Intellectual Property and Bankruptcy: The IP Value Proposition that Startups Should Not Overlook During Financial Distress

The international economic disruption caused by COVID-19 presents unprecedented challenges. Thriving tech startup companies worth millions in January might find themselves struggling to stay afloat today. This article highlights the value of intellectual property (IP) that companies – particularly small companies without an IP department – can sometimes overlook in times of financial distress.

The policy goals behind IP rights are at odds with the goals of bankruptcy law. Bankruptcy laws in the United States are “debtor friendly” and, in their most simplistic form, shield the party from certain debtors while forcing the sale of assets to pay other debts. But court ordered sales tend to undervalue complex property like IP. This is particularly apparent when it comes to patents.

The evolution of a quasi-securities market based on patents developed in response to the growing value and proliferation of patents. After the creation of the Federal Circuit in 1982, that court consistently upheld patent rights. Because of the value of patents, financial firms bought patent rights and accrued massive patent portfolios. These patent holding companies (PHCs) or non-practicing entities (NPEs) sometimes earned the colloquialism “patent trolls” because of their tenacious techniques. By virtue of scale, these companies bought, sold, licensed, and litigated patent rights. Many of them made a heap of money.

Given the current economic state, some of these companies are able to buy up patents from struggling tech companies. Others might be bleeding themselves. Regardless which position, there is significant value in a well-researched, thoughtfully enforced patent portfolio that can be easily overlooked when facing bankruptcy or solvency issues.

Patent Rights in Bankruptcy

Patent sales in bankruptcy have many differences than typical patent sales. These differences fall into three categories: the court’s role, rights of third-party licensees, and clear and certain title.

The Court’s Role

In chapter 11 bankruptcy, a court or court-appointed trustee dictates the timeline for patent sales. This usually results in an auction. Unlike the typical sales process, a court supervised auction does not afford buyers as much control over the process and time for due diligence. On the other hand, buyers receive perfect title to the patent, free of encumbrances except any court approved, pre-established licenses.

Rights of Third-Party Licensees

Court ordered bankruptcy sales can put third-party licensees in a compromising position. Because a court ordered sale grants perfect title, for an existing license contracts to remain, the court must approve it. This can be both a blessing and a curse since buyers are afforded complete transparency. On the one hand, a patent free of licenses or encumbrances is free to use and enforce however the buyer wants. On the other hand, existing license agreements provide value.

Clear and Certain Title

As discussed above, patent sales in bankruptcy offer clear title. Any encumbrances or licenses that pass with the title must be approved and documented by the court. The court also typically absolves any liens or bank securities attached to the patent. Therefore, buyers have a unique opportunity to gain patent rights with complete transparency. 

Recommended Action

What steps should a patent holder take when faced with financial problems? First, strategically evaluate your patents. Some might be more valuable to others than they are to you. Other patents might be vital to the core operation of your business. There are certainly patent holding companies still looking to buy. Shedding unneeded patents could provide short term liquidity. But, be sure to appropriately valuate those patents.

Considering bankruptcy? As shown here, patents are generally worth more to you pre-bankruptcy. The push and pull between patent rights and bankruptcy protections shows the evolution of an under-regulated market in the United States.

Who will come out ahead? There is too much uncertainty to say, but if you are a software startup, consider selling your unused patents and developing the next Zoom—under trade secret protections.

Image Source: https://commons.wikimedia.org/wiki/File:SmoothWaxBar.BaltimoreMD.12April2020_(49772138717).jpg