Application of Bankruptcy Law to Internet Assets

New Jersey Law Journal February 20, 2017 

Jonathan Bick Bick is of counsel at Brach Eichler in Roseland. He is also an adjunct professor at Pace and Rutgers law schools, and the author of 101 Things You Need to Know About Internet Law (Random House 2000).

Internet assets generally, and Internet asset licenses in particular, are increasingly subject to bankruptcy proceedings. Under United States Bankruptcy Law, Title 11 U.S.C. §363(f), allows a debtor licensor to sell Internet property "free and clear" of any license under certain conditions. Typically, three types of licenses must be addressed by a debtor licensee when seeking to sell Internet assets in a Chapter 11 or Chapter 7 bankruptcy. These three types of licenses include: a non-exclusive license; a sub-license; and an exclusive license.

A two-step analysis is required for the optimal disposition of Internet assets subject to a bankruptcy proceeding. The first step involves considering licensing laws that are external to bankruptcy. In particular, the three sets of laws which most often govern the transfer of Internet assets are related to non-exclusive licenses, sub-licenses and exclusive licenses. The second step involves the integration of said laws, which are external to bankruptcy, and bankruptcy law which permits the employment of an Internet asset license free and clear of third-party claims under §363(f).

Internet assets are essentially anything that exists in a digital format and whose right of use on the Internet is owned by an entity. Digital photography, logos, illustrations, animations, audiovisual media, presentations, spreadsheets, word documents, electronic mails, software and domain name addresses are examples of Internet assets. Most Internet assets are forms of Internet content and hence subject to copyright protection. Most copyright protected asset rights are transferred via licenses.

Internet assets may be subject to non-exclusive, subordinate and exclusive licenses. A non-exclusive license grants to the licensee the right to use an Internet asset, but allows a debtor licensor to remain free to exploit the same Internet asset and to allow any number of other licensees to also exploit the same Internet assets. The law external to bankruptcy places few, if any limitations on selling Internet assets which are subject to non-exclusive licenses.

A subordinate license, or sub-license, is a license granted to a third party by a licensee, extending some rights or privileges that the licensee enjoys. The law external to bankruptcy places direct and precise limitations on selling Internet assets which are subject to sub-licenses. Such limitations are generally found in the Internet asset sub-licenses agreements. The rights granted by sublicenses for Internet assets ranges from an unfettered grant to only upon approval of the licensor. Additionally the scope of Internet assets rights that the licensee can sublicense is often narrower than the scope of the original Internet asset license. Internet asset sub-licenses usually include additional Internet asset sub-licensee limitations, including limiting the Internet asset use by subcontractors, requiring notice and/or copies of any granted Internet asset sublicenses, requiring the licensee to be responsible for compliance of Internet asset sub-licensees, and preventing Internet asset sub-licensees from granting further Internet asset sub-licenses themselves.

An exclusive Internet asset license means that no entity other than the named licensee can exploit the relevant Internet assets. Significantly, the licensor is also excluded from exploiting the relevant Internet assets. The law external to bankruptcy normally treats exclusive Internet asset license as asset sales.

The plain language of 11 U.S.C. §363(f), which governs free and clear sales in bankruptcy, provides that the trustee may sell property free and clear of any interest in such property of an entity other than the estate, only if one of the following five conditions is satisfied. First, applicable non-bankruptcy law permits sale of such property free and clear of such interest. Second, such entity consents. Third, such interest is a lien and the price at which such property is to be sold is greater than the aggregate value of all liens on such property. Fourth, such interest is in bona fide dispute. Fifth, such entity could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.

Thus, only one of the five conditions need be applicable for a bankruptcy court to approve the sale. It should be noted that some exceptions are possible. For example, consider a Section 363(f)(3) security interest exception. In this case a security interest attaches to the sale proceeds, leaving the previously secured property unencumbered by the security interest. Additionally, the Bankruptcy Code will allow a sale with a stipulation. For example, consider a sale subject to §363(f)(4) bankruptcy. In this case the court will allow the sale to proceed when the interest is in a bona fide dispute but protects the interest holder so that the issue can be later resolved.

The federal and state law external to bankruptcy follow different license sale rules. The general federal rule with respect to copyright licenses is one of non-assignment (prohibiting sale) of copyright licenses. For example, the court in Unarco Indus. v. Kelley Co ., 465 F.2d 1303 (1972), applied federal, not state, law under an exception in Erie R. Co. v. Tompkins , 304 U.S. 64 (1938), and holding a non-exclusive patent license is not assignable. Subsequently, this finding has been applied to copyright licenses.

This general rule of non-assignment (prohibiting sales) is the opposite of state contract law which favors free assignment of license which are a form of contract. Consider Superbrace v. Tidwell , 124 Cal. App. 4th 388 (2004), which notes that state statutes favor a policy of free transferability of property, including contracts.

Bankruptcy courts generally attempt to maximize the value of executory contracts of firms involved with Chapter 11 or Chapter 7 bankruptcy. These contracts include intellectual property licenses, including Internet asset licenses, the value of which may be maximized by selling them to third-parties. A debtor has three options with respect to Internet asset license. First, assume the Internet asset license and continue using it. Second, assume the Internet asset license and then assign it to a third-party buyer for valuable consideration. Third, terminate the license.

Most non-exclusive Internet asset licenses may be assumed, assigned (sold) or terminated by the debtor. If the debtor is the licensor and terminates the Internet asset license, then the licensee normally would be prohibited from continuing to use the Internet asset, which may have serious financial implications. Section 363 of the Bankruptcy Code, however, allows the licensee of a terminated license to "elect" to retain its rights under the license, upon certain conditions such as continuing to pay license royalties. The Bankruptcy Code specifically grants this statutory protection for copyright licensees which have been terminated. Since most Internet assets are covered by copyright law, this code section provides significant protection.

Exclusive Internet asset license treatment is just the opposite of the treatment of non-exclusive Internet asset licenses. This treatment change results from the fact that an exclusive license grants rights and privileges to a single entity, which sometimes has re-licensing privileges. Consequently, an exclusive Internet asset license, without any on-going obligations to perform by the licensor other than to collect royalties, may be deemed by a court to be an outright sale rather than a license. As in the case of most assets which are subject to outright sale, Section 363 protections discussed above may not apply to the debtor in bankruptcy, and it will be free to transfer the asset without the licensor's consent.

Sub-licenses have components of both non-exclusive and exclusive elements. Thus, sub-licenses must be considered on a case-by-case basis.

Accordingly, the determination of the exclusive or non-exclusive nature of the Internet asset license is important so as to determine if a licensee of Internet assets can be assumed or assigned (sold). An assumed Internet asset license allows the debtor to cure any defaults and continue to use the license in bankruptcy. An assigned (sold) Internet asset license allows a third party to use the license, with consideration for that use flowing to the licensee, not the licensor.

Normally, a licensor must consent to the licensee's assumption or assignment. Most courts consider law outside of Bankruptcy Law and hold that if a licensor can prohibit its license from being assigned to another party, then the licensor may withhold its consent from the licensee either assigning or even assuming the license. The practical effect of these decisions is that licensees filing for bankruptcy could lose their licenses at the licensor's discretion.