Are IP Escrow Agreements Enforceable?

Customers often negotiate for IP Escrow Agreements from their Suppliers. This is how an IP Escrow Agreement works: 

The Customer wants to have a reliable source for products. Therefore, the Customer asks its Supplier to put all of the IP required to manufacture the Supplier’s product into an escrow account with an Escrow Company. The Escrow Company holds the IP and agrees to only release it to the Customer under certain circumstances. These circumstances are usually something drastic, like the Supplier going out of business.

The trouble is that it may not be enforceable. If the Supplier goes into bankruptcy (US) (“administration” in the UK), that IP is an asset that the Bankruptcy court will want to sell to help pay off the Supplier’s creditors. This creates several problems for the Customer. If the Customer has not provided real consideration for the IP, the Bankruptcy court will want that consideration. A non-exclusive license could cost more than the Customer anticipated. Worse still, if the Customer wants an exclusive license, then the Customer will likely have to buy the IP outright (if the Supplier is to be liquidated), and that could be very expensive. If the Customer does not want to buy the IP, the Bankruptcy court will sell it to a third party, who will want to block the Supplier from using it. All the time and money the Customer spent in the IP Escrow, will have been money wasted.

A perfect example of this is the controversial decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.,  756 F.2d 1043 (4^th Cir. 1985).  In that case, the Bankruptcy court rejected the Customer’s license and the Customer lost the right to use the IP pursuant to 11 U.S.C. §365(a). The result was so controversial, that three years later, Congress amended the Bankruptcy Code, adding §365(n) which allows licensees to continue using the IP after rejection, provided it the license meets certain conditions, the main two of which are 1) it can only be used as long as the original contract was to run; and 2) the licensee continues to make royalty payments.

This creates a few problems for the Customer, however, because 1) often the Customer’s contract is open ended in which case it could be terminated at the end of the current logical interval (and that could be as short as fulfilling the most recent purchase order); 2) often the Customer is not paying a separate royalty, and could thus fail this part of the test; and 3) the Bankruptcy Code does not include “trademarks” in its defined list of “Intellectual Property” protected by this section.

As a result, some courts have been willing to step in and save the agreements, but others have not.  A good example is the case of Sunbeam Products, Inc. v. Chicago American Manufacturing, LLC, Case No. 11-3920 (7^th Cir., decided July 9, 2012)  In this case, the court saves the contract, and is critical of the Lubrizol decision. It highlights the split between the US Circuit Courts on this issue.

So this is a serious trap that varies from court to court. Your contracts that create an IP Escrow arrangement need to include at a minimum:

• IP licensing principles;
• A clear discussion of the consideration in terms of a royalty, or analogous to a royalty; and
• How long the contract will run.

All contracts are a bit different, so the foregoing terms may not be all you need. You will likely need bespoke terms as well.  So if it is worth it to you to get IP escrow, it would behoove you to speak to an experienced attorney to help you craft the terms correctly. Otherwise, after all that effort requiring your Supplier to put its IP into escrow, checking to make sure it is complete and paying for the escrow account, you may have just engaged in expensive folly.

Should you have any questions regarding IP Escrow Agreements be sure to contact our specialist intellectual property lawyers on (UK) +44(0)203 287 9500, (USA) +1(949)431-5438 or make an online enquiry here and we will contact you.