IP Licenses and Bankruptcy

You’ve entered into a software license agreement with a development company. Things are going well until one day you receive notice that the licensor company is bankrupt. Does the licensor’s bankruptcy terminate the license? Well, the answer is a two-step process. First, the trustee presiding over the licensor’s bankruptcy must move to reject the license agreement as executory (legalese for not fully-performed). Next, it’s up to you, the licensee.

Tip #1: Include express language in the agreement where the parties acknowledge that Section 365(n) applies to the licenses of intellectual property.

While specifically stating in the license agreement that the parties consent to Section 365(n) is not required in order for the provisions to apply, by providing notice that the parties are aware of and consent to Section 365(n) may avoid a dispute down the line.

Section 365(n) of the U.S. Bankruptcy Code protects licensees of patents, copyrights and trade secrets by affording the licensee the option to either (i) elect to terminate the contract as a breach of contract by licensor, or (ii) continue the license and retain its rights as such rights existed before the bankruptcy was commenced. 11 U.S.C. § 365(n). Permitting the licensee to even extend the duration of the license as long as the underlying license agreement provides for such. Id.

It is important to note that Section 365(n) does not apply to licenses of trademarks. However, this may be changing and at least one court has extended the protections of Section 365(n) to a licensee of a trademark. See In re Lakewood Eng’g & Mfg. Co., 459 B.R. 306 (Bankr. N.D. Ill.2011), aff’d sub nom. Sunbeam Prods., Inc. v. Chi. Am. Mfg., 686 F.3d 373 (7th Cir. 2012).

Tip #2: Use present grant language, such as “Licensor hereby grants to Licensee a license” as opposed to “Licensor will grant to Licensee a license.”

While the above language is usually always desirable by a licensee, it has further importance in a situation where the licensor goes into bankruptcy. Often times, in software development agreements, the parties will agree to place the source code in escrow until final payment has been issued, and that bankruptcy can trigger the release of escrowed source code to the licensee.

The potential issue that may arise in this situation is the bankruptcy court, driven by its goal of keeping the bankruptcy estate intact, may characterize a license whose release is triggered by bankruptcy of licensor as an unenforceable transfer of assets from the bankruptcy estate. While not foolproof, one tactic to guard against this from occurring is using “present grant of rights” language.

Another tactic is to expand the conditions which may trigger release of the source code from bankruptcy to include indications that bankruptcy may be imminent, such as when licensor is unable to or fails to render payments to its creditors as they come due.

Tip #3: Include a release from the non-solicitation/no-hire clause with regard to licensor’s programmers in the event of licensor’s bankruptcy.

If the parties include a non-solicitation or no-hire clause in the agreement, a licensee should include language that carves out bankruptcy. Specifically, if bankruptcy releases the source code from escrow, the licensee is permitted to hire the licensor’s programmers. By having their expertise involved, the licensee would have an easier time discerning the source code.