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.