Amendments to the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) have recently come into force that purportedly protect licensees of intellectual property (IP) if their licensors become insolvent or bankrupt. There are, however, a number of uncertainties surrounding the scope of protection afforded by these amendments. Until these uncertainties are resolved, licensees may wish to consider augmenting their statutory rights by contractual and other legal mechanisms. A Bankruptcy Remote Entity (BRE) is one potential mechanism.
In the life sciences industry, a licensee's rights upon bankruptcy or insolvency of a licensor are particularly important for two reasons: (i) licensing has long been prevalent as a development and commercialization strategy in the life sciences industry; and (ii) pharma and big biotech are increasingly looking to biotech companies for new drugs and technology at a time when biotech companies are experiencing a restricted access to capital markets that may lead to heightened concern over their long-term viability.
BIA and CCAA Amendments
The recent BIA and CCAA amendments seek to answer the following question: if a company becomes insolvent, what happens to the licences it has granted to its technology? Historically, licensees whose Canadian licensors became insolvent or bankrupt were vulnerable under the BIA, CCAA and relevant case law to two risks: (i) their licence may be disclaimed, regardless of the terms in the licence; or (ii) the IP assets of a licensor may be sold under a vesting order by the court, effectively making the licence rights held by the licensee meaningless since the licensor no longer holds the IP. Under either scenario, the licensee is left with an unsecured or compromised damages claim against the licensor.
The BIA and CCAA amendments seek to provide greater security to IP licensees. The amendments provide for an express ability of debtor licensors to disclaim contracts, including IP licences, if those contracts are not economically beneficial or could impede the debtor's ability to restructure. However, an IP licensee whose licence is disclaimed has the option of maintaining the right to "use" the IP for the term of the licence agreement, including any extensions and including on an exclusive basis, if the original licence is exclusive ─ subject to the licensee continuing to perform its obligations in relation to "use" of the IP. If the licensee chooses to accept the disclaimer, it would lose the licence and have a provable claim for losses against the licensor.
Uncertainty over the Scope of Protection to Licensees under the BIA and CCAA Amendments
While the BIA and CCAA amendments purport to protect licensees if their licensors become insolvent or bankrupt, there are a number of uncertainties or unanswered questions around the scope of the protection:
- The amendments protect a licensee's right to "use" the licensed IP. Are other commonly licensed rights, such as the right to develop, enhance, commercialize or distribute the IP, also protected ─ or could those other types of rights still be disclaimed? If these other types of rights can be disclaimed, does this mean that the licensee would be relieved from its obligations related to the disclaimed rights, such as an obligation to develop the licensed IP and make milestone payments based upon achieving development milestones?
- The amendments do not expressly address whether other continuing obligations on the licensor (e.g., indemnification, technical assistance, new developments) continue, or whether the licensor is relieved from these continuing obligations.
- The amendments do not expressly exclude or otherwise protect IP licences from the sale of the IP assets to a third party under a vesting order. Can a court still sell the underlying IP to a third party under a vesting order free and clear of the licensee's protected licence? This possibility may seem remote given the intent of the BIA and CCAA amendments to protect licensees. However, since those amendments do not foreclose this possibility, the question can still be asked until the courts have had the opportunity to consider the issue.
BRE — Rationale
Given these uncertainties and potential gaps concerning the protection offered by the BIA and CCAA amendments, licensees may still wish to consider contractual and other legal mechanisms to better protect themselves. One such mechanism is the BRE, which originated in the US to provide additional protection to a licensee over and above the protected statutory licence that is available under s. 365(n) of the United States Bankruptcy Code.
Section 365(n) of the United States Bankruptcy Code has offered licensees in the US statutory protection to their licences since the provision was passed in 1988. The protection is very similar to that contained in the Canadian BIA and CCAA amendments discussed above. Under s. 365(n) of the United States Bankruptcy Code, a licensee whose licence is rejected due to the insolvency of its licensor has the right to retain its licence rights as they existed at the time of the commencement of the insolvency proceedings, including the right to enforce any exclusivity, subject to a continued obligation to perform the licensee's obligations (e.g., make royalty payments), but without the right to compel the trustee in bankruptcy to perform the licensor's other, non-licence obligations under the licence. Alternatively, under the US statute, if the licence is rejected, the licensee may opt to treat the licence as terminated and make a claim against the insolvent licensor's estate for losses caused by loss of the licence.
Why did the BRE mechanism develop in the US, even though licensees have the protection of s. 365(n) of the United States Bankruptcy Code? The reason is primarily that the US statute on its face only protects licences to US patents and copyrights, and therefore arguably does not protect non-US patent and copyright licences, and does not protect trade-mark licences at all. In situations where these unprotected licence rights are particularly important, the BRE can be used to reduce the risks that these licence rights be rejected on an insolvency.
A similar analysis is possible for licensees of Canadian licensors with regard to the BIA and CCAA amendments: for example, a licensee who is concerned that the protected right to "use" the IP is not broad enough for the licensee's business, or who is concerned that an insolvent licensor may still attempt to obtain a vesting order to sell the licensed IP to a third party free of the licensee's licence, may wish to consider private means of providing stronger protection to its licence, such as a BRE.
BRE — Structuring
The BRE is a subsidiary formed to own and then license the IP to the licensee. The BRE protects the licensee since the BRE is structured to minimize the risks that the BRE can go insolvent, and therefore it also minimizes the risk that the licence could be disclaimed. It does this as follows:
- The licensee is granted at least one share in the BRE, and the BRE's corporate articles are drafted to provide that no voluntary bankruptcy, sale of the IP, or change of control can occur without the vote of the licensee's share.
- Restrictions are placed on the BRE incurring liabilities (e.g., the BRE is prohibited against carrying on material business activities, other than licensing IP).
- In order to shelter the BRE from any insolvency of the parent, the BRE is set up and operated to have its own offices, management, corporate records, books of account, assets, facilities, and business separate from those of the parent, and to conduct business in its own name and not that of the parent, so that the BRE is not an "alter ego" of the parent.
- The licence to the licensee is structured as a "bare" licence, i.e., one without warranties, indemnities or obligations. These are instead placed in a separate contract between the licensee and the parent. The BRE then grants a licence back to the parent of any rights the parent requires in order to fulfill the warranties, indemnities or obligations, and also for any rights to the IP that are not licensed by the BRE to the licensee.
The BRE structure minimizes the risk of insolvency of the IP licensor, and therefore, of the licensee's licence being disclaimed. However, since it is not possible for the BRE to operate without assuming any debts or liabilities, the risk of its insolvency is not completely removed. The BRE structure requires careful planning and initial and ongoing transaction costs and efforts. Since the IP is transferred from the parent to the BRE, tax considerations will also apply to ensure that the transfer is done on a tax-free or tax-deferred basis. For these and other reasons, the BRE structure will not be viable for all transactions. Indeed, the structure (which originated in the US) is relatively unknown in licensing transactions in Canada.
Canada has at long last legislated to provide protection to licensees whose licensors become bankrupt or insolvent. Recent amendments to the BIA and CCAA provide licensees whose licences are disclaimed in an insolvency or bankruptcy of the licensor with the right to elect to continue to "use" the licensed IP. Whether BREs will come to be used in Canada as a means of augmenting this statutorily protected licence right remains to be seen.
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.