Most companies do not own all of the intellectual property (IP) rights that their businesses rely on. It is not uncommon for some portion of a company’s IP rights to be in-licensed from other persons or entities under a license agreement. In such cases, the licensee has contractual rights to use the IP that is the subject of an in-license but not full ownership of such IP. In the day-to-day operations of a company, the distinction between owned IP rights and in-licensed IP rights can easily get lost. But what happens if a licensor files for bankruptcy? Will an in-license protect the licensor’s right to continue to use the IP rights?

IP Licenses in Bankruptcy

When a licensor files for bankruptcy, it may reject (i.e., stop performing) its executory contracts. IP licenses can be considered executory contracts if the bankrupt licensor and other party still have obligations to perform and if nonperformance would constitute a material breach. Congress gave licensees protection against losing their IP rights in this situation when it enacted section 365(n) of the Bankruptcy Code.

Under this section, if the license is executory and its subject matter is granting a right to IP, a licensee may either (1) consider the contract terminated or (2) keep its IP rights under the contract and supplementary agreements (excluding specific performance) for the duration of the contract and any extensions the licensee would have rights to under the contract.

Although a bankruptcy court will have broad discretion in making the final determination about whether section 365(n) applies to any license, a licensee can help the court make such a determination by using clear and unambiguous language in the in-license to explicitly describe the parties’ intent and by understanding how the license should be treated in the event of a licensor’s bankruptcy.

Drafting Tips

To help protect the licensee’s IP rights in the event of a licensor’s bankruptcy, the contract should state that

• the license is intended by the parties to be a grant of a right to “intellectual property,” as defined by the Bankruptcy Code;

• the parties intend for the protections of section 365(n) of the Bankruptcy Code to apply to the license;

• nothing in the license limits the licensee’s rights under section 365(n) of the Bankruptcy Code; and

• if the licensor’s obligations under the in-license are terminated in bankruptcy, the licensee shall receive a copy of all applicable IP (and embodiments thereof).

Sample Provision

All licenses and rights to licenses granted under or pursuant to this Agreement by one Party to the other Party are intended to be, for purposes of section 365(n) of the US Bankruptcy Code (the Code), and any such equivalent law in the United States or any other country, licenses of rights to “intellectual property” as defined under section 101(35A) of the Code. The Parties agree that the non-bankrupt Party, as a licensee of such rights under this Agreement, shall retain and may fully exercise all of its rights and elections under the Code and any such equivalent law. The foregoing is without prejudice to any rights that the non-bankrupt Party may have arising under the Code or other applicable law.

Upon commencement of a bankruptcy proceeding by or against the other Party under the Code, the non-bankrupt Party shall be entitled to a complete duplicate of or complete access to any such intellectual property and all embodiments of such intellectual property. Such intellectual property and all embodiments thereof shall be promptly delivered to the non-bankrupt Party (i) upon any such commencement of a bankruptcy proceeding upon written request therefor by the non-bankrupt party, unless the bankrupt Party (or the bankruptcy trustee) elects to continue to perform all of its obligations under this Agreement or (ii) if not delivered under (i) above, upon the rejection of this Agreement by or on behalf of the non-bankrupt Party upon written request therefor.

Even with the recommended language above, it is possible that a bankruptcy court will not afford a license the protections of 365(n) of the Bankruptcy Code and will terminate a licensee’s right to use such IP. There are other ways that a licensee can ensure continued use of such IP, including IP escrow agreements and step-in rights. Before entering into any key IP licenses, consult with a strategic commercial transactions lawyer to make sure that your IP rights are protected to the greatest extent possible.