Maximizing Bankruptcy Protection in Software and SaaS Agreements

In today’s digital age, cloud computing has lowered the barrier of entry into many marketplaces by providing network access to a shared pool of configurable computing resources. Cloud services allow business to forego upfront capital costs on servers, network infrastructure, and software allowing companies to focus on establishing and differentiating its business instead of worrying about its IT resources. Additionally, it is typically a “pay as you go” service meaning that businesses can scale up or down as needed in real time. However, entrusting a third-party as the sole source of the company’s network, software, and data storage functionality puts the company at risk of losing these services should the provider enter bankruptcy.

Because the majority of cloud computing services provide a “pay as you go” utility-type subscription service under software as a service (SaaS) agreements, they are unlike the typical software license agreements utilized for enterprise software. Software licenses permit the customer to possess and use the software in object code form while under SaaS agreements, the customer only has remote access to the software. This is typically not an issue as long as the software functions properly and data access is maintained. However, without access to the source code, the customer could be at risk of losing access to the software and its data should the cloud service provider enter bankruptcy.

Section 365(a) of the Bankruptcy Code gives the party in bankruptcy the ability to reject and terminate any executory contracts to which it is a party. This typically would include software licenses and SaaS agreements because they have compliance, service, and other material obligations that the party in bankruptcy would be required to perform if the agreements were not rejected under the statute. Should the cloud service provider reject the software licenses/SaaS agreement, the customer would not only lose the ability to use the software or its hosted applications, but potentially access to its data stored on the cloud.

The Bankruptcy Code does contain some exceptions to the party in bankruptcy’s ability to reject and terminate contracts. Specifically, section 365(n) permits the licensee/customer to elect to retain rights to intellectual property and embodiments to intellectual property. Section 365(n) also requires the party in bankruptcy to provide the licensee/customer any embodiments of intellectual property, such as software source code and documentation, if included as a provision to the license/agreement. However, this does not fully protect licensees/customers, as the rights to specific performance of the provider’s service obligations are expressly excluded and the Bankruptcy Code and controlling case law is silent on whether SaaS agreements are “licenses.”

Given that the Bankruptcy Code and relevant case law provide little protection and guidance, there are steps that drafters of these licenses/agreements can take to maximize a cloud computing customer’s ability to maintain access to cloud services. One way is to draft software licenses and/or SaaS agreements as licenses to intellectual property to invoke section 365(n) of the Bankruptcy Code. This would include drafting the agreements as licenses, under a present license grant (not contingent or future grant), to use the licensed software and require the provider to deliver the software source code, object code, and related documentation should the provider reject the agreement under 365(a) or fail to perform its obligations.

Another way is to effectuate a software escrow agreement. The terms of the escrow agreement could be incorporated into the original license/agreement or drafted as a supplement. The provisions of a software escrow agreement should include means for the licensee/customer to possess and perform all acts necessary to continue the operation of its business. This can be done by including, at a minimum, a license to possess, use, maintain, and develop the software source code or the right to sublicense a third-party to perform those services. The software escrow agreement should also invoke 365(n) of the Bankruptcy Code and require the provider to deliver copies of the software’s object and source code and all related documentation. Lastly, for SaaS agreements, the escrow agreement should require the escrow agent to maintain mirrored SaaS services for rapid implementation should the provider no longer support those services.

In light of the above, an example of how the license grant in a SaaS agreement could be drafted is as follows:

Vendor, as service provider and licensor, hereby grants to Customer, as service user and licensee, and Customer hereby accepts from Vendor, subject to the terms and conditions of this Agreement, a nonexclusive, worldwide, nontransferable, revocable license to use the Services for the Term specified on an Order. The Services may be used only for Customer’s internal business purposes and not as a service bureau, ASP, or other service provided to third parties. Customer is solely responsible for obtaining and maintaining the hardware, software, and telecommunications equipment needed to access the Service. To facilitate access to the Service, Vendor will supply default administrator login credentials (“Login Credentials”) for Customer to assign user names and passwords to all personnel that will access the Service. Customer assumes sole responsibility for use of the Login Credentials. Except for trademarks, the license to use the Services and all rights and privileges related to the Services granted to Customer by this license, including all Customer Confidential Information are, and shall be, for purposes of Section 365(n) of the U.S. Bankruptcy Code, a license to Customer of rights to “intellectual property” as defined by Section 101 of the Bankruptcy Code, it being understood and agreed by the Vendor and Customer that said Services and the related rights and privileges (including all Customer Confidential Information) constitute “intellectual property” for purposes of said Section 101.

In the event that a case under the United States Bankruptcy Code (11 U.S.C. § 101, et seq.), or a proceeding for either the liquidation or financial restructuring or reorganization under any other applicable law (including, but not limited to a receivership proceeding) be brought by or against Vendor and either Vendor or any fiduciary appointed in such case or proceeding with authority to do so, rejects either the entirety of this Agreement or the aforesaid license granted by Vendor to Customer, upon such rejection, Vendor shall deliver to Customer any source code pertaining or relating to the Services and all related documentation as set forth in and according to the terms of that certain Software Escrow Agreement of even date herewith between and among Vendor, Customer and the Escrow Agent identified as such in said Software Escrow Agreement.

This is the first in a series of posts focusing on maximizing protection in software licenses and SaaS agreements. Be sure to regularly check the Gibbons IP Law Alert for future posts on this topic.

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