Recommendations of the ABI Commission to Study the Reform of Chapter 11: Intellectual Property Licenses

Beginning in 2012, a distinguished group of bankruptcy attorneys, academics and judges known as the American Bankruptcy Institute (ABI) Commission to Study the Reform of Chapter 11 (the Commission) held periodic meetings throughout the U.S. to analyze and discuss comprehensive reforms to chapter 11 of the Bankruptcy Code. The results of their analyses and recommendations were published on Dec. 8, 2014, in a written format, Final Report and Recommendations (the Report).[1] Not counting appendices, the Report is 331 pages long and covers just about every aspect of chapter 11 practice. For each topic, the Commission made specific recommendations to amend the Bankruptcy Code in an attempt to make chapter 11 more efficient and useful and generally to bring chapter 11 practice in alignment with the current realities of a 21st Century financial world. These recommendations included addressing intellectual property licenses.

Part V of the Report addresses issues related to the administration of a chapter 11 bankruptcy case. This section covers issues relating to executory contracts and leases. Part V.A.4 deals with “intellectual property licenses,” followed by a separate Part V.A.5 dealing with “trademark licenses.”[2] The Commission began its analysis of intellectual property licenses within the current state of the law. Bankruptcy Code § 101(35A) defines the term “intellectual property,” and the definition notably excludes both (1) foreign patents and copyrights, and (2) trademarks.[3] The Commission also noted the tension between the policies underlying bankruptcy law, which is designed to maximize benefit to creditors, and intellectual property licenses, which are concerned with the right of a licensor to control the intellectual property.

While Bankruptcy Code § 365(f) generally invalidates contractual anti-assignment provisions, some bankruptcy courts have interpreted Bankruptcy Code § 365(c) as an exception to § 365(f) in the context of intellectual property licenses, thereby allowing nondebtor licensors to prohibit the assignment by a debtor/licensee. In addition, the Commission recognized the split in authority on the interpretation of § 365(c) in the context of assumption — but not assignment — of intellectual property licenses, giving rise to “hypothetical” and “actual” jurisdictions. Specifically, under the hypothetical approach, unassignable licenses cannot be assumed, even if the debtor has no intention of actually assigning it. The actual approach, in contrast, only addresses assignability if the debtor actually seeks to both assume and assign the license.[4]

The Commission also discussed Bankruptcy Code § 365(n), which provides nondebtor licensees with certain protections following the debtor/licensor’s rejection of the license. The Commission noted that confusion arises from the fact that foreign intellectual property and trademark licenses are not clearly included in the § 365(n) protections.[5]

The Commission addressed each of these issues with specific recommendations. With respect to assignment of intellectual property licenses, the Commission sided with the § 365(f) general rule that any provision prohibiting such assignment should not be enforced. However, the Commission’s recommendation allows for a narrow exception in the context of an attempted assignment to a competitor of the nondebtor licensor. In that situation, the Commission recommended that the nondebtor licensor be permitted to demonstrate to the bankruptcy court that the hardship imposed on the licensor would “significantly outweigh” the benefit that the assignment would bring to the debtor’s estate. The nondebtor licensor would bear the burden of proof on this issue.[6]

The Commission also recommended the adoption of the actual approach in the context of the assumption of an intellectual property license. The Commission averred that the hypothetical approach “results in artificial barriers to the reorganization of the debtor in possession – an outcome that directly undercuts a fundamental policy underlying the Bankruptcy Code.”[7]

As to foreign intellectual property, the Commission saw no basis for excluding it from the Bankruptcy Code definition of intellectual property and recommended that § 101(35A) be amended to include such property for all purposes, including the § 365(n) protections. Moreover, as to trademarks (including service marks and trade names), the Commission recognized that the rejection of a trademark license “could devastate the nondebtor’s business,” and that the licenses are particularly important in the franchising context. The Commission went on to note that a licensor/debtor’s reorganization may “hinge, at least in part, on its ability to repossess its trademarks and associated goodwill and then redeploy these assets in a more productive manner consistent with its reorganization efforts.”[8]

The Commission’s recommendation attempted to strike a balance between these two policy considerations through the inclusion of trademarks in the § 101(35A) definition, accompanied by amendments to the effect of a license rejection under § 365(n). Under current law, § 365(n) allows for a nondebtor licensee to elect to maintain certain rights under the license following rejection by the debtor/licensor. Section 365(n), as amended by the Commission’s recommendations, would allow trademark licensees to make this election, subject to specific obligations on the part of the licensee to comply with the license agreement, including: “(i) the products, materials, and processes permitted or required to be used in conduction with the licensed marks; and (ii) any of its obligations to maintain the sourcing and quality of the products or services offered under or in connection with the licensed marks.”[9] In addition, the debtor would not have any continuing obligations to the licensee, but would have the right to oversee and enforce quality control. Furthermore, the Commission recommended that § 365(n) be amended to make clear that royalty payments owing by the licensee to the debtor would include “other payments” contemplated under the license agreement.[10]

Taken as a whole, the Report is an ambitious undertaking that will require legislation amending significant portions of the Bankruptcy Code. Whether Congress will have the desire or the ability to push through such legislation remains to be seen. In the context of intellectual property licenses, however, the Commission’s recommendations are fairly limited and will likely provide welcome guidance to issues that have given rise to confusing splits in bankruptcy case law.

Editor’s Note: This article was originally published in the American Bankruptcy Institute’s Technology & Intellectual Property Committee Newsletter, Vol. 12 Num 1.

[1] A copy of the Report is available to ABI members at https://abiworld.app.box.com/s/vvircv5xv83aavl4dp4h.

[2] See Report at pages 122-29.

[3]Id. at 122-23.

[4]Id. at 123-24 & n. 456, 457 (citing case law adopting either the hypothetical or actual approaches).

[5]Id. at 124.

[6]Id. at 125.

[7]Id. at 124.

[8]Id. at 127-28.

[9]Id. at 129.

[10] Id. at 126, 128-29.