What is the value of the intellectual property rights of your potential distressed investment target? If a U.S. bankruptcy is a possibility for this target, its IP rights may be worth far less than you might expect.
An earlier column reported on the special protections for licensees of intellectual property when the licensor attempts to use bankruptcy law to “reject” the license.1 The case discussed in that column has since been affirmed on appeal,2 confirming that even in a non-U.S. bankruptcy (in that case, in Germany), a powerful U.S. public policy of protecting IP licenses may well intervene to deprive the debtor-licensor of the full, unrestricted value of its IP rights (an estimated loss of $50 million in the German-U.S. case).
When the shoe is on the other foot, and the licensee is the one in bankruptcy, one would expect U.S. bankruptcy law to provide similar if not greater protection to the vulnerable debtor-licensee. Not necessarily. The complex interplay between U.S. law governing intellectual property and bankruptcy creates the potential for a double standard, disfavoring debtor-licensees even as the law discussed above favors non-debtor licensees. This is yet another case where careful choice of forum can make or break a reorganization effort. The Delaware bankruptcy court reaffirmed its position on this surprising double standard last year in the high profile case of Trump Entertainment Resorts.3
A flamboyant real estate mogul, TV personality, and now Republican candidate for the U.S. presidency, Donald Trump enjoys seeing his name prominently displayed. Indeed, the new Trump Tower in Chicago is controversially festooned with a garish display of 6-meter-high backlit letters trumpeting the name of its developer: “TRUMP.” So when Trump founded Trump Entertainment Resorts to run several Atlantic City resort hotel-casinos, his name was sure to figure quite prominently in the business. Trump and his wife conveyed to the resorts a perpetual, royalty-free license to use their names and likenesses, exclusive within a six-state area along the U.S. East Coast, subject only to a termination process based on “quality control” of the resorts’ use of the Trump marks.
Donald Trump’s vanity is matched only by his ruthlessness in dealing with what he views as failure (as reflected in his unofficial motto, “You’re fired!”). When the resorts did not live up to Trump’s quality expectations, he sought in state court to terminate the license. Removing these “ubiquitous” marks would be costly and problematic and would likely detract from the value of the business, so the resorts sought refuge in U.S. Bankruptcy Court to stop Trump’s frontal attack on their key IP rights. The debtors closed one resort but proposed to maintain and concentrate their business in the Trump Taj Mahal Casino Resort. They proposed a seemingly simple Chapter 11 reorganization, wiping out old equity in a debt-for-equity swap and assuming the Trump license to continue to run the Taj Mahal resort as before, with a clean balance sheet and revamped business model.
The debtors made one crucial mistake: They filed their case in Delaware. In light of the centrality of the IP license to the reorganized business, this was a shockingly short-sighted move. Since 1988, the appellate Third Circuit, governing Delaware, had interpreted a key provision of the Bankruptcy Code, section 365(c), to prevent debtors from preserving the value of their IP licensee rights in the face of licensor opposition. That provision prevents a debtor from assigning contracts, such as IP licenses, to third parties so long as the relevant law restricts assignment without licensor consent. A simple contract restriction on assignment is generally unenforceable in U.S. bankruptcy, but an anti-assignment provision in the governing law is specifically preserved by section 365(c). While this is not entirely clear in all cases (especially if the license is exclusive), the courts have generally read the intellectual property laws to prohibit assignment of IP licenses over the licensor’s objection.
But the casino simply wanted to “assume” the license, preserving those rights for itself. Why is the anti-assignment law relevant here? This is the Delaware complication. Launching a long-simmering disagreement, the Third Circuit in 1988 read the “plain language” of section 365(c) to prevent not only assignment, but also assumption of license rights by the debtor-licensee itself, so long as a hypothetical assignment would be prohibited.4 This restrictive position was later adopted also by the Ninth Circuit, encompassing many key technology companies.5 In contrast, the New York bankruptcy court (as well as the appellate First Circuit, governing Boston) interpreted section 365(c) as preventing only actual assignments, not assumption of such contract rights by debtor-licensees themselves.6
In February 2015, less than six months after Trump Entertainment Resorts filed their case, the Delaware bankruptcy court announced its unsurprising decision: Because trademark law prevents the assignment of the Trump license without Trump’s consent, the “hypothetical” gloss on section 365(c) also prohibited the resort itself from assuming the license. Had this case been filed in New York, the result might well have been different, but the result in Delaware was not at all unexpected.
The value of the trademark license to Trump Taj Mahal Casino Resort may well be limited, though the cost of removing the marks will certainly divert crucial resources. In a case involving more vital trademark or patent licenses, in contrast, the result could be devastating. The U.S. bankruptcy law’s heightened sensitivity to the plight of non-debtor licensees stands in stark contrast to Delaware’s value-destroying approach to debtor-licensees. Both aspects of this odd double standard impact powerfully and quite negatively on the value of IP rights held by distressed companies. Caveat investor.
- See “Increasing volatility at the intersection of intellectual property and restructuring law,” Cayman Fin. Rev., 4th Quarter 2012, issue 29, at 72.
- See Jaffe v. Samsung Elec. Co. (In re Qimonda), 737. F.3d 14 (4th Cir. 2013).
- See In re Trump Entertainment Resorts, Inc., 526 B.R. 116 (Bankr. D. Del. Feb. 20, 2015).
- See In re West Electronics Inc., 852 F.2d 79 (3rd Cir. 1988).
- See In re Catapult Entertainment, Inc., 165 F.3d 747 (9th Cir. 1999).
- See In re Adelphia Communications Corp., 359 B.R. 65 (Bankr. S.D.N.Y. 2007); Institut Pasteur v. Cambridge Biotech Corp., 104 F.3d 489 (1st Cir. 1997).