A legitimate fear among companies negotiating license agreements exists, and that is the fear of the license counterparty filing for bankruptcy. Given the business interruption that ultimately could occur as a result of a restructuring event, it is vital for practitioners to address bankruptcy or insolvency issues upfront during the negotiation of the license agreement. This is especially true for licensees who often rely heavily, if not exclusively, on a licensor for significant aspects of their business.

There are several negotiation and drafting tips that practitioners can utilize to help protect their licensee clients in the event of a bankruptcy filing under chapter 11, of Title 11, of the United States Code (the “Bankruptcy Code”) by the licensor counterparty. These include:

• Specify that all intellectual property covered by the agreement is intended to be “intellectual property” within the meaning of the Bankruptcy Code

• Specify that § 365 applies and refer specifically to § 365(n)

• Negotiate narrowly defined royalty payments and clearly differentiate royalty payments from payments for ongoing licensor affirmative obligations such as maintenance, service and upgrades

• Negotiate for a separate “supplemental” escrow agreement for source code or other embodiments of the intellectual property

• Obtain a security interest in the licensed intellectual property

• Negotiate separate agreements for the license, research, development, manufacturing, distribution and any other functions

Bankruptcy Law Framework

Section 365.

Section 365 of the Bankruptcy Code gives the debtor and debtor in possession (the “Debtor”) the option to (1) assume, (2) assume and assign, or (3) reject its unexpired leases and executory contracts in order to maximize the value of its estate.

Section 365(n).

In 1988, Congress enacted section 365(n) of the Bankruptcy Code to provide protections to licensees whose licenses have been rejected by Debtor-licensors. Section 365(n) gives a non-Debtor licensee of “intellectual property” faced with rejection the power to either treat the license as terminated or retain its rights under the license.

Practice Tips: Licensee Negotiation and Drafting Tips

Keeping the legal framework in mind, it may be helpful to consider the following tips when negotiating a license agreement on behalf of a licensee.

1. Specify that all intellectual property covered by the agreement is intended to be “intellectual property” within the meaning of the Bankruptcy Code.

2. Specify that § 365 applies and refer specifically to § 365(n).

3. Negotiate narrowly defined royalty payments and clearly differentiate royalty payments from payments for ongoing licensor affirmative obligations such as maintenance, service and upgrades.

4. Negotiate for a separate “supplemental” escrow agreement for source code or other embodiments of the intellectual property (e.g., designs and drawings) accompanied by a license to use such materials.

5. Obtain a security interest in the licensed intellectual property.

6. Negotiate separate agreements for the license, research, development, manufacturing, distribution and any other functions.