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The Bankruptcy Protector

November 16, 2018

Bankruptcy Purchasers Beware: Fifth Circuit Holds that Unscheduled Patent License Automatically Rejected and Not Among Assets Purchased in Bankruptcy Sale

Affirming the lower court’s decision, the Firth Circuit recently held that a patent license purchased by a company in a bankruptcy sale was a rejected executory contract and could not have been transferred by the sale in question.

In RPD Holdings, LLC v. Tech Pharmacy Services (In re Providers Meds, LLC), No. 17-11113, 2018 WL 5317445 (5th Cir. Oct. 29, 2018), the executory contract at issue was a patent license that was not disclosed in the schedules.  After the case was converted from chapter 11 to chapter 7, the chapter 7 trustee sold all of the estate’s assets.  The order approving the trustee’s sale provided that all executory contracts were assumed and assigned to the purchaser.  Problematically, however, the patent license was not specifically listed as an asset on the schedules because the trustee was unaware of its existence.

A year later, the patent holder filed suit in Texas state court, alleging that the debtors had failed to comply with their obligations under the patent license agreement to file quarterly reports and to pay licensing fees.  The company that had purchased the assets from the chapter 7 trustee intervened and removed the proceeding to the bankruptcy court, arguing that it had acquired the debtors’ rights under the license agreement by means of assignment.  The bankruptcy judge, and subsequently the district court, both agreed sided with the licensor and held that the license could not have been sold because it had been automatically rejected by operation of law.

On appeal, the Fifth Circuit affirmed the lower courts, concluding that the license agreement was an executory contract that was deemed rejected by operation of law prior to the bankruptcy sale in which the purchaser allegedly acquired the license.

The first issue that the Fifth Circuit grappled with was whether the patent license was an executory contract.  Recognizing that an executory contract is one that requires ongoing performance by both parties, the court held that the license qualified as an executory contract because material, reciprocal obligations remained outstanding on both sides.  The patent holder had a continuing contractual obligation to refrain from suing licensees for patent infringement stemming from their introduction of new machines.  The debtors, in turn, had corresponding material obligations under the license agreement to file quarterly reports and to avoid discussing the parties' settled lawsuit.  The fact that the license was “perpetual” for so long as the patent was valid and enforceable did not render the debtors’ obligations immaterial, the court found.

Next, the court held that the license agreement was rejected by operation of law prior to the bankruptcy sales in question.  Pursuant to section 365(d)(1) of the Bankruptcy Code, an executory contract not assumed within 60 days of conversion is deemed rejected.  Here, because the patent license was not assumed prior to the expiration of the applicable 60-day period, it was deemed rejected.  The purchaser attempted to argue that because the debtors had failed to list the license agreement in their schedules, the deadline imposed by section 365(d)(1) should not apply because the trustee was unaware of the license’s existence.  However, the Fifth Circuit declined to read such an exception into the statute, noting that the Bankruptcy Code obligates a trustee to investigate a debtor’s financial affairs.

Finally, the Fifth Circuit rejected the purchaser’s argument that setting aside the sale amounted to a collateral attack on the sale-approval order.  By the time the sale orders were finalized, the 60-day deadline had passed for each estate and the license agreement, being deemed rejected, had exited the bankruptcy estates, such that it was outside the power of the trustees to include the license agreement within the assets sold to the purchaser. “This is not a matter of collateral attack, but merely an interpretation of the bankruptcy court's orders,” the court stated.

For purchasers in a bankruptcy sale, the most important takeaway from this case is to be diligent about knowing what is to be included in the assets that you are purchasing.  If there is an asset that you intend to purchase but is not listed in the schedules, it is imperative that you have the debtor amend the schedules to properly list the asset.  Specifically, if there are any associated lease agreements that you intend to purchase, those need to be listed as executory contracts.

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