What Now? Protecting Your IP When a Licensee Or Licensor Goes Bankrupt

Technology license agreements are a very common way for businesses to access or share innovations and intellectual property with partners. If you’re involved in a licensing agreement with a counterparty you suspect or know is heading to bankruptcy, it’s important to understand your rights and options, and to plan ahead.

Bankruptcy Basics

When a company enters bankruptcy to dissolve (Chapter 7) or reorganize (Chapter 11), the normal rules of contract interpretation yield to the Bankruptcy Code.  Boilerplate provisions that might seem to terminate a license when a company goes bankrupt may not protect you, as bankruptcy judges usually find them unenforceable. The power to dispose of the debtor’s assets lies with the bankruptcy trustee as approved by a bankruptcy judge.  This has important implications for all contracts, and license agreements in particular.

Executory Versus Non-Executory Licenses

IP rights in bankruptcy usually hinge on whether the judge decides a license is a an “executory” contract — one requiring both parties to have ongoing material performance obligations, as opposed to a “non-executory” contract where neither party owes obligations to the other. A license granting an ongoing nonexclusive license in exchange for royalties would usually be deemed an executory contract, while a paid-up exclusive license with no ongoing obligations would likely be viewed as non-executory.

Bankrupt Licensee

If you license your technology, trademarks, or patents to another business, your licensee declares bankruptcy, and the bankruptcy judge decides your license is executory — the bankruptcy trustee may “assume” (continue) or “reject” (terminate) the license.

 If assumed, the trustee may consider the license to be an asset of the business that can be sold or assigned to another entity. With non-exclusive licenses, and depending on the facts and jurisdiction, your consent is generally (but not always) required for the trustee to assume the licenses or assign it to another entity.  With exclusive licenses, your consent is less likely to be required.

If the bankruptcy trustee rejects an executory license, you may claim a breach of contract, and seek unsecured damages in bankruptcy, in line with any other unsecured creditors.

And if the judge decides your license agreement with a licensee is non-executory, your rights and obligations continue - but as the property of the estate, the trustee can either keep the license, or sell it off — even to your competitors.

Bankrupt Licensor

If you license technology or intellectual property from a company that goes bankrupt, you owe ongoing royalty payments to the licensor, and the bankruptcy judge decides your license is executory, the license may be assumed or rejected by the licensor’s bankruptcy trustee.

If the license is assumed by the licensor’s trustee, then the license continues to operate; you retain your rights to the licensed technology and must continue to fulfill your obligations. If the bankruptcy forces the licensor out of business, and they stop fulfilling their obligations, there will likely be a breach.

But if the license is rejected by the bankruptcy trustee, Section 365(n) of the U.S. Bankruptcy Code includes special protections for licensees:

• For patent, copyright, and trade secret licenses (but not trademark licenses), licensees can simply continue to satisfy their obligations and retain their license rights. This often means continuing to pay royalties in order to continue using the licensor’s technology, and may include the right to enforce any exclusivity provision, such as suing competitor’s for infringement of the licensed rights.  You may not, however, be able to enforce prospective rights such as making modifications to licensed software.

• Licensees also have the option to treat the license as breached and bring an unsecured claim for money damages arising out of the breach.

For trademark licensees, the Supreme Court’s Mission Products Holdings, Inc. v. Tempnology, LLC decision held that a rejection in bankruptcy merely acts as a licensor’s breach, and licensees can continue to use the trademark as long as they meet their continuing obligations.

For example, if you licensed critical software components from a vendor that declares bankruptcy, the licensor’s trustee’s rejection cannot prevent you from continuing to use that software to operate your business as long as you continue to make royalty payments and take other actions required under the terms of the software license. On the other hand, if you think continuing to use that software with the possible risk that it may not be supported by the debtor licensor, then you can take the second option, bring a claim, and find another vendor.

If the bankruptcy judge decides your license is non-executory, then everything continues as if there was no bankruptcy event. For example, you could go on using paid-up licensed software even if your software vendor declared bankruptcy.

Upshot - Plan Ahead

Bankruptcy of a licensor or licensee partner can present multiple legal and business challenges.  Here are some recommendations to consider now, before issues arise:

• Consider procedures to assess and monitor the ongoing financial situation of potential and current licensing partners. Advance knowledge can help you plan, prepare and react, whereas an unexpected bankruptcy filing by a licensing partner may leave you scrambling.

• Review key licenses and assess how they will be treated if the counterparty files for bankruptcy. Evaluate whether to make changes to existing and new licenses now, before a bankruptcy event becomes likely.

• If you are licensing bet-the-company technology, a non-executory paid-up license rather than an ongoing contract could provide you with additional protection in a bankruptcy. Naturally, this decision needs to be balanced with the cash flow implications.

• From a practical business perspective, if you think there is any possibility that a licensor could go out of business and be unable to continue to provide services, it makes sense to have a back-up plan for an alternate partner. And conversely, if revenue from a licensee forms a significant portion of your income, it’s also smart to plan for a scenario where the licensee may be unable to continue to pay their royalties.

To discuss specifics, please contact Klaiber IP Law here.