Introduction
When bankruptcy law and intellectual property law converge, disastrous results can ensue for those who are ill prepared. This was recently illustrated in the Eleventh Circuit decision Thompkins v. Lil' Joe Records, Inc., 476 F.3d 1294 (11th Cir. 2007), in which a musician was unable to sue for copyright infringement because he had lost ownership of his copyrights and an enforceable claim to royalties during a record company's bankruptcy. The Thompkins case highlights that an astute owner of intellectual property can protect its rights with proper planning prior to a bankruptcy filing by its licensee and with diligent enforcement of its rights during the bankruptcy case.
Thompkins
Jeffrey Thompkins, a rap/hip-hop artist, entered into a recording contract with Luke Records, Inc. Under the recording contract, Thompkins was required to record and deliver master recordings for production and release by Luke Records, and Luke Records received the worldwide exclusive copyrights in the sound recordings.
Thompkins produced three albums for Luke Records. Luke Records, however, became subject to several lawsuits over unpaid royalties, and eventually Luke Records landed in bankruptcy court. In 1996, the Bankruptcy Court confirmed the plan of reorganization proposed for Luke Records. The plan provided for a sale of numerous assets, including the copyrights to Thompkins' songs. The plan also rejected the royalty contract between Thompkins and Luke Records. Thompkins did not actively participate in the bankruptcy cases and consequently failed to object to the asset sale or the rejection of the royalty contract.
In 2002, Thompkins sued the asset purchaser for copyright infringement. Thompkins argued that the ownership of the copyrights reverted back to him based on Luke Records' rejection of his executory contract for the royalties. The Eleventh Circuit disagreed, finding that the rejection of the executory contract did not change the fact that Luke Records owned the copyrights outright. Since Luke Records owned the copyrights, it was able to sell them free and clear in the bankruptcy case, and Thompkins could not maintain his infringement action. Additionally, since Thompkins failed to timely file a proof of claim for his damages based on the rejection of the royalty contract, he waived his claim for damages. Consequently, the purchaser maintained the rights to the music without having to pay any royalties to Thompkins.
Proper Planning
Thompkins could have obtained significantly better results with proper planning at the time he entered into the recording contract with Luke Records. Rather than selling the copyrights, Thompkins could have retained ownership and licensed the copyrights to Luke Records on an exclusive or non-exclusive basis. Moreover, Thompkins could have required Luke Records to create a bankruptcy remote entity or a trust and licensed the copyrights to this newly created entity or trust. Thompkins also could have obtained a security interest in the copyrights to secure payment of the obligations owing under the recording contract. These structures would have better insulated Thompkins from the financial problems suffered by Luke Records.
Thompkins also could have actively monitored the licensee's compliance with the license agreement and upon the occurrence of a default, could have issued a notification terminating the license. If the licensor waits until the licensee commences a bankruptcy case, an automatic stay is issued enjoining the licensor and other creditors from virtually all collection efforts, including a post-bankruptcy notification attempting to terminate the license agreement or otherwise curtail a licensee's use of intellectual property. However, by actively monitoring the licensee's pre-bankruptcy compliance, the licensor may be able to issue a pre-bankruptcy notice terminating the license agreement as of a particular date, which will validly terminate the license agreement, even when the effective date occurs post- bankruptcy, if the licensee/debtor has no post-bankruptcy cure rights. Moody v. Amoco Oil Co., 734 F.2d 1200, 1213 (7th Cir. 1984) (automatic stay does not toll simple passage of time). See also, In re Personal Communications Network, Inc., 249 B.R. 233 (Bankr. E.D. N.Y. 2000) (pre-petition termination of FCC license was effective when grace period expired prior to bankruptcy filing).
Enforcing Your Rights In Bankruptcy
It is also critical for an owner of intellectual property to actively monitor its rights during the course of a bankruptcy proceeding. Section 365(a) of the Bankruptcy Code gives the debtor the option to assume or reject a license agreement that constitutes an executory contract. If assumed, the debtor generally has the ability to assign an executory contract to a third party under Section 365(f) of the Bankruptcy Code. In order to assume a license agreement which constitutes an executory contract1, the licensee must cure all defaults thereunder and provide adequate assurance for its future performance. Consequently, a licensor needs to ensure that the debtor is complying fully with these requirements. If the licensee rejects the license agreement, the licensor is entitled to a pre-bankruptcy unsecured claim for the damages caused by the rejection. The licensee must treat the agreement as a whole, rather than assuming only the beneficial aspects and rejecting the burdensome ones. In re UAL Corp., 346 B.R. 456, 467 (Bankr. N.D. Ill. 2006). Pending a decision to assume or reject the executory contract, the debtor is obligated to pay for the reasonable value of the benefits received under the contract. NLRB v. Bildesco & Bildesco, 465 U.S. 513, 531 (1984). Moreover, the licensor should consider whether to file a motion to compel the debtor to assume or reject the contract in order to address any doubt concerning the status of the contract or any prejudice suffered by the licensor by continuing to perform under the contract. See e.g., In re National Steel Corp., 316 B.R. 287, 306-307 (Bankr. N.D. Ill. 2004).
There are some exceptions to these general principles. For example, the licensor may be able to obtain relief from the automatic stay if the licensor can establish that the debtor/licensee's continued use of the intellectual property is damaging the reputation of the licensor or infringing upon the goodwill associated with the licensor's property rights. See e.g., In re Tudor Motor Lodge Assoc., 102 B.R. 936, 954-958 (Bankr. D. N.J. 1989); In re Gainesville P-H Properties, Inc., 77 B.R. 285, 289-294 (Bankr. M.D. Fla. 1987). In addition, in many jurisdictions, the debtor/licensee of a non-exclusive license of intellectual property cannot assign such license agreement without the licensor's consent. See e.g., In re Valley Media, Inc., 279 B.R. 105, 135-136 (Bankr. D. Del. 2002). Finally, trademarks are excluded from the definition of "intellectual property" under the Bankruptcy Code, and a recent decision has concluded that trademark licenses are non-assignable absent an express provision of the license agreement to the contrary. In re Wellington Vision, Inc., 2007 WL 762398 (S.D. Fla. Feb. 20, 2007).
Conclusion
Thompkins is an important reminder that a licensee's bankruptcy can adversely affect valuable intellectual property. Through proper planning and active participation in a bankruptcy case, owners of intellectual property can minimize the effects of a licensee's bankruptcy.
Footnotes
1 Congress did not define the term "executory contract" in the Bankruptcy Code, choosing instead to leave the term to judicial interpretation. Most courts have settled on a definition of an executory contract as one "under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other." See In re Cardinal Industries, Inc., 146 B.R. 720, 727 (Bankr. S.D. Ohio 1992). Intellectual property licenses, including copyright licenses, are generally executory contracts. In re Adelphia Communications Corp., 307 B.R. 404, 428 n102 (Bankr. S.D. N.Y. 2004).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
