Canada: Insolvent Licensors - New Legislation May Protect Licensees

Last Updated: February 22 2006

This article was originally published in Blakes Bulletin on Intellectual Property - February 2006

Article by Linc Rogers, ©2006 Blake, Cassels & Graydon LLP

On November 25th, 2005, Bill C-55, which proposes sweeping changes to Canada’s principal insolvency statutes, received Royal Assent – the final step in the Canadian legislative process before a bill is proclaimed in force. Prior to dissolving Parliament and calling a Federal election for January 23, 2006, the Liberal Government gave assurances to the Senate Committee on Banking, Trade and Commerce, which is charged with oversight and review of Bill C-55, that it would not proclaim the Bill in force prior to June 30, 2006 (it is not known whether the new Conservative Government will honour this commitment). If enacted in its current form, the amendments will have a material impact on the rights and obligations of various participants in formal insolvency proceedings in Canada. One of the most important provisions seeks to protect the rights of a licensee of intellectual property during a court-supervised restructuring.

Currently, the general tenor of Canadian jurisprudence is that restructuring debtors have a broad power to terminate or “disclaim” contracts that are no longer economically beneficial to the debtor’s estate. In a typical example, a debtor selling goods pursuant to the terms of a long-term contract at less than current market rates may terminate the supply contract and seek to renegotiate a new agreement with its purchaser on more favourable terms. The purchaser may assert an unsecured claim for damages in the insolvency proceeding resulting from the termination of the supply agreement but generally will not be able to insist on performance of the contract.

A debtor’s ability to disclaim contracts in this manner has caused significant concern for intellectual property licensees, especially those that depend on crucial licensed intellectual property for operation of their businesses. The concern is that an insolvent licensor may disclaim the licence and seek to prohibit the licensee from continuing to use the licensed intellectual property, even if only to negotiate terms more favourable to the licensor. Although the disclaimer could potentially cause the failure of the licensee’s business, the licensee may be left with the inadequate remedy of simply being entitled to assert an unsecured claim for damages arising from the termination of the licence.

Bill C-55 contains a protection providing that, in a reorganization under the Bankruptcy & Insolvency Act or the Companies’ Creditors Arrangement Act, the disclaimer of a licence does not affect the licensee’s right to use the intellectual property licensed thereunder, so long as that licensee continues to perform its obligations in relation to the use of the intellectual property, such as the continued payment of royalties, etc.

This provision is similar to one found in the United States. To understand the Canadian provisions, it is instructive to consider the manner in which this issue has been addressed in the United States Bankruptcy Code (the U.S. Code) as the two insolvency regimes utilize a similar approach. The U.S. Code allows debtors to disclaim “executory” contracts. Executory contracts are contracts where parties on both sides of the contract have unfulfilled obligations. An ongoing supply contract, where one party has an obligation to supply and the other an obligation to purchase such supply, is a classic example of an executory contract. An example of a non-executory contract is a term loan where the entirety of the loan has been advanced and the only remaining obligation is the obligation of the debtor to repay the loan.

The protection in the U.S. Code for intellectual property licences is in the form of an exception to the general right to disclaim executory contracts.

Bill C-55 also protects licensees by providing an exception to a general right to disclaim contracts, but, does not use the term executory. The drafters were concerned about litigation in the U.S. about what constituted an executory contract and the resulting uncertainty. The drafters wanted to avoid similar uncertainty in Canada. Accordingly, Bill C-55 provides a general right to a debtor to disclaim “agreements” subject to a number of exceptions including intellectual property licences.

Another distinction between the two regimes is that the U.S. Code provision does not incorporate licences of trade-marks in the protection granted to licensees from the disclaimer of contracts. The proposed Canadian counterpart, on the other hand, does not distinguish between categories of licensed intellectual property and would include trade-marks.

Also of note, Bill C-55 does not include express language found in the U.S. Code that confirms that a licensee may enforce exclusivity rights, notwithstanding any disclaimer by the debtor. Therefore, the window is open for a restructuring Canadian debtor to argue that although it cannot prevent a licensee from continuing to use the licensed intellectual property, the debtor is free to ignore any contractual exclusivity and licence the intellectual property to a third party. Any resulting damage to the licensee, the debtor would argue, should simply be an unsecured claim against the estate.

Given this seeming omission in Bill C-55, licensees may wish to draft licence agreements containing an express provision which provides not only that the parties intend that the licensed intellectual property be subject to the protections set out in Bill C-55, but also that the parties intend such protection to extend to any exclusivity provision contained in the agreement. It should also be made clear that the parties intend any such protection to extend to any ancillary agreements such as source code escrow agreements. In light of Bill C-55, careful consideration should also be paid to the wording of default provisions upon the occurrence of an “Insolvency Event” in connection with the licensor and the remedies available to the licensee upon such occurrence.

Although not perfect, the inclusion of protection for licensees in Bill C-55 is an appropriate acknowledgement of the true value of licensed intellectual property in today’s marketplace. Hopefully, Canadian courts will interpret this protection and the licence agreements which are subject to it, in a manner that is consistent with this commercial reality.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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