IP and Bankruptcy: A Legal Balancing Act

Understanding how intellectual property (IP) and bankruptcy law interact is more crucial than ever. Whether you’re a debtor under Chapter 11 or a company holding vital IP licenses, how those rights are treated in bankruptcy can shape the future of your business.

What Is Intellectual Property?

Patents protect inventions and discoveries. Governed by the Patent Act and overseen by the USPTO, patents grant a 20-year exclusive right. Wick notes the system now follows a “first to file” approach, not “first to invent.”
Copyrights cover original works fixed in a tangible medium—like writing, music, and art. These rights, issued by the U.S. Copyright Office, can be exclusive or non-exclusive.
Trademarks, defined under the Lanham Act, distinguish goods in the marketplace. They must be actively used in commerce. While federal registration isn’t required, Wick says it offers significant advantages like “nationwide presumptions of ownership.”
Trade Secrets include confidential formulas, methods, or processes. Most states follow the Uniform Trade Secrets Act.
Domain Names are not traditionally licensed IP but often tie into trademarks and hold substantial value as digital assets.

What the Bankruptcy Code Covers — and What It Doesn’t

The Bankruptcy Code does define “intellectual property”—but notably excludes trademarks and foreign IP. When determining rights, bankruptcy courts frequently rely on non-bankruptcy law, such as federal or state IP laws. This distinction is important.

How IP Licenses Are Treated in Bankruptcy

Most IP licenses are treated as executory contracts, meaning both parties still have performance obligations. This matters because under Section 365 of the Bankruptcy Code, the debtor can:

Assume (continue the contract),
Reject (breach the contract), or
Assign (transfer the contract to another party).

However, not all IP contracts are treated the same. Exclusive licenses might be viewed as assignments (not executory), while non-exclusive licenses are more likely to be considered executory, as they grant usage rights but not ownership.

Licensee Protections: Section 365(n)

To counter the controversial Lubrizol decision, which allowed bankrupt licensors to revoke IP licenses, Congress enacted Section 365(n).

This provision gives licensees a choice: they can either treat the license as terminated and file a claim, or continue using the IP (if it qualifies under the Code) and keep paying royalties.

Importantly, 365(n) does not cover trademarks or foreign IP. Sullivan urges licensees to “be proactive and pay close attention to how their licenses are drafted and recorded.”

Rejection Doesn’t Mean Termination

In the landmark 2019 Supreme Court decision, Mission Product Holdings v. Tempnology, the Court ruled that a license rejection under bankruptcy law is a breach—not a rescission.

Assignment and Assumption: Complex Legal Terrain

Debtors wishing to assign IP licenses to third parties may encounter legal roadblocks. Section 365(c) restricts assignments when “applicable law bars performance by anyone other than the original party.” This is especially relevant for IP licenses, often considered personal service contracts.

Courts take different approaches here:

Hypothetical Test (Majority Rule) – If the contract couldn’t be assigned under non-bankruptcy law, it also can’t be assumed.
Actual Test – Focuses on whether the debtor actually intends to assign the contract.
Footstar Approach – A minority view that distinguishes a debtor-in-possession from a trustee, potentially allowing assumption even when assignment is barred.

Selling IP in Section 363 Sales

In bankruptcy, debtors often sell assets—including IP—under Section 363. However, these sales carry risks.

These include difficulties in accurately valuing IP assets (particularly if usage is unclear) and risks of confidentiality breaches, especially if licensing agreements or NDAs are improperly disclosed during the sale process.

Securing Liens on IP: What Lenders Should Know

We cautions lenders to tread carefully when using IP as collateral. The rules for perfecting security interests vary by asset type:

Patents and trademarks must be recorded with the USPTO.
Copyrights must be recorded with the U.S. Copyright Office.
Trade secrets follow state law and typically aren’t registered, making liens more difficult to enforce.

Key Takeaways for Businesses and Legal Counsel

For companies navigating the intersection of IP and bankruptcy, our Maryland IP attorneys recommend considering these steps:

Draft licenses with bankruptcy in mind, ensuring clarity and contingency planning.
Understand which IP rights are protected under the Bankruptcy Code—and which are not.
Be prepared to assert or defend 365(n) rights if a license is rejected.
Track the debtor’s strategy around assumption and assignment.