WHEN WORLDS COLLIDE: Intellectual Property and Arbitration Rights in Bankruptcy Cases

Dispute Resolution Journal, Aug-Oct 2004 by Hanessian, Grant, Stoker, Michael A, Samet, Joseph

The interplay between arbitration and bankruptcy law when an intellectual property licensee has a dispute with a licensor that has files or is about to file a bankruptcy petition.

The decline of some technology businesses, and the widespread use of arbitration clauses in technology license agreements-particularly between parties in different countries-has required many licensees of "intellectual property"1 to focus on whether they retain their license and arbitration rights if a licensor files for bankruptcy relief in the United States. This article examines the interplay between arbitration and bankruptcy law with respect to certain intellectual propepty-rights, and explores options available to a licensee engaged in an arbitrable dispute with a licensor that is, or may soon be, insolvent.

Arbitration and Bankruptcy

Many intellectual property agreements contain arbitration clauses. Particularly in international transactions, arbitration is widely viewed as a more efficient and equitable process than litigation in many national courts. A bankruptcy filing in the United States automatically stays substantially all actions, including pending arbitration proceedings, against the debtor. Creditors may not continue to pursue such actions unless a bankruptcy court terminates or modifies the automatic stay.

Pursuant to � 362(d)(1) of the Bankruptcy Code, an automatic stay may be terminated or modified "for cause." As part of the "cause," the moving party needs to demonstrate the existence of a valid arbitration agreement.2 The burden then shifts to the debtor to demonstrate that the purpose of the Bankruptcy Code would be significantly impaired or violated by enforcing the arbitration clause at that time.3 If the showing of cause has not been adequately rebutted, bankruptcy courts are likely to enforce the strong federal policy favoring enforcement of arbitration agreements.

This policy is rooted in the Federal Arbitration Act (FAA), which provides that arbitration agreements are "valid, irrevocable and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract."4 The U.S. Supreme Court has stated in Shearson/American Express v. McMahon that the FAA establishes a federal policy favoring arbitration, which requires courts to rigorously enforce agreements to arbitrate.5

Federal courts have repeatedly emphasized the preeminence of arbitration as a national policy and limited the discretion of bankruptcy courts to withhold recourse to arbitration.6 Indeed, this policy is so strong that there is case law holding that bankruptcy courts have no discretion to decline to enforce an arbitration agreement in a "noncore" adversary proceeding.7 However, for the most part, the law requires bankruptcy courts to carefully determine whether any underlying purpose of the Bankruptcy Code would be adversely affected by enforcing an arbitration clause, and then enforce the clause unless the objectives of the Code would be seriously jeopardized.8

Since the claims in arbitration are based on agreements to arbitrate entered into before a bankruptcy petition has been filed, and not on any right created by federal bankruptcy law, arbitration may be the most efficient forum in which to resolve them. For this reason, debtors often cannot demonstrate that the purposes of the Bankruptcy Code would be violated by enforcing an arbitration agreement. Thus, bankruptcy courts would be correct in terminating or modifying an automatic stay to permit a pending arbitration to continue. The same would be true even with respect to a "core" proceeding,9 since the proper inquiry for a bankruptcy court would be to determine whether enforcing an arbitration clause would so significantly violate the Code that Congress would not have intended the FAA to override it.10

The Intellectual Property Bankruptcy Act

Recognizing that the licensing of technology plays a substantial role in the process of technological development and innovation in the United States, Congress passed the Intellectual Property Bankruptcy Protection Act of 1988 (IPBPA), which added � 365(n) to the Bankruptcy Code. The purpose of this addition was to protect the rights of intellectual property licensees when the licensor files a bankruptcy petition.11 The enactment of � 365(n) was specifically intended to overrule the result in Lubrizol Enterprises v. Richmond Metal Finishers.12

Generally, � 365 of the Bankruptcy Code governs the trustee, or debtor-in-possession's, treatment of executory contracts in bankruptcy.13 Subsection (a) allows the trustee to evaluate executory contracts of the debtor and assume the ones that would be beneficial and reject the ones that would be detrimental to the estate.14

However, not all executory contracts are treated identically under the Bankruptcy Code, and such is the case with intellectual property licenses. Generally, both exclusive and non-exclusive intellectual property licenses are treated as executory contracts. When a debtor rejects an executory contract in which it is the licensor of intellectual property, � 365(n) allows the licensee to elect pursuant to � 365(a) either to treat the license as terminated or to assume the license, subject to certain limitations. Prior to the enactment of � 365(n), a licensee could lose its rights in the intellectual property if the licensor filed a bankruptcy petition and subsequently rejected the license as an executory contract.