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Those who faithfully read “Doonesbury” were recently treated, in a series of comic strips, to the cutthroat negotiations by Mike Doonesbury’s precocious daughter to acquire intellectual property owned by failed dot-com companies at bargain-basement prices. The series generated wry satisfaction at the notion of paper millionaires brought back to reality and former “killer apps” and other IP assets selling for a few cents on the dollar. In the real world, the economic downturn (or meltdown, in some sectors) will have less than humorous consequences. Many corporate clients’ wealth in recent years has become increasingly concentrated in intellectual property rather than traditional “bricks and mortar” assets. In particular, a client may own patents generating income from licenses granted to other companies, while its business may concurrently depend on technology derived from others through patent licenses. The client’s business plans may be significantly impacted when the other party to a patent license files for bankruptcy protection. In this article, we will briefly discuss the effect of a bankruptcy filing when the debtor is an assignor of patent rights to your client or an assignee of patent rights owned by your client. BACKGROUND: EXECUTORY CONTRACTS IN BANKRUPTCY The familiar rule under 11 U.S.C. �365 — designed to maximize the value of the estate — is that when a debtor files for protection under a chapter of the Bankruptcy Code, it may assume or reject or assume and assign, executory contracts. An executory contract is generally defined as one in which, at the time of the bankruptcy filing, “the failure of either party to complete performance would constitute a material breach … excusing the performance of the other party.” In the Matter of Murexco Petroleum Inc., a 5th U.S. Circuit Court of Appeals case from 1994, patent licenses are generally considered executory contracts under this prevailing definition. A debtor rejecting an executory contract is no longer bound by the contract; the rejection is treated as a pre-petition breach, resulting in a claim for pre-petition damages that will share in whatever distribution is available for pre-petition creditors. If the debtor assumes an executory contract, the contract is reinstated according to its original terms. Generally, a debtor desiring assignment of an executory contract must assume the contract by curing outstanding defaults or by providing adequate assurance of cure, and provide adequate assurance of future performance. The assumption of an executory contract transforms it into a post-petition obligation constituting an administrative expense of the estate. THE DEBTOR AS LICENSOR Assumption of an executory contract by a debtor-licensor obviously results in a continuing relationship with the licensee and does not ordinarily generate any unusual issues. However, the debtor’s rejection of a license could devastate a licensee whose business is dependent on the licensed technology. Accordingly, in 1988 Congress created statutory protections for licensees modifying �365(n) of the Bankruptcy Code as part of the Intellectual Property Licenses in Bankruptcy Act. Section 365(n) gives a licensee of intellectual property — which includes, among other things, copyrights and trade secrets as well as patents — the option to retain its rights or treat the license as terminated. If the licensee elects to retain its rights, the licensee must continue making royalty payments, and the debtor is required to permit the licensee to exercise its contract rights under the license. THE DEBTOR AS LICENSEE Patent license agreements commonly include anti-assignability clauses limiting the licensee’s ability to transfer rights without the licensor’s consent. Additionally, a federal common-law presumption provides that patent licenses are not assignable to third parties unless specifically addressed in the license agreement. SIGNIFICANT RESTRICTIONS No bankruptcy-related issues arise in connection with patent rights owned by the debtor under an exclusive patent license or an outright patent assignment. The assignee under an outright assignment or exclusive license may exclude others from using the patented technology and therefore does not need to assume a right it already owns, as shown in In re Access Beyond Technologies Inc., a 1999 Bankruptcy Court decision out of Delaware. When a debtor’s rights are derived from a non-exclusive license, significant restrictions exist on the debtor-licensee’s right to assume the license without the licensor’s consent. Section 365(c)(1) of the Bankruptcy Code provides that a debtor may not assume an executory contract without the nondebtor’s consent where applicable law precludes assignment of the contract to a third party. Most courts interpreting �365(c)(1) in the context of a non-exclusive patent license apply a “hypothetical test” for determining whether assumption by a debtor may occur: “[U]nder the applicable law, could the [licensor] refuse performance from ‘an entity other than the debtor or the debtor-in-possession,’ ” stated a 1988 3rd U.S. Circuit Court of Appeals decision, In re West Electronics Inc.Thus, because federal patent law generally makes non-exclusive patent licenses personal, most courts effectively preclude a debtor-licensee from assuming a license without the licensor’s consent, as shown in In re Catapult Entertainment Inc., a 1999 9th U.S. Circuit Court of Appeals decision. A minority of jurisdictions apply a different rule, known as the “actual test,” wherein the court conducts a “case-by-case inquiry into whether the nondebtor [is] ‘forced to accept performance under its executory contract from someone other than the debtor party with whom it actually contracted,’ ” as noted in Institut Pasteur v. Cambridge Biotech Corp., a 1st U.S. Circuit Court of Appeals decision in 1997. In Institut Pasteur, the debtor-cross licensee sought to assume a patent license and confirm a plan involving the transferal of the debtors’ stock to one of its licensor’s direct competitors. The agreement contained a non-assignability clause that the court found so broad that the debtor-licensee’s rights could conceivably terminate upon any change of the debtors’ stockholders. Given that the debtor-licensee had insisted on a similar, more tailored provision, the court concluded the licensor could have anticipated that the debtor-licensee might experience a change in stock ownership. Therefore, the licensor had an opportunity to preclude the transfer of stock to a named competitor and could not terminate the agreement. Thus, the choice of the forum for filing for bankruptcy protection may significantly affect the ability of a debtor-licensee to realize value from a non-exclusive patent license. As society’s dependence on advanced technology grows, the stakes involved in building the better mousetrap are steadily becoming higher. Businesses are taking greater care to secure their rights in new discoveries or innovations, thus making it common for the principal assets of any given company to consist of intellectual property. Whether representing licensors or licensees, lawyers are finding new challenges in servicing their clients. Having a firm grasp of the unique positions facing those parties engaging in intellectual property agreements will aid in accomplishing the ultimate goal — providing the best possible protection for your clients. T. Ray Guy practices in the litigation department of the Dallas office of Weil, Gotshal & Mangesand has an emphasis on intellectual property law. Stephen A. Youngman practices in the business finance and restructuring department of the Dallas office. The authors acknowledge the contributions of Jeffrey Gleit, associate with the New York office, and Julie Linares, associate with the Dallas office.

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