The COVID-19 pandemic poses a major challenge for large parts of the economy, causing many companies to fail and a domino effect on other companies with which they had business relationships. Where a party to an IP license becomes insolvent and regular insolvency proceedings are commenced, an insolvency administrator will take over the management of the business. German insolvency law confers on the administrator (or the self-administrating debtor) a choice as to whether to affirm or terminate a non-exclusive license agreement.
License agreements generally include continuing and recurring obligations for each party, most notably, ongoing license payments and the continued grant of the right to use the respective IP rights. Such agreements fall within the scope of Sec. 103 of the German Insolvency Code, which applies to agreements containing reciprocal and ongoing obligations for each party as at the date of insolvency. This provision grants the administrator (or the self-administrating debtor) the right to opt between performance (i.e. affirmation) and non-performance of the license agreement (i.e. termination). This causes serious uncertainty for the non-defaulting party:
- the licensee can lose the right to use the licensed IP rights owned by the insolvent licensor, and the licensee’s business can become infringing;
- any unpaid royalties and damages claims for early termination due to the licensor by the insolvent licensee will be regular unsecured insolvency claims, and there will be delays in exploiting the IP rights (and generating future royalties) with a new licensee.
According to Sec. 119 of the German Insolvency Code, the right to opt between performance and non-performance cannot be circumvented by contractual terms, but there are certain options for structuring license agreements in order to mitigate the risks, namely by:
- Agreeing an exclusive license
- Establishing an in-rem right securing the licensee’s right to use the IP
- Agreeing a subsequent purchase and transfer of the IP rights to the licensee in the potential event of licensor’s insolvency
- Granting a sub-license to an affiliate company of the licensee
- Ensuring that the licensor can validly terminate the license agreement when the licensee shows signs of distress
If an existing license agreement is subsequently amended though, such measures may be challenged in the course of subsequent insolvency proceedings under German insolvency clawback rules (Sec. 129 et seqq. of the German Insolvency Code). Therefore, it is preferable to address the insolvency risks when the initial license agreement is negotiated.
In view of the potential impact of German insolvency law, the parties of non-exclusive license agreements are encouraged to review the terms of their licenses. Particularly in the unprecedented, uncertain times of the COVID-19 pandemic, it would be advisable to explore what can be done to mitigate any potential insolvency risks, even if imminent issues may not yet be apparent. There are legal means which may help to reduce risks associated with an insolvency of a party to the license agreement; however, it is important that the parties take such measures before the threat of insolvency arises.