Canada: Technology Licences Upon Bankruptcy

Imagine that a critical part of your business is dependent on a software program that you licence from a software supplier. This scenario is not that hard to imagine, because in fact most businesses and other organizations are indeed reliant on licensed software — it is simply a fact of life in the computer age.

Now, imagine that your software supplier goes bankrupt and the trustee in bankruptcy terminates your software licence. Gulp! Can that really happen?, you ask (nervously). Well, it can, but thankfully the legislation to fix (most of) this problem should come into effect later this year. But why, you might ask, has it taken so long?

Before turning to the legal issues raised by tech licences upon bankruptcy, it is worth noting that this important issue of course does not arise, from a practical perspective, when you are dealing with most larger software companies. Not much thought has to be given to this concern when licensing software from a huge, profitable multinational software company with billions in worldwide revenues.

At the other end of the spectrum, however, are small software suppliers that have a few bright people and some (rented) desks, chairs and computer workstations. You want to do business with them because they have some great ideas and are about to release a powerful new software product. But alas, their risk profile is quite problematic from a bankruptcy perspective. It is when dealing with these sorts of companies that the following discussion is relevant.

The US Lubrizol Case

As often happens in intellectual property (IP) and technology law matters, the US addressed the issue of bankruptcy and tech licensing well before we did. Their wake-up call came in the form of the Lubrizol case, a 1985 decision in which a court concluded that a trustee in bankruptcy for a bankrupt licensor of a metal coating process could terminate all of the debtor's non-exclusive licences in order to improve the terms of sale of the technology to another company from the bankrupt licensor. The result in Lubrizol was that the licensee lost its right to work the technology.

The Lubrizol case sent shock waves through the American technology community. A cloud of uncertainty hung over software licences (as well as other technology and IP licences). Users were nervous and quickly lobbied Congress for a change in the law to fix this problem.

US Law Reform

The result in the US was the relatively swift adoption of Section 365(n) of the US bankruptcy statute. Under this section, if a bankruptcy trustee disclaims an IP licence, the user may nevertheless affirm the licence. In that case, the user can continue to use it in return for giving up the right to sue for any damages from the bankrupt estate.

Usefully, Section 365(n) makes it clear that rights that can be so affirmed include a right to enforce any exclusivity provision of such contract. As well, the affirmed right is for the duration of the contract, as well as any period for which such contract may be extended by the licensee as of right.

Canada After Lubrizol

The Lubrizol case prompted a debate in legal circles in this country as to whether a similar result could be expected here. Some commentators argued that Lubrizol was unique to the specific "executory contracts" provisions of the US bankruptcy statute. However, others warned that, conceptually, judges in Canada could come to the same conclusion if they wanted to.

Several years ago, one judge in Canada did just that and upheld the disclaimer of a trade-mark licence upon the trade-mark owner's insolvency. For all intents and purposes, this was Canada's Lubrizol, and the heat was turned up for a legislative response (just as Section 365(n) of the US bankruptcy statute fixed the US's Lubrizol problem).

Canadian Law Reform

At long last, in 2005, the government amended Canada's bankruptcy laws (essentially, the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangement Act) to expressly provide a regime for the disclaimer of agreements to which the debtor is a party. A provision was added in this regime that if the debtor has granted in any agreement the use of any IP, the disclaimer does not affect the licensee's right to use the IP so long as the licensee continues to perform its obligations in relation to the use of the IP.

This is a very useful law reform measure, though none of the revisions to the law made in 2005 ever came into force, as the government wanted to fine-tune the new provisions. In the event, a revised set of amendments was passed in December 2007 (generally known as Bill C-12).

The Current Statute

The current bankruptcy statute (which, please note, is not yet in force!) provides as follows for the disclaimer of agreements. Essentially, the bankrupt company can decide if it wishes to disclaim certain contracts. If the trustee in bankruptcy agrees with the disclaimer, then the counter-party can contest the disclaimer in court. And if the trustee does not agree with the disclaimer — typically done to enhance the prospects of a viable restructuring proposal being made in respect of the debtor — the debtor may apply to the court as well.

Additional protection, however, is extended to the counter-party if the agreement being disclaimed pertains to the licensing of IP. In that case, in language fairly reminiscent of Section 365(n) of the US bankruptcy statute, the disclaimer does not affect the party's right to use the IP. And, as with its American counterpart, the right to use includes the licensee's right to enforce an exclusive licence. As well, the duration of the use includes any period for which the licensee extends the agreement as of right.

Not Quite Perfect

The new Canadian bankruptcy law rule relating to IP licences — once it comes into force — is a very useful development (and, frankly, should have been done years ago). But it's not perfect.

For example, the section speaks only of a "right to use." There are, however, often other IP rights granted by software (and other IP) licences, such as the right to modify, copy or distribute. Will these rights withstand a contract disclaimer under the new law?

On the face of the new legislation, the answer is unclear. The rationale behind the contract disclaimer regime in the bankruptcy law is to permit debtor companies to shed uneconomic contracts that present an obstacle to a viable restructuring of the debtor. The policy decision reflected in preserving rights to use IP is presumably that a licensee's internal right to use some IP would likely not detract from the IP's value in the context of a sale of the debtor licensor.

Can the same be said for a licensee's modification or distribution rights? Reasonable arguments can be marshalled on both sides of this question, and we will have to wait for jurisprudence under the new section to clarify the question. In the meantime, if you are a distributor or reseller of some one else's IP, you might want to continue thinking about ways to protect yourself from the new bankruptcy law's contract disclaimer rules.

One such vehicle might be to take a partial ownership interest in the relevant IP. Such a co-ownership interest arguably should survive any disclaimer because the grant of the interest occurred prior to the bankruptcy filing. But again, it will likely take some jurisprudence to clarify this question.

In conclusion, the IP licensing provisions of the new bankruptcy law are helpful, but still leave some important questions unanswered.

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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