Perlman v. Catapult Entertainment, Inc. (In re Catapult Entertainment, Inc.)
165 F.3d 747 (1999)
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Rule of Law:
Under the 'hypothetical test' for Section 365(c)(1) of the Bankruptcy Code, a debtor in possession may not assume an executory contract without the non-debtor party's consent if applicable law would prohibit assignment of the contract to a hypothetical third party. This prohibition applies even if the debtor in possession does not intend to actually assign the contract.
Facts:
- In 1994, Stephen Perlman granted two nonexclusive patent licenses to Catapult Entertainment, Inc. ('Catapult') for use in its online gaming network.
- The licenses granted Catapult the right to exploit certain technologies covered by Perlman's patents and patent applications.
- In 1996, Catapult entered into a merger agreement with Mpath Interactive, Inc. ('Mpath').
- The agreement contemplated that Catapult would file for Chapter 11 bankruptcy and then undergo a reorganization that would result in it becoming a wholly-owned subsidiary of Mpath.
- Perlman did not consent to Catapult continuing to use the licenses as part of this reorganization plan.
Procedural Posture:
- Catapult Entertainment, Inc. filed for reorganization under Chapter 11 of the Bankruptcy Code in the bankruptcy court.
- As part of its reorganization plan, Catapult filed a motion to assume its patent license agreements with Stephen Perlman.
- Perlman objected to the motion to assume the licenses.
- The bankruptcy court granted Catapult's motion, approving the assumption of the licenses and confirming the reorganization plan.
- Perlman, as appellant, appealed the bankruptcy court's decision to the U.S. district court.
- The district court affirmed the bankruptcy court's order, leading Perlman (appellant) to appeal to the U.S. Court of Appeals for the Ninth Circuit, with Catapult (appellee) defending the lower court's decision.
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Issue:
Does Section 365(c)(1) of the Bankruptcy Code bar a debtor in possession from assuming an executory contract, without the non-debtor's consent, if applicable non-bankruptcy law would prohibit its assignment to a hypothetical third party, even when the debtor has no intention of actually assigning it?
Opinions:
Majority - Fletcher, Circuit Judge
Yes. Section 365(c)(1) bars a debtor in possession from assuming an executory contract over the non-debtor's objection if applicable law would prohibit assignment to a hypothetical third party. The court adopted the 'hypothetical test,' which strictly adheres to the plain language of the statute. The statute states a trustee may not 'assume or assign' a contract if applicable law excuses the other party from accepting performance from an entity other than the debtor. Federal patent law is an 'applicable law' that excuses a licensor from accepting performance from anyone other than the original licensee of a nonexclusive patent license. Therefore, because Perlman did not consent, Catapult, as the debtor in possession, is barred from assuming the licenses, regardless of whether it actually intended to assign them.
Analysis:
This decision solidifies the Ninth Circuit's adoption of the 'hypothetical test' for § 365(c)(1), aligning it with the Third and Eleventh Circuits and deepening a circuit split with the First Circuit, which uses the 'actual test.' This ruling significantly strengthens the rights of licensors of intellectual property, particularly patents, in bankruptcy proceedings. It means a licensor can prevent a bankrupt licensee from keeping a non-assignable license during reorganization, giving the licensor substantial leverage and potentially disrupting the debtor's ability to reorganize.
