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.
What is insolvency?
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.
What is the impact of insolvency on IP licences?
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.
Issues for licensees with an insolvent licensor
Can the licensee terminate the licence?
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.
What are the powers of the insolvency practitioner?
There are various options available to an insolvency practitioner when dealing with IP subject to a licence.
Disposal of IP and other property
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.
Disclaimer of onerous property and contracts
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.
What happens to IP remaining in the insolvent company on striking off?
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).
How can a licensee protect its position against an insolvent licensor?
Prudent licensees should consider the following steps to protect their position:
- Registration – Licensees of registered IP should ensure the licence is noted on the applicable IP register in each territory covered by the licence. For key territories, the licensee should also consider taking local law advice on any other steps they can take to protect their interest.
- Step-in rights – Licensees should consider including step-in rights in the licence to enable them to pay renewal fees for registered IP in the event the licensor or its insolvency practitioner fails to pay or threatens not to pay.
- Ongoing monitoring – Licensees of critical IP should consider monitoring the financial position of the relevant licensor. In the event a licensor appears to be at risk of insolvency, the licensee should consider what general proactive steps can be taken to mitigate the impact. For more information on dealing with potentially insolvent counterparties, please see our article.
- Taking security – Licensees of critical IP should consider taking a fixed charge over that IP (and registering their security interest). This would put the licensee in the position of a preferred creditor, restrict the ability of the insolvency practitioner to deal with the IP in the event of the licensor's insolvency and allow the licensee to appoint its own receiver. Moreover, the registration of the security interest may have the effect of putting a buyer or new licensee on notice of the existing licence. However, whether this is feasible will depend on the extent of any obligations or liabilities of the licensor that could actually be secured. For more detail on the taking of security over IP, please see here.
- Insolvency remote vehicles – Licensees of critical IP may want to consider more unusual structures to reduce the risks associated with insolvency, including requiring the licensor to place the IP in an "insolvency remote vehicle". This is a company set up solely to hold the relevant IP and without any other liabilities, thereby reducing the risk of the licensor becoming insolvent. For additional protection, the licensee might also consider taking security over the shares in this company to enable the licensee to take possession of the shares (and so the relevant IP) on enforcing the security.
- Escrow arrangements in software licences – Licensees who depend on licensed-in software should consider entering into an escrow agreement with the relevant licensor. The agreement will require the licensor to deposit the software source code with an escrow agent, to be released to the licensee upon the licensor's insolvency or another agreed trigger event. The licensee should ensure the trigger events are sufficiently broad and that it has all of the rights (and practical capability) it needs to use the source code in the event of the licensor's insolvency, including the ability to independently maintain and update the software in the future.
- Being proactive on insolvency – Licensees should contact the insolvency practitioner as soon as they are appointed to ensure they are aware of the licence and will notify any purchaser of the underlying IP of the licence's existence. This is particularly important for licences of unregistered IP. Licensees may also consider making an offer to the insolvency practitioner to purchase the underlying IP. For more detail on leveraging or asserting IP-related rights in the event of insolvency, please see our article.
- Sub-licensees of IP should also consider how to protect themselves against the insolvency of their immediate licensor - If company A grants a licence to company B, and company B grants a sub-licence to company C, company C should request a covenant from company A that its sub-licence will survive any termination of the head licence (perhaps structured so that, following termination of the head-licence, sums payable under the sub-licence by company C would be paid directly to company A and the sub-licence would be treated as being between company A and company C).
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.
Issues for licensors with an insolvent licensee
Can the licensor terminate the licence?
Licensors should also consider how to protect themselves against the possibility of a licensee becoming insolvent. As discussed above:
- At common law a licence will not automatically terminate upon a licensee's insolvency. The express terms of the licence itself will determine the extent to which it is terminable following the insolvency of the licensee.
- Most IP licences will contain such a provision (although in some circumstances such licence terms may be overridden by statute and might be ineffective under the new Corporate Insolvency and Governance Act).
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.
Powers of the insolvency practitioner
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.
How can a licensor protect its position against an insolvent licensee?
Prudent licensors should consider the following steps to protect their position:
- Front-loading fees – Licensors should consider front-loading payments under a licence and making royalty payments due as a minimum every quarter. There is a risk that a licensor may not receive important milestone or royalty payments if its licensee becomes insolvent before they are required to make payment. Royalty payments could also be payable in advance, rather than arrears. A licensor could also consider taking a charge over any of the licensee's goods which embody the licensed IP.
- Termination rights – As well as including a right to terminate the licence if the licensee enters an insolvency process, licensors should also consider including an earlier trigger, such as a failure to make timely payments under the licence. If the licensee wants to act on that earlier trigger, it should bear in mind that the statutory moratorium will likely prevent it acting on breaches occurring before the insolvency process once the insolvency process has commenced – so it will need to act fast. Licensors may also consider including a right to require licensees to deliver any unsold stock manufactured under the licence to the licensor on termination.
- Unwanted licensees – Licensors should consider the risk of valuable IP becoming subject to a licence to an undesirable licensee (such as a competitor) following an insolvency process. They will want to ensure that the licence cannot be assigned without their consent, and they may also consider a change of control provision, allowing them to terminate where the control of the licensee is transferred to a third party. However, a change of control provision is unlikely to be popular with a young licensee company thinking ahead to an exit by way of a share sale.
- Conditional licences – Licensors may also consider making the grant of the licence subject to and conditional on timely payment of royalties. In such circumstances, if the licensee fails to pay on time but continues to exercise its licensed rights, the licensor may (depending on the type of IP right) be able to assert IP infringement in addition to a claim in breach of contract for any failure to pay.
- Survival of sub-licence - Generally a sub-licence will terminate on termination of the head-licence. However, there is no rule of law to this effect and the courts will determine each case on its facts. If a sub-licensee can establish that the parties intended that a sub-licence should survive termination of the head licence, then the courts may allow the sub-licensee's right to continue using the licensed IP to survive. So where a head licensor enters into a head licence which includes the right to grant sub-licences, and wants to ensure that both the head licence and any sub-licences can be terminated on the insolvency of the licensee, it should ensure that both the head licence and any sub-licence contain express termination provisions to this effect. Alternatively, a head licensor may wish to include step-in rights in the head licence to enable it to take over its licensee's sub-licences (and to receive the royalties payable under them) in the event of its licensee's insolvency. The head licence should also provide that no agency relationship exists or should be implied between the parties and require the head licensor's prior approval of any sub-licence.
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.
What can you do now?
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.
