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The Insolvent Licensor – New Canadian Laws Provide Some Protection For Licensees of Intellectual Property

Published: 10/28/2009

By Deborah S. Grieve, Bernice Karn

When an IP licensor goes bankrupt or obtains creditor protection in order to restructure, what happens to the rights of its licensees? Can the licenses be disclaimed, effectively terminating the licensees’ rights? Can a secured creditor of the insolvent licensor sell the license free and clear of the obligations to the licensee?

Until the recently-proclaimed amendments to the Bankruptcy and Insolvency Act ("BIA")and the Companies’ Creditors Arrangement Act ("CCAA"), there had been no clear answers to those questions. Just concerned licensees – and with good reason.

The critical issue is whether a license is merely a contract to use property (which can be terminated in a bankruptcy) or whether it conveys an interest in property (in which case the license cannot be terminated). 

Some Canadian courts have ruled that an IP licence is merely a contractual right to use the IP without interference from the licensor.  In the CCAA proceedings involving the Eaton’s department stores in 1999, the Ontario Superior Court allowed Eaton’s to repudiate an exclusive license to use its trade mark on the basis that the license did not confer a property interest on the licensee.  In the recent Body Blue case, the Ontario Court also upheld the right of a court-appointed receiver to sell IP, under an approval and vesting order, free and clear of exclusive licensing rights that the debtor had granted, leaving the licensee with only a claim for damages against the proceeds of sale.   

On the other hand, a British Columbia court has held that where a bankrupt had granted exclusive marketing rights to a film, the rights granted were property rights and accordingly the trustee was not able to disclaim, or terminate, those rights as they had already been disposed of prior to the bankruptcy.

In the United States, executory contracts such as licenses can be rejected under the United States Bankruptcy Code. However, as a result of a controversial 1985 Lubrizol decision, where a debtor was allowed to reject an IP license despite devastating consequences to the licensee, a provision was added to the Code in order to protect IP licensees. Section 365(n)(1) of the US Bankruptcy Code now provides licensees with the option to retain their rights under the license, provided that they continue to pay royalties, although they do lose the right of set-off. The amendments to Canadian insolvency legislation that came into force in September, 2009 bring the Canadian law closer to the US approach.

The new Canadian provisions now provide rules for the disclaimer or assignment of contracts. The rights of a party to use IP, including the right to enforce exclusive use, are not affected by the disclaimer of a license - CCAA section 32(6) and BIA s.65.11(7).  Section 32(6) of the CCAA provides:

32(6) If the company has granted a right to use intellectual property to a party to an agreement, the disclaimer or resiliation does not affect the party’s right to use the intellectual property — including the party’s right to enforce an exclusive use — during the term of the agreement, including any period for which the party extends the agreement as of right, as long as the party continues to perform its obligations under the agreement in relation to the use of the intellectual property.

Although these amendments are a welcome improvement, they fall short of providing a complete security blanket for licensees.  Unlike the US situation, trade mark licenses are not excluded from the new provisions. The amendments also leave a number of issues unclear: What happens to the other rights of a patent licensee, such as the right to manufacture or to market certain products using the IP? What about rights to modifications or upgrades to the IP, and to the product derived from the use of the IP? Where payment for the license is bundled with ongoing support payments, as is frequently the case for software licenses, will the licensee be forced to pay for support or other services that it will not receive, just to preserve its rights to use the IP? 

These are just some of the questions that remain unanswered for licensees, despite the improved protection of the new amendments. We expect that interpretive litigation on the new amendments will not be long in coming.