The recent economic turmoil has brought to the forefront concerns by licensees as to what happens to their rights to licensed intellectual property upon the bankruptcy of a licensor. Unfortunately, under Canadian law, the answer to that question is not clear.
Background
In Canada, it is generally accepted that a bankruptcy trustee
has the right to disclaim certain types of contracts, in order to
promote a viable restructuring of a bankrupt business. However, it
is not clear whether an IP license agreement can be disclaimed as
an executory contract (which are contracts with ongoing obligations
on both sides) by a bankrupt licensor's trustee in
bankruptcy.
The issue has been highlighted, but not decided, in several
Canadian cases. For example, in the 2001 British Columbia Supreme
Court case In Re Erin Features No. 1 Ltd., the Court noted
that Canada's Bankruptcy and Insolvency Act "is
silent on the point and the matter fraught with difficulty."
As the case was decided on other grounds, the determination of the
issue was left for another day.
The issue arose again in 2004 in the Ontario case Osiris Inc.
v. 1444707 Ontario Ltd. In that case, trade-mark licenses had
been granted pursuant to franchise agreements between the owner of
the marks, Telemark Inc., and its franchisees. The relationship
between Telemark and its licensees broke down, and eventually the
licensees obtained an injunction preventing Telemark from
interfering with their rights under the franchise agreements and
enforcing their right to use the licensed trade-marks. Shortly
thereafter, Telemark made an assignment in bankruptcy, and the
trustee in bankruptcy, though it continued operating Telemark's
business, purported to disclaim the franchise and license
agreements. However, the licensees refused to stop using the
trade-marks, claiming that the trustee was bound by the injunction
allowing them to continue using the marks. Subsequently, the
trustee sold Telemark's assets to Osiris Inc., but as a result
of an objection by the licensees, the trustee was forced to delete
the condition that the purchase would be free of all liabilities.
Osiris, as the new owner of the trade-marks, began an action for
trade-mark infringement against the licensees, and brought a motion
for an interlocutory injunction restraining them from using the
trade-marks.
In dismissing the motion, Sachs J. decided that there was a serious
question as to whether the trustee had effectively terminated the
franchise and license agreements. Sachs J. observed that if the
trustee were held to have stepped into Telemark's shoes, the
purported disclaimer of the franchise and license agreements would
appear to have been in violation of Telemark's legal
obligations, and thus could not be effective in terminating the
agreements. Furthermore, if the agreements were not properly
terminated, there was a serious issue as to whether the rights of
the licensees constituted an obligation or a liability attaching to
the trade-marks that Osiris had purchased. Although the Osiris case
remained open until at least 2006, no final decision was rendered
that resolved these issues.
The active involvement of licensees in a licensor bankruptcy
appears to be necessary to try to avoid an outcome similar to that
in a 2008 decision in Ontario, Royal Bank v. Body Blue
Inc. In that case, an insolvent patent owner's assets were
transferred to Body Blue 2006 Inc. by means of an Approval and
Vesting Order issued by the Ontario Court. The bankrupt had
previously granted another entity, Herbal Care, a license to use
its patented technology, and that license was never formally
disclaimed by the receiver. However, the Approval and Vesting Order
stated that the technology was transferred "free and clear of
and from any claims and liens." Herbal Care asked the Ontario
court to rule on the issue of whether Body Blue 2006 could have
acquired the technology free from the license granted to it by the
previous owner.
The Ontario Superior Court of Justice held that the Approval and
Vesting Order had the effect of ending Herbal Care's rights to
use the technology, and that Herbal Care's only remedy lay in a
claim against the proceeds derived from the transfer. In making
that decision, the Court criticized Herbal Care's failure to
appeal the Approval and Vesting Order. Such criticism appears to
leave open the possibility that the licensee could have preserved
its rights by appealing the Approval and Vesting Order or seeking
to vary it to acknowledge Herbal Care's license.
When a Canadian court does finally decide this matter, however, it
will likely look to both the United States and the United Kingdom,
where bankruptcy trustees do have the right to disclaim. In the
United States, a 1985 decision of the U.S. Fourth Circuit Court of
Appeal in Lubrizol Enterprises Inc. v. Richmond Metal Fisheries
Inc., held that the trustee in the bankruptcy of the licensor
could terminate all of the non-exclusive licenses for a metal
coating process, in order to increase the value of the sale of the
technology to another company.
The decision was criticized for the commercial uncertainty it
created, and the U.S. Bankruptcy Code was amended
relatively quickly thereafter to create a special exception for
intellectual property contracts. Section 365(n) of the U.S.
Bankruptcy Code provides that if a trustee in bankruptcy
rejects an intellectual property license, the licensee has the
option of retaining its rights under the license as they existed
prior to the bankruptcy for the rest of the term of the license, as
well as for any periods for which the licensee had the right to
extend the license. However, the definition of "intellectual
property" in the Code excludes trade-marks, leaving a
large number of IP licenses unprotected by this provision. The
protection is not absolute: the licensee may retain any right to
exclusivity in its license, but does not have the ability to obtain
specific performance of this right if it is later breached; and the
licensee must continue paying royalties under the license, but
without any right of setoff to which it may previously have been
entitled. Finally, the section limits the licensee's rights to
those that existed at the time of the bankruptcy; therefore, the
licensee would not have a right to any upgrades or creations made
after the bankruptcy filing.
The vulnerable situation of a licensee of IP owned by a bankrupt
licensor under Canadian law could be somewhat ameliorated if
amendments to Canada's Bankruptcy and Insolvency Act
were brought into force. These amendments, enacted in 2005 and in
2007, are supposed to come into force following the completion of a
study by the Senate's Banking, Trade and Commerce Committee,
but it is not known when this is likely to occur. It does not
appear imminent.
The amendments to Canada's BIA would clarify that a
receiver or trustee in bankruptcy has the right to disclaim
agreements, but would create an exception to allow a licensee to
continue using any licensed IP as long as it continued to fulfill
its own obligations under the license. The term "intellectual
property" is not defined in the amendments to the
BIA, but would likely be understood to include at least
the traditional types of registrable IP, such as copyright,
patents, trade-marks and industrial designs. The inclusion of
trade-marks is notable, because trade-marks are not covered by the
equivalent provision in the United States. Another notable
difference from the U.S. law is that the Canadian legislation would
not deprive a licensee of the right to seek the remedy of specific
performance (rather than a claim for damages for breach of
contract) to enforce any exclusivity granted in the license.
Potential solutions
One possible strategy to minimize risks arising from the
bankruptcy of a licensor is to attempt to obtain a proprietary
right in the licensed IP. It is generally accepted that a trustee
can only succeed to the rights of a bankrupt and has no higher or
greater interest. Therefore, a trustee cannot terminate property
rights that have passed prior to the bankruptcy. Thus, in a
bankruptcy context, the characterization of a licensee's rights
as proprietary could ensure the survival of those rights beyond the
bankruptcy of the licensor. For example, in Erin Features,
the grant of distribution rights to a film, which occurred prior to
the film's completion, was held to be a "sale" of
those rights, and could not be reversed after the bankruptcy
"simply because there is an element of the contract of sale
which remains to be carried into operation."
It appears to be well established, for both trade-marks and
patents, that a mere license to use such intellectual property does
not give the licensee a proprietary interest. However, exclusive
licensees of copyright may be in a slightly better position,
following the Supreme Court of Canada (SCC)'s 2007 decision in
Euro-Excellence Inc. v. Kraft Canada Inc. One of the
central issues raised in that case was the nature of rights granted
to and held by an exclusive licensee under the Copyright
Act. The court was tightly split on this issue, but a small
majority of the SCC accepted that an exclusive copyright license is
the grant of a proprietary interest in the copyright itself. (For
an extensive analysis of the case, please see the
September 2007 edition of Stikeman Elliott's
Intellectual Property Update.)
Options for obtaining a proprietary interest can involve complex legal considerations, and are likely to be unacceptable to the vast majority of licensors. In appropriate situations, however, such a response may be appropriate to eliminate the risks implicit in a licensor's bankruptcy.
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.