How Does Bankruptcy Affect Patent Law and Intellectual Property?

We all have a basic understanding of these concepts: bankruptcy, patent law, and intellectual property rights. Boiled down, bankruptcy means a person or organization can no longer afford to pay their debts. Owning a patent means a person or organization owns the rights to a product or invention. Intellectual property means a person or organization owns the rights to an idea, art, or something else intangible. 

What most of us don’t realize, though, is how interconnected these concepts really are.

Big business bankruptcy is up by about 120 percent in the last eight months. Almost all of these big businesses hold a great number of assets, including intellectual property and patents. These are at least as important as physically assets like infrastructure and land. Section 365 of the US Bankruptcy Code guarantees a debtor the opportunity to perform its financial and service obligations both during and after a successful bankruptcy filings through something called an “executory contract.”

There are other options as well. A debtor might also choose to assign the executory contract to another party or reject such a contract outright. Should the debtor reject the contract, damages must be paid. Only when such a contract is assumed does the debtor need to provide proof to a bankruptcy court that obligations will continue. This is called the “adequate assurance of future performance.”

Chapter 11 bankruptcy therefore means that an organization has transformed into something else entirely, because now that organization will be “owned” by the bankruptcy court. This is important to acknowledge and understand when filing for bankruptcy when IP is held. That’s because there is often a distinction made between “owning” and “licensing” IP. If the owner of an IP licenses it to another party, and the other party becomes swallowed by debt, then the owner might not want to continue licensing to the debtor. This is why bankruptcy filings can cause contractual issues that need to be worked out first.

The court case Lubrizol Enters v. Richmond Metal Finishers, Inc. held that Richmond Metal had the right to reject a license previously made to Lubrizol — even though the license was a critical factor for Lubrizol’s continued business. 

This is one of the reasons why both parties — licensor and licensee — should understand the potential consequences should one party fall into a state of bankruptcy. Contractual obligations for this contingency should always be worked out ahead of time to prepare for potential pitfalls later. Although the aforementioned court case does provide a certain level of precedent, similar cases are almost always determined at the discretion of a judge based on the individual details relevant to that case. 

That means organizations with patents or IP should never assume they know exactly what will happen should a party be forced into bankruptcy. We can’t predict the future — unless it’s already written. That’s why the easiest way to avert disaster before it happens is to provide terms in contractual writing before those disasters are upon them.

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