Licensees Beware: A Licensee's Risk in the Insolvency of the Licensor

Written By Martin Kratz, Mark Laugesen and Sean Zweig

With technology licenses so prevalent today, a licensee is well advised to consider the ramifications that the insolvency of their licensor may have. To date, there has been little litigation directly related to what may happen to a license for intellectual property rights in an insolvency proceeding in Canada.

With the recent decision in Royal Bank of Canada v. Body Blue Inc. 2008 CanLII 19227 (ON S.C.), some judicial guidance is now available. While proposed amendments to Canadian insolvency laws may help to further clarify the law on this point with respect to restructuring proceedings, ambiguity in the reform legislation and legislative silence with regard to bankruptcy/receivership proceedings may still leave licensees concerned in the event of a licensor's insolvency.

Facts

Body Blue Inc., which we will refer to as Old BB, had been the owner of certain intellectual property rights pertaining to a paraben glycol free technology, PG Free for the sake of this article. On April 28, 2006, an Interim Receiver and Manager was appointed over Old BB. On May 17, 2006, Body Blue 2006 Inc. (BB 2006 for this article) obtained a vesting order transferring to BB 2006 all rights in the assets of Old BB, including PG Free. By agreement dated May 19, 2006, Old BB's right, title and interest in and to the purchased assets were transferred to BB 2006. Pursuant to the order, upon the filing of the Receiver's Certificate with the Court, all right title and interest of Old BB in the purchased assets, including PG Free, vested in BB 2006.

On June 9, 2006, counsel for Herbal Care advised counsel for BB 2006 that while Old BB had been the owner of PG Free, Old BB had licensed to Herbal Care the exclusive rights to manufacture and sell PG Free. Herbal Care took the position that its right to manufacture and sell PG Free was not affected by the order.

BB 2006 brought a motion for an order declaring that title to PG Free was conveyed to BB 2006 by the vesting order and that Herbal Care's contractual or licensed rights, if any, ended with the transfer.

The Court's Decision

Herbal Care did not provide any additional evidence in support of any property interest in PG Free and the Court found that the license agreement did not constitute a property claim. The Court found that, at best, Herbal Care had an exclusive licence to use the PG Free technology. The Court noted however that, even if established, a licence agreement only creates a contractual agreement as between the parties but does not create proprietary rights.

Although Herbal Care had not been given notice and was not represented at the hearing giving rise to the vesting order, the Court found that this did not impact the motion. Herbal Care had taken no steps after becoming aware of the order to set aside or vary it and had not appealed it. The Court found that Herbal Care was bound by the terms of the vesting order.

Consequently, the Court held that Herbal Care had a contract claim against Old BB but that the claim did not affect the transfer of title to the property, assets and undertaking of Old BB to BB 2006. The Court concluded that BB 2006 held the transferred assets free and clear of any claim of Herbal Care.

Conclusion

Licensees reading the Body Blue decision should rightly be concerned about the potential loss of their license rights in the event of the bankruptcy or receivership of their licensor. What are some lessons to be learned from this case?

Herbal Care could have taken steps to dispute or appeal the vesting order. While difficult to obtain in most license transactions, Herbal Care could have sought to include language in the license agreement that spoke to a proprietary interest in the underlying intellectual property rights or to even obtain a partial interest in the intellectual property itself. Further, in an appropriate case, a security interest could be sought and registered to protect the licensee's interest. Complex parallel structures could also be set up to diminish the risk of licensor insolvency.

Sidebar: Law Reform

In the United States, the loss of a license in Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc. 756 F.2d 1043 (1985) lead to reform of the US Bankruptcy Code.

Proposed insolvency reform legislation in Canada may at least partially address the license problem in Canadian insolvency proceedings. Bill C-55¹ (now S.C. 2005, C. 47) and Bill C-12² (now S.C. 2007, c. 36), have both received royal assent but for the most part have not been proclaimed into force. While the proposed reforms provide for, among other things, a licensor's right to disclaim agreements, including license agreements in restructuring proceedings, the amending legislation also attempts to address the concerns of licensees by providing for a licensee's right to continue to use intellectual property so long as the licensee continues to perform its obligations in respect of the use of the intellectual property.

It is significant to note that the amending legislation does not address (and therefore neither expressly allows nor expressly prohibits) disclaimer by a trustee in bankruptcy in a bankruptcy or a receiver in a receivership. The reforms contemplated in the amending legislation speak to restructuring proceedings under both the BIA and the Companies' Creditors Arrangement Act. Therefore, in a bankruptcy or receivership proceeding, like Body Blue, the common law will still govern on the issue of disclaimer.

Further, once the amending legislation is proclaimed into force, licensees of intellectual property in a restructuring proceeding will still need to be cautious as a result of some potential ambiguity as to which rights of an intellectual property licensee are preserved. The original amendment in Bill C-55 provided that disclaimer does not affect the licensee's right to “use” the intellectual property. The subsequent amendment in Bill C-12 then attempted to clarify the word “use” by adding that it includes the right to enforce an exclusive use. However, ambiguity still remains. For example, would a licensee of a software program be entitled to the source code of that piece of software? It also remains unclear whether “use” includes other distinct rights recognized under applicable intellectual property law, such as the right to make and sell under the licensed patent, which was one issue in Body Blue.

Licensees seeking to conclude critical licenses therefore need to rethink the risk profile of the licensor and the licensee's options in the event of insolvency.

Notes

1. Bill C-55, An Act to establish the Wage Earner Protection Program Act, to amend the Bankruptcy and Insolvency Act and the Companies' Creditors Arrangement Act and to make consequential amendments to other Acts - S.C. 2005, c. 47.
2. Bill C-12, 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 – S.C. 2007, c. 36.