"I did not want you to hear this on the news for the first time, but we are filing for bankruptcy next week." "This is a difficult call to make. We are going out of business and will probably be filing a chapter 7 in the next couple of days." Needless to say, bankruptcy is problematic for a licensor: the licensee may cease performing, the royalty stream may run dry, and the licensee or a trustee could attempt to sell or assign the license in bankruptcy to an undesirable licensee, or even a competitor. There is however one silver lining in these scenarios - the licensor received a heads up about the bankruptcy before it was filed.
With the benefit of advance notice, a licensor should consider terminating the license before the licensee actually goes into bankruptcy.1 Once the licensee files for bankruptcy protection, the automatic stay will enjoin the licensor from taking any action against the licensee. While termination may still be possible in bankruptcy, first the licensor will need to obtain relief from the automatic stay. Needless to say, it is much easier to terminate a contract outside of bankruptcy than it is to obtain the bankruptcy court's permission to do so.
It is essential to draft licenses with the possibility of bankruptcy in mind. While most of the tips discussed below are straightforward, a recent bankruptcy case from Hawaii, In re Minesen Co., illustrates the peril of seemingly innocuous language on the licensor's ability to protect itself in the event of its licensee's bankruptcy.2
Termination Before Bankruptcy
But first, what actions can a licensor take with advance notice of a bankruptcy? Step one is to review the license and ascertain whether an event triggering the termination right has occurred. At the drafting stage, include as many default and cross-default triggers as possible. For example, in addition to insolvency and material adverse change clauses, consider authorizing termination if the licensor deems itself insecure, if the licensee fails to pay a debt to a third party over a threshold dollar amount, or judgment of a specified size is entered against the licensee. When drafting, be mindful of the timing of any notice provisions and make certain that the termination will be effective as quickly as possible (ideally, immediately). When pulling the termination trigger, follow the contractual provisions precisely. Send the notice to the right recipient at the correct address, and in the manner specified (i.e., by certified mail, overnight delivery or facsimile). If the address has changed...
