In IP Licensing, the Pandemic Poses Perils for Both Sides

May 6, 2020Alerts

Unexpected business closures can have a disruptive effect in the context of intellectual property licenses, particularly if the license includes a provision whereby one party agrees to sell a minimum number of goods within a particular time period or pay a fixed royalty amount to the other party on a regular basis (i.e., monthly or yearly).

The mass business closures occasioned by the COVID-19 pandemic may make it all but impossible for licensees to comply with such contractual obligations and difficult for licensors to enforce them. Now is the time to review your existing licenses – before a dispute arises over a party’s inability to perform – to identify your options for seeking to enforce or excuse contractual obligations in light of the current economic environment.

Regardless of whether you are seeking to enforce or excuse nonperformance of a contractual obligation, your starting point should be the language of the license. In reviewing a license, pay particular attention to performance obligations (e.g., minimum sales, production or royalty requirements, and the timing within which the performing party must satisfy such requirements), cancellation and/or termination provisions, choice of law provisions, and force majeure clauses.

Performance Obligations

Except in limited circumstances, such as where the contract is the product of fraud, well-settled principles of contract law require courts to enforce the parties’ expectations as manifested in the plain language of the parties’ written agreement. For this reason, courts routinely enforce the remedies that the parties negotiate in a license for resolution of performance problems. Consider whether the license identifies a specific remedy for nonperformance of a contractual obligation; a court is likely to enforce that remedy.

Cancellation and Termination Provisions

Cancellation and termination provisions are also key. Some provisions permit a party to avoid contractual obligations, entirely or in part, by providing notice to the other party in a specified manner or form. Pay particular attention to any timing requirements that specify when a party must provide such notice to the other party. Other cancellation and termination provisions allow the parties to suspend contractual obligations under certain circumstances, rather than terminate the license outright. Still other cancellation and termination provisions specify certain damages that a breaching party might owe to the non-breaching party – for example, liquidated damages in an identified amount. Be aware of these potential damages before deciding on a course of action because liquidated damages are intended to serve as a deterrent and constitute a form of penalty. As a result, the amounts provided for in the license can oftentimes be quite high.

Force Majeure Provisions

Like many commercial agreements, intellectual property licenses frequently include force majeure clauses that excuse nonperformance under certain circumstances. Such circumstances may include war, acts of terrorism, strikes and labor disputes, acts of governmental authorities, illness, and/or “Acts of Gods” (e.g., extreme nature or geological events). While the COVID-19 pandemic may seem like a clear-cut basis upon which to invoke a force majeure provision, the determination of whether you can invoke a force majeure clause is a fact-intensive inquiry that depends largely on the specific language of the license.

Courts generally interpret force majeure clauses narrowly in light of their purpose, which is to limit damages in a case where circumstances beyond the control of the parties have frustrated the parties’ expectations and performance of the license. Where the parties expressly define the contours of a “force majeure” in the license, those contours will dictate the application, effect and scope of the force majeure provision.

When reviewing a force majeure provision in your license, consider these four questions:

How does the license define a “force majeure”?

What events does the license include in the definition of “force majeure”? Does the license exclude specific types of events from the definition of “force majeure”? Of particular relevance in the context of the COVID-19 pandemic, does the definition of “force majeure” include illness, epidemics and/or pandemics? Does the provision cover other potentially relevant events, such as quarantines, embargoes (importation and/or exportation restrictions), or travel restrictions that may impede a party’s ability to perform under the license? Does the provision include “catch-all” language that could conceivably cover the current pandemic?

To what performance obligation(s) does the force majeure provision apply?
Some force majeure provisions apply to all contractual obligations. Others are limited to only certain performance obligations. Additionally, some force majeure provisions, allow a party to terminate the license in its entirety, whereas others allow a party to suspend performance only during the course of the force majeure event.  Does the force majeure provision in your license apply to the particular type of nonperformance at issue?

Does the license include a choice of law provision?
Although well-settled principles of contract law are common across all jurisdictions in the United States, there are nuances in the law, by State, that could prove critical in any contractual dispute. For that reason, it is of the utmost importance to assess what law will control regarding interpretation and enforcement of the license by examining a choice of law provision in the license or by determining where the parties “created” the license. The issue of choice of law is a particularly important consideration for licenses involving international parties.

What steps must you take to invoke the force majeure provision?
Some force majeure provisions require you to take certain steps – in particular, providing notice to the other party in a specified manner or form – before invoking the provision to excuse performance. Still other provisions may require the parties to meet and confer regarding potential means of mitigating the effects of the force majeure event – namely, taking “reasonable” efforts to secure performance.

Extra-Contractual Doctrines

If circumstances sufficient to invoke a force majeure clause do not exist, you may still be able to seek relief through other extra-contractual doctrines such as frustration of purpose or commercial impracticability.

The doctrine of frustration of purpose may discharge contractual obligations where an unforeseeable event outside the parties’ control frustrates the primary purpose for which the parties entered into the license such that a basic assumption in the parties’ agreement has not materialized. The event must be unforeseeable such that the parties could not have protected against its occurrence in the license.

Impracticability or impossibility, on the other hand, may excuse nonperformance where an intervening and unforeseeable event would cause a party unreasonable difficulty, expense, injury, or loss if the party performed its contractual obligations.

Due to the complex factors a court considers in determining whether a party legitimately claimed impracticability, impossibility, or frustration of purpose, you should coordinate with legal counsel if you seek to rely on these extra-contractual doctrines as a defense to nonperformance.

Increased Bankruptcy Filings

We can also expect to see a considerable increase in bankruptcy filings during this economic downturn, and many of the bankruptcy petitioners will be intellectual property licensors or licensees.

Where a licensor files for bankruptcy, the licensor may request court approval to “reject” an existing intellectual property license. However, the U.S. Supreme Court recently held in Mission Products Holdings, Inc. v. Tempnology, LLC, that, when the licensor of a trademark files for bankruptcy, its “rejection” of a trademark license under Section 365 of the Bankruptcy Code does not terminate the licensee’s rights in the trademark. Rather, the rejection of a trademark license under Section 365 constitutes a breach of the license. Thus, the licensee may continue to use the mark at issue.

Conversely, where a licensee files for bankruptcy, one must consider whether the license includes clauses that provide for automatic reversion of intellectual property rights to the licensor or automatic termination of the license. The enforceability of such clauses may vary by jurisdiction and may depend, in significant part, on how the parties drafted the clauses.

In both of these circumstances, you should carefully consider the parties’ potential rights before deciding on a course of action. Either way, going forward, a trademark licensor should consider ways to tie a trademark license to certain other rights or obligations that may cease in the event of a bankruptcy, whereas licensees should seek to avoid the inclusion of such terms.