Buyer does not acquire patent license agreement from chapter 7 bankruptcy trustee

This case involved the purchase of a patent license agreement out of bankruptcy of several related companies. For purposes of illustration the facts have been modified by describing the sale out of bankruptcy of a patent license agreement from just one company. This modification does not impact the validity of the lesson learned from this story.

The story begins before Seller filed for bankruptcy. Licensor held a patent on a system, software, and related methods of remote pharmaceutical dispensing. In 2010, it sued Seller for infringing this patent by using Seller’s own remote pharmaceutical dispensing machines to remotely dispense pharmaceuticals from the machines to nurses in long-term care facilities. Seller counterclaimed challenging Licensor’s patent.

Licensor and Seller agreed to settle the litigation, entering into a license agreement, granting a non-exclusive perpetual license to Seller for so long as the patent was valid and enforceable. Seller agreed to pay a one-time licensing fee of $4,000 for each Seller machine placed into operation after the execution of the agreement, and to provide quarterly reports reflecting all new machines placed in service.

Later, Seller filed for reorganization under chapter 11 of the bankruptcy laws in a Texas bankruptcy court. The case was later converted to a liquidation proceeding under chapter 7 of the bankruptcy laws. Despite the bankruptcy requirement that Seller schedule all assets and creditors, however, Seller did not list the license agreement or Licensor on Seller’s bankruptcy schedule.

Buyer had a security interest in Seller’s collateral. Buyer agreed to purchase the collateral from Seller’s bankruptcy estate. Buyer and Seller laid out the terms of sale in an asset purchase agreement, and the sale was approved by the bankruptcy court in a separate sale order.

The asset purchase agreement did not explicitly reference the license. The sale order approved the sale of Seller’s property—providing that to the extent that any of the property was an executory contract, the executory contract was hereby assumed by Seller’s bankruptcy estate and immediately assigned to Buyer under the applicable provisions of section 365 of the Bankruptcy Code.

Buyer and Seller agreed that Buyer was not aware of the license until after the bankruptcy court approved the sale.

Later, Licensor filed a petition in Texas state court against Seller, alleging that Seller had failed to comply with Seller’s obligations under the license agreement to provide quarterly reports and pay licensing fees for new machines. Buyer intervened and removed the proceeding to the bankruptcy court, arguing that Seller’s estate had assigned or otherwise transferred the license to Buyer.

The bankruptcy court and then the federal district court held that Buyer had not acquired the license agreement. Buyer appealed the decision to the federal court of appeals.  Buyer struck out there too.

The court of appeals first said that Buyer’s fate on this dispute depended upon whether the license agreement was an “executory contract” under the bankruptcy law.

The court said that the license agreement would be an executory contract if performance remains due to some extent on both sides (both Seller and Licensor) and if at the time of Seller’s bankruptcy filing, the failure of either Seller or Licensor to complete performance would constitute a material breach of the license agreement, thereby excusing the performance of the other party.

The court had no problems finding the license agreement to be an executory contract. It noted that Licensor had an ongoing obligation under the license agreement to refrain from suing Seller for patent infringement for machines placed into service after execution of the license agreement. The court further concluded that Seller licensee had ongoing material obligations because Seller was required to provide quarterly reports as to new machines, pay a one-time licensing fee of $4,000 to Licensor for each new machine, and refrain from making public statements about a settled lawsuit.

The court then explained why the licensing agreement being an executory contract was bad for Buyer. Under the bankruptcy law, the court noted that the trustee of Seller’s bankruptcy estate had 60 days after Seller’s case was converted to a bankruptcy chapter 7 liquidation from a chapter 11 reorganization to accept or reject the license agreement. Buyer would have acquired the license agreement if the trustee had accepted the license agreement during this 60 day window. The trustee, however, did not accept the license and so under the bankruptcy law, the license agreement was deemed rejected by the trustee and thus not an asset of the estate which the trustee could sell to Buyer.

Buyer then made an argument for justice, saying that trustee did not know about the license agreement because Seller had not scheduled the license agreement or the Licensor on its bankruptcy schedules. The court was not persuaded, noting that the trustee had a fiduciary duty to look for unscheduled assets for the benefit of the bankrupt estate’s creditors.

This case is referred to as In The Matter Of Provider Meds, LLC, No. 17-11113, United States Court of Appeals, Fifth Circuit (October 29, 2018).

Comment. Unfortunate outcome for Buyer. Apparently, Buyer did not know about the license agreement until it was too late.

I am not an insolvency lawyer, so I don’t know whether or not Buyer could have realistically learned about this problem through due diligence.

By John McCauley: I help people start, grow, buy and sell their businesses.



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Posted in bankruptcy sale, distressed business acquisitions, executory contracts

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