License Rights – The case of the broke licensor

October, 2008

It has become commonplace that more and more clients of legal services require intellectual property licences.  As the services industry continues to grow, the astute management of intellectual property rights remains an important ingredient in the greater success of individuals and businesses.

However, it has been the law that the rights of a licensee of intellectual property were greatly prejudiced at the intersection between intellectual property rights and bankruptcy and insolvency law.  Generally, it is the goal of bankruptcy and insolvency law to wipe clean the slate of a debtor, which may involve the compensation of creditors and a resuscitated debtor.  In that respect, it may make sense to remove the debtor from a distribution agreement which requires the debtor to purchase a certain amount of goods over time, especially where the debtor has no prospect to further re-sell such goods.

Yet, a license agreement concerning intellectual property is wholly different from a distribution agreement.  Generally, the debtor has not agreed to actively do anything; rather the debtor/licensor has simply given a licensee permission to do something.  Such grant may require the debtor/licensor to do no more than collect royalty payments.  In acknowledgement of the various problems which arise for a licensee, where a debtor/licensor is able to repudiate a license agreement in bankruptcy and insolvency law (in some cases simply to increase the amount of the license fee), e.g. uncertainty about whether the same or similar subject material may be licensable and the possibility of the debtor/licensor licensing the subject intellectual property to a competitor of the licensee, the federal legislature has made changes to the bankruptcy and insolvency legislation.

Amendments to the Bankruptcy and Insolvency Legislation

In December 2007, the House of Commons passed Bill C-12 entitled An Act to amend the Bankruptcy and Insolvency Act, the Companies’ Creditors Arrangement Act, the Wage Earner Protection Program Act and chapter 47 of the Statutes of Canada, 2005.

We are interested in the newly introduced section 65.11 of the BIA and section 32 of the CCAA.[1]  Generally, Bill C-12 states that a debtor, in respect of whom a notice of intention or proposal is filed in the case of the BIA, or, on notice given in the prescribed form and manner in the case of the CCAA, may disclaim or resiliate any agreement to which the debtor is a party on the day on which the notice of intention or proposal is filed or proceedings are commenced under the CCAA, as the case may be.

Moreover, Bill C-12 also provides that if a debtor has granted a right to use intellectual property to a party under an agreement, then the disclaimer or resiliation does not affect such 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 during any renewal periods, so long as the party remains in compliance with the agreement.  It is also important to note that the debtor appears to be free to disclaim its obligations not related to the licensee’s use of the intellectual property, i.e. ongoing technical support.  As “intellectual property” is not defined in either the BIA or the CCAA, it may be broadly interpreted.

These changes have generally been welcomed, nonetheless deficiencies remain.  Bill C-12 does not address whether the intellectual property of a debtor, over which a trustee in bankruptcy or a receiver has been appointed, may be sold to a third party free and clear of all encumbrances.  It would require the involvement of the courts to rule about whether a receiver or trustee in bankruptcy may disclaim or terminate a license agreement.

Direction from the Courts: Body Blue

The Ontario Superior Court of Justice has provided some guidance, where the bankruptcy and insolvency laws were silent.  In Royal Bank of Canada v. Body Blue Inc.[2], the court had to rule on whether a vesting order transferring certain intellectual property extinguished the rights of a licensee to the intellectual property under an agreement.

Body Blue concerned the status of Herbal Care’s rights to intellectual property, which the debtor granted to Herbal Care under an agreement.  The agreement provided Herbal Care with the exclusive right to manufacture and sell a certain product.  An interim receiver and receiver and manager were appointed over the debtor in April, 2006.  In May 2006, the receiver transferred all right, title and interest in and to certain assets, expressly including the intellectual property licensed to Herbal Care, by way of an approval and vesting order to Body Blue 2006 Inc. for over $7 million dollars.

Herbal Care advised Body Blue 2006 Inc. that it took the position that the approval and vesting order did not affect Herbal Care’s exclusive right to manufacture and sell the product.  Body Blue 2006 Inc. brought a motion for an order declaring that title to the subject intellectual property of the debtor was transferred to Body Blue 2006 Inc. by way of the approval and vesting order and that Herbal Care’s contractual or licensed rights, if any, ended by reason thereof.

In analyzing the facts, the court found that Herbal Care, at best, had an exclusive license to use the intellectual property.  The license created only a contractual agreement between the parties.  Herbal Care did not acquire any property interest in such right.  If Herbal Care is to have any remedy, then such remedy is contractual in nature.

The claim of Herbal Care did not affect the transfer of the intellectual property, which is the subject of the license agreement, to Body Blue 2006 Inc.  Rather, Body Blue 2006 Inc. holds the intellectual property free and clear of any claim of Herbal Care.   

Conclusion

Body Blue has clarified that the rights of a licensee to use intellectual property under an agreement can be lost, if a receiver or trustee in bankruptcy transfers such intellectual property to a third party.  In that instance, the rights of the licensee will not be protected under either the BIA or the CCAA.

While one issue not addressed in the legislation has been resolved in Body Blue, questions still remain.  Does the licensee have any right post-bankruptcy to any improvements that the debtor/licensor may have made to the intellectual property?  Would a licensee of software be entitled to the source code escrow?  Does the preservation of the right to “use” the intellectual property include the right to manufacture and sell products in accordance with a license?  It may be that these questions become the topics of other cases before the courts.   

In the meantime, in order to address the possible bankruptcy of an important licensor of intellectual property, a licensee may be assisted by including language into a license agreement, which gives the licensee a proprietary interest in the intellectual property, permits the licensee to take security over the intellectual property, has a third party hold the intellectual property in escrow, and separates all other obligations of a licensee in the agreement from its obligations relating to the use of the intellectual property, i.e. the fee paid to use the intellectual property against the fee paid for the technical support of the licensor.

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Ryan K. Smith is a lawyer and trade-mark agent at Feltmate Delibato Heagle LLP. He specializes in corporate and commercial law with expertise in intellectual property matters including trade-marks, copyrights, privacy, information technology, and confidential information.  You can reach Ryan at rsmith@fdhlawyers.com and (905) 287-2215.

 


[1] Bill C-12 received Royal Assent on December 14, 2007.  However, section 65.11 of the BIA and section 32 of the CCAA have not yet been proclaimed into force. 

[2] 2008 CanLII 19227 (ON S.C.).