Intellectual property rights are critical to various economic sectors. Many companies depend on licensed technology to operate and survive. The licensor-licensee relationship may deteriorate, especially if the licensor starts showing signs of distress or, even worse, becomes insolvent. Canadian legislation offers some clarity regarding each of the parties' rights and obligations in the event of a licensee's insolvency or bankruptcy. However, there is a significant degree of uncertainty with respect to what may happen to an intellectual property license in the event of a licensor's insolvency.

There are four main avenues for a company facing insolvency: (i) assignment into bankruptcy; (ii) a proposal under the Bankruptcy and Insolvency Act;¹ (iii) proceedings under the Companies’ Creditors Arrangement Act;² and (iv) private or court-ordered receivership. This article will focus on proposals under the BIA and proceedings taken under the CCAA which entail reorganization rather than liquidation. The proposal provisions in the BIA and the provisions of the CCAA dealing with the termination or disclaimer of contracts offer insolvent licensees some reprieve.

Insolvency of the Licensor

The Canadian Position

Historically, due to the previous absence of any statutory authority,³ Canadian jurisprudence generally held that trustees in bankruptcy, receivers, and debtor companies undergoing reorganization had the power to disclaim executory contracts⁴ that had been entered into prior to the debtor’s insolvency.⁵ The existing Canadian jurisprudence is unclear as to whether a license for intellectual property can be characterized as an executory contract.

Depending on the circumstances, it might be advantageous to an insolvent licensor to disclaim its technology licenses so that it can: (i) terminate its obligations to take certain required steps under the license; (ii) attempt to re-license its technology at a higher rate to either the licensee or a third party; or (iii) sell the intellectual property outright, free and clear of any licenses or encumbrances, for a higher price than if it were encumbered. If the license is disclaimed, the licensee is precluded from continuing to use the licensed intellectual property,⁶ and merely has an unsecured claim for contractual damages against the insolvent licensor, which claim, if successful, would be paid from the remaining property of the insolvent licensor, if any.⁷

Canadian courts in various jurisdictions, and in different insolvency contexts, have attempted to resolve this issue, with differing results. In Re Erin Features No. 1 Ltd.,⁸ the British Columbia Supreme Court held that an agreement made by Erin Features, which was in bankruptcy, granting exclusive marketing rights in Canada to Modern Cinema could not be characterized as an executory contract because the film company had "… alienated its property in the film for the purpose of distribution in Canada"⁹ through a valid conveyance. The Trustee in bankruptcy was not permitted to disclaim the agreement, as it had no better right to the property than the bankrupt and could not terminate property rights that were passed to a third party prior to the bankruptcy.

Conversely, in T. Eaton Co., Re,¹⁰ a proceeding pursuant to the CCAA, the T. Eaton Company repudiated a Card License and Services Agreement as well as a Trademark License Agreement, which collectively allowed National Retail Credit Services Company to act as T. Eaton Company's private label credit card provider. The Ontario Superior Court of Justice held that the exclusive license granted to National Retail Credit Services Company did not have the effect of transferring any proprietary interest to the licensee, and could thus be repudiated pursuant to the Eaton's plan of arrangement.

In addition to the risk of having its license agreement disclaimed under the existing jurisprudence, a licensee dealing with an insolvent licensor also faces the risk that the underlying intellectual property license is sold to a third party. For example, in Royal Bank of Canada v. Body Blue Inc.,¹¹ which involved a receivership, the licensee, Herbal Care, argued that its right to manufacture and sell the licensed technology was not affected by an order vesting all right, title and interest of the licensor’s assets, including the technology, to a third party. The Ontario Superior Court of Justice found that the license agreement did not constitute a property claim and concluded that the process by which the assets of the licensor were transferred was conducted in accordance with applicable law and the court orders made in the proceeding. The Court held that the licensee had an exclusive license to use the technology, but that even an established license agreement only creates a contractual agreement between the parties, not a property claim. The third party obtained the technology free and clear of Herbal Care's license and all Herbal Care was left with was an action in contract against the insolvent licensor.

Legislative Amendments

In recent years, Parliament has amended both the BIA and the CCAA. These amendments create more certainty in relation to the treatment of licenses of technology in bankruptcy proposals and restructuring under the CCAA. Both the BIA and the CCAA¹² enable an insolvent licensor to "disclaim or resiliate" any agreement to which it is a party upon the commencement of proposal proceedings under the BIA or a restructuring under the CCAA, except where the licensee continues to perform its obligations under the applicable agreement, in which case it will have the right to continue using the licensed technology, and to enforce an exclusive use.¹³

To date, such provisions have not been judicially considered and the ambiguity in the scope of protection afforded by these sections has not been clarified. Neither the BIA nor CCAA define the terms "intellectual property" or "use". Also, it is unclear whether ancillary obligations surrounding the license, such as maintaining trademarks and other intellectual property, enforcement, updates, and technology support can be disclaimed or are included in the term "intellectual property" for the purposes of these provisions. Whether a licensee's right to use the intellectual property includes other distinct rights recognized under applicable intellectual property law, such as the right to make and sell under a licensed patent, also remains unclear.

The aforementioned legislative amendments have partially aligned Canadian bankruptcy and insolvency law with the legal framework adopted in the U.S., as discussed below.

The American Position

Subsection 365(a) of the U.S. Bankruptcy Code¹⁴ permits a trustee who is vested with the property of the bankrupt licensor to reject "executory contracts" (i.e., contracts that contain ongoing obligations of the licensor). As the Code is silent with respect to how executory contracts should be defined, it has been left up to the courts to define this term, and consequently, the scope of subsection 365(a).

In applying subsection 365(a) of the Code, the United States Court of Appeals, Fourth Circuit, held in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc.¹⁵ that a contract is executory if the "… obligations of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete the performance would constitute a material breach excusing the performance of the other".¹⁶ The Court held that the licensing agreement in this case was executory because the licensor continued to owe the licensee, among other things, core obligations of forbearance and notice and the licensee owed the licensor a continued duty to account for and pay royalties for the duration of the agreement. Accordingly, the trustee for the bankrupt licensor was able to disclaim all of the debtor’s non-exclusive licenses in order to improve the terms of sale of the technology to another company from the bankrupt licensor. In effect, the licensee lost the right to continue to use the licensed technology.

In response to this decision, Congress passed the Intellectual Property Bankruptcy Act,¹⁷ which amended the Code by adding subsection 365(n), which provides, in part, that if a trustee (or a chapter 11 debtor in possession) disclaims an intellectual property license, the licensee may elect to either treat the license as terminated,¹⁸ or retain its rights, including a right to enforce an exclusivity provision, for the duration of the agreement¹⁹ such right is subject to the licensee’s obligation to make all payments due under the license.²⁰

Key Differences Between the Canadian and U.S. Approach

The BIA and the CCAA²¹ address the same problems highlighted in Lubrizol. One of the key distinctions between the U.S. and Canadian legislation relates to the wording of the exclusions in respect of licenses: the U.S. approach saves the entirety of the license agreement granting the licensee the option of retaining all of its rights under the license, or "under any agreement supplementary" to the license, for the duration of the license or any period for which the license can be extended. By contrast, the BIA and CCAA do not prohibit the disclaimer or termination of an intellectual property license; rather they make such a disclaimer or termination ineffective with respect to a party's right to use intellectual property,²² as long as the licensee continues to abide by its contractual obligations in relation to such use.

Another significant difference between the Canadian and U.S. approaches is the treatment of the term "intellectual property". This term has been defined in the Code to include, among other things, trade secrets, patents, and copyrighted matter.²³ Trademarks, however, are not included. Unlike the Code, "intellectual property" has not been defined in the BIA or the CCAA, which may result in the protections extending to all forms of registerable intellectual property, including trademarks. This issue has yet to be considered by a court.

Conclusion

Given the unclear position that licensees of intellectual property are in as a result of the current state of the law, a licensee should consider what steps can be taken in advance to mitigate the risks arising from a licensor's insolvency.

Options may include seeking to include language in the license agreement characterizing the license as a non-executory contract, or requiring that any sale of the intellectual property by the licensor be subject to the licensee's consent or its right of first refusal. In addition, a licensee should try to obtain a proprietary interest in the underlying intellectual property rights because a trustee cannot disclaim property rights that are transferred prior to insolvency.

Licensees have good reason to be concerned about the potential loss of their license rights in the event of bankruptcy or receivership of the licensor. Prior to entering into a license arrangement, licensees should consider the risk profile of licensors with whom they contract, and consult with counsel as to the licensee’s options in the event of insolvency.

Notes

1. R.S.C. 1985, c. B-3 [hereinafter BIA].
2. R.S.C. 1985, c. 36 [hereinafter CCAA].
3. Save for provisions dealing with commercial leases at s. 65.2, the BIA had been silent with respect to whether any other type of agreement can be disclaimed.
4. In Canada, a contract has generally been held to be executory if any of the parties have yet to satisfy their obligations thereunder (Kary Investment Corporation v. Tremblay, 2005 ABCA 273).
5. See, for example: New Skeena Forest Products Inc., v. Don Hull & Sons Contracting Ltd., 2005 BCCA 154, and the cases cited therein; and Re Blue Range Resource Corp., (1999), [2000] 245 A.R. 172, 72 Alta. L.R. (3d) 196 (Alta. Q.B.); reversed on other grounds at [2001] 2 W.W.R. 454, 87 Alta. L.R. (3d) 329 (Alta. C.A.). Some courts, however, have stated that the power of trustees to disclaim agreements is tenuous. In Re Erin Features No. 1 Ltd., 8 C.B.R. (3d) 205 (B.C.S.C.), for example, Donald J. held at para. 4 that "… the power to disclaim was weakly supported in argument by dicta in Canadian authority". See also Triangle Lumber & Supply Co., Re, 21 O.R. (2d) 221, 90 D.L.R. (3d) 152 (Ont. Sup. Ct.).
6. It should be noted that Professor Roderick J. Woods holds the view that a disclaimed license agreement does not necessarily equate to the termination of a license agreement; rather, a disclaimer simply enables a licensee to elect to treat the license agreement as terminated or continue with its future performance under the agreement, and thus continue using the licensed intellectual property (R. J. Woods, Bankruptcy and Insolvency Law (Toronto: Irwin Law, 2008) at 162).
7. T. Eaton Co., Re, 14 C.B.R. (4th) 288, [1999] O.J. No. 4216 (Ont.S.C.).
8. 8 C.B.R. (3d) 205 (B.C.S.C.) [hereinafter Erin Features].
9. Ibid. at para. 2.
10. Supra note 10 [hereinafter T. Eaton].
11. [2008] O.J. No. 1628 (Ont. Sup.Ct.) [hereinafter Body Blue].
12. Section 65.11 of the BIA and section 32 of the CCAA.
13. Subsection 65.11(7) of the BIA and subsection 32(6) of the CCAA.
14. Bankruptcy Code, 11 U.S.C. [hereinafter Code].
15. 756 F.2d 1043 (4th Cir. 1985) [hereinafter Lubrizol] at 1045.
16. It should be noted that this definition is narrower than the one generally adopted by Canadian jurisprudence. Accordingly, both material as well as non-material obligations would, in theory at least, be captured by the Canadian definition of "executory contract".
17. Pub. L. No. 100-506 [the "IPBA"].
18. s. 365(n)(1)(a) of the Code, supra.
19. Ibid. at s. 365(n)(1)(b).
20. Ibid. at s. 365(n)(2).
21. Supra 12
22. Subsection 65.11(7) of the BIA and subsection 32(6) of the CCAA.
23. Ibid. at s. 101(35A).