Articles
Strange Results Abound in High Tech Bankruptcies
December 3, 2002
The high profile bankruptcies of large technology firms such as Global Crossing and WorldCom have dominated the business news this year. They are not alone. Hundreds of technology companies, both large and small, have sought refuge in the bankruptcy courts over the past several months. In 2001 alone, over 500 e-commerce companies either shut down or declared bankruptcy, leaving behind creditors and investors who naively believed that e-commerce companies were worth the billions of dollars they poured into them. The bankruptcy courts and lawyers are left to decide how traditional laws apply to these new misfits of the business world.
Shaped by the emergence of the internet as a viable business tool, these high tech companies tend to rely heavily on intangible assets, such as information technology products, and have very little in the way of tangible assets. Many of these companies have developed their own technologies, while others have chosen to license technologies developed by others. These information technology assets are often protected by intellectual property laws. This special protection is mainly found in the form of patents, trademarks and copyrights. The rights to intellectual property are often the most valuable assets of a high tech company. Such rights are typically managed through leases, licenses, and sales contracts.
One of the advantages of bankruptcy is that it gives a debtor the ability to better manage its executory contracts. Executory contracts are those that involve continuing performance, such as the lease for space in a shopping center. A bankrupt debtor is generally allowed to continue those executory contracts that are advantageous, and to reject those that are not. For example, a bankrupt retailer might be allowed to continue with the leases on its stores in shopping centers where it operates profitably and to reject, or walk away from, those shopping center leases where business is not going well.
For financially troubled companies whose business models rely on more traditional assets, the ability to assume or reject contracts is one of the key reasons to seek protection in the bankruptcy courts. for the high tech firm whose business model relies heavily on contracts for the use of assets protected by intellectual property laws, however, the right to simply assume or reject its contracts is severely limited.
Intellectual property licenses are generally treated as executory contracts under the Bankruptcy Code. One might then assume that a high tech company in bankruptcy would be able to pick and choose which of its intellectual property licenses it would like to honor on a going forward basis. Nothing could be farther from the truth. The Bankruptcy Code greatly restricts the ability of the debtor to terminate contracts under which it licenses its intellectual property to third parties. The third party will retain the right to continue using the licensed technology throughout the term of the license, as long as it continues to honor the terms and restrictions of the license. This will be true even in the context of an exclusive license which the bankruptcy e-commerce company would otherwise be able to terminate and possibly license to another customer at a higher price.
A very similar problem exists in the reverse situation, where the bankrupt company wishes to continue using intellectual property it licenses from another. Keep in mind that when a company files for bankruptcy protection, a new entity, either a trustee or a debtor-in-possession, is formed to operate or liquidate the business for the benefit of creditors. Consider the result for a high tech company that depends on patented technology it licenses from another under a nonexclusive patent license. If the company files for bankruptcy protection, the trustee or debtor-in-possession wil need to continue using the patented technology. Since patent law prohibits assignment of a nonexclusive patent license, the bankruptcy entity may not be able to use the key technology. While such a result certainly seems illogical at first blush, the courts are split as to whether a nonexclusive patent can be assumed by the debtor-in-possession or its trustee. Thus, depending on the jurisdiction in which the bankruptcy proceeding is filed, the debtor may not be able to assign key intellectual property involved, a company entering bankruptcy could lose the right to even assume an intellectual property license it was using prior to the bankruptcy filing, potentially hampering the value of other intellectual property assets of the company and in turn the enterprise itself.
A high tech company contemplating bankruptcy needs to take a careful look at its key technology. If that technology is protected by intellectual property law, the company will need to consider how that technology will be treated under bankruptcy law. If the company faces a situation where it may not be able to assign key technology to a trustee or debtor-in-possession, management will need to consider whether alternatives for reorganizing or liquidating the company outside of bankruptcy should be pursued.
