Rapper Can’t Deal with Rejection, or Why You Need to Protect Your Copyright Before and During a Chapter 11
by: Stuart Larsen
Kahn Kleinman, LPA; Cleveland
The Eleventh Circuit’s recent decision in the Thompkins case provides a graphic illustration of how bad things can happen to copyright holders who do not factor in the potential bankruptcy of another contracting party. 1 The facts presented a nightmare scenario for the recording artist, Jeffrey Thompkins, who performed under the name “JT Money” as part of a group named “Poison Clan.” Thompkins transferred title in his copyrights to a recording company, Luke Records, without retaining control over the copyrights. Then he compounded his woes by failing to protect his rights in Luke Records’ chapter 11 bankruptcy case. The Eleventh Circuit found that Thompkins’ copyright infringement claims failed against the purchaser of the copyrights in bankruptcy, Lil’ Joe Records Inc. The court reached its conclusion based on:
- the rejection of Thompkins’ contracts by the debtor, Luke Records;
- Luke Records’ sale of the copyrights to Lil’ Joe free and clear of liens; and
- Thompkins’ failure to object to the sale or prosecute his claims in bankruptcy court.
Thompkins’ Contracts Convey His Copyrights to Luke Records
In 1989, Thompkins entered into an exclusive recording agreement with Luke Records. He agreed to make albums under the group name “Poison Clan.” Among other things, his agreement transferred his copyrights in a number of songs to Luke Records. The agreement left Thompkins with the right to collect royalties on records released by Luke Records. However, it gave him no control over the copyrights. In another agreement, Thompkins granted Luke Records part ownership in his musical composition copyrights.
Luke Records’ Bankruptcy Case
Bad things followed for Thompkins. Creditors filed an involuntary bankruptcy petition against Luke Records, which converted to a chapter 11 reorganization. Although Luke Records initially filed a motion to assume its contracts with Thompkins, it withdrew the motion and Luke Records rejected the contracts in its reorganization plan. Luke Records later sold the copyrights to Lil’ Joe free and clear of liens and encumbrances in its plan. Thompkins never objected to the sale, nor did he respond to an objection to the proof of claim he filed.
Thompkins’ Federal District Court Action Against Lil’ Joe
A number of years passed after the bankruptcy sale. Thompkins sued Lil’ Joe, the purchaser of the copyrights in federal district court, for copyright infringement. The court dismissed Thompkins’ infringement claims. It found that Luke Records obtained title to the copyrights under its recording agreement even though it later breached its obligation to pay royalties to him. The court found that Thompkins had no infringement claim because Lil’ Joe held title to the copyrights.
The Eleventh Circuit affirmed. The court based its decision as to the impact of Luke Records’ rejection of Thompkins’ executory contracts on a straightforward reading of §365(g). “[T]he rejection of an executory contract or unexpired lease of the debtor constitutes a breach of such contract or lease[.]” 2
The Eleventh Circuit found that Luke Records did not forfeit all of its rights under its contracts when it rejected them. “[R]ejection differently affects the unperformed portions of an executory agreement and those provisions of the agreement that, by their nature, are fully executed.” 3 “[R]ejection does not embody the contract-vaporizing properties so commonly ascribed to it.” 4
How Can Intellectual Property Owners Act to Protect Themselves?
In order to gain more control of its intellectual property, an owner should consider granting a license in the technology, not making an absolute conveyance that merely reserves the right to royalty payments. For copyrights and patents, a license may provide significant leverage to the copyright owner. In a number of jurisdictions, intellectual property owners who grant nonexclusive licenses that prohibit assignment often times possess the right to block a proposed assignment of the license. 5 The case law is not as clear on this point for intellectual property such as trademarks and “know how.” 6 Obviously, the intellectual property owner’s success in obtaining such treatment in its contract depends on the amount of negotiating leverage.
Alternatively, an intellectual property owner should consider retaining a security interest in the intellectual property to collateralize the transferee’s obligations under the contract. Filing a UCC financing statement with the licensor’s state of “location” will perfect the security interest in these circumstances with regard to all of the licensees’ rights, 7 except for registered copyrights that must be perfected by filing with the copyright office. 8
Intellectual property owners and their counsel must understand the impact of a future bankruptcy. Thompkins should serve as another warning of the cost of inattention prior to a bankruptcy. Equally important, contracting parties must take timely action in the bankruptcy court to protect those rights. Sales of assets and motions to assume or reject executory contracts involving intellectual property may have serious implications for nondebtors.
1 Thompkins v. Lil’ Joe Records, Inc., 476 F.3d 1294 (11th Cir. 2007).
2 The Eleventh Circuit’s finding that the rejection constituted a breach, not a termination, of the contract is consistent with the great weight of the authority interpreting the statute. See, e.g., Eastover Bank for Savings v. Sowashee Venture (In re Austin Dev. Co.) 19 F.3d 1077 (5th Cir. 1994) (debtor/lessee’s deemed rejection of ground lease did not extinguish bank’s leasehold mortgage); Kopolow v. P.M. Holding Corp. (In re: Modern Textile Inc.), 900 F.2d 1184, 1191 (8th Cir. 1990) (rejection of lease constituted a breach of lease, not a termination, in concluding that rejection of lease discharge obligations of guarantors). See Medical Malpractice Insurance Assoc. v. Hirsch (In re Lavigne), 114 F.3d 379, 384-85 (2nd Cir 1997) (rejection of insurance contract represented a breach, rather than a termination, of insurance contract) (citations omitted); Mercedes-Benz Credit Corp. v. Dailey (In re Dailey), unreported, 1994 WL 55518, Case No. 92-36891, (9th Cir. Feb. 24, 1994) (“The lease was merely breached, not rescinded or declared void ab initio [by rejection];” bankruptcy court erred in ignoring lease’s choice of law provision and damage calculation formula based on its opinion that rejection of lease constituted “termination of lease”); Leasing Services Corp. v. First Tennessee Bank National Assoc., 826 F.2d 434, 436-37 (6th Cir. 1987) (rejection of lease did not extinguish equipment lessor’s security interest in property that was the subject of the lease, it merely represented a breach of contract by the debtor); see, also, Durkin v. Benedor Corp. (In re G.I. Indus. Inc.), 204 F.3d 1276, 1282 (9th Cir 2000) (stating “The rejection of an executory contract creates a statutory breach under §365(g).”); In re Tri-Glied Ltd., 179 B.R. 1014, 1017-18 (Bankr. E.D.N.Y. 1995) (deemed rejection constitutes a breach of the lease, not a termination); In re Yasin, 179 B.R. 43, 49 (Bankr. S.D.N.Y. 1995) (“While rejection constitutes a breach of the contract or lease, 11 U.S.C. §365(g), it does not terminate it. ”) (citations omitted).
3 Id.
4 Thompkins, 476 F.3d at 1307 (quoting In re Drexel Burnham Lambert Group Inc., 138 B.R. 687, 703 Bankr. S.D.N.Y. 1992).
5 See, e.g. Hirschman, Fatall and Spingola, “Assignability of Intellectual Property Licenses in Bankruptcy,” IPL Newsletter, Fall 2002.
6 Id.
7 In re Cybernetic Services Inc., 252 F.3d 1039 (9th Cir. 2001); In re Tower Tech Inc., unreported, 67 Fed. App. 521, 2003 WL 21300345 (10th Cir. 2003); In re Pasteurized Eggs Corp., 296 B.R. 283 (Bankr. D. N.H. 2003) (perfection of security interest in patents governed by UCC); In re Together Development Corp., 227 B.R. 439 (Bankr. D. Mass. 1998), aff'd, 255 B.R. 606 (D. Mass. 2000) (perfection of a security interest in a trademark is governed by the applicable version of the Uniform Commercial Code, not by federal law); In re 199Z Inc., 137 B.R. 778 (Bankr. C.D. Cal. 1992) (security interest in trademarks should be perfected in accordance with the UCC).
8 In re World Auxiliary Power Co., 303 F.3d 1120, 1128 (9th Cir. 2002).