Future Royalties and Bankruptcy: The Royalty Rollercoaster

When selling intellectual property, the common setup usually includes getting an upfront payment plus future royalty payments, which are a slice of the revenue earned from the IP. This approach can give sellers a steady income over time. However, while royalties offer ongoing revenue and a stake in the IP's success, relying only on future royalties involves risks.

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Edward L. Schnitzer

Transcript

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When selling intellectual property, the common setup usually includes getting an upfront payment plus future royalty payments, which are a slice of the revenue earned from the IP. This approach can give sellers a steady income over time.

However, while royalties offer ongoing revenue and a stake in the IP's success, relying only on future royalties involves risks. These risks become clear if the buyer runs into financial trouble or bankruptcy, which can threaten the payments and turn a secure revenue stream into an unsecured claim.

Bankruptcy can shake up contracts, so it's important to understand the difference between unsecured and secured claims. When a debtor files for bankruptcy, existing contracts, including those with future royalties, might be affected. The contract's structure could leave the seller exposed, especially if the royalties are unsecured without collateral backing. In bankruptcy, unsecured claims often take a backseat compared to secured claims, which are backed by a security interest in the debtor's assets. Creditors risk their claims being downgraded, possibly receiving just a fraction of the expected payments.

A notable example of these issues is the case between Sanofi and Mallinckrodt. Sanofi sold its rights to a drug for $100,000 plus annual royalties. When Mallinckrodt filed for bankruptcy, the court ruled against Sanofi, classifying its royalty payments as an unsecured claim. This situation highlighted the risks creditors face when counting on future royalties, as Sanofi’s anticipated income from a successful drug was greatly reduced due to the bankruptcy.

This case emphasizes the importance of structuring IP deals to protect future royalties. Without safeguards, sellers might be at a disadvantage. To mitigate risks, careful contract structuring is key. Licensing IP instead of selling it outright is one strategy; this lets the seller keep ownership while the buyer pays royalties for use, offering more protection in bankruptcy situations. Another approach is securing a security interest for future royalty streams, ensuring the seller’s claim is backed by collateral. Creating a joint venture for shared IP ownership can also help, preserving the seller's royalty rights.

For IP sellers, drafting contracts with potential bankruptcy scenarios in mind is crucial. Contracts should have provisions that protect their interests if a buyer faces financial difficulties. It's important to clearly outline royalty payment terms and secure payment mechanisms, while regularly reviewing and updating agreements to reflect current legal and financial landscapes. Consulting with legal and financial experts can help craft contracts that safeguard future royalties, providing tailored strategies for each situation.

Navigating IP transactions and future royalties demands careful planning and strategic thinking. By understanding potential risks and taking protective measures, sellers can secure their interests and ensure a stable income stream. Success depends on smart transaction structuring and seeking expert advice. Reviewing contracts and considering discussed strategies, along with consulting legal professionals, can protect IP investments. Reviewing existing agreements and consulting with experts is crucial to safeguarding future royalty interests, as the financial future depends on it.

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