4 ways to Save an IP license: companies must protect their rights to intellectual property and information technology they have licensed from another insurer in case that insurer becomes insolvent.

When corporate counsel are called in to plan for the acquisition of an insurance company or a line of business from an insurer, they are unlikely to rank intellectual property issues as a top priority. But intellectual property and information technology--from the insurer's trademarks to its trade-secret customer data, proprietary claims processing, billing and client relationship management software and computer systems-are an integral part of any successful insurance business.

Even if intellectual property rights are not the driving force behind an acquisition from an insurance company, access to or transfer of the intellectual property rights and information technology often is essential to the seamless transition of business from the seller to the purchaser. For example, in the sale of an insurance subsidiary or line of business, the seller typically licenses to the purchaser the right to use certain software and information technology systems, or agrees to provide certain services to the purchaser with respect to the purchased subsidiary or line of business. This eases the transition to and integration of the subsidiary or line of business with the purchaser. The purchaser also may license the seller's name and trademark so that it can market new policies and correspond with holders of existing, purchased policies.

There are many other scenarios. The purchaser may license back to the seller intellectual property, and technology to enable the seller to handle run-off of old business that is not transferred but is in the same line as the transferred business, or to handle other retained business. An insurer may license internally developed software to, or perform outsourced services for, another insurer. Each scenario presents traps for the unwary Key among these is the risk that the selling insurance company will become insolvent and be placed into receivership. Insurance companies are organized, licensed and regulated under state insurance laws, and receiverships of insurers are governed not by the Federal Bankruptcy Code but by state insurance receivership laws and relevant case law, which vary from state to state. Like the federal code, these state receivership laws give receivers the power to disaffirm or reject contracts to which the insolvent insurer is a party. Unlike the code, however, state insurance receivership laws do not protect entities that acquire rights and services.

The problem is that many intellectual property and technology agreements are drafted without input from insurance counsel, and even when they are, these agreements are not always attuned to the need for bankruptcy code-like protections. The agreements therefore often lack provisions that could help protect the acquirer if the insurer is placed into receivership. Some of the issues to consider in structuring the acquisition of intellectual property and information technology from insurers, and different mechanisms for mitigating the risks related to the insurer's insolvency, are described below.

The Risk of Rejection

As noted above, state receivership laws do not provide code-like protections to entities acquiring rights and services. Under the code, if a trustee seeks to reject a license of intellectual property, the licensee may either treat the contract as terminated or continue to perform its obligations under the contract and retain the licensed rights as they existed before the bankruptcy case. In contrast, if an entity acquires rights from an insurer that becomes insolvent, and the receiver rejects the license, the acquirer risks losing the acquired rights or services. At best, the acquirer may have an unsecured claim against the insolvent insurer and would need to find a substitute for the licensed intellectual property or contract for services.

The bankruptcy code also prohibits the trustee from assuming and assigning a contract, regardless of the provisions in the contract, if applicable law other than the code would prohibit the debtor from assigning the contract without the consent of the other party. For example, most states deem a contract to acquire rights to software and for attendant support services as personal to the acquirer and not assignable by the provider. Thus, the code protects acquirers by not forcing them to contract with third parties, who may be competitors or provide inferior services.

Since state receivership laws do not provide such protections, insurers should consider the following approaches to licensing transactions.

1 Contract with a Receivership-Remote Entity

One way to avoid problems resulting from a receiver's rejection of a contract is to structure the transaction so that the contract is not with an insurer, but rather with a legally distinct entity that is subject to the bankruptcy code, such as a parent holding company that is not a licensed insurer. It also may be possible to transfer the licensed intellectual property and technology to a receivership-remote, third-party affiliate or subsidiary of the insurer. However, because the receivership-remote entity could transfer the contract or underlying intellectual property and technology to an insurer subject to the state receivership laws, it would be necessary for the contract to expressly limit such assignments and other transfers.

Additionally, there are limitations to the protections provided by the code. Notably, Section 365(n) of the code, which provides a licensee with the ability to retain rights to intellectual property, applies only to certain intellectual property, as defined in the code, including trade secrets, U.S. patents and U.S. copyrights, but not to trademarks or database compilations that are not otherwise protected. Furthermore, Section 365(n) of the code only provides a licensee with rights as they existed before inception of the bankruptcy case. Therefore, to fall within the scope of Section 365(n), the contract must include a present grant of all necessary rights, as opposed to an option to acquire rights at a later time or a grant triggered upon a later-occurring condition precedent.

In the case of software, such a grant ideally includes the right to make modifications (for example, to comply with changes in applicable regulations), the right to use third-party contractors and the right to receive the source code--the human-readable form of the software--under an escrow agreement, which itself falls within the scope of Section 365(n). Similarly, the term should be sufficient to meet the acquirer's needs (for example, successful transition of an acquired business), as opposed to providing for a shorter initial term with the ability to extend upon mutual agreement of the parties.

2 Provide Incentives Not to Reject

An alternative to removing the contract from the scope of state receivership laws and the receiver's power to reject is to structure the contract so that the receiver has incentives to affirm it. For example, acquirers of rights or services can provide an incentive by withholding payments until the end of the contract or by making periodic payments. In such cases, the contract should state clearly that the unpaid fees are consideration for future performance and have been withheld in contemplation of the completion of such future performance.

Where an acquirer obtains multiple items of intellectual property, perhaps with a bundle of services as well, it may be preferable to structure the transaction with a single contract, rather than separate contracts covering separate rights and services, each having its own payment provision. If there are multiple contracts, a receiver can "cherry-pick"-affirming the most profitable contracts and rejecting the less profitable ones--whereas a single contract presents the receiver with an all-or nothing situation.

3 Purchase, Rather Than License

Another potential solution for mitigating the risk that a receiver may reject a license is to purchase, rather than license, the intellectual property. Though the original owner often is skeptical of such a proposal, proper drafting can alleviate its concerns.

The original owner often wants to continue using the intellectual property and will want to do so without limitation. Although receiving a license back, the original owner may be concerned that the license will be rejected in the event of insolvency of the purchaser insurance company or that the purchaser may dilute the value of the intellectual property by subsequent assignments, sublicensing and public disclosure.

In addition to providing a license back of the intellectual property to the original owner, the transaction could include an option to buy back the transferred intellectual property. Such a buy-back can be at an agreed-upon price and time, such as expiration of a reasonable transition period.

Another potential solution is joint ownership. Although joint ownership enables the acquirer to use the intellectual property without risk of losing rights in the event of the insurer's insolvency, it also ensures that the original insurer-owner continues to have the right to use the intellectual property. Even though joint ownership may address the original owner's concern regarding insolvency of a would-be licensee, however, joint ownership can create issues regarding maintaining, enforcing and licensing the underlying intellectual property: In addition, as the parties seek to address such issues and to protect the original owner's rights by placing restrictions on the assignee's use and enjoyment of the intellectual property and technology, if too mare restrictions are placed on the assignee's rights, the transfer may be viewed as a license rather than an assignment.

Another alternative is for the contract to provide the licensee with an option to take ownership. Such option must not run afoul of applicable state law provisions regarding automatic stays, injunctions or void-able preferences.

The National Association of Insurance Commissioners' Insurers' Rehabilitation and Liquidation Model Act provides that an application or petition for a court seizure, commencement of delinquency proceeding, rehabilitation order or liquidation order operates as an automatic stay, prohibiting, among other acts, the transaction of further business by the insurer, waste of the insurer's assets, and other "threatened or contemplated action that might lessen the value of the insurer's assets or prejudice the rights of policyholders, creditors or shareholders." The Uniform Act permits courts to issue an injunction to prevent similar occurrences.

Because the automatic stay and injunctive powers accrue upon the insurer entering receivership, such option should be exercisable upon a pre-receivership event, such as a significant rating downgrade or suspension, a predetermined inadequacy of the insurer's risk-based capital, a predetermined ratio of the insurer's loss and loss adjustment expense reserves, or other action falling short of receivership. Indeed, to prevent the option from being rejected, the option should be exercisable prior to receivership.

There may be a question as to whether such an option should be deemed a voidable preference. In certain circumstances, a pledge of collateral by an insurer can be deemed a "voidable preference," resulting in the secured party unable to retain the collateral. Section 32 of the Model Act defines a "preference" as "a transfer of any of the property of an insurer to or for the benefit of a creditor, for or on account of an antecedent debt, made within one year before the filing of a successful petition for liquidation under this Act, the effect of which transfer may be to enable the creditor to obtain a greater percentage of this debt than another creditor of the same class would receive."

Section 32 continues by identifying certain circumstances in which a liquidator may avoid a preference, including if the transfer was made within four months before the filing of the petition and if the creditor receiving the transfer had reasonable cause to believe the insurer was about to become insolvent.

States that have enacted versions of the Uniform Act typically have enacted a voidable preference provision that permits a receiver to avoid any pledge of assets made within a certain period (in some cases up to one year) prior to commencement of the receivership if the pledge was made with the intent of giving a preference and the creditor had reasonable cause to believe that the preference would occur.

At the time such an option is granted, the grant is not "on account of an antecedent debt," and therefore may not be considered a preference. Were a court to focus on the timing of the exercise of the option, however, it might view the transfer as a voidable preference--deeming it to have been made at a time when the insurer's potential insolvency was readily apparent and with the intent of giving the acquirer a preference. In short, the effectiveness of an option to take ownership in protecting the acquirer may depend on the law of the applicable jurisdiction.

4 Acquire a Security Interest

Acquirers of rights and services from insurers may further protect their interests by acquiring a security interest in the licensed software, patents, copyrights or other intellectual property and technology. If the acquirer has a security interest in the underlying intellectual property and technology when the insurer becomes insolvent and the contract is rejected, the acquirer may, as a general rule, foreclose on its security interest and take possession of the collateral.

However, obtaining meaningful protection from a security interest requires an understanding of the subject intellectual property, as well as an understanding of the requirements for perfection of the security interest. For example, in the case of software, the licensee should obtain a security interest in both the object code and the source code, as access to the source code is necessary to maintain and modify, the software.

Obtaining the grant of a security interest is only hall" the battle. Affirmative steps must be taken to properly perfect the security interest. These steps will vary depending on the type of intellectual property collateral. For example, in the case of software, which is covered by revised Article 9 of the Uniform Commercial Code, perfection entails filing a UCC-1 form with the state office. In the case of patents and trademarks, the secured party should file a UCC-1 form, as well as record the security interest with the United States Patent and Trademark Office. Furthermore, software frequently is copyrighted, and security interests in copyrights must be recorded with the U.S. Copyright Office to be perfected.

Although not traditionally viewed as an intellectual property or technology driven business, insurance companies rely heavily on both. Consequently, companies entering into transactions with other insurance companies need to consider the risks associated with the potential insolvency and loss of rights. There is no quick fix; different solutions may be applicable to different situations depending upon the relative degree of leverage between the parties and the particular facts surrounding the transaction. At a minimum, the risks should be acknowledged and weighed.

Key Points

* Transfer of intellectual property rights by licensing is often essential to the transition of insurance business from the seller to the purchaser.

* State receivership laws give receivers the power to disaffirm or reject contracts to which the insolvent insurer is a party.

* Different mechanisms can be used to mitigate the risks related to the insurer's insolvency.

Contributors: Ian G. DiBernardo is a partner in the Intellectual Property Practice Group of Stroock & Stroock & Lavan LLP. William W. Rosenblatt is a partner it, Stroock's Insurance Practice Group and Stroock's Mergers, Acquisitions and Joint Ventures Practice Group.

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