Consequences and contractual options
Staff shortages, liquidity bottlenecks and supply chain disruptions are not the only direct impacts of the corona-crisis on businesses. Wherever companies depend on the use of IP rights of third parties or generate income from licensing them, any economic distress on the part of the contractual partner can have severe effects on the company. The insolvency of a licensor can result in the termination of the licence agreement and the risk of losing the right to manufacture or sell key products or goods. The insolvency of a licensee on the other hand, can mean the loss of substantial revenue and create the risk of losing control over the licensed IP.
Insolvency of the licensor
German law does not generally protect a licence against the insolvency of the licensor. While certain lease or rental agreements are protected from insolvency by statue under the German Insolvency Code (InsO), this is not the case for licence agreements.
If the licensor becomes insolvent, the licence agreement does not simply continue. Instead, the insolvency administrator of the licensor will decide in each individual case whether a continuation of the licence agreement is economically viable (section 103 InsO). Should the administrator elect to continue the licence agreement, the rights and obligations under the agreement will remain in place. The administrator can also choose to discontinue the licence agreement in which case, the licensee will no longer have a right to exploit the licensed rights.
The licensee can assert claims for non-fulfilment, but such claims, including damages claims, will be treated as unsecured claims against the insolvent entity. Their value will therefore generally be low. Because the licence has ended, the administrator will then be free to pursue the exploitation of the IP rights in other ways, for example by granting other licences or selling the rights to the highest bidder.
This outcome is a deliberate decision by the German legislator. Several attempts at passing statutory provisions that expressly deal with the fate of licences in insolvency situations have been introduced, but ultimately abandoned. For now, this leaves licensees with little protection under statutory law.
In order to mitigate this situation and protect the licensee’s business in the event of an insolvency of the rights owner, appropriate contractual safeguards should therefore be provided for in the licence agreement. The following issues should be covered.
Licence or purchase of rights?
Not all assignments of IP rights are equally affected by the insolvency of the licensor. If the right is not licensed but has been assigned by the original owner, it will generally have been transferred to the purchaser before the insolvency event. One of the regular features of such a purchase of rights is that a lump sum remuneration is agreed for the use of the right for an unlimited period of time.
A full assignment of an IPR by way of purchase will generally not be affected by the insolvency of the seller, unless there is a right for the administrator to rescind the transaction retroactively. A general right for the administrator to choose whether to continue an agreement only exists for reciprocal contracts which have not been completely fulfilled at the time the insolvency proceedings are opened. This will generally be the case where licence agreements featuring continuing obligations are concerned. A limited term, regular royalty payments or reporting obligations are examples of such ongoing obligations.
Licence or sub-licence?
Where a licence is granted in the form of a continuing obligation, a distinction needs to be made as to whether the licence originates directly from the rights owner or has been acquired by a principal licensee.
Insolvency of the rights owner as licensor
If the licence originates directly from the rights owner who then becomes insolvent, the insolvency administrator has the right to elect whether to continue the licence for the insolvency estate or to refuse its continuation (section 103 InsO).
While many details are disputed, the prevailing view is that this does not apply where the licensee holds an exclusive licence. The German courts have considered such an exclusive licence – at least where a patent was concerned – as a property right rather than merely a contractual right. Consequently, the licensee should enjoy a right to separate the exclusive licence from the remaining insolvency assets (section 47 InsO). In effect, this means that the holder of an exclusive licence can raise an objection with the administrator that the licence is not part of the assets involved in the insolvency proceedings, whereas a non-exclusive licence is not a property right and will generally be subject to the administrator’s right to choose or refuse performance of the contract.
If the insolvency administrator refuses the continuation of a (non-exclusive) licence, for example because the licence fees are not economically beneficial or an even more lucrative alternative exploitation of the property right is expected, the licence ends.
The licensee can claim for non-performance, which mostly means claiming for damages (section 103 (2) InsO). However, as insolvency claims, these will generally only be satisfied proportionally, which means that the licensee can only rarely obtain compensation for the actual loss resulting from the termination of the licence.
In order to avoid these disadvantages, the licensee should include a clause in the licence agreement which provides for the continuation of the licence beyond the insolvency event.
Although the German courts strengthened the position of the licensee in the event of the insolvency of the licensor in several decisions, none of these judgments provides a reliable contractual formula for protecting the licensee. The main obstacle here is the provision of section 119 InsO, according to which all agreements purporting to restrict the insolvency administrator’s right to choose to continue or abandon ongoing contracts pursuant to section 103 InsO are invalid.
One option is to extend a non-exclusive to an exclusive licence. This may be considered in cases where the licensor has not already granted further licences. Of course, a licensor can be expected to charge a significantly higher licence fee for such an upgrade. Often, the added security in the case of an insolvency will not justify paying substantially higher royalties where no exclusive rights would otherwise be required.
A further possibility suggested by case law is to provide for a transfer of the full rights subject to a condition precedent, such as the termination of the contract because the licensee cannot reasonably be expected to continue the agreement. Ideally, such a termination right should not expressly refer to the case of an insolvency. In this case, the licensee acquires a contingent right before the insolvency, which matures into a full right upon realisation of the condition precedent. The disadvantage of this solution is that it will encumber the licensor’s rights with the contingent right which may result in a significant reduction in its value.
Insolvency of the principal licensee
A sub-licensee (ie the party deriving the right of use from a principal licensee) will be in a stronger position in the event of an insolvency. According to the majority view in case law and legal writing, the sub-licence is considered to be bankruptcy-proof, regardless of whether the rights owner as the principal licensor or the principal licensee as the person who granted the sub-licence becomes insolvent.
The reason for this different treatment is that many IP laws do expressly protect sub-licences against assignments or other forms of succession concerning the main right. They stipulate that the fate of the sub-licence should be independent of that of the principal licence. If, for example, the principal licence is transferred to a third party after a sub-licence has been granted, this transfer does not affect the validity of the sub-licence. The outstanding licence fees are then payable to the rights owner as the principal licensor or the insolvency administrator of the insolvent principal licensee.
This protection from succession can also be used to secure licences in the event of the insolvency of the licensor. In the context of company groups, it is possible to obtain licences to a subsidiary acting as a licence holder and to grant a sub-licence to the respective operative subsidiaries. Should the licensor become insolvent, the continuation of the main licence agreement with the licence holder can be refused by the insolvency administrator pursuant to section 103 InsO. The sub-licence between the licence holder and the subsidiary will, however, remain unaffected.
Another possible solution is to agree on a beneficial use or usufruct right (Nießbrauch) in the licensed rights subject to a condition precedent. The condition precedent is the refusal of the administrator to continue the licence agreement. If the condition occurs, a usufruct right is created in favour of the licensee, which is a right in rem pursuant to section 47 InsO that does not belong to the insolvency estate. The content and scope of the right must be agreed in a separate agreement, which will follow the terms of the licence agreement closely.
Insolvency of the licensee
If insolvency proceedings cover the assets of the licensee, the licensor is faced with the question of compensation for lost licence fees and the fate of the licensed right. Here too, section 103 InsO grants the insolvency administrator a right to choose or refuse the continuation of the licence agreement. The fate of the licence is thus initially in the hands of the insolvency administrator, which can prevent the licensor from a potentially more lucrative alternative exploitation of the licence.
Right of election of the insolvency administrator
Refusal of performance
If the insolvency administrator refuses to continue the licence, the right of use under the licence ends and the licensor can exploit the licensed rights in other ways.
The licensor is in principle entitled to claim damages for non-performance of the licence agreement, including lost licence fees. However, this claim, as well as any outstanding licence fees from the period prior to the opening of the insolvency proceedings, is to be regarded as an insolvency claim; the claims will therefore only be satisfied on a pro rata basis.
If the insolvent licensee has legitimately granted sub-licences, the prevailing view is that these sub-licences are not affected by the termination of the principal licence. The fees for sub-licences are then due to the principal licensor.
Continuation of the licence agreement
If, on the other hand, the licence administrator decides to continue the licence agreement, the licence fees accruing in future are to be regarded as preferred liabilities of the insolvency estate pursuant to section 55 (1) no. 2 InsO, and must be satisfied from the insolvency estate with priority over any insolvency claims.
Possibility of termination by the licensor
Of course, the licensor may have a strong interest in terminating the licence agreement with the insolvent licensee itself.
The contractual options are significantly restricted here by the provisions of sections 112, 119 InsO, according to which insolvency-related terminations of rental and lease agreements (and by extension of licence agreements) are not permissible after the opening of insolvency proceedings due to a previously occurring default in payment or a deterioration in the debtor’s financial circumstances. In addition, agreements which serve to circumvent this provision are null and void.
A contractual right of termination must therefore be structured in such a way that it is not linked to insolvency as such, but to typical events associated with it, in particular, termination for breach of a contractually defined obligation to operate or for falling short of contractually defined sales figures. If the insolvency administrator does not continue the business operations of the insolvent licensee, these grounds for termination may exist.
