Kodak’s recent filing for Chapter 11 bankruptcy saw a pillar of the American experience seek protection due to falling victim to the world’s digital revolution, and its demise will be followed by many more business failures from high-tech companies, both large and small.
Indeed, as our economy continues to become more technology-based, bankruptcies in which high-tech assets and issues predominate will become far more common. And because our technology-based economy is an incubator for both business success and failure, issues common to high-tech bankruptcies should be known by business lawyers, creditors, investors and management.
Fundamentally, a Chapter 11 for a technology company has many of the same characteristics as a Chapter 11 for a non-technology based company. The management of both types of companies are fiduciaries charged with maximizing the recovery for the stakeholders. But when a technology-steeped company like Kodak files for Chapter 11 relief, certain additional considerations should be noted.
1. R & D. Many technology companies will need to innovate and break new ground to continue competing in the marketplace. Research and development does not come cheap. In Chapter 11, a debtor cannot operate in the red for very long and the bankruptcy system is designed to quickly ferret out money-losing debtors and shut them down. If market share or competitiveness depends on innovation, and innovation requires revenue sucking research and development, the challenge to remain competitive may be daunting in Chapter 11. Knowing this can help management of a distressed technology company develop a realistic restructuring strategy.
2. Sale or transfer of IP. Sometimes the most valuable asset owned by a technology company is its intellectual property portfolio. Yet once it becomes distressed, prospective purchasers won’t offer adequate consideration for fear that their purchase will be subjected to later scrutiny should the seller subsequently file for Chapter 11. In bankruptcy, however, a company’s sale of its IP is supervised by the bankruptcy court using Section 363 of the Bankruptcy Code and the successful bidder walks away from the bankruptcy with the asset free from the claims of creditors and with the best title money can buy—a federal court order. For a bidder, that is a great result. For the technology company, as the seller, certainty of title and court supervision can create a more robust selling environment and higher values. 3. Selling disputed IP. Chapter 11 may not necessarily help a company sell disputed intellectual property. Section 363 is a great tool for selling an asset free of the claims of creditors, but usually it can’t help if the company’s title to the asset is disputed. Generally, the debtor can only sell what it owns, and a sale free and clear of creditor claims will not sidestep the question of ownership. Thus, if a technology company is embroiled in a dispute over its right to certain intellectual property, the bankruptcy judge may not be much help in getting that question resolved.
4. Benefits for licensees. Licensees of intellectual property can enjoy the benefits of their licenses even though their licensor files for Chapter 11. Generally, a licensee of intellectual property can enforce its right to use that license even though the licensor files for Chapter 11. Section 365 of the Bankruptcy Code greatly minimizes the legal effect on the licensee if the licensor walks away from the license (by rejection—a bankruptcy term of art) or simply fails. Protection for the licensee is not unlimited.
5. Remain vigilant. A sleepy licensee can lose its right to the license, so it must be watchful. Although a licensee is protected under Chapter 11, an inattentive licensee can have the intellectual property licensed to it sold free of the claims of creditors, of which it as licensee is one. But by exercising some vigilance, the licensee can object to such a sale to protect its license and continue to enjoy the benefits its license provides once the intellectual property on which it is based gets sold.
Dealing with a distressed technology company can be challenging, especially when the spectre of Chapter 11 looms. When facing that shadow, it is critical that the nuances unique to a high technology company Chapter 11 be kept in mind at all times.