Addressing licensing agreements in bankruptcy presents unique issues. End-User License Agreements (“EULAs”) are specific software license agreements in which the licensor provides the end-user/licensee—under the guise of a sale—a personal and non-transferable license to use the purchased software. Given the unique nature of a EULA, how is such a license treated in bankruptcy?

End-User License Agreements (“EULAs”) are specific software license agreements in which the licensor provides the end-user/licensee—under the guise of a sale—a personal and non-transferable license to use the purchased software.[1]  For example, when a consumer purchases an operating system for her personal computer, after loading the software she must assent to the terms of the EULA before being able to use the newly purchased software.  Given the unique nature of a EULA, how is such a license treated in bankruptcy?

IP Licenses as Executory Contracts in Bankruptcy

Nonexclusive software license agreements—which only grant the licensee the right to use the software, leaving ownership rights with the licensor—are generally treated as executory contracts with ongoing material obligations and duties for both the licensee and licensor.[2]  Section 365 of the Bankruptcy Code allows a debtor in possession or a trustee to reject, assume, or assume and assign a debtor’s executory contracts.[3]  The assignability of IP licenses in bankruptcy generally is largely determined by non-bankruptcy law (e.g., copyright law),[4] and the same bundle of IP laws applies to software license agreements in bankruptcy determinations.[5]  A debtor’s decision with respect to executory contracts is subject to court approval, and New York courts typically give deference to the business judgment of a debtor in approving a motion to reject, assume, or assume and assign an executory contract.[6]  Absent a showing of bad faith, or an abuse of business discretion, a debtor’s business judgment will typically not be overruled.[7]

Assumption and Assignment of IP Licenses

Debtor-Licensee. For a debtor-licensee, the Bankruptcy Code generally allows a debtor to assume an IP license agreement considered executory if the debtor-licensee cures or provides assurance that it will cure all outstanding defaults.[8]  The Bankruptcy Code also allows a debtor to assign the license to a third party if the debtor can provide adequate assurances that the assignee can perform the obligations of the license agreement.[9]  A debtor can typically assign the IP license agreement even if the agreement has a clause that restricts assignment in its own terms.[10]

 Debtor-Licensor. Typically, a debtor-licensor’s major concern when it comes to assuming or rejecting its license agreements is Section 365(n) of the Bankruptcy Code. Section 365(n) allows the licensee to retain some of the rights of the IP license despite a debtor-licensor’s decision to reject the contract.[11]  However, unlike a debtor-licensee of a nonexclusive IP license agreement, a debtor-licensor retains exclusive rights to the IP[12] and the end result is the assignability is fairly easy for the debtor-licensor of wholly-owned IP as long as it follows the baseline Bankruptcy Code procedures of assignment.[13]

EULAs as Executory IP License Agreements

Although there are few bankruptcy cases specifically addressing EULAs, EULAs have generally been treated as executory contracts and subject to Section 365 of the Bankruptcy Code.[14]  For example, the court in In re Chapin Revenue Cycle Management[15] treated the EULA at issue as an executory contract with unperformed mutual obligations because the licensor had the ongoing duty to allow the continued use of the software by the licensee, and the licensee had the obligation to maintain the confidentiality of the licensor’s software under the terms of the EULA.[16]

Conversely, a EULA could be non-executory for any reason any other IP/software license agreement could be considered as such.[17]  Additionally, similar to other software license agreements,[18] courts may find EULAs to be non-executory sale agreements rather than software license agreements when the licensee does not assent to the EULAs terms[19] and subsequently, for the purposes of bankruptcy proceedings, not subject to the protections and privileges of Section 365.[20]

EULAs, if determined executory IP license agreements by the court, can be assumed and assigned pursuant to Section 365 of the Code.   Although EULAs have particularities that make them unique from ordinary IP license agreements in bankruptcy proceedings, the analysis is similar to the assumption and assignment of IP licenses in general.

Debtor-Licensee.  Before being able to assign a EULA, a debtor-licensee must be able to assume such an agreement.  The idiosyncrasies of the terms, duties, and obligations of EULAs may create confusion in determining whether a default of a EULA has occurred and whether such default is incurable as to prohibit the debtor-licensee from assuming the EULA.  In Chapin, the court held that, with court approval, the debtor-licensee could assume the EULA under Section 365 as long as there has been no default on the EULA or the licensee-debtor “cures, or provides adequate assurance that the trustee will promptly cure” any default on the EULA as an executory contract.[21]  The court held that the debtor-licensee had indeed defaulted on the EULA by allowing remote access to the software and distributing portions of the software source code to potential hires in contravention of the terms of the EULA and that this default was incurable.[22]  However, the court further held that the default under the EULA was not material as the licensor suffered no substantial economic harm, and thus such incurable default did not preclude the debtor-licensee from assuming the EULA under Section 365.[23]

In sum, the status of a EULA an IP license agreement may present challenges for a debtor-licensee to assume and assign the EULA absent the consent of the licensor, particularly if the agreement is in default.

Debtor-Licensor. Similar to other IP license agreements, a debtor-licensor of software would likely have an easier time assuming and assigning EULAs under Section 365 of the Code. Generally, a debtor-licensor owns the software licensed by the EULA and has exclusive IP rights to the software, and therefore the public policy concern that free assignability of IP licenses would make the protections afforded by IP laws meaningless is not applicable when a debtor-licensor intends to assign a EULA.

In absence of any state or federal law targeted at EULAs or similar software license agreements, Bankruptcy Code Section 365(c) (which places certain restrictions on assumption and assignment of an executory contract if applicable law excuses a party, other than the debtor, to such contract from accepting performance from or rendering performance to an entity other than the debtor) would likely not cause any serious issues for a debtor-licensor who intends to assume and assign its EULA, allowing free assignability of such EULA as long as the debtor-licensor provides adequate assurances of future performance of the duties and obligations of the EULA in accordance with Bankruptcy Code Section 365(f).[24]

Similar to a debtor-licensee, a debtor-licensor must make sure any default on the EULA on its part is cured or able to be cured in the future to be able to assume the EULA before assigning it.[25]  Due to the particularities of EULAs, many defaults on the terms of a EULA may be historical and incurable and thus not assignable in bankruptcy proceedings.  However—as seen in Chapin—if the default is not considered a material breach of the EULA causing significant economic harm to the other party, then the court may allow the assumption despite a default.[26]

Ultimately, the debtor-licensor who has exclusive rights to the software licensed likely faces few obstacles in assuming and assigning its EULAs pursuant to Section 365.

[1]                      Rebecca K. Lively, Microsoft Windows Vista: The Beginning or the End of End-User License Agreements as we Know Them? 39 St. Mary’s L.J. 339, 342, 345–46 (2007).

[2]                      See In re Fieldstone Mortg. Co., 427 B.R. 364, 374 (Bankr. D. Md. 2010) (finding a nonexclusive software license agreement to be executory where the licensor had to continue to allow the licensee to use the software and provide maintenance); See In re Sunterra Corp., 361 F.3d 257, 264–65 (4th Cir. 2004) (finding a software license agreement to be executory due to the continuing material duty to maintain the confidentiality of the source code of the software developed by the licensor and the enhancements developed by the licensee); Neil S. Hirshman et al., Is Silence Really Golden? Assumption and Assignment of Intellectual Property Licenses in Bankruptcy, 3 Hastings Bus. L.J. 197, 220 (2007).

[3]                      11 U.S.C. § 365.

[4]                      See Hirshman et al., supra note 2, at 199.

[5]                      See Sunterra, 361 F.3d 257 (software license agreements); In re Chapin Revenue Cycle Management, LLC, 343 B.R. 728 (Bankr. M.D. Fla. 2006) (EULAs); Hirshman et al., supra note 2, at 199, 208, 220.

[6]                      In re Penn Traffic Co., 524 F.3d 373, 383 (2d Cir. 2008); In re Orion Pictures Corp., 4 F.3d 1095, 1099 (2d Cir. 1993).

[7]                      In re G Survivor Corp., 171 B.R. 755, 757 (Bankr. S.D.N.Y. 1994).

[8]                      11 U.S.C. § 365(b).

[9]                      11 U.S.C. § 365(f).

[10]                    Id.

[11]                    11 U.S.C. § 365(n).

[12]                    See id.; Traicoff v. Digital Media, Inc., 439 F.Supp.2d 872, 876–80 (S.D. Ind. 2006) (relying

on Patient Education Media to find exclusive IP licenses to be freely assignable); see also In re Golden

Books Family Entm’t, Inc., 269 B.R. 311, 318–19 (Bankr. D. Del. 2001) (relying on Patient Education

Media to find an exclusive IP license freely assignable).

[13]                    See 11 U.S.C. § 365(f) (stating that a trustee may assign an executory contract only if the trustee provides “adequate assurance of future performance by the assignee”).

[14]                    See, e.g., In re Redpath Computer Services, Inc., 181 B.R. 975 (Bankr. D.Ariz. 1995).

[15]                    Chapin, supra note 5.

[16]                    Id. at 730.

[17]                    In re Exide Technologies, 607 F.3d 957, 962–64 (3d. Cir. 2010) (software license agreement found to be non-executory due to absence of material obligations on both sides that would constitute breach if unperformed under New York law).

[18]                    See In re DAK Industries, Inc., 66 F.3d 1091, 1095–97 (9th Cir. 1995).

[19]                    See SoftMan Products Co., LLC v. Adobe Sys., Inc., 171 F.Supp. 2d 1075, 1083–89 (C.D. Cal. 2001).

[20]                    In re Stein and Day Inc., 81 B.R. 263, 265–67 (Bankr. S.D.N.Y. 1988).

[21]                    Chapin, 343 B.R. at 730; 11 U.S.C. § 365(b)(1)(A).

[22]                    Id. at 731.

[23]                    Id. at 731.

[24]                    11 U.S.C. § 365(f).

[25]                    11 U.S.C. § 365(b).

[26]                    Chapin, 343 B.R. at 728.