Disclaiming “onerous property” under IBC 2016: A perspective from the end of IP owners

Intellectual Property (IP) rights have paved the way for transforming intangible properties of an individual (e.g. creativity, knowledge) to valuable assets that one can put to strategic use for its monetization.  IP owners by way of assignment or license, transfer their rights in the IP to another person/company with the intention of monetizing their own creations. However, there is an underlying difference between the two modes of transfer. Where assignment of IP refers to the permanent transfer of the rights and interest attached to the IP, licensing of IP merely grants the right to use the IP with certain representations and warranties, while maintaining the ownership of IP.

IP licensing has been a lucrative avenue in today’s market, as it offers a great opportunity to IP owners to monetize their IP and receive recurring returns, without directly engaging in marketing, manufacturing, or distribution activities. Subsequently, it also allows the licensee to trade in the products or use such technology, the IP of which is owned by someone else. Having said that, an IP license becomes vulnerable when either of the parties to the agreement becomes insolvent and goes into bankruptcy.

It is a matter of fact that an insolvency proceeding not only results in the complete reshuffling of the rights of the debtor but it also influences the right of payment of various classes of creditors. The intersection of IP licensing with insolvency and bankruptcy regulations has given rise to various concerns over the fate of the rights and obligations of the licensee and the licensor, in case either of them goes into insolvency.

In the present article, the treatment of IP licenses has been traced in the Indian Insolvency regime when either of the parties to the agreement becomes insolvent and goes to liquidation on the failure of the resolution process. The IBC does not explicitly protect IP licenses. However, it allows the insolvency trustee under Section 160 of the Code to disclaim onerous property (which includes any unprofitable contract), under the ambit of which IP licenses can be covered.

The provision for the treatment of IP licenses in the Indian bankruptcy regime under Section 160 of the Code has found its genesis and groundwork in Section 365 of the American Bankruptcy Code (ABC), which provides an exhausting and far-reaching framework for treating IP licenses in case of bankruptcy. However, the aforementioned provisions only provide the manner of treatment of IP license in circumstances where the licensor (IP owner) becomes bankrupt. However, the current provision remains silent on the treatment of IP licenses when it is the licensee who goes into bankruptcy.

The ABC follows a debtor-in possession model that tends to favour the debtor by protecting the debtor from being fragmented by its creditor. Section 365 of the ABC is one such instance that highlights the presence of the aforementioned model in the American Bankruptcy regime. However, with respect to IP licenses and their regulation, Section 365 has had a controversial history in American bankruptcy jurisprudence.

Section 365, in its original form, allows a bankruptcy debtor to either “reject” or “assume” onerous contracts that were entered into before the initiation of the insolvency proceedings, subject to the approval of the Bankruptcy Court. If the debtor decides to assume the contract, then the said contract will retain the same status as a contract entered into post-petition. In case the debtor thereafter breaches the contract, the creditor’s claim will be treated as “administrative expenses” which as per the governing law, would have to be paid first and assume priority over other unsecured creditors. However, in cases where the debtor chooses to reject the “onerous contracts”, the debtor relieves itself from the obligations required to be performed on its behalf. In such cases, the creditor’s claim of breach of contract is treated as general unsecured debts that only receive a fraction of repayment during liquidation.

Pertinently, the threshold requirement for the application of Section 365 is that the contract must be “executory”, a term undefined in the American Bankruptcy Code. However, in the case of Lewis Bros Bakeries Inc v. Interstate Brands Corp (In Re: Interstate Bakeries Corp) the Court of Appeal approved the definition of “executory contracts” in the following words:

“An executory contract is a contract 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.”

However, the US Court of Appeals while delivering its judgment in the case of Lubrizol v. RMF, stated that the rejection of an IP license would not only free the licensor from material foregoing obligations, but it would also restrain the licensee from using the licensed IP, i.e. the rejection would tantamount to a complete recession of the license.

This judgment thus created a potentially negative impact on the ongoing IP license transactions as it has left the licensees vulnerable to the choices of the debtor. As a consequence of the same, the American government adopted the Intellectual Property Bankruptcy Protection Act, 1988 (IPBPA) which introduced section 365 (n) into the ABC.

The newly inserted Section 365(n) acting as a deviant from the debtor-in-possession model, now provides a veto power to a licensee, at its discretion to employ, in situations where a debtor rejects the license agreement / “onerous contracts." The Section states that in case the debtor rejects an executory contract under which the debtor is a licensor of an IP rights, the licensee under such contract would have the following options from which it may choose:

1. Treat such contract as terminated; or

2. Retain its rights, except the right to specific performance of the contract. Under such retention, the licensor would be released from its contractual obligations but the licensee would still be entitled to enforce an exclusivity clause for the remaining term of the contract, allowing it to use the licensed IP.

The articulation of the aforementioned Section indicates that its application is exclusively concerning the situations where the licensor is the debtor. But there still looms an ambiguity and bearing on the cases where the licensee is undergoing bankruptcy. Though Section 365 (n) provides clarity concerning the position of the licensee’s rights in the license agreement when the licensor goes into Bankruptcy but is still ambiguous for the licensor’s rights in the license agreement when it is the licensee who is the debtor.

Unlike the ABC in the United States, in India, the Code does not specifically address how a licensee's or licensor's bankruptcy may affect their rights and responsibilities under the terms of a license agreement. Even after eight years of judicial pronouncements, the existing gap continues to loom in the absence of any decision/ precedent from the Indian judiciary with respect to the issues of IP licensing in cases of insolvency and bankruptcy.

The closest enunciation to Section 365 of the ABC happens to be Section 160 of the IBC 2016. However, even the said Section merely provides for a disclaimer of unprofitable contracts. Section 160 of IBC allows the insolvent entity to disclaim any “onerous property” which forms part of the estate of the insolvent entity by giving notice to the “insolvent/bankrupt” or any “person interested in the onerous property." Such disclaimer of the property will have a two-fold effect:

1. “The disclaimer will determine the rights, interests and liabilities of the bankrupt in respect of the onerous property disclaimed, as from the date of such notice”; and

2. “It shall discharge the bankruptcy trustee from all personal liability in respect of the onerous property as from the date of appointment of the bankruptcy trustee.”

The said power is granted to the bankruptcy trustee subject to two protections. The first is incorporated under Rule 10 of Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 which makes the said power subject to the approval of the Adjudicating Authority by requiring the liquidator to make an application before the Adjudicating Authority for disclaiming the property or contract. The second limits the effect of such a disclaimer on the rights and liabilities of any interested person only to the extent required for relieving the corporate debtor and its property from liability.

Section 160 of IBC provides a general treatment of all such contracts that fall within the category of “onerous property”, which is defined as “an unprofitable contract and any unsaleable or not readily saleable property of the estate of bankrupt” under Explanation to Section 160(5) of IBC 2016.

Thus, unlike Section 365(n) of the ABC, the Indian Insolvency regime does not provide a differential treatment of rights and obligations of the licensor and licensee in the IP licensing agreement based on who is undergoing bankruptcy. The position of IP owners in cases of a licensee’s bankruptcy under the Code is dependent on whether the IP license agreement incorporating the rights of the licensor is a profitable or unprofitable contract for the corporate debtor.

Now the issue pertains to the fact that in general circumstances the licensee under the license agreement is obliged to pay royalties or fees for the use of IP and in return monetize such use by distributing goods or services under the trademark owned by the licensor. Since the power of disclaimer intends to enable a bankrupt debtor to reject the performance of contracts, the maintenance of which is unprofitable, it is obvious that the agreement requiring payment of royalties would be termed, in most cases, as an unprofitable contract. Therefore, the right to payment of royalties of the IP owner would be in a vulnerable position in the bankruptcy proceedings of the licensee.

Additionally, Rule 10 of Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016 states that a person affected by the disclaimer under this Regulation shall be deemed to be a creditor of the corporate debtor and will be paid in liquidation as per Section 53(1)(f), i.e. any remaining debts and dues which comes at the end of the priority list under the waterfall mechanism. Therefore, IP owners (licensor) will receive their claims only if any amount remains in the estate of the debtor after paying to all other creditors.

Analyzing the two legislations and the prevalent legislative regime, it is apparent that the rights of the IP owners under the IP license agreement on the licensee’s bankruptcy are left by the legislator to the whims and fancies of the debtor. There are no specific guidelines or regulations or for that matter judicial precedent that exists concerning the fate of the IP owners’ rights on licensee’s bankruptcy under the Indian Insolvency regime.

About the authors: Yashodhara Burmon Roy is a Senior Associate and Prakarti Shrivastava is a Fellow at Hammurabi & Solomon Partners.

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