prepetition, general unsecured claim. Drafting tip: Use liquidated damages provision to protect against difficulty in determining damages.

22 2. Election to Retain Rights Under License Agreement Non-debtor licensee: Retains its rights under the license agreement in existence at the time of the bankruptcy filing (does not include right to future improvements, upgrades, service, support and maintenance, etc.); must continue to make all royalty payments under the license agreement for its duration and any extensions; and will be deemed to have waived any (1) right of setoff it may have with respect to the license agreement (under both the Code and non-bankruptcy law); and (2) administrative expense claim against the debtor-licensor arising from the performance of the license agreement.

23 2. Election to Retain Rights Under License Agreement (Cont.) The debtor-licensor: will no longer have an affirmative duty to perform any of its obligations under the license agreement (e.g., service, support and maintenance, etc.); and upon written request of the licensee, the debtor must, to the extent set forth in the agreement: provide to licensee any intellectual property (including any embodiment thereof) held by the debtor; and refrain from interfering with the rights of the licensee under the license agreement.

24 a. Use of Escrow Agreements Drafting tip: The non-debtor licensee may want to consider making arrangements for the licensor to transfer the embodiment or key elements (e.g., source codes) of the licensed intellectual property to an escrow agent, pursuant to an escrow agreement, to ensure turnover of the intellectual property (and embodiments) to licensee in the event of a bankruptcy filing by the licensor. Drafting tip: Structure the escrow agreements in two separate agreements: i. between the licensor and escrow agent (placing the embodiments or key elements in escrow including regular updates or supplements, prior to the commencement of the bankruptcy case); and ii. between the licensee and the escrow agent (which releases the items from escrow upon the occurrence of certain triggering events).

25 a. Use of Escrow Agreements (Cont.) Drafting tip: The escrow agreement should also direct the escrow agent to release the escrowed property to the licensee upon the occurrence of an event of default by the licensor pursuant to the license agreement.

26 b. Royalty Payments Drafting tip: In order to limit the amount of the royalty payments required to be paid, the non-debtor licensee should seek to include a very narrow definition of the term Royalty Payments (i.e., use separate definitions for Royalty Payments and Other Payments ). Drafting tip: Include a provision that decreases the amount of royalty payments paid to the debtor-licensor if improvements, modifications, other services or research and development are discontinued. Drafting tip: Include a provision conditioning the debtorlicensor s receipt of additional payments upon the provisions of such items to the licensee.

27 F. Period after Petition Date until Assumption or Rejection After the bankruptcy petition date, but prior to assumption or rejection: Non-debtor licensee can request the debtor-licensor to continue to perform its obligations under the license agreement. If such request is made in writing, the debtor must, to the extent provided under the agreement: continue to perform its obligations under the agreement; or provide to the licensee any intellectual property (including any embodiment thereof) held by the debtor. In addition, during this period, the debtor cannot interfere with the rights of the licensee under the agreement.

28 G. Assumption and Assignment of License Agreements Review: A debtor (including a licensor) may assume and assign any executory contract or license (whether or not the agreement says otherwise) unless: applicable non-bankruptcy law excuses the non-debtor party from accepting performance from, or rendering performance to, any party other than the debtor; and the non-debtor does not consent to such assumption or assignment; or such contract is a contract for personal services or to loan money or issue securities, or is a lease of non-residential real property that was terminated prior to the petition date.

29 1. Where the Debtor is the Licensor, the License is Generally Assignable Provisions imposing restrictions on assignment, increased fees, limitations on the identity or type of assignees, etc., are generally unenforceable. Only those limitations which apply to an existing counterparty will be enforceable against an assignee in bankruptcy (e.g., financial covenants, ratios, etc.)

30 2. Where Debtor is Licensee, Assignment is More Restrictive Where the debtor is a licensee, several courts have determined that nonexclusive US patent and US copyright license agreements are not assumable by a debtor-licensee nor assignable to third parties over the objection of the non-debtor-licensor, since applicable non-bankruptcy law (i.e., federal patent and copyright law) precludes assignment of such agreements without first obtaining the non- debtor s consent. Less authority on trademarks, but generally in accord with trend of case law on patents and copyrights. Drafting tip: include robust licensor consent provisions to any sale, assignment or disposition.

31 2. Assignment of License Agreements (Cont.) Courts are divided, however, on the issue of whether non-exclusive license agreements may even be assumed by a debtor or licensee. If debtor cannot assume the license, it will be rejected and the licensor s recourse is to file a general unsecured claim for rejection damages. There is also a split of authority on whether a debtor-licensee may assume and assign an exclusive license.

32 Strategies for Acquiring Intellectual Property in

33 Primary IP Acquisition Options in Make Acquisition Outside Section 363 Asset Acquisition in

34 Sale Outside of Confidentiality of the proposed sale and its terms. Ability to impose no-shop clauses (subject to corporate law and fiduciary duty limitations). Proposed purchaser has more control and input in the process. Court approval is not required. Assets sold subject to pre-existing liens. Subject to potential fraudulent conveyance claims.

35 Sale Inside of Assets sold free and clear of liens (subject to limited exceptions). Not subject to fraudulent conveyance claims. Purchaser can pick and choose assets. Unexpired leases, executory contracts, and other burdensome assets can be excluded Process is open to the public no confidentiality. All bids are subject to higher offers initial purchaser may be outbid. Court approval required (for sales outside ordinary course) can substantially delay process. process can be expensive. Streamlined process allows for the completion of a 363 sale. Typically takes approximately 30 to 90 days from date of bankruptcy filing

36 Relevant Issues reorganization requires funding and time. Distressed companies may not have sufficient finances Debtor in Possession ( DIP ) financing has become constrained Section 363 of the Code provides a streamlined process which can allow buyers to: purchase assets at fire sale prices pick and choose the assets to be purchased acquire the assets free and clear of liens Courts can be cautious with sales early in a case. Concerned about lack of information and want creditors to have a reasonable opportunity to evaluate Sales usually take place through an auction process.

37 Necessary Court Findings Sound Business Purpose Appropriate Marketing and Diligence Process Accurate and Reasonable Notice Fair and Reasonable Purchase Price Good Faith Put the property up for sale without a stalking horse (also known as an open auction ); or Reach a deal with a stalking horse bidder and then have an auction at which parties can exceed that bid.

38 Stalking Horse Bidder A stalking horse bidder is the initial bidder that enters into a purchase agreement with the debtor. Debtors may negotiate with various interested parties to determine who will become the stalking horse Stalking horse bidder typically has to expend greater resources than other bidders (costs of due diligence setting the baseline for the transaction) To compensate the stalking horse, certain bid protections are usually negotiated Court s objectives are best price and certainty of closing.

39 Protections Approved by Courts Break-Up Fees Usually 2-3% of the Purchase Price Topping Fees Typically range from 20-25% of the amount of the overbid and subject to more resistance than break-up fees No Shop and Window Shop Clauses Expense Reimbursements Lock-Ups

40 Timing of Sale Sale of debtor s property requires at least 20 days notice to creditors and other parties in interest. Notice period can be reduced for cause Auction can be held after 20 day notice period expires Shortly after the auction, a hearing is held before the Court to confirm the winning bidder. After the hearing, sale can close. Generally, entire sales process takes 30 to 90 days. Ability to move quickly is critical

41 Sale Free and Clear of Existing Liens Existing liens will be extinguished if: Applicable non-bankruptcy law permits sale free of liens; The lien holders consent; The price of the asset being sold is greater than the value of all liens; The lien is in bona fide dispute; or The lien holder could be compelled to accept money to satisfy its interest. Liens will attach to proceeds of sale.

42 Most common exception to selling free and clear is successor liability. Most courts hold that the purchaser of assets does not assume liabilities, unless one of the following exceptions is present: Agreement to assume liability Merger of the debtor and the purchaser Where the purchaser is mere continuation of the seller Fraudulent purpose Product line rule

43 Contact Information Questions? Larry Engel, Partner Phone: (Hebrew)