Achieving Balance in Patent License Transfers through Application of the Common Law of
Contracts
I.
Introduction
Intellectual property assets are increasingly at the forefront of commercial transactions in
the digital age. According to one study, general intangibles comprised 62% of the value of the
world’s large industrial companies in 1992, up from 38% just a decade before.1 Despite the
growing importance of these assets, the law governing the treatment of intellectual property in
the United States remains unsettled in several fundamental areas. One particularly problematic
area concerns the right of a licensee to transfer a non-exclusive patent license.
This article will address several key points of contention in this area. Part II will frame
the conflicting policy considerations surrounding the transferability of patent licenses within
both U.S. patent law and bankruptcy law.2 Part III will examine patent licenses as executory
contracts in bankruptcy. Particular focus will be given to the resolution of the relevant
“applicable law” considered by §§ 365(f)(1) and 365(c)(1)(A) of the Code. Part IV will examine
the problems posed by the difficult language of § 365(c) and the current split among circuit
courts concerning the assumption of an executory contract by a debtor licensee in bankruptcy.
Part V considers justifications offered for the preemption of state laws concerning the
assignability of patent licenses and the affect this “applicable law” has had on questions of
assumption under § 365(c)(1). Part VI concludes by suggesting that, through the application of
1
See William J. Murphy & Thomas Ward, Proposal for a Centralized and Integrated Registry for
Security Interests in Intellectual Property, 41 IDEA 297, 301 (2002) (citing Swiss Reinsurance
Company, The Significance of Intellectual Property Assets, Risks and Insurance (2000)).
2
All references are to 11 U.S.C. § 101 et seq. (the “Code”) (2000).
1
the common law of contracts to issues of assignability of patent licenses in bankruptcy, courts
can achieve the proper balance between allowing licensees the flexibility to reorganize both
inside and outside of bankruptcy while maintaining full protection of the licensor’s benefit of the
bargain under the original license agreement.
II.
Policy Clash: The Conflicting Goals of the Patent Act and Bankruptcy Code
Like other intellectual property statutes, the Patent Act arises from the grant in Article I,
clause 8, section 8 of the United States Constitution, authorizing Congress “to promote the
Progress of Science and Useful Arts, by securing for limited Times to Authors and Inventors the
exclusive Right to their respective Writings and Discoveries.” The right to exclude others from
using one’s invention is therefore the central right granted under the Patent Act.3
The Patent Act seeks to promote innovation by rewarding patentees with an exclusive
right to make, use, sell, and offer for sale their patented inventions for a fixed period of time.4
The Act further provides that these exclusive rights “shall have the attributes of personal
property,” and this property interest “shall be assignable in law by an instrument in writing.”5
When rights granted under a patent are transferred, the transaction may take one of two
forms. In the first instance, the patentee may assign its’ interest in the patent, thus transferring
legal title to the assignee. The Supreme Court has recognized three types of assignment:
The patentee… [may] convey, either (1) the whole patent, comprising the
exclusive right to make, use and vend the invention throughout the United States;
3
In re Supernatural Foods, LLC, 268 B.R. 759, 802 (Bankr. M.D. La. 2001) (“The granting of a
patent does not grant a person the right to use, make or sell a product…What is granted is the
right to exclude others from using one’s invention….”).
4
35 U.S.C. §271 (2000).
5
35 U.S.C. §261 (2000).
2
or (2) an undivided part or share of that exclusive right; or (3) the exclusive right
under the patent within and throughout a specified part of the United States. A
transfer of these three kinds of interests is an assignment, properly speaking, and
vests in the assignee a title or so much of the patent itself … Any assignment or
transfer, short of one of these is a mere license.6
Alternatively, the patentee may transfer some lesser right in the invention thereby
granting a “mere license” to use the patent. Typically a license grants the right to use an
innovation in favor of either a one-time payment or an on-going obligation to make royalty
payments. A patent license can be either exclusive or non-exclusive and is commonly granted
pursuant to a written agreement, but may also be conveyed orally or implied.7 Additionally,
when analyzing whether a transfer is an assignment of the patent res or a “mere license” to rights
under the patent, courts have looked beyond the language used by the parties to classify the
transaction.8
Where a patentee grants a non-exclusive license, the licensee holds only a contract right
and not a property interest in the patent itself.9 This contract right is tantamount to a promise of
immunity from an infringement claim. Indeed, even an exclusive license does not grant the
licensee a property interest in the patent unless it has the legal effect of an assignment.10
6
Waterman v. Mackenzie, 138 U.S. 252, 255, 11 S. Ct. 334 (1891).
Wang Labs., Inc. v. Mitsubishi Elecs. Am., Inc., 103 F.3d 1571, 1580 (Fed. Cir. 1997) (citing
De Forest Radio Tel. Co. v. United States, 273 U.S. 236, 241, 71 L. Ed. 625, 47 S. Ct. 366
(1927)).
8
Waterman v. Mackenzie, 138 U.S. 252, 256, 11. S. Ct. 334 (1891), Control Components, Inc. v.
Atlantic Richfield Co., 439 F. Supp. 654, 655-656 (E.D. Pa. 1957), Speedplay Inc. v. Bebop, Inc.,
211 F.3d 1245, 1250 (Fed. Cir. 2005) (“A party that has been granted all substantial rights under
the patent is considered the owner regardless of how the parties characterize the transaction that
conveyed those rights.”).
9
Board of Regents of the University of Nebraska v. BASF Corp., 2007 WL 3342406 (D. Neb.
2007) (quoting Unarco Indus. Inc. v. Kelley Co., Inc., 465 F.2d 1303, 1306 (7th Cir. 1948)).
10
Waterman v. Mackenzie, 138 U.S. 252, 11 S. Ct. 334 (1891). See also Rhone Poulenc Agro,
S.A. v. DeKalb Genetics Corp., 284 F.3d 1323, 1334 (Fed. Cir. 2002). Compare Sicom Systems,
Ltd. v. Agilent Technologies, 427 F.3d 971 (Fed. Cir. 2005).
7
3
As discussed in Part V below, courts have long applied a rule of federal common law that
holds patent licenses non-transferable without the consent of the patent holder.11 The Ninth
Circuit has justified the application this rule in preemption of state law on two grounds.12 First,
the court stated that allowing free transferability under state laws would undermine the incentive
for innovation by allowing any party seeking to use the patent to obtain an assigned license from
an existing licensee rather than the patent owner.13 The second rationale offered to support the
presumption of non-assignability concerns the importance of identity of the licensee.14 The court
raised the specter that any license of the patent – “even to the smallest firm in a product market
most remote from its own” – could result in the transfer of that license to the patent holder’s
largest competitor.15
In conflict with the broad rights granted to patentees to control the use of their inventions,
§ 365 of the Code grants debtors undergoing reorganization similarly broad rights to reject,
assume or assign their ongoing contract rights and obligations existent as of the date of filing.16
Allowing debtors broad flexibility in dealing with their existing contract rights and obligations is
in keeping with the policy goal of providing honest debtors a fresh start through bankruptcy.17 In
11
See e.g., Troy Iron & Nail Factory v. Corning, 55 U.S. (14 How.) 193, 216 (1852), In re
CFLC, Inc., 89 F.3d 673, 679 (9th Cir. 1996), PPG Industries, Inc. v. Guardian Indus. Corp.,
597 F.2d 1090, 1093 (6th Cir. 1979), Unarco Indus., Inc. v. Kelley Co., 465 F.2d 1303, 1306 (7th
Cir. 1972), Rock-Ola Mfg. Corp. v. FilbenMfg. Co., 168 F.2d 919, 922-923 (8th Cir. 1948).
12
In re CFLC, Inc., 89 F.3d 673 at 679.
13
Id.
14
Id.
15
Id.
16
11 U.S.C. § 365(a) (2000) (“the trustee, subject to the courts approval, may assume or reject
any executory contract or unexpired lease of the debtor.”); 11 U.S.C. § 365(f)(2) (“The trustee
may assign an executory contract only if… the trustee assumes such contract”).
17
See e.g., Adelphia Communications Corp., 359 B.R. 65, 73 (Bankr. S.D.N.Y. 2007) (“Code
section 365(f) implements a Congressional policy determination that executory contracts are
valuable assets of the estate, and that except in rare cases where the realization of their values
gives rise to material prejudice to the contract counterparty other than the loss of a prospective
4
a Chapter 11 case, the focus is on preserving the on-going value of an enterprise in financial
difficulty so that it may re-emerge as a profitable entity.
The difference in focus and policy considerations between the Patent Act and the
Bankruptcy Code has been extremely problematic for courts to resolve when patent licensees file
for relief under Chapter 11.18 Moreover, as discussed in Part III, the complexity in resolving this
conflict is exacerbated by the extremely difficult language in the Bankruptcy Code used to
determine a debtor’s rights in its’ executory contracts.19
III.
Executory Contracts and “Applicable Law” in Bankruptcy
Before a court will permit a debtor to reject, assume or assign a license to use intellectual
property, it must first determine that the license is an executory contract, rather than a nonexecutory contract or assignment. As noted above, bankruptcy courts will look behind the
terminology used by the parties to the actual nature of the transaction.20
The term “executory contract” is not defined in the Code; however, courts have typically
employed the Countryman definition requiring that the obligations of both parties “are so far
unperformed that the failure of either to complete performance would constitute a material
breach excusing the performance of the other."21 The case law is nearly uniform in holding that
windfall, the economic value in such contracts should go not to the contract counterparty, but
rather to the debtor’s creditor community generally.”).
18
See David R. Kuney, Restructuring Dilemmas for the High Technology Licensee: Will “Plain
Meaning” Bring Order to the Chaotic Bankruptcy Law for Assumption and Assignment of
Technology Licenses?, 44 Gonz. L. Rev. 123 (2008); Peter S. Menell, Bankruptcy Treatment of
Intellectual Property Assets: An Economic Analysis, 22 Berkeley Tech. L.J. 733 (2007).
19
11 U.S.C. § 365 (2000).
20
See n.8 supra.
21
Vern Countryman, Executory Contracts in Bankruptcy: Part I, 57 Minn. L. R. 439, 460 (1973).
5
non-exclusive licensing agreements are executory contracts within the meaning of § 365 of the
Bankruptcy Code.22
Although there is broad agreement that a non-exclusive license is an executory contract,
there is a great deal of controversy over how § 365 should be applied in determining a debtor’s
rights in its licensing agreement. As noted above, § 365(a) makes executory contracts generally
assumable subject to certain exceptions.23 Similarly, once an executory contract is assumed, §
365(f) allows such contract to be assigned to third parties.24 Further, the assignability authorized
by subsection (f) nullifies a “provision in an executory contract … of the debtor, or in applicable
law, that prohibits, restricts, or conditions the assignment of such contract….”25 However, both
of these broad rules allowing assumption and assignment by the trustee are expressly made
subject to an exception specified in 11 U.S.C. § 365(c)(1) which provides:
(c) The trustee may not assume or assign any executory contract or unexpired
lease of the debtor, whether or not such contract or lease prohibits or restricts
assignment of rights or delegation of duties, if –
(1)(A) applicable law excuses a party, other than the
debtor, to such contract … from accepting performance
from or rendering performance to an entity other than the
debtor or the debtor in possession, whether or not such
22
In re Catapult Entertainment, Inc, 165 F.3d 747 (9th Cir. 1999); Institut Pasteur v. Cambridge
Biotech Corp., 104 F.3d 489 (1st Cir. 1997); In re Novon Int’l Inc., 2000 WL 432848 (W.D.
N.Y. 2000); In re Access Beyond Tech., Inc., 237 B.R. 32 (Bankr. D. Del. 1999).
23
11 U.S.C. § 365(a) (2000).
24
11 U.S.C. § 365(f) (2000).
25
Id. However, courts have not applied subsection (f)’s nullification principle to narrower,
business-justified contract provisions limiting assignment. See e.g., In re Pioneer Ford Sales,
Inc., 729 F.2d 27 (1st Cir. 1984) (assignee must meet minimum capital requirements); In re
Morande Enterprises, Inc., 335 B.R. 188, 192 (Bankr. M.D. Fla. 2005) (a “location provision” in
an auto dealership agreement served to assure adequate future performance by assignee pursuant
to § 365(f)(2)(B), and therefore was a business justified limitation on assignment outside the
scope of § 365(f)(1) nullification).
6
contract … prohibits or restricts assignment of the rights or
delegation or duties; and
(B) such party does not consent to such assumption
or assignment.26
At first glance, the “applicable law” excuse in subsection (c)(1)(A) appears to take away
what the “notwithstanding a provision … in applicable law” clause of subsection (f) grants to the
debtor. In order to resolve this apparent conflict, the case law has focused on the scope of the
“applicable law” in each subsection.27
In deciding In re Pioneer Ford Sales, Inc., the Court of Appeals for the First Circuit
attempted to resolve this potential conflict in “applicable law” by giving a very narrow reading to
subsection (f)(1).28 The court focused on the “whether or not” language of subsection (c) to infer
that it applied when the contract was silent to limitations on assignability, and read the absence
of any similar limitation in (f)(1) to mean that the nullification of applicable law in that
subsection only applied to state laws enforcing express contract provisions prohibiting
assignment.29
This extremely narrow reading of applicable law in (f)(1) has been criticized by courts
and commentators alike as being generally unsupported by the statutory language.30 Indeed, the
First Circuit’s construction of (f)(1) effectively eliminates the words “or in applicable law” from
the Code. If subsection (f) were intended merely to nullify express contractual limitations on
26
11 U.S.C. § 365(c) (2000).
See e.g., In re Sunterra, 361 F.3d 257 (4th Cir. 2004); In re Magness, 972 F.2d 689 (6th Cir.
1992); In re Pioneer Ford Sales, Inc., 729 F.2d 27 (1st Cir. 1984).
28
In re Pioneer Ford Sales, Inc., 729 F.2d 27 (1st Cir. 1984).
29
Id. at 29.
30
In re Magness, 972 F.2d 689, 695 (6th Cir. 1992); Thomas M. Ward, Intellectual Property in
Commerce § 4.93 (2009).
27
7
assignment, the existence of that limitation in a federal statute alone would surely be sufficient to
invalidate any state laws attempting to uphold such express contractual limitations.31
A more natural interpretation of the intended scope of “applicable law” in sections
(c)(1)(a) and (f)(1) has been offered by the Sixth Circuit. That Court’s decision in In re
Magness32 reads subsection (f)’s nullification language much more broadly. In Magness the
court held that § 365(f) applied to all blanket contract provisions and applicable state laws
limiting assignment regardless of contract language. The court then placed its emphasis on what
limitations on assignment were saved by the carefully crafted exception in subsection (c)’s
“applicable law” provision, concluding that the excuse language used in (c) referred to common
law principles allowing a contracting party to refuse to render or accept performance from a third
party whenever the identity of the original contracting party was material.33
The classic example of a contract where the identity of the original contracting party is
material is a personal service contract. A personal service contract involves reliance on the
unique skill set of the party rendering performance. Examples of personal service contracts
include agreements involving performance from artists or highly skilled tradespeople. Were an
assignment of obligations to occur in this context, the non-assigning party would not receive the
full benefit of its original bargain by substitute performance because the unique skills of the
individual were a material part of that bargain. However, the Magness decision did not limit the
application of subsection (c) to personal service contracts.34 There are additional circumstances
where the identity of the original contracting party is material, such as when performance by a
substitute party would increase the risks or burdens of the non-assigning party. This concept is
31
Ward at § 4.93.
In re Magness, 972 F.2d 689 (6th Cir. 1992).
33
Id. at 699-700 (Guy, J. concurring).
34
Id. at 694.
32
8
well established under the general common law of contracts as well as in § 2-210(2) of the
Uniform Commercial Code.35 That section of the U.C.C. prohibits assignments that would
“materially change the duty of the other party, or increase materially the burden or risk imposed
on him by his contract, or impair materially his chance of obtaining return performance.” 36
This more restricted view of the excuse provided by subsection (c) applicable law has
been rejected by some courts.37 Those courts typically rely on the Fifth Circuit’s opinion in In re
Braniff Airways, Inc.38 for the supposition that the excuse provided in subsection (c) extends to
more than limitations of assignment based on the nature of the original contracting party. In
Braniff a debtor airline wished to assign its “landing slots” at Washington National Airport;
however, the Washington National Airport Act39 gave control of those landing slots to the airport
administrator to lease as “he may deem proper.” Similarly the FAA had promulgated Special
Federal Aviation Regulation ("SFAR") 44-4, 47 Fed.Reg. 22,492 (1982) restricting commercial
activity at Washington National Airport without the approval of the airport administrator. These
provisions in law generally applicable to all contracts were held to be “applicable law” restricting
assignment under § 365 (c) by the Fifth Circuit.40
Subsequent decisions have built upon the holding in Braniff to distinguish between
general provisions in law applicable to all contracts, and operation of law that is dependent on
express contractual provisions.41 The former being recognized as exceptions to assignability
35
U.C.C. § 2-210(2). See also U.C.C. [amended] § 2-210(1)(a).
Id.
37
See e.g., In re Adelphia Communications Corp., 359 B.R. 65, 73-78 (Bankr. S.D. N.Y. 2007);
In re Supernatural Foods, LLC, 268 B.R. 759, 792 (Bankr. M.D. La. 2001).
38
In re Braniff Airlines, Inc.700 F.2d 935 (5th Cir. 1983).
39
7 D.C. §§ 1101-1107
40
700 F.2d at 943.
41
In re Adelphia Communications Corp., 359 B.R. 65, 73-78 (Bankr. S.D. N.Y. 2007); In re
Supernatural Foods, LLC, 268 B.R. 759, 792 (Bankr. M.D. La. 2001).
36
9
under section (c) applicable law, and the latter being nullified under subsection (f) applicable
law.
This reading of the scope of applicable law in § 365 is unfounded for two reasons. First,
Braniff can be distinguished as relying on federally created anti-assignment law. While § 365 is
not expressly limited to exclude federal anti-assignment provisions, it may be presumed that
Congress did not intend to nullify other federal policies that conflict with § 365(f)(1).42 For this
reason federal law limitations on assignment are best interpreted as existing outside the intended
scope of subsection (f) nullification. Therefore, the extension of the reasoning in Braniff to state
laws of general applicability is misplaced.
Second, the language in subsection (f) expressly refers to provisions of applicable law,
while the language in subsection (c) refers to excuses under applicable law generally. This
distinction in the language of the two subsections comports with the idea that subsection (c)
excuses to assignment should be limited to common law considerations on the nature of
performance, while the “provisions” of applicable law nullified in subsection (f) refer to
statutorily based limitations on assignment, including state law limitations of general
applicability intended to apply regardless of express contractual restrictions.43
For these reasons, the better reconciliation of the “applicable law” in subsections (c) and
(f) is that offered by Judge Guy in Magness.44 As stated by the Ninth Circuit, “In order to
determine whether a law is overridden by 365(f)(1), … a court must ask why ‘applicable law’
prohibits assignment.”45 Where there is no applicable federal law limiting assignment,
determinations of assignability should hinge on whether or not the non-debtor party will continue
42
See Ward at §4.93.
Id.
44
972 F.2d at 699-700 (Guy, J. concurring).
45
In re Catapult, 165 F.3d at 752 (citing In re Magness, 972 F.2d at 700 (Guy, J., Concurring)).
43
10
to receive the full benefit of its bargain under a proposed assignment. This line of demarcation
between the subsections serves to maximize flexibility to a debtor and is in keeping with the
policies and intent of the Bankruptcy Code, while still protecting the non-debtor party’s
legitimate interest in preserving the benefit of the bargain made in the original contract.
Applying these rules for assignability, courts will need to exercise a substantial degree of
discretion, and it may well be appropriate to require a debtor to bear the burden of demonstrating
that no material increase in burden or risk would result from a proposed assignment.
IV.
Assumption of Executory Contracts in Bankruptcy: The § 365(c) Problem
Another area of significant controversy in § 365 concerns the application of subsection
(c) to situations where a Chapter 11 debtor seeks to assume, but not assign, its rights under an
executory contract. Courts have delineated three different approaches in applying the language
of subsection (c) to the proposed assumption of an executory contract in bankruptcy.
A.
The Hypothetical Test
The first line of cases interpreting assumption under § 365(c) employs the “hypothetical
test” which purports to adhere to the “literal language” of the Code by emphasizing the
disjunctive “assume or assign” language in subsection (c).46 This test was first announced in
46
In re Catapult Entertainment, Inc., 165 F.3d 747, 750 (9th Cir. 1999); See also In re Sunterra
Corp., 361 F.3d 257, 268-69 (4th Cir. 2004); Matter of West Electronics, Inc., 852 F.2d 79, 8283 (3rd Cir. 1988) (also holding, contrary to the Supreme Court’s decision in N.L.R.B. v. Bildisco
and Bildisco, 465 U.S. 513, 528, 104 S. Ct. 1188 (1984), that the debtor in possession is a
separate entity for purposes of the hypothetical test); In re James Cable Partners, L.P., 27 F.3d
534, 537-38 (11th Cir. 1994); David Kuney, Restructuring Dilemmas for the High Technology
11
1988 by the Third Circuit in Matter of West Electronics, Inc., which sought to answer the
question of whether a debtor could assume a government contract if it had no intention of
assigning it. For purposes of the case, the “applicable law” barring assignment was 41 U.S.C. §
15 which prevents parties to a government contract from assigning those contracts to third
parties. The Court announced the test as follows:
11 U.S.C. § 365(c)(1) creates a hypothetical test – i.e., under applicable law,
could the government refuse performance from ‘an entity other than the debtor or
the debtor in possession.’ … thus, the relevant inquiry is not whether 41 U.S.C. §
15 would preclude an assignment from West as a debtor to West as a debtor in
possession, but whether it would foreclose an assignment by West to another
defense contractor.47
Thus, as applied, the hypothetical test prevents a debtor from assuming an executory
contract whenever “applicable law” would excuse the non-debtor party from accepting
performance from a third party, regardless of whether the debtor actually seeks to assign the
contract.48 The Court in West Electronics appropriately relied on the federal statute as the source
of applicable law barring assignment (and therefore, in the Court’s view, assumption). The
Court did not consider the federal common law of patents, nor did it assess the materiality of
performance to the question of assignability under applicable law.
The hypothetical test was first applied in the context of intellectual property law by the
Ninth Circuit in In re Catapult Entertainment, Inc.49 which was the earliest circuit court decision
to hold that a non-exclusive patent license could not be assumed in bankruptcy without the
Licensee: Will “Plain Meaning” Bring Order to the Chaotic Bankruptcy Law for Assumption
and Assignment of Technology Licenses, 44 Gonz. L. Rev. 123, 146-47.
47
Matter of West Electronics, Inc., 852 F.2d 79, 83 (3rd Cir. 1988)
48
See n.22, supra.
49
165 F.3d 747 (9th Cir. 1999).
12
consent of the licensor.50 The court relied on its earlier decision in In re CFLC, Inc., discussed in
Part II above and Part V below, in concluding that “federal common law constitutes ‘applicable
law’ within the meaning of section 365(c) and that non-exclusive patent licenses are ‘personal
and assignable only with the consent of the licensor.’”51
Five years after Catapult, the Fourth Circuit also adopted the hypothetical test in deciding
In re Sunterra.52 That case arose in the context of a software licensing agreement. As in
Catapult, the court emphasized a “plain language” approach to interpreting subsection (c), and
refused to deviate from the “assume or assign” language therein.53 Further, the Court relied on
federal copyright law as the “applicable non-bankruptcy law” providing the non-debtor an
excuse from accepting assignment without consent.54
The results of the hypothetical test have been widely criticized by commentators as
frustrating the intent of the Bankruptcy Code while causing significant hardships for licensees. 55
Additionally, despite the fact that a majority of Circuit Court decisions favor the hypothetical
test, it appears that the majority of bankruptcy courts do not follow it.56
The problems with the hypothetical test, as applied when employing federal common law
restrictions on the assignment of patent licenses, become apparent upon examining its effects on
50
Id. at 748.
Id. at 750 (quoting In re CFLC, Inc., 89 F.3d 673, 680 (9th Cir. 1996)).
52
361 F.3d 257 (4th Cir. 2004).
53
Id. at 267-70. (The court rejected arguments that, read literally, the statue produced an absurd
result or was contrary to the intent of Congress at the time of drafting)
54
Id. at 262 n.7.
55
See e.g., Thomas Ward, Intellectual Property in Commerce, § 4:89 (2009); David Kuney,
Restructuring Dilemmas for the High Technology Licensee: Will “Plain Meaning” Bring Order
to the Chaotic Bankruptcy Law for Assumption and Assignment of Technology Licenses?, 44
Gonz. L. Rev. 123, 149 (2008); Lawrence King, Collier on Bankruptcy § 365.06[1][d][iii] (15th
ed. Rev. 2006).
56
In re Catapult Entertainment, Inc., 165 F.3d 747, 750 n.2 (9th Cir. 1999) (collecting
bankruptcy court decisions adopting the actual test); TechDyn Sys. Corp., 235 B.R. 857, 860861 (Bankr. E.D. Va. 1999).
51
13
a business dependent on a favorable patent license. Such a business may be effectively
precluded from reorganization in bankruptcy because under the hypothetical test it would either
lose its patent license in Chapter 11 or be forced to purchase the licensor’s consent to an
assignment – perhaps at a price beyond the reach of the debtor licensee. Thus a company that
would be otherwise viable after reorganization might well be forced to liquidate.
B. The Actual Performance Test
A minority of circuit courts have rejected the hypothetical test in favor of a more fact
intensive inquiry into whether the assumption of an executory contract actually forces a nondebtor to accept performance from an entity other than the original counter party to the
contract.57 The actual performance test places emphasis on the “accepting performance from or
rendering performance to an entity other than the debtor or debtor in possession” language of
(c)(1)(A). Courts employing the actual test contend that giving full effect to this language
requires a separate analysis for attempts to assume (where the entity is not “other than the debtor
or debtor in possession”) and attempts to assign (where the entity is in fact not the debtor).
In 1995 the First Circuit rejected the hypothetical test and became the initial circuit court
to utilize the actual test.58 The Court did not deny that the hypothetical test’s construction of §
365(c) was a possible reading of the statute; however, after finding the language of § 365(c)
ambiguous, the court buttressed its own interpretation requiring separate tests for assumption and
57
Summit Inv. And Development Corp. v. Leroux, 69 F.3d 608, 612-14 (1st Cir. 1995); In re
Mirant Corp., 440 F.3d 238, 254 (5th Cir. 2006) (applying the actual test to termination issues
under § 365(e)(2)(A) and suggesting, but not holding, that a “sensible view” would apply the
same actual performance test to assumption of an executory contract by a debtor).
58
Summit Inv. And Development Corp. v. Leroux, 69 F.3d 608 (1st Cir. 1995).
14
assignment by reference to the amendments and legislative history of § 365(c).59 The Court first
noted that, prior to amendment in 1984, the language of subsection (c) was identical to the
language used in the current version of § 365(e)(2)(A).60 That amendment replaced the
disjunctive “to the trustee or to an assignee” language currently found in (e)(2) with the singular
“to an entity other than the debtor or debtor in possession.”61 The Court then cited a 1982
Committee Report declaring that the amendment was intended to:
make[] clear that the prohibition against the trustee's power to assume an
executory contract does not apply where it is the debtor that is in possession and
the performance to be given or received under a personal service contract will be
the same as if no petition had been filed because of the personal nature of the
contract.62
The Court relied on the committee’s statement to infer that the amendment contemplated
individual analysis for assumption distinct from that of assignment.63
Two years later the First Circuit decided Institut Pasteur v. Cambridge Biotech Corp64
expressly affirming its analysis in Leroux and the application of the actual performance test in
59
Id. at 612.
Id. at 613. 11 U.S.C. § 365(e)(2)(A) allows for termination of an executory contract if
“applicable law excuses a party, other than the debtor, to such contract … from accepting
performance from or rendering performance to the trustee or to an assignee of such contract …”
(emphasis supplied).
61
Id. See also Thomas Ward, Intellectual Property in Commerce, § 4:87 (2009) (discussing in
detail the changes made to 365(c) by the 1978, 1984 and 1986 amendments. Prof. Ward
contends that the 1984 amendment to § 365(c) inadvertently destroyed the original parallel
disjunctives contained between the “assume or assign” language and the “trustee or … assignee”
language. He concludes that this parallel disjunctive language required the actual performance
test).
62
H.R. Rep. No. 1195, 96th Cong., 2d Sess. § 27(b) (1980).
63
Leroux at 613.
64
104 F.3d 489 (1st Cir. 1997) (abrogated on other grounds by, Hardemon v. City of Boston,
1998 WL 148382 (1st Cir. 1998)).
60
15
the context of a patent license. Again the court employed a fact-intensive analysis of whether the
non-debtor was being forced to accept performance “from someone other than the debtor party
with whom it originally contracted.”65 The Court ultimately affirmed the lower court’s decision
allowing assumption and held that the debtor’s stock transfer was not a de facto assignment since
it preserved the legal identity of the original contracting party.
The result in Institut Pasteur is somewhat problematic from a “benefit of the bargain”
perspective. Under the facts of the case the stock transfer resulted in a direct competitor of the
debtor acquiring the rights granted under the patent license.66 The First Circuit however framed
the “benefit of the bargain” inquiry narrowly, and examined the non-debtor’s expectations solely
from the restrictions on assignment contained in the licensing agreement.67 The court
distinguished its decision from the Sixth Circuit’s holding in PPG Industries, Inc v. Guardian
Industries Corp.68 on the grounds that the licensing agreement permitted the use of the license by
an affiliate of the debtor.69 This reliance on the contract language is troubling since assumption
and assignment under § 365(c) applies “whether or not such contract … prohibits or restricts
assignment of rights or delegation of duties.” Certainly the contract is material for determining
the “benefit of the bargain” originally conferred, but that analysis properly hinges on the nature
of performance rather than solely on the presence or absence of assignment restricting language
in the agreement.
Despite this disturbing aspect of Institut Pasteur’s analysis of common law excuse, the
actual test appears to achieve an appropriate balance of interests between patent holders and
65
Id. at 493.
Id. at 490.
67
Id. at 494-95.
68
597 F.2d 1090, 1096 (6th Cir. 1979) (preventing assumption where the license contained an
anti-assignment provision in the event of a change in stock ownership).
69
Institut Pasteur at 494.
66
16
licensees; yet, this balance is only accomplished by ignoring the literal “assume or assign”
language of subsection (c).
C. The Alternative “Plain Meaning” Test
A third solution to the § 365(c) problem of assumption has emerged more recently. This
line of cases recognizes a distinction between the debtor in possession and the trustee when
applying subsection (c) to a proposed assumption. While not yet adopted by any circuit court,
this alternative view of the “plain meaning” of subsection (c) has found favor in several recent
decisions.70
This new approach was first articulated by Judge Adlai Hardin, Jr. in In re Footstar,
Inc.71, and pointed to a “basic misconception” in previous attempts to resolve the language of
subsection (C) under both the hypothetical and actual tests.72
Subsection (c) limits the power
of “the trustee” to “assume or assign” a contract under the perplexing conditions expressed in
(c)(1)(A).73 As the Footstar court noted, prior decisions held that the term “trustee” includes
debtors in possession either without citation to the Code or by reference to § 1107.74 Section
1107(a) defines the “rights, powers, and duties” of a debtor in possession. It provides:
70
In re Footstar 323 B.R. 566 (Bankr. S.D. N.Y. 2005); In re Adelphia Communications Corp.,
359 B.R. 65 (Bankr. S.D.N.Y. 2007); In re Aerobox Composite Structures, LLC, 373 B.R. 135
(Bankr. D. N.M. 2007). See also David Kuney, Restructuring Dilemmas for the High
Technology Licensee: Will “Plain Meaning” Bring Order to the Chaotic Bankruptcy Law for
Assumption and Assignment of Technology Licenses?, 44 Gonz. L. Rev. 123, 152-57 (2008).
71
323 B.R. 566 (Bankr. S.D. N.Y. 2005).
72
Id. at 571.
73
11 U.S.C. § 365(c) (2000).
74
323 B.R. 566 at 571-72 (quoting In re Catapult Entm’t Inc., 165 F.3d 747, 750 (9th Cir. 1999)
and In re West Elecs., Inc., 852 F.2d 79, 82 (3rd Cir. 1988)).
17
(a)
Subject to any limitations on a trustee serving in a case under
this chapter, and to such limitations or conditions as the court
prescribes, a debtor in possession shall have all the rights, …
and powers, and shall perform all the functions and duties … of
a trustee serving in a case under this chapter75
Reasoning that the Code does not make the term “trustee” synonymous with “debtor” or
“debtor in possession”, the Footstar court held that the “critical language” in § 1107(a) for
purposes of interpreting §365(c) was the prefatory clause “subject to any limitations on the
trustee….”76 Here, the Court contended, a trustee should be differentiated from the debtor in
possession because the appointment of a trustee is a de facto statutory assignment of the contract,
whereas there is no similar assignment to a debtor in possession because a debtor in possession is
deemed to be the same legal entity as the pre-petition debtor.77 This distinction, the court
concluded, was sufficient to exclude a debtor in possession from being equated with a trustee for
purposes of assumption under subsection (c).78
This result was held to be in keeping with the basic objectives of § 365(c)(1) because a
debtor in possession assuming it’s own executory contract does not involve a potentially
unlawful assignment. Further, while the results of this analysis closely resemble the results
under the “actual test” discussed above, this approach differentiates itself from that analysis in
that it purports to give “full effect” to the all the language in § 365(c).79
75
11 U.S.C. § 1107(a) (2000).
In re Footstar, Inc., 323 B.R. at 572.
77
Id. at 573-74 (citing N.L.R.B. v. Bildisco and Bildisco, 465 U.S. 513, 528, 104 S. Ct. 1188
(1984)).
78
Id.
79
Id. at 574.
76
18
This alternative “plain meaning” approach was first applied to non-exclusive patent
licenses in In re Aerobox Composite Structures, LLC.80 There the court agreed with the analysis
in Footstar that a debtor is not materially different than a debtor in possession, and that to read
the term “trustee” in (c) to be the equivalent of a debtor in possession “would render the
provision a virtual oxymoron, since mere assumption [by the debtor in possession] (without
assignment) would not compel the counterparty to accept performance from or render it to an
‘entity other than’ the debtor.”81
However the Footstar logic is troubling when applied to a fact pattern like the one in
Instituit Pasteur.82 As discussed above, in that case the debtor in possession remained the same
legal entity as the pre-petition debtor, and therefore, under the Footstar analysis would
presumably be the outside the scope of § 365(c). However, from a “benefit of the bargain”
perspective, the performance rendered by the debtor in possession after a stock transfer to a
direct competitor of the counterparty might well be considered to materially affect the patent
holder’s original bargain, and thus be subject to common law excuse limitations on assignment
under subsection (c) “applicable law”.
In summary, none of the current efforts to resolve the unclear language of § 365(c) are
without problems. Either the results achieved are contrary to the general policies underlying the
Code, as in the hypothetical test and, to a lesser extent, in the alternative “plain meaning” test, or
the disjunctive “assume or assign” language is not given its apparent literal interpretation.
80
373 B.R. 135 (Bankr. D. N.M. 2007).
Id. at 142 (quoting Footstar, 323 B.R. at 573).
82
104 F.3d 489 (1st Cir. 1997).
81
19
Unfortunately, the Supreme Court recently denied certiorari on a case that may have
provided some much needed guidance on this issue.83 In N.C.P. Marketing Group v. BG Star
Productions, Inc. the Court was asked to consider application of the hypothetical test in the
context of a trademark license.84 Justice Kennedy, joined by Justice Breyer, issued a short
statement recognizing the importance of resolving the division over the meaning of § 365(c)(1),
but agreeing that the facts of the N.C.P Marketing Group were less than ideal because their
resolution “might first require [the Court] to resolve issues that may turn on the correct
interpretation of antecedent questions under state law and trademark protection principles.”85
Therefore, without further action from Congress clarifying this issue, an entirely satisfactory
solution to the 365(c) problem seems unlikely over the near term.
However, as applied to non-exclusive patent licenses, there does exist a well-reasoned
way to mitigate the negative outcomes that a literal reading of § 365(c) has on debtor licensees
while still protecting the licensor’s full expectation under the licensing agreement. In order to
achieve this result, Courts must engage in a critical examination of the justifications for a federal
common law rule on patent license transferability.
V.
Questioning the “Unquestioned” Rule: Is There Sufficient Justification for a
Rule of Federal Common Law to Issues of Patent License Transfers?
In the context of a proposed assumption of a patent license, federal courts have
consistently determined that the “applicable law” barring assignment (and therefore assumption
83
N.C.P. Mktg. Group v. BG Star Prods., Inc., 129 S. Ct. 1577 (2009).
Id.
85
Id. See also Jason Binford, Supreme Court Passes On Assumption and Assignment of
Trademark License Agreements, 28-5 ABIJ 36 (2009).
84
20
under the hypothetical test) is the federal common law rule restricting patent assignments.86 This
“unquestioned” line of cases hold that federal common law preempts state laws favoring the free
assignability of contracts as those laws are applied to rights granted under the Patent Act.87
However, recognizing that the Patent Act is silent regarding the issue of licensing, not all courts
and commentators agree that preemption should apply to the transferability of patent licenses. 88
In Erie R.R. Co. v. Thompkins the Supreme Court announced the Erie doctrine declaring
there “is no federal general common law.” Therefore, in the absence of an express federal statute
on the assignability of patent licenses, a court must demonstrate that there is a “significant
conflict between some federal policy or interest and the use of state law.”89 Furthermore, the
scope of the preemption of state law must be tailored to extend no further than the conflict
between the state law and the special federal interest.90 The Supreme Court has stated that
instances justifying the application of federal common law rules based on special federal
interests are “few and restricted”91 and are warranted only in “extraordinary cases.”92
Despite these strict requirements for invoking a federal common law rule, most federal
courts confronted with applying such a rule to the assignability of patent licenses have not
86
In re CFLC, Inc., 89 F.3d 673, 679 (9th Cir. 1996); PPG Industries, Inc. v. Guardian
Industries Corp., 597 F.2d 1090, 1093 (6th Cir.), cert. denied, 444 U.S. 930, 100 S. Ct. 272
(1979), Unarco Industries, Inc. v. Kelley Co., 465 F.2d 1303, 1306 (7th Cir. 1972) (“The
question of assignability of a patent license is a specific policy of the federal patent law dealing
with federal patent law. Therefore, we hold federal law applies to the question of the
assignability of the patent license in question.”), cert. denied, 410 U.S. 929, S. Ct. 1365 (1973).
87
Board of Regents of the University of Nebraska v. BASF Corp., 2007 WL 3342406 (D. Neb.
2007) (quoting Unarco Indus. Inc. v. Kelley Co., Inc., 465 F.2d 1303, 1306 (7th Cir. 1948)).
88
Superbrace, Inc. v. Tidwell, 124 Cal App. 4th 388, 396, 21 Cal. Rptr. 3d 404, 409 (4th Dist.
2004); Farmland Irr. Co. v. Dopplmaier, 48 Cal. 2d 208, 308 P.2d 732 (Cal. Sup. Ct. 1957)
89
Wallis v. Pan American Petroleum Corp., 384 U.S. 63, 68, 86 S. Ct. 1301 (1966).
90
See e.g., Kamen v. Kemper Financial Services, Inc., 500 U.S. 90, 98, 111 S. Ct. 1711 (1991);
Boyle v. United Tech. Corp., 487 U.S. 500, 508;108 S. Ct. 2510 (1988); United States v. Kimball
Foods, 440 U.S. 715, 728, 99 S. Ct. 1448 (1979).
91
Wheeldin v. Wheeler, 373 U.S. 647, 651, 83 S. Ct. 1441 (1963).
92
O’Melveny & Myers v. F.D.I.C. Corp., 512 U.S. 79, 89, 114 S. Ct. 2048 (1994).
21
squarely addressed the issue of whether federal preemption is warranted to protect unique federal
interests.93 Even those that have considered the issue have failed to specifically address the state
laws at issue and why a judicial displacement of those rules is required.94
In 1957 Judge Roger Traynor, writing for a unanimous California Supreme Court in
Farmland Irrigation Co. v. Dopplmaier,95 was the first to question the application of the federal
common law rule. The court in Dopplmaier first noted that every action involving a patent “is
not for that reason governed exclusively by federal law.”96 For example, states have long
regulated the manufacture and sale of patented items dangerous to public safety and state courts
have exclusive jurisdiction over actions to set aside, specifically enforce or recover royalties on a
patent license contract.97
Further, the court noted that the bulk of cases establishing a federal rule of construction
for the transfer of patent licenses were either decided prior to the Supreme Court’s decision in
Erie R.R. v. Thompkins98 or failed to examine its ramifications to these issues and therefore
93
See e.g. Rock-Ola Mfg. Corp. v. Filben Mfg Co., 168 F.2d 919 (8th Cir. 1948) (failing to
address the justifications for preemption); Unarco Indus., Inc. v. Kelley Co., 465 F.2d 1303,
1306-07 (7th Cir. 1972) (citing Rock-Ola for the proposition that a federal rule of nonassignability “has been unquestioned”); PPG Indus., Inc. v. Guardian Indus. Corp., 597 F.2d
1090 (6th Cir. 1979) (citing Unarco and Troy Iron & Nail v. Corning, 55 U.S. (14 How.) 193
(1852) for the federal rule that patent licenses are “not assignable unless expressly made so.”).
94
See e.g., In re CFLC, Inc., 89 F.3d 673, 678-80 (9th Cir. 1996) (holding that the federal
policies underlying the Patent Act warrant application of the federal common law rule, but not
addressing the actual scope of conflict between that rule and California state law).
95
48 Cal. 2d 208, 308 P.2d 732 (Cal. Sup. Ct. 1957). See also Aaron Fellmeth, Control Without
Interest: State Law of Assignment, Federal Preemption, and the Intellectual Property License, 6
Va. J.L. & Tech. 8 (2001); Caroline A. Quinn & R. Scott Weide, Violation of the Erie Doctrine:
Application of a Rule of Federal Common Law to Issues of Patent License Transferability, 32
Creighton L. Rev. 1121 (1999).
96
48 Cal. 2d 208, 216, 308 P.2d 732, 737 (Cal. Sup. Ct. 1957).
97
Id at 216-217 (collecting cases).
98
Erie Railroad Co. v. Thompkins, 304 U.S. 64, 78 (1936)
22
“involved no conscious choice between state and federal law.”99 As stated above, in the 53 years
since Dopplmaier, the justifications for application of federal common law remain unexamined
to the full extent required by the Supreme Court’s mandate.100
One federal court decision that did give substantial consideration to the special federal
interests in this area is the Ninth Circuit’s decision in In re CFLC, Inc.101 In that case, the court
expressly considered Dopplmaier and previous cases invoking the federal common law rule.102
While the court admitted that previous justifications for preemption were “less firm than might
be wished” it held that the federal policies underlying the Patent Act were enough to justify the
application of federal law.103 Specifically, the court stated:
Allowing free assignability – or, more accurately, allowing states to allow
free assignability – of nonexclusive patent licenses would undermine the reward
that encourages invention because a party seeking to use the patented invention
could either seek a license from the patent holder or seek an assignment of an
existing patent license from a licensee. In essence, every licensee would become
a potential competitor with the licensor-patent holder in the market for licenses
under the patents. And while the patent holder could presumably control the
absolute number of licenses in existence under a free-assignability regime, it
would lose the very important ability to control the identity of its licensees. Thus,
any license a patent holder granted – even to the smallest firm in the product
market most remote from its own – would be fraught with the danger that the
licensee would assign it to the patent holder’s most serious competitor, a party
with whom the holder itself might be absolutely unwilling to license. As a
practical matter, free assignability of patent licenses might spell the end to paidup licenses…. Few patent holders would be willing to grant a license in return for
a one-time lump-sum payment, rather than for per-use royalties, if the license
could be assigned to a completely different company which might make far
greater use of the patented invention than could the original licensee.104
99
48 Cal. 2d at 219.
See n. 87, supra.
101
89 F.3d 673, 678-80 (9th Cir. 1996).
102
Id. at 677-78.
103
Id. at 678-79. See also Part II, supra.
104
Id. at 679. (emphasis in original) (this rationale was expressly adopted by Board of Regents
of Univ. of Neb. v. BASF Corp., 2007 WL 3342406 (D. Neb. 2007)).
100
23
Thus, the court identified two main concerns with allowing free transferability of patent
licenses: (1) that they might be transferred to parties in competition with the patentee, and (2)
that the marketplace for licenses would be adversely affected.
The first concern could, of course, be entirely controlled through simple contractual
language limiting the assignability of a license. Protecting patent holders from entering into
contracts that fail to limit the assignability a license is a poor reason for preempting state contract
laws. As discussed above, the real issue is that a patent license may be assumed or assigned
notwithstanding contractual language limiting assignment in the bankruptcy context. Aside from
the dubious contention that federal bankruptcy law necessitates preemption of a state’s common
law of contracts to further the policies of federal patent law, these same state common law
principles provide an excuse restricting assignment under § 365(c) when the full “benefit of the
bargain” is denied to the licensor because of material changes in its expectation of performance.
Thus, the concerns raised by the Ninth Circuit regarding a patent holder’s interest in controlling
the identity of licensees could be entirely alleviated by the proper application of state law.
The contention that the marketplace for paid-up licenses would evaporate in the wake of
free-assignability is likewise flawed. First, the rights granted under the Patent Act only provide
the exclusive right to make, use, sell and offer for sale the patented invention. There is no
assurance grounded in federal law that a patent holder should receive adequate compensation
under a licensing agreement, just as there should be no protection for a patentee that enters into a
licensing agreement without express restrictions on assignment. Instead, the law is neutral on
these points, and allows the patent holder to transfer his or her rights as desired.
24
Contrary to the justifications offered for the common law rule, there are several instances
where its application has an unduly harsh affect on licensees. A few examples illustrate these
problems. As discussed in Part IV above, a business dependent on a patent license may be
effectively precluded from filing for Chapter 11 reorganization because that license could be
assumed under the test employed by a majority of circuit courts. Further, an individual or sole
proprietor holding a patent license could not incorporate and transfer that license to the resulting
entity without risk that the patent holder could effectively block such assignment. Also, if an
individual acquiring a paid-up patent license should die shortly thereafter, his or her estate is
currently unable to transfer that patent license or receive any of the deceased’s expected benefit
from the agreement.
Thus the application of a federal common law rule of assignability to patent licenses is
not only unwarranted but, as applied, may be extremely harmful to licensees seeking to
reorganize or transfer their rights either inside or outside of bankruptcy. Courts should instead
resolve these issues by applying the jurisdictional state’s robust and well-understood common
law of contracts.
VI.
Conclusion
Federal courts have long applied a federal common law rule to patent assignments.
However, application of such a rule is justified only if required to protect a special federal
purpose, and only to the extent that such purpose is actually contradicted by state laws. To date
no court has sufficiently articulated an adequate reason for employing the preemptive federal
rule. On the contrary, application of such a rule has placed unnecessary burdens on licensees and
25
resulted in a windfall for licensors who are able to renegotiate license terms any time a transfer
of rights under the license is desired, without regard to effects on the nature of performance
resulting from the transfer.
Courts should instead allow free assignability under the common law of contracts.
Concerns regarding license transfers in bankruptcy to parties that would materially alter the
original benefit of the licensor’s bargain may be dealt with by regarding jurisdictional state’s
common law of excuse as “applicable law” for purposes of § 365(c). Thus, by removing the
federal common law rule, a proper balance is struck between a licensee’s ability to transfer its
rights under a contract and the patent holder’s legitimate expectation to receive the full benefit of
its bargain under the original license terms.
Applying state law would have the added benefit of substantially resolving the problems
encountered when a debtor seeks to assume a patent license in bankruptcy in a hypothetical test
jurisdiction. No longer would “applicable law” restrict assignment, and thus assumption, unless
there was a legitimate reason to protect the value of the bargain struck by the patent holder. For
these reasons, the application of state law is best suited to patent license transfers.
26