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Bankruptcy Risk Management for IP Licensees and Licensors

Bankruptcy Risk Management for IP Licensees and Licensors

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As the United States transitions to an information economy, intellectual property (IP) has become one of the most valuable assets a company can possess or license. The rise of IP has led directly to a boom in IP law. Most media attention has focused on patent law, especially as it relates to long-running court battles between major technology companies. However, one of the key factors that businesses must consider when dealing with IP law is how it intersects with the U.S. Bankruptcy Code, particularly as it concerns IP license agreements. Given the importance of these licenses, both the licensor and licensee have an incentive to pursue proactive legal maneuvers to protect themselves in the event of a partner’s bankruptcy.

For licensors, one of the major issues is whether or not the IP license counts as an “executory contract,” a term which has been used to describe agreements in which parties are mutually responsible for meeting the agreement’s obligations and that entitle creditors to only relatively paltry unsecured claims when rejected by a debtor. However, case law suggests that license agreements that require prepaid fees, or licenses that include any type of ownership rights, are considered “disguised sales” and not executory contracts, and a licensee that files for chapter 11 is often regarded by the courts as owning the IP.

Furthermore, when licensors enter into exclusive license agreements, some courts have interpreted this as conferring ownership benefits to a debtor-licensee that include the right to transfer the license or otherwise assign it to a third party. Given the case law, licensors must carefully weigh the benefits of exclusivity and prepayments, especially when dealing with financially unstable partners, and consider the merits of “accelerated fees provisions” that have resulted in larger financial awards for licensors who have become creditors.

Conversely, licensees who must deal with a debtor-licensor must choose between terminating a rejected license or continue to hold the license. In most cases, licensees avoid terminating the agreement, as it deprives them of the IP while categorizing them as unsecured debt holders. Retaining the license, however, generally requires waiving all claims on anything other than assorted unsecured debt, and the licensor is freed of so-called “affirmative obligations,” which may impact their ability to administer the IP. Experts have recommended that as long as the license is considered an executory contract, the best risk management strategy for licensees involves creating an escrow agreement with the licensor. In the event of a material breach of the license agreement, an escrow agreement can ensure that a licensee obtains the licensed intellectual property with minimal legal difficulty and becomes better positioned to obtain proprietary rights to the IP during a licensor’s post-bankruptcy proceedings.

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