2 July 2020
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As the impact of COVID-19 is felt throughout the economy, even those companies able to weather the storm are likely to feel the effects of corporate insolvency as collaborators, customers and suppliers find themselves in financial difficulty. This article focuses on the impact of insolvency on IP licences from the perspective of both licensors and licensees. It also contains our top tips for mitigating the risks. A more general look at dealing with insolvent counterparties is available here.
In the UK, a company can become "cash flow insolvent" – meaning it is unable to pay its debts as they fall due – or "balance sheet insolvent", where its liabilities exceed its assets. If the company is judged not to be able to pay its debts as they fall due, it will be insolvent regardless of whether its assets exceed its liabilities.
There are a range of procedures available to creditors and debtors of insolvent companies, including administration and liquidation, both of which involve control of the company being passed to a licensed insolvency practitioner. Creditors of an insolvent company that has entered administration or liquidation will be paid in accordance with a statutory order of priority. In either case, this typically puts counterparties to a licence at the bottom of the pecking order alongside any other unsecured creditors.
The impact of insolvency on an IP licence will depend on whether it is the licensee or the licensor entering an insolvency procedure. In both cases, the fate of the insolvent company will typically be in the hands of the insolvency practitioner who will have powers to deal with the licence and associated obligations in line with their statutory obligations. It is therefore important for any counterparty to a licence to understand where the insolvency of its licensee or licensor might leave its rights and obligations and what it can do before, during and after an insolvency process to protect its position.
A licence will not, as a matter of English law, automatically terminate upon a licensor's insolvency. The express terms of the licence itself will determine the extent to which it is terminable. Whether a licensee would choose to terminate a licence where it had the right to do so is likely to depend on the circumstances. Where the licensed IP is essential to the licensee's business, it will want the licence to continue.
However, if the licensed IP is of marginal relevance and/or the terms of the licence are onerous (high royalties, burdensome reporting obligations, requirements to license-back improvements etc), the licensee may use the licensor's insolvency as an opportunity to escape ongoing obligations and terminate the licence.
There are various options available to an insolvency practitioner when dealing with IP subject to a licence.
The insolvency practitioner may decide to assign the underlying IP, either as part of a sale of the business as a whole or as an individual asset. Insolvency practitioners typically sell only such right, title and interest as the insolvent company may have in the underlying IP and on terms that exclude any representations as to title, quality, value or validity and any implied statutory warranties.
Where the territory of a licence agreement covers several jurisdictions, the consequences of assigning IP which is subject to the licence may need to be considered on a jurisdiction-by-jurisdiction basis, which can be a complex exercise. In what follows, we consider only the position in the UK for licence agreements governed by English law.
In the UK, the consequences of assigning IP which is subject to a licence is governed by statute. The precise wording of the relevant statutes differs depending on the type of IP, but the general position is that any assignee will take subject to the licence, unless it is a purchaser in good faith for valuable consideration without actual or constructive knowledge of the licence. For registered IP, recordal of the existence of the licence on the relevant IP register will be sufficient to ensure the purchaser has constructive notice and is bound by the licence. For unregistered IP, the licensee should take steps to ensure both the insolvency practitioner and any potential purchaser are put on notice of the licence.
It is important to bear in mind that even though the purchaser of the IP might acquire that IP subject to the licence, this does not necessarily mean that the purchaser will be bound by all of the provisions of the licence itself. Assigning the underlying IP subject to a licence is not the same as assigning the benefit of the licence itself. In one recent case, an assignee of registered trade marks had notice of the existence of an exclusive licence covering those marks, and was held to be bound by the licence (including the exclusivity). However, all the licensor's other obligations under the licence agreement were found to have remained with the assignor of the underlying trade marks, and could not be enforced by the licensee against the assignee of the marks.
Depending on the nature of the licence, this could leave the licensee in a difficult position especially if obligations such as those to maintain and police the licensed rights or provide training and updates are not transferred to the purchaser. This fact is often not known to insolvency practitioners and contracting parties. Where possible (and this can be difficult), a separate assignment or novation of the licence itself should be entered into.
Liquidators (but not administrators) have the power to disclaim unprofitable contracts or property of a company which are unsaleable or not readily saleable or which may give rise to a liability to pay money or perform any other onerous act.
This is yet to be tested before a court in the context of IP licences, so there is some uncertainty about the type of provisions which would have the effect of making an IP licence onerous property for the purposes of UK insolvency legislation. However, licences regarded at risk of disclaimer include those that contain terms which are financially disadvantageous for the licensor (such as a royalty-free exclusive licence, or an exclusive licence that does not produce sufficient royalties), or licences requiring the licensor to assume active obligations.
In any event, the effect of a disclaimer is to determine (end) the rights, interests and liabilities of the company under the contract disclaimed; but it does not, except to the extent necessary for the purpose of releasing the company from any liability, affect the rights or liabilities of any other person. A licensee will generally retain the benefit of the IP licence if it complies with its own obligations but will not have the benefit of the licensor's obligations. If a licensee suffers loss as a result of the disclaimer, it can prove for that loss in the licensor's winding up but will rank as an unsecured creditor in the liquidation and so will be unlikely to be paid out in full. Whether a licensee could rely on any right of set-off under the licence agreement in such circumstances to justify withholding its royalty payments is an open question. For more detail on bringing a claim in an insolvency process, please see our article.
The underlying IP can also be disclaimed (for example to avoid the costs of prosecution and maintenance). An exclusive licensee is particularly likely to be concerned by any attempt to do so. This could expose the licensee to unwanted competition in the market. In that situation, the licensee may be able to apply to the Court under s181 Insolvency Act 1986 to have those disclaimed IP rights vested in it on the basis that it has an interest in them as licensee.
If the underlying IP has not been assigned or disclaimed by the insolvency practitioner and the licensor is dissolved, the IP will pass to the Crown bona vacantia. The licensee (along with any other third parties) will then need to liaise with the Treasury Solicitor if it wishes to purchase the IP (see Purchasing IP from distressed companies).
Prudent licensees should consider the following steps to protect their position:
If the licence has not been terminated on insolvency and the insolvency practitioner continues to trade the licensor company, then the licensee should consider continuing to pay any royalties that are due under to the licence. Otherwise, the licensor (or its insolvency practitioner) is likely to have the right to terminate the licence for the licensee's failure to pay.
Licensors should also consider how to protect themselves against the possibility of a licensee becoming insolvent. As discussed above:
Where a licence is expressed to be "perpetual", this does not in itself mean that the licence will survive the insolvency of the licensee if the licence contains other provisions permitting termination in those circumstances. If a licence is not intended to be terminable in any circumstances, it should expressly state that this is the parties' intention (or at least use the word "irrevocable"), and it should not contain any termination provisions which are potentially inconsistent with an irrevocable licence.
However, even where it has the right to terminate, a licensor may wish to consider whether it should permit the insolvency practitioner to continue to use the licence (and pay royalties) and then permit a new purchaser of the business to take over the licence. If the licensor does not approve of the new purchaser it might at that stage, subject to the terms of the licence, be able to terminate the licence or seek to argue the assignment of the licence was invalid.
While the insolvency practitioner has wide-ranging powers in relation to the licensee's assets in order to allow it to perform its duties, including sale of assets, it can only sell the benefit of the licence agreement if it is capable of assignment. This will depend on the terms of the licence agreement itself. In many cases, a well-drafted licence agreement will prohibit the assignment by the licensee of the benefit of the licence agreement.
Prudent licensors should consider the following steps to protect their position:
Licensors of potentially insolvent licensees should also be aware of the possibility of the licensee entering into a company voluntary arrangement. Broadly speaking, this is where a company agrees an arrangement with its creditors to compromise or discharge its debts. If the necessary majority of creditors approve the proposal, then the arrangement will bind all unsecured creditors (even those who did not vote in favour of it). Licensors should therefore look out for any notices for meetings relating to company voluntary arrangements to reduce the risk of losing out on unpaid royalties.
Whether a licensor or a licensee, companies should ensure that they take into account the risks of insolvency of their counterparty when negotiating IP licences.
It is also worth reviewing all key existing IP licences to understand the degree of insolvency protections already included in them, and considering whether further protective measures should be taken, including ensuring that all licensee interests are registered with appropriate national IP offices, where applicable. Strong, active management of important licence relationships will also help to identify early warning signs of impending insolvency.
by Multiple authors
by Simon Jupp
by Marie Keup