When it comes to bankruptcy, you want to make sure your right to payment will put you in line to receive payment from the trustee, if your claim is secured. If intellectual property was used as collateral to secure a debt owed to you, you want to make sure you follow the proper rules to be able to collect the money owed to you and recapture the collateral. Let’s look at the intersection of commercial and bankruptcy law to see how the process works.

Intellectual property as defined under the bankruptcy code

The bankruptcy code does provide a definition of intellectual property, but some things are not included. Under 11 U.S.C.A. § 101 (35)(B) of the bankruptcy code, intellectual property includes trade secrets, patents under Title 35 of the U.S. Code granted by the United States Patent and Trademark Office, patent applications, plant varieties, inventions, processes, designs, and works of authorship protected by copyright under U.S. Code Title 17. The bankruptcy code’s definition of IP does not include trademarks or trade names, service marks, and any overseas intellectual property.

Executory contracts

Generally, intellectual property will be treated as an executory contract in bankruptcy court. However, an executory contract is not defined in the bankruptcy code. Because the code does not define it, the definition is determined by case law. The question basically becomes whether non-performance is a material breach of the promises agreed to in the contract, and whether either party is so far from being able to perform it that it would excuse their performance. The ‘material breach test’ is the majority rule in courts.

Avoidable transfers and unsecured collateral under UCC Article 9

Now, intellectual property is considered personal property, which makes it subject to the provisions under Article 9 of the Uniform Commercial Code in the state in which the debtor resides. In bankruptcy, any interest or right to payment from the debtor that is not properly secured may be voidable. In order to obtain legal relief and recapture collateral whether it is in bankruptcy court or otherwise, you need to make sure the property is properly secured.

Perfection & priority of security interests to ensure a debt is secured under Article 9 is important because in bankruptcy, creditors are ranked by priority of their security interests, which determines their right to payment. Proper perfection of a security interest makes it enforceable, and includes filing a UCC 1 financing statement with the Secretary of State. There are other steps in the process, such as the description of the collateral sufficient to identify the property secured, being sure to use the debtor’s legal name or the business’s registered name, having a signed security agreement and the exchange of value. The UCC 1 has to be periodically updated after a set amount of time to remain enforceable. Once the interest is properly perfected, the date of that UCC filing is your priority date: first in line, first in right to be paid.

Furthermore, once a debtor files bankruptcy, the automatic stay goes into effect protecting the business, person, and their property from any act to recover or receive payment. This is the ‘breathing room’ provided by a bankruptcy action. The stay is lifted if the judge grants a motion to lift the automatic stay, or it lifts upon the debtor’s discharge and the trustee’s abandonment of property within the bankruptcy estate. Once the debtor receives a discharge, the automatic stay is replaced by a permanent injunction barring collection of the debt from the debtor. Therefore, you want to make sure you take part in the bankruptcy process with properly perfected collateral.