Protecting Licensees and SaaS Customers Against Software Licensor or Provider Bankruptcy

Practical Law Legal Update 2-525-3492 (Approx. 5 pages)

Protecting Licensees and SaaS Customers Against Software Licensor or Provider Bankruptcy

by PLC Intellectual Property & Technology

Background: US Bankruptcy Code

Section 365(a) of the Bankruptcy Code empowers a party in bankruptcy, as debtor-in-possession (DIP), or its trustee, to reject and terminate its performance of its executory contracts (§ 365(a), Bankruptcy Code). Typically, because software license and SaaS agreements have license compliance, service and other material obligations that remain to be performed, they are deemed executory contracts and made subject to the debtor licensor's or provider's rejection under this statutory section.

Section 365(n) of the Bankruptcy Code provides partial relief to a software licensee against the licensor debtor's rejection of the license agreement by according the licensee the rights to:

Elect to retain the license rights as a licensee of "intellectual property" and "embodiments" of "intellectual property" as these terms are defined and used in the Bankruptcy Code (see §§ 101(35A) and 365(n), Bankruptcy Code).
Require the debtor licensor or its trustee to provide to the licensee any embodiments of intellectual property, such as software source code and documentation, that are held by the debtor or its trustee if the parties have included this requirement in the software license or a supplementary agreement, such as a source code escrow agreement (§ 365(n)(3), (4), Bankruptcy Code).

However, the Bankruptcy Code fails to fully protect software licensees and SaaS customers in at least two important respects:

Section 365(n) expressly excludes any right to specific performance of the licensor's contract service obligations.
The Bankruptcy Code and controlling case law are silent on whether an SaaS agreement is a "license" ― or mere service agreement — for purposes of section 365(n)'s licensee protections.

This results in both licensees and SaaS customers being unable to enforce critical software service obligations under a rejected agreement, including, for example:

For software license agreements, the licensor's obligations to provide software development, maintenance or support services.
For SaaS agreements, the SaaS provider's obligation to host and maintain the SaaS software for the customer's remote access and use.

Maximizing Licensee and SaaS Customer Protection

Two essential steps can be taken to help maximize the software licensee's or SaaS customer's chances of preserving its right to continued use of licensed software or SaaS services if the licensor or SaaS provider falls into bankruptcy:

Drafting the parties' software license or SaaS agreement to conform, as closely as possible, to the language and requirements of section 365(n) of the Bankruptcy Code. This includes:
- framing the parties' agreement as a license to intellectual property and embodiments of intellectual property as defined and used in sections 101(35A) and 365(n) of the Bankruptcy Code because, while not binding on the courts, this serves to express the parties' understanding and intent that their agreement be, and be deemed to be, a license of intellectual property for purposes of section 365(n)'s licensee protections (see, for example, Standard Document, Software License Agreement (Pro-licensee): Section 20.1);
- granting a present license (for example, "Licensor (or Provider) hereby grants"), rather than a future-contingent, springing license or agreeing to grant a license, to use the licensed software either directly (in the case of a software license agreement) or remotely (in the case of an SaaS agreement), because section 365(n) preserves only license rights that exist before (and not on the occurrence or as a result of) the commencement of the debtor's bankruptcy; and
- providing, in the parties' principal or supplementary agreement (for example, a software escrow agreement), for the licensee's or SaaS customer's right to require the software licensor or SaaS provider to deliver the software source code, object code and related documentation to the licensed party or its designee if the debtor licensor or SaaS provider rejects the agreement or otherwise fails to perform its software service obligations (§ 365(n)(3), (4), Bankruptcy Code).
Where economically justified and feasible, entering into a software escrow agreement. The escrow agreement should include provisions:
- granting to the software licensee or SaaS customer, as applicable, a present license to possess and perform all acts necessary or useful to continue to make effective use of the software, including the rights to self-host, correct, maintain, support, modify and further develop the software source code, object code and related documentation for this purpose;
- authorizing the licensee or SaaS customer to retain a third-party service provider (through sublicensing or otherwise) to perform the foregoing services;
- invoking and implementing the software licensee's or SaaS customer's rights under section 365(n) to require the debtor licensor or SaaS provider to deliver copies of the software object code, source code and related documentation to the licensed party or its designee (§ 365(n)(3), (4), Bankruptcy Code and see Standard Document, Software Source Code Escrow Agreement); and
- in the case of SaaS agreements, requiring the escrow agent to maintain mirrored SaaS services that may rapidly be activated and hosted by the SaaS customer, the escrow agent or the customer's chosen other third-party service provider (see, for example, Standard Document, Software Source Code Escrow Agreement: Section 5.2).

For model licensor bankruptcy and software escrow provisions, see Standard Document, Software License Agreement (Pro-licensee): Section 20.1 and Standard Document, Software Source Code Escrow Agreement.

For more information on the provisions and uses of software source code escrow agreements, see Practice Note, Software Source Code Escrow Agreements.

For more information on the effect of a party's bankruptcy on intellectual property licenses, see Practice Note, IP Licenses and Bankruptcy.

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