Treatment of Internet Licenses in Bankruptcy

New Jersey Law Journal   VOL. 215 - NO 6         FEBRUARY 10, 2014     

Treatment of Internet Licenses in Bankruptcy

How to handle this relatively new form of intangible asset

By Jonathan Bick Bick is of counsel at Brach Eichler in Roseland. He is also an adjunct professor at Pace and Rutgers law schools, and the author of 101 Things You Need to Know About Internet Law (Random House 2000).

Increasingly, entities are accumulating Internet assets. These assets include web-sites, web logs (blogs), Internet stores, social media connections, Internet applications, content, domain names and crypto currency (such as bitcoin), to name a few. Since many Internet assets are intangible, licenses for such assets are a noteworthy type of contract that has not yet been fully performed. Both licensors and licensees are well advised to know what can happen to Internet asset licenses when a bankruptcy is filed.

Businesses and service providers, by and large, have Internet sites and blogs. In order to secure sites and blogs, entities must acquire various Internet assets, including domain name, Internet hosting agreement, and content acquisition and management system. These intangible assets are normally memorialized by contracts and transferred by licensing agreements.

E-commerce providers offer technology that allows new channels for sales. Such technology is typically implemented via software. The e-commerce software is either premade or custom. Both are subject to licensing agreements.

Advertising and publicity that sup­ports Internet transactions has been in­tegrated into social media sites such as Facebook. Contracts govern the use of these social media sites and other Inter­net sites which facilitate Internet interac­tions such as LinkedIn, YouTube, Twitter, Google+ and Pinterest. The use of such facilitators is governed by terms of use agreements that are universally licensed.

Internet content is the underpinning of an Internet presence, and that content is subject to intellectual property law, particularly copyright. Such copyrights are usually governed by licenses.

A licensor in bankruptcy (or its bankruptcy trustee) has the option of as­suming or rejecting a license. Generally, a debtor licensor can assume a license if it meets the same tests required to assume other contracts which have not yet been fully performed (i.e., cures de­faults and provides adequate assurance of future performance). Many licensees will not have a problem with assump­tion of their license as long as the debtor can actually continue to perform. Instead, the real concern for licensees is the fear of losing their rights to the licensed intellectual property, which often can be mission-critical technology, if the license is rejected.

Recognizing this concern, the Bankruptcy Code, in Section 365(n), provides licensees with special protections. This Section provides that, in the event a contract that has not been fully performed, and under which the debtor is a licensor of rights to intellectual property, is rejected in the licensor’s bankruptcy, the licensee may elect one of two sets of options: (1) treat the rejection as terminating the license, leaving the licensee with its various rights as a contract creditor under the Bankruptcy Code; or (2) retain its rights under the license, as such rights existed immediately before the case commenced.

When a bankruptcy court finds rejection of an intellectual property license to be appropriate, if the licensee so elects, the licensee’s right to the intellectual property as it existed at the time of the filing is protected. If the licensee elects to retain such rights, then a requirement to continue making all royalty payments arises.

The licensee also can retain rights under any agreements related to the li-cense, such as access to source code or escrowed technology. Said provisions protect a licensee from being stripped of its rights to continue to use the licensed intellectual property.

While many people would expect intellectual property to include trade-marks, the Bankruptcy Code has its own limited definition of “intellectual property.” The bankruptcy definition includes trade secrets, copyrights, patents and patent applications, but not trademarks. This means that trademark licensees are not protected by Section 365(n); they are at risk of losing their trademark rights in a bankruptcy.

Intellectual property licensing agreements are normally dependent upon the type of intellectual property, ownership conditions of the licensor, the licensee and involve parties other than the licensor and licensee. Intellectual property li-censing agreements are generally unique. The Bankruptcy Code recognizes that unique intellectual property agreements are regularly memorialized, enabling samples and models.

For instance, the licensor may have agreed to provide the licensee with Internet content or an Internet communication channel incorporating the licensed intellectual property, and may have agreed that the licensee would only have access to information necessary to produce the licensed intellectual property in the event of the licensor’s inability or unwillingness to supply the licensee. To assure the licensee of access to said intellectual property despite changes in the licensor’s circumstances, the licensor may have agreed to turn over certain content or enabling software to a third party to be held in escrow until the triggering event. The third-party escrow agent would be a party to an intellectual property licensing agreement, and the agreement would be set forth in a document separate from the basic license.

Section 365(n)(1)(B), thus, speaks of the retention by the licensee of rights to the intellectual property under “any agreement supplementary to such con-tract.” The licensee retains both the rights set forth in the rejected license itself and any agreement supplementary thereto, whether the supplementary agreement was itself the subject of a rejection by the trustee.

Among the rights retained by the licensee electing under Section 365(n)(1) (B) is the right to any embodiment of the intellectual property to which the parties’ contracts entitle the licensee. For instance, the parties might have agreed that the licensor would prepare a prototype Internet site incorporating the licensed intellectual property. If said Internet site was arranged prior to the filing of the petition for relief, but had not been delivered to the licensee at that time, then the licensee can compel the delivery of the prototype in accordance with the terms of the rejected license.

The law is different when an intellectual property licensee files bankruptcy. Section 365(c)(1) of the Bankruptcy Code contains an exception to the general rule that contracts which have not yet been fully performed can be assumed and assigned to third parties if defaults are cured and adequate assurance of future performance is demonstrated. The exception is initiated when “applicable law” precludes such an assignment absent consent of the non-debtor party.

Case law from several United States Courts of Appeals holds that “applicable law,” including patent and copyright law, precludes an assignment of rights under an intellectual property license unless the intellectual property holder has consented. These courts have ruled that nonexclusive patent and copyright licenses are personal and non-assignable. As a result, a patent or copyright holder can prevent a debtor licensee from assuming and as-signing a nonexclusive license to a third party without the licensor’s consent.

The court in In re Catapult Entertainment, 165 F.3d 747 (9th Cir. 1999), found a technicality associated with Section 365(c)(1) of the Bankruptcy Code, which allows a licensor to not only stop a debtor from assigning the license to a third party, but can even prevent a debtor from keeping the license for itself.