Intellectual Property and Bankruptcy
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Intellectual property receives special treatment in bankruptcy. It's important to evaluate applicable law, review licenses, contracts, ownership status, and navigate IP laws, bankruptcy laws, contract laws, and state laws before filing a bankruptcy.
Written by the Upsolve Team. Legally reviewed by Attorney Andrea Wimmer
Updated August 28, 2020
Intellectual property (IP) is treated as an asset in bankruptcy. IP goes through some of the same processes as real property and personal property, but often receives special treatment. Intellectual property is owned or licensed, and often an IP license is classified as an “executory contract.” If you’re considering filing bankruptcy and have an interest in intellectual property, it’s important to learn the basics of how IP is treated in bankruptcy so that you can better determine whether bankruptcy is the right option for you and your IP rights.
Understanding What Intellectual Property Is
Stories, songs, movies, computer codes, slogans, designs, and inventions are types of intellectual property. Intellectual property rights can take the forms of copyrighted material, trade secrets, trademarks, and patents. There can be different types of IP associated with a single product. For instance, your favorite web app could be protected by a copyright, trademark, and patent. The copyright, trademark, and patent can be treated as different IP protections, even though the software as a whole is one product. Essentially, intellectual property is the protected physical form of an idea. For example, a code in software is one idea, the images and logos are different ideas. Intellectual property is treated as an asset under the law. Specifically, IP is classified as an intangible asset even though there may be a physical form to intellectual property.
Certain forms of intellectual property may be licensed. An IP licensor owns the license in question and traditionally receives royalty payments when the product, service, or idea protected by the license is profitable. The IP licensee has the right to use the IP and usually pays the IP licensor to use the intellectual property, either exclusively or non-exclusively. License rights are evaluated during the bankruptcy process; they may or may not be favorable to a bankruptcy filer. A bankruptcy filer with exclusive licensee rights will have different options than a bankruptcy filer with a nonexclusive license. Bankruptcy courts and federal law generally permit transfers of exclusive licenses for patents and copyright but prohibit licensees from assigning non-exclusive IP rights to someone else.
Filing bankruptcy may be a viable debt relief solution even for IP holders. Laws try to balance the filer’s rights with the rights of creditors and IP license holders. After debts are discharged, creditors no longer have any legal right to collect on those debts. There are different types of bankruptcy proceedings; each is identified by chapters of the Bankruptcy Code. Chapters 7, 11, and 13 are the most common types of bankruptcy proceedings. In all bankruptcy proceedings, a debtor’s assets, income, and expenses are examined. Some assets are classified as exempt from the proceedings, but non-essential assets are not usually exempted. For instance, you may be able to keep one car, but not three cars.
To file a Chapter 7 bankruptcy, you must qualify per the restrictions of the Chapter 7 means test, which limits eligibility based on income. Only low-income filers may pursue a Chapter 7 bankruptcy. The basic idea in Chapter 7 is that non-exempt assets are sold to pay debt. At the conclusion of a successful bankruptcy, eligible unsecured debts that you’re not able to pay are discharged—gone for good. In Chapter 13 bankruptcy, you have the option to make affordable payments to pay down your debt over a 3-5 year period. If you stick to the payment plan, your remaining eligible debt is discharged. A Chapter 11 bankruptcy is usually used by businesses because it allows organizations to reorganize business-related debt. Individuals can also file a Chapter 11, but it’s more expensive and complex than a Chapter 7 or Chapter 13 bankruptcy.
In bankruptcy, the term “bankruptcy estate” refers to all of your property. You can imagine a file cabinet filled with all your assets. The bankruptcy court has control of that file cabinet—the bankruptcy estate. Bankruptcy estate assets include your full and partial legal interest in property, including IP, and income from pre-petition investment sources, such as a rental property.
Intellectual Property and the Bankruptcy Code
Regardless of what chapter of the Bankruptcy Code you file, you will benefit from the protections afforded by the automatic stay. The automatic stay goes into place as soon as you file your bankruptcy petition. The automatic stay puts an immediate stop to all collection activity on debts that were due before you filed your bankruptcy petition. The automatic stay also means that if someone was suing you for patent infringement before your bankruptcy filing, that lawsuit will pause. If you’re suing someone claiming they made money off your website app, then that claim becomes property of the bankruptcy estate. Timing is everything. Claims made before your bankruptcy petition are treated differently than claims that can only be made after you file your bankruptcy petition.
Bankruptcy has look-back and look-forward periods. Thus, a review of past financial circumstances and future financial circumstances will affect the bankruptcy estate and creditor claims. For instance, the look-back period applies to the Chapter 7 means test. The bankruptcy court will look at your past income to determine whether you qualify for a Chapter 7 bankruptcy. A bankruptcy trustee often uses a look-back period to see if various claims were unfairly paid.
Look-forward periods help determine future expenses and asset values for the bankruptcy estate. For instance, an upcoming tax return may show that you can expect a refund in the future. That refund would become part of the bankruptcy estate, even though it has not yet been issued. Intellectual property licenses might have future value. For instance, if you had a claim against a software company that used a software code you wrote (your IP), that claim could be considered an asset in the bankruptcy estate.
IP Executory Contracts in Bankruptcy
Many types of intellectual property are licensed, and licensing involves contracts. An IP license agreement is a contract. These types of contracts (that remain active, not completed or terminated) are called “executory contracts” because both parties, the licensor and licensee, generally have remaining duties to perform. After a Supreme Court case involving Lubrizol and Richmond Metal Finishers, Congress created The Intellectual Property Bankruptcy Protection Act to amend section 365 of the Bankruptcy Code. The Act supports intellectual property rights and amended laws that help reduce the impact of bankruptcy on non-debtors and debtor licensees and licensors.
The Bankruptcy Code has rules and regulations that determine how assets and creditor claims are handled during the bankruptcy process, and these apply to intellectual property licenses. The Bankruptcy Code features provisions that can help debtor licensees keep valuable intellectual property licenses and laws that help debtor licensees get relief from debt, but the counterparty’s interest is also considered.
Section 365 allows certain IP contracts to be rejected, assumed, or assumed and assigned, depending on individual circumstances. If the bankruptcy filer has a licensing contract and chooses to assume the licensing rights, the filer must clear up any default to keep the agreement with the counterparty.
In bankruptcy, a creditor that claims a security interest in IP must “perfect” the security interest. This means all the documents should be filed in relation to the IP. For example, a UCC financing statement must be reported if the creditor is claiming a security interest in a patent, and valuable copyright licenses should be registered with the United States Copyright Office if the creditor is claiming a security interest in copyrighted material.
Oftentimes, an IP license contract will have a clause that explains what happens if the IP licensor or licensee files for bankruptcy. Lawyers must look at federal and state laws to sort out the details when determining whether an intellectual property license may be sold to pay a creditor claim. IP and bankruptcy is an issue that can get complicated very quickly.
The U.S. Patent and Trademark Office and the U.S. Copyright Office are overseers of IP laws made by Congress. The laws for IP are different than the laws for bankruptcy, but they can intertwine during a bankruptcy case featuring IP assets. For instance, a 2019 U.S. Supreme Court trademark license decision from the First Circuit Court discussing breach of contract said a debtor’s bankruptcy rejection of a trademark license doesn’t automatically terminate a licensee’s rights because the rights are determined by non-bankruptcy law. Contract laws, IP laws, and bankruptcy laws had to be examined simultaneously in this bankruptcy case.
Copyright laws, trademark laws, and patent laws may be found in the federal set of laws called the United States Codes (U.S.C.). Copyright and patent laws were created to encourage innovation and protect rights, trademark laws were created to prevent consumer confusion and protect the intellectual property rights of businesses. Bankruptcy laws exist to give people overwhelmed in debt a fresh start.
Federal bankruptcy laws are referred to as the Bankruptcy Code and they are part of the U.S.C. under Title 11. In Title 11, there’s a specific definition of intellectual property that applies only to bankruptcy. The bankruptcy IP definition includes trade secrets, inventions, processes, designs, certain plants and plant varieties, patent applications, certain works of authorship (for example, books, music, and software coding), and mask work. (Mask works are related to semiconductors, not medical masks). You might have noticed that trademarks and service marks are not included in this definition. Attorneys have noticed this too. Case law sorts out the confusion involving trademark rights.
IP bankruptcy cases have been held in the Court of Appeals in the Ninth Circuit (9th Cir) and Fourth Circuit (4th Cir) to help determine IP license rights. Though the Ninth Circuit (9th Cir) and Fourth Circuit (4th Cir) sometimes agree, there are times they have opposing views and cases end up going to the U.S. Supreme Court. These cases generally involve section 365 of the Bankruptcy Code which addresses executory contracts. (More on 365 later!) Attorneys handling a bankruptcy case with IP assets must consider federal laws governing IP and bankruptcy as well as applicable state laws governing licensing contracts and property.
The Bankruptcy Code allows for certain assets to be exempt from the bankruptcy process. Those assets cannot be sold by the bankruptcy trustee to pay off creditors. Common exemptions are homestead and motor vehicle exemptions. Federal and state laws determine what can be exempt and the limited value of the exemptions. States have different exemption limitations. Non-valuable IP could be exempt in a Chapter 7 bankruptcy, but a valuable IP would be non-exempt in most bankruptcies. IP assets are treated differently in Chapters 7, 13 and 11. In Chapter 7, assets that are not exempt may be sold to pay off debt. In Chapter 13, payment options are available that allow debtors to keep valuable assets, and in Chapter 11, reorganization plans are available.
IP value is based on market conditions, replacement value, projected royalty value, liquidation value, and technology factors. For instance, a patent license for outdated technology will have less value than a patent license for technology with current mass appeal. You’ll want to take your IP’s value into account when determining a bankruptcy plan.
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What Can Happen to Your Intellectual Property In Bankruptcy
If your IP is non-exempt per bankruptcy laws, then it may be seized and sold by the bankruptcy trustee assigned to your case. However, it may be possible to negotiate with a bankruptcy trustee to buy back IP assets from the bankruptcy estate. For example, Toni Braxton, a famous singer, filed for Chapter 7 bankruptcy. Her songs were valuable and non-exempt, so they were auctioned to pay off debt.
She lost her licensing rights to those songs, and someone else was able to collect the royalty payments. Fortunately for Ms. Braxton, she was able to buy back some song rights over time. A trustee may also decide that debtor license assets are worthless and choose not to pursue seizure and sale of these non-exempt assets.
Imagine Toni Braxton was a coder and the licensor of a software program, and the non-debtor was the licensee that used Ms. Braxton’s software to keep a music business running. If Ms. Braxton files bankruptcy as a debtor licensor and her IP license is sold, the non-debtor licensee could go out of business. Ms. Braxton (the licensor in this example) may want to terminate the license. But, section 365 allows the non-debtor licensee the first option to allow the licensor to reject an IP license. If someone relies on your IP license, it’s a good idea to hire a bankruptcy attorney.
Intellectual property receives special treatment in bankruptcy. If you have IP and want to file for bankruptcy, working with an attorney may therefore be a wise decision. Lawyers can evaluate applicable law, review licenses, contracts, ownership status, and navigate IP laws, bankruptcy laws, contract laws, and state laws to work on your behalf. Once you find a bankruptcy attorney who you’re interested in working with, you may be able to take advantage of a free consultation about your IP and bankruptcy options. If you can’t afford an attorney, Upsolve has a free website app that can help you file bankruptcy pro se so you can get your debt under control on your own. Bankruptcy is one way to manage debt with IP licenses. It’s a debt relief tactic that businesses, creatives, and famous people use all the time—and so can you. You are not alone, and Upsolve is here to help.