Note: For the convenience of our colleagues in Asia, this alert also is available in translation.
Many Asian entities are party to joint venture arrangements with U.S. companies under which the joint venture manufactures products using intellectual property (such as patents, trade secrets and trademarks) owned by the American entity and licensed to the Asian joint venture. With the financial difficulties facing many U.S. manufacturing companies, the effects of a bankruptcy filing by the U.S. owner must be considered.
Intellectual Property Rights
The first question an Asian party must address is whether its licensor is in bankruptcy. If only a parent is in U.S. bankruptcy, this has no effect on a license by a subsidiary (unless provided for in the license agreement). Where the licensor is in bankruptcy, under U.S. bankruptcy law, the license of intellectual property to another entity is almost certainly classified as an “executory contract” if the licensor files bankruptcy. U.S. law permits a bankruptcy estate to assume or reject such executory contracts. This would apply to even overseas contracts. Generally, assumption will require the bankruptcy estate to continue to perform all of its obligations and permits it to enjoy all of the rights under the contract. Any default becomes an administrative claim in the bankruptcy that must be paid under any plan of reorganization. Rejection, on the other hand, acts as a breach of the contract for which the nondebtor party receives a damage claim determined under applicable nonbankruptcy law. Usually this will be the relevant governing contract law. This claim is deemed to arise the moment before bankruptcy, and thus, will be treated the same as other prepetition claims. In other words, unless secured it will receive the classic “pennies on the dollar” provided to prepetition claims at the end of the bankruptcy case. The nondebtor party cannot obtain specific performance as a remedy for this deemed default. Perhaps most important, although rejection does not “undo” performance that has already been rendered, nor entitle the estate to recover performance rendered prior to rejection, it does relieve the bankruptcy estate of all future obligations to perform under the contract.
Where the relevant contract is a license, courts have reached different conclusions as to what has been “performed” and what remains to be performed. The majority of cases view a license as a continuing authorization to use property, and reject the argument that once the licensed property is “delivered” the licensor has performed its essential obligation. Thus, they permit a licensee who rejects a license to terminate the nondebtor party’s right to use the intellectual property. This fact puts many businesses dependent on licenses of intellectual property at great risk, and has resulted in very specific provisions in the U.S. Bankruptcy Code addressing intellectual property licenses.[1] To greatly simplify, those provisions permit a licensee of intellectual property to elect to continue to enjoy the licensed rights notwithstanding rejection, but require him to make all payments called for under the contract. However, there are significant pitfalls to these protections that Asian companies with U.S. joint ventures may wish to consider. For example, it is not clear whether these protections apply to overseas licenses of intellectual property. Nor is their applicability to trademarks certain. Finally, the special intellectual property protections limit their reach to intellectual property as it exists at the moment of bankruptcy – future developments of the property are not protected by the special provisions of the U.S. Bankruptcy Code.
Overall, an Asian joint venture must carefully examine the rights to intellectual property licensed by a U.S. company with an eye towards potential bankruptcy of that company.
Control of the Joint Venture In contemplating the potential for a U.S. bankruptcy by a U.S. co-venturer, the Asian entity should consider the management structure regarding the joint venture. Bankruptcy of the U.S. parent may result in new managers of the U.S. entity including workout professionals or an independent trustee. It will be critical to determine whether the joint venture party is itself in a U.S. bankruptcy proceeding, or merely the subsidiary or other affiliate of a U.S. bankruptcy debtor. If the joint venture party is not a U.S. bankruptcy debtor, contractual provisions regarding management should operate according to their terms, and the Asian partner may wish to consider any rights to replace the joint venture manager under the applicable agreement. However, if the joint venture partner itself becomes a U.S. bankruptcy debtor (and this relief is available even to entities not formed under U.S. law if they have assets in the United States such as books, records, deposit accounts and the like), the joint venture agreement will become an asset of the bankruptcy estate. The Asian partner may therefore be prevented under U.S. law from exercising its rights without permission from the bankruptcy court. By the same token, the joint venture agreement itself would become an executory contract subject to assumption or rejection as discussed above. In fact, a third option may become relevant in these circumstances. The Bankruptcy Code permits a debtor estate not only to assume or reject a contract, but to assume the contract and then assign to a third party. Often, prohibitions on assignment will be overridden by the U.S. bankruptcy law. Accordingly, an Asian partner to a joint venture might find itself involuntarily with a new joint venture partner. However, where a generally applicable law such as Article 20 of China’s Implementing Regulations for the Law of Chinese-Foreign Equity Joint Ventures requires approval by both the Asian party and Chinese government for any transfer, these provisions may be enforced by a U.S. bankruptcy court. The analysis of rights and defenses in such circumstances becomes extremely complex and should be addressed carefully with counsel on the specific facts.
Purchase of Joint Venture Assets If the joint venture partner or its ultimate parent becomes a U.S. debtor, there may be interest by the Asian entity in buying, or by the U.S. debtor in selling, either the assets of the joint venture or the joint venture interest. Contractual provisions for rights of first refusal or matching rights by the Asian joint venture party in the event of sale must be carefully analyzed under the specific terms of the agreement, as well as U.S. bankruptcy law. The enforceability of such provisions under U.S. bankruptcy law is not certain, and demands specific knowledgeable analysis.
Guarantees Often the joint venture partners must guarantee outside joint venture debt. These guarantees may be joint or several, and often are triggered by bankruptcy of one of the partners or affiliates. The U.S. bankruptcy debtor will be protected from action on its guarantees, causing the creditors to look solely to the Asian partner. Furthermore, the protections of the U.S. bankruptcy apply only to the bankruptcy debtor, so the Asian partner will be fully exposed to these creditors. Indeed, the non-debtor’s rights to recover from a co-venturer if it pays the debts may be impeded by bankruptcy of the U.S. entity. The joint venture agreement will presumably require the U.S. partner to compensate in some way the Asian partner if the latter pays more than its share of the guaranteed debt. If the U.S. bankruptcy debtor assumes the joint venture agreement such provisions should be enforceable. However, if the U.S. bankruptcy debtor rejects the agreement, as noted above the Asian partner will have a damage claim. Unfortunately, if the Asian partner has future liability on guarantees, but has not actually made payment, those amounts may be excluded from the damage claim by virtue of provisions of the bankruptcy code which disallow contingent guaranty claims. Furthermore, if the joint venture agreement itself does not encompass the obligation to repay the Asian joint venturer, but rather the obligation arises from a distinct agreement, the claim may be a general unsecured claim even if the joint venture agreement is assumed. Again, analysis of the specific arrangements is critical.
Conclusion Asian entities party to joint venture agreements with U.S. manufacturers should carefully consider the effects that bankruptcy of the U.S. partner or its parent may have upon intellectual property licenses, operational management of the joint venture, and agreements regarding potential disposition of joint venture assets. O’Melveny & Myers with leading practitioners in Asia and the United States is uniquely situated to assist clients in this analysis. For further information, please contact Evan Jones at ejones@omm.com or Michael Sage at msage@omm.com.
[1] For a more detailed discussion of these provisions, see our colleagues' work "IP Licenses and Bankruptcy,"
Morgan Stanley PricewaterhouseCoopers: The Americas Restructuring and Insolvency Guide 2008/2009 by Evan M. Jones and Ana Acevedo, published by Globe White Page and the American Bankruptcy Institute. O'Melveny & Myers can provide a copy to those interested.