FALL 2010

Trade Secrets


Course No. 9200-704 (& 804)-801

ID No. 85737 & 85736

Time:  W 6:30 - 9:30 p.m.
Room:  W-215
Professor Jay Dratler, Jr.
Room Across from 231D (IP Alcove)
Home: 330-835-4537
Copyright © 2000, 2002, 2003, 2006, 2008, 2010   Jay Dratler, Jr.   For permission, see CMI.

Questions and Notes on Lubrizol and the Bankruptcy-Related Risks of Licensing

1.  The Lubrizol case involved a license of patents, not trade secrets.  Nevertheless, you must understand Lubrizol in order to understand corrective legislation that affects both patents and trade secrets, as well as other intellectual property.

The Lubrizol decision was based on the power of a trustee in bankruptcy to affirm or reject so-called "executory contracts."  This power arises under Section 365 of the United States Bankruptcy Code, 11 U.S.C. § 365.  If the trustee affirms such a contract, the debtor must generally perform it in accordance with its terms.  If the trustee rejects it, the debtor is free of its performance obligations.  The other party to the contract still may have a claim for breach of contract, but that claim is treated as an unsecured general claim, with the same right to participate in the bankrupt estate as have all the estate's general creditors.

As the Lubrizol court notes, the trustee's decision to affirm or reject a contract is subject to the same sort of "business-judgment rule" that governs decisions of directors of corporations.  The trustee's decision cannot be questioned as long as it is made in good faith in the best interest of the bankrupt.  The rejection power allows the trustee to "shed" contractual obligations for the puprose of giving the debtor a "fresh start," and the trustee has broad discretion in determining what course of action would advance that purpose.  So much is black-letter bankruptcy law and policy.

2.  Nevertheless, at the time it came down, the Lubrizol decision electrifed the IP bar.  Can you understand why? In determining whether the patent license before it was an executory contract, the Fourth Circuit applied the "material breach" test developed by the late Vern Countryman, a professor at Harvard Law School and one of the nation's foremost authorities on bankruptcy and secured transactions.  Try to articlulate that test as precisely as possible.   Under that test, what specific obligations (of both sides) under the patent license in Lubrizol made that license "executory" and therfore subject to the trustee's power to affirm or reject?

Now consider how generally applicable the result in Lubrizol might be.  Are most patent licenses likely to have obligations like those which the Lubrizol court found made the license "executory"?  Are many trade-secret licenses likely to have similar provisions?  What about the licenses discussed in Aronson, Mestre, and Boggild?  Based on your analysis, is Lubrizol an anomaly, or is similar reasoning likely to apply to the vast majority of IP licensing arrangements?

3.  Now look at the consequences of Lubrizol.  Who was the bankrupt party, the licensor or licensee?  What leverage does the right to reject a license in bankruptcy law give the bankruptcy trustee, and over whom?  Does it make any difference if the licensee has built an entire business or product line around its commercial exploitation of the rights granted under the license?   In the general case (although perhaps not in Lubrizol) what would you expect to happen, outside the courtroom, after a trustee rejects a license?  Who would seek negotiations with whom, for what, and with what likely result?  In the end, who would likely gain, and who would likely lose?  Can you see now why the IP bar was electrified?

4.  As you can see from reading an unedited version of 11 U.S.C. § 365, the trustee's rejection power is riddled with exceptions, many of which relate to leases of real property.  The IP bar, however, had not asked for its own exception.  Although it took a few years of lobbying, the IP bar eventually got one in the form of the Intellectual Property Bankruptcy Protection Act of 1988, Pub. L. No. 100-506, 100th Cong., 2d Sess., 102 Stat. 2538 (October 18, 1988), which added subsection (n) to Section 365 and added the definition of "intellectual property" in Section 101.

Take a close look at subsection (n) of Section 365 and the correlative definition of "intellectual property" in Section 101.  Do the amendments cover trade secrets?  Do they cover most other IP?  What kind of IP, if any, do they appear not to cover?

5.  How does subsection (n) affect the result in Lubrizol?  Does it change the rules for deciding whether a license agreement is an "executory contract"?  Does it preclude a trustee in bankruptcy from rejecting an executory license agreement, or does it just change the effect of rejection?  Whom does it benefit, and how?  Does a party to a license agreement still have something to fear from the other party's bankruptcy?  If so, which party, and what fear?  Can that party reduce its risk by changing its business arrangements?  by changing the terms of the license?  If so, how?

6.  Suppose you represent a party about to enter into an important licensing agreement with a firm on shaky financial footing.  Under what circumstances would you warn that party about the risks of the other party's bankruptcy, what would your warning say, and what would you suggest that your client do?

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