On February 5, 2007, the United States Court of Appeals for the Eleventh Circuit affirmed defendants L’il Joe Records Inc. et al (“L’il Joe”).

The defendants were purchasers of certain copyrights and other assets of debtors Luke Records, Inc. and Luther Campbell under a confirmed chapter 11 plan.Prior to the filing of the debtors’ bankruptcy cases, plaintiff Jeffrey J. Thompkins had conveyed his copyrights in sound recordings and musical compositions to the debtors in exchange for the payment of royalties.This conveyance was embodied in agreements (the "Agreements") that provided for the "exclusive, unlimited and perpetual rights throughout the world" to the copyrights in sound recordings and musical compositions created by Thompkins, along with "an undivided 50% of the publishing interest" in all such compositions, in exchange for Thompkins’ right to be paid royalties and, in some cases, for one-time cash advances.

A chapter 7 involuntary bankruptcy petition was filed against Luke Records, Inc. in 1995, which was later converted to a chapter 11 reorganization and administered together with the individual chapter 11 bankruptcy case of Luther Campbell, president of Luke Records, Inc.During the debtors’ bankruptcy cases Thompkins filed a proof of claim for certain unpaid pre-petition royalties.The official committee of unsecured creditors objected, and the bankruptcy court ultimately expunged the claim when Thompkins failed to respond.The debtors and the committee filed their chapter 11 plan, which included provisions for the conveyance of certain assets to L’il Joe Records, including all copyrights and publishing rights belonging to the debtors, "free and clear of any and all liens, claims, encumbrances, charges, setoffs and recoupments" in consideration for L’il Joe’s payment of $800,000 to the debtors’ estates.

L’il Joe elected not to designate any of the Agreements for assumption and assignment to it by the debtors, and the plan, including the provisions for purchase by and conveyance to L’il Joe of the copyrights and publishing rights previously conveyed by Thompkins to the debtors, was confirmed and approved by the bankruptcy court in March 1996.This effectively provided for the interests in the intellectual property conveyed to the debtors under the Agreements to be transferred by the debtors to L’il Joe even though the Agreements themselves were rejected under Section 365 of the Bankruptcy Code.

Six years later, Thompkins sued L’il Joe seeking damages, declaratory relief, permanent injunctive relief for alleged violations of copyright and trademark and state law contract claims.The District Court granted summary judgment in favor of L’il Joe on the grounds that the order confirming the plan in 1996 (the "Confirmation Order") precluded Thompkins’ claims.On appeal, the Eleventh Circuit went beyond the preclusive effect of the Confirmation Order to discuss the way in which the Agreements were treated, and the effect, if any, such treatment had on the debtors’ ownership of the copyrights and publishing rights and ability to convey such copyrights and publishing rights to L’il Joe.

The Eleventh Circuit rejected the argument that rejection of the Agreements under Section 365 of the Bankruptcy Code should be treated as a rescission of the Agreements, rendering the Agreements void and placing the parties to the Agreements back in their original positions.Explaining that "rejection ‘does not embody the contract vaporizing properties so commonly ascribed to it…. Rejection merely frees the estate from the obligations to perform; it does not make the contract disappear,’" citingCohen v. Drexel Burnham Lambert Group, Inc. (In re Drexel Burnham Lambert Group, Inc.), 138 B.R. 687, 703 (Bankr. S.D.N.Y. 1992), the court observed that rejection affects unperformed portions of a contract differently than those provisions which can be considered to have been fully "executed" at the time of rejection.

In this way, the Eleventh Circuit advocated a bifurcation of the provisions embodied within a single contract into those obligations where some future performance is contemplated and those where performance has already been completed – thereby providing one party thereto with certain complete rights, such as ownership rights, while potentially depriving another party thereto of its right under the same contract.Accordingly, the court held that the transfer of the copyrights and publishing rights under the Agreements were fully executed and absolute prior to the filing of the bankruptcy cases and could be conveyed to L’il Joe under the chapter 11 plan as ownership rights free and clear of Thompkins’ claims, while the requirement to pay royalties to Thompkins under the same Agreements were treated as future obligations capable of rejection.

Although the Eleventh Circuit appeared unconcerned with the ability of parties to "cherry-pick" those provisions in an agreement which benefit debtors, and the inequitable effect such action may have on the non-debtor counterparties to such contracts, as a result of this opinion, artists may now have reason to be concerned with laws which may allow copyrights to be conveyed and exploited without the requirement that the original artist be paid the royalties which would usually be associated with such copyrights.

Author:Malani J. Sternstein