The general principle is that security granted on tangible property also charges the property’s accessories. That is not the case however when intellectual property (“IP”) rights belonging to a third party attach to inventory1. For such rights are not considered to be accessories and thus are not charged by the security, unless the holder of the IP rights has otherwise agreed. 

If the grantor of the security goes bankrupt, enforcement of the creditor’s security could thus be compromised because of the third-party IP rights.  

Patents 

Close attention must be paid to the contract between the grantor of the security and the holder of the IP rights, as it may contain significant restrictions on assignability and the enforceability of security on patented merchandise and equipment. The enforcement of a hypothec on patented merchandise could be compromised or contested, notwithstanding the provisions of the Bankruptcy and Insolvency Act

If the grantor goes bankrupt, such contractual restrictions can be set up against the trustee-in-bankruptcy by the manufacturer or vendor by notifying the trustee in writing of its rights before the property is sold by the trustee. Once on notice, the trustee is obliged to acquire the property at its depreciated invoice price. 

Copyright  

A hypothecary creditor who enforces its security on merchandise to which copyright applies does not have to pay royalties to the copyright holder2

However, in a bankruptcy situation, section 83 of the Bankruptcy and Insolvency Act provides that in the case of works of literature, they must either be returned to the author, or royalties must be paid to the latter, depending on whether or not copies of the work have been published and put on the market at the time of the bankruptcy. 

Trademarks and licences 

When inventory is covered by a licence to use, the licencee may be denied the right to grant security in that inventory. Licence agreements often contain a non-assignability clause that prohibits the granting of security in the licensed property. 

Even where the licence does not prohibit the granting of security in the property, it will still be necessary to review the licensing agreement carefully to see whether there are any conditions that apply to how the property can be marketed. 

The Bankruptcy and Insolvency Act surprisingly does not deal with the enforcement of security on trademarked property. Courts must therefore take into account any contractual provisions binding the owner of the property and the holder of the trademark. 

In the matter of Scanwood Canada Ltd. (Re)3, a bankrupt furniture manufacturer had entered into a contract with IKEA which provided that once manufactured, the furniture could only be sold to IKEA or one of its authorized distributors. IKEA had no obligation to purchase the furniture in the event of the manufacturer’s bankruptcy however, and in this particular case it refused to do so. The receiver accordingly asked the Court for permission to sell the property for the benefit of the creditors. The Court refused (albeit reluctantly) and ordered the property destroyed! The Court pointed out that it could not supersede the contract between the debtor and IKEA. 

In the absence of clear contractual provisions, however, courts tend to favour the interests of creditors generally. For example, in the matter of 185107 Canada Inc. (Groupe de compagnies Bennett Little ltée–Bennett Little Group of Companies) (Trustee of)4, the Superior Court of Quebec authorized the sale of a bankrupt’s inventory distributed under the trademark of a third party. A bank with security in the inventory applied for and obtained the appointment of a receiver. The licensor then sent a notice of cancellation of the licence with both immediate and retroactive effect. By then the receiver had found a purchaser for the disputed inventory. 

The receiver then applied to the Court for authorization to sell the inventory. The Court acquiesced, citing the absence of any provisions in the licensing agreement regarding the disposition of the trademarked inventory in the event of cancellation of the licence. 

It is thus evident that before taking security in inventory, it is important to check whether there are any rights attaching to the merchandise that may compromise the creditor’s rights in the event of enforcement and/or the cancellation of an IP licence.