Friday, October 7, 2016

The Status of Intellectual Property Licences in Insolvency Proceedings

Today's post is a guest post by Professor Anthony Duggan, the Hon. Frank H. Iacobucci Chair in Capital Markets Regulation at the University of Toronto Faculty of Law.

THE STATUS OF INTELLECTUAL PROPERTY LICENCES IN INSOLVENCY PROCEEDINGS

1.      Introduction
If an intellectual property owner grants a licence and subsequently becomes insolvent, can the insolvency administrator disclaim the licence? Or, alternatively, can the insolvency administrator sell the intellectual property free and clear of the licence? Norman Siebrasse and I explored these questions in depth in a report we wrote for Industry Canada in 2013 and in an article, based on the report, which was published in the Annual Review of Insolvency Law in 2014.[1] The questions recently came up for consideration in Golden Opportunities Fund Inc. v. Phenomenome Discoveries Inc.,[2] where the court overlooked nearly all the key points.

2.      The disclaimer of intellectual property licences
Section 65.11 of the Bankruptcy and Insolvency Act[3] provides for the disclaimer of contracts in BIA proposal proceedings. Section 32 of the Companies’ Creditors Arrangement Act[4] is a parallel provision which applies in CCAA proceedings. BIA, s.65.11(7) and CCAA, s.32(6) apply to intellectual property licence agreements where the debtor is the licensor and they provide that disclaimer of the agreement does not affect the licensee’s right to use the intellectual property during the term of the agreement, provided the licensee continues to perform its obligations under the agreement. These provisions are loosely based on s.365(n) of the United States Bankruptcy Code.[5] Their immediate purpose is to protect the licensee’s reliance interest, but the larger objective is to preserve the licensing system as a means of sharing and exploiting intellectual property rights.

Inexplicably, there are no corresponding provisions for bankruptcy proceedings or receiverships. The GOFI case involved a receivership and the court held that the above provisions were inapplicable.[6] The court went on to hold that, in the absence of any relevant statutory provisions and subject to any relevant provisions in the receivership order, a receiver is not bound by the debtor’s contracts and is free to disclaim them.[7] This is subject to the exception that “a receiver cannot disclaim a contract that has granted a property right”.[8] However, in  the GOFI  case the court, following Royal Bank of Canada v. Body Blue Inc.,[9] held that a licence “does not confer any interest or property in the thing being licensed” and so the licensee’s rights are purely contractual.[10] The implication is that if the receiver in the present case had sought to disclaim the licence agreement, the court would have upheld its right to do so and it would further have ruled that the disclaimer precluded the licensee from continuing to use the intellectual property.[11]

But this is wrong as a matter of both law and policy. It is a mistake to think of the issue in terms of property rights. Disclaimer of a contract in insolvency proceedings is a breach of contract, not rescission. The essence of a licence agreement is that the licensor promises not to sue the licensee for infringement, provided the licensee observes the terms of the licence. Outside insolvency, if the licensor sued the licensee for infringement even though the licensee was in compliance with all its obligations under the licence agreement, the licensor would be in breach of its primary obligation under the licence agreement and the court would disallow the action. In principle, the position should be the same in insolvency proceedings. In other words, disclaimer of a licence should not prevent the licensee from continuing to use the intellectual property; if the insolvency administrator sues the licensee for infringement, the court should disallow the action, just as it would have done outside insolvency.[12] Furthermore, as indicated above, there are strong policy reasons for not allowing disclaimer. These policy reasons apply regardless of the form the insolvency proceedings happen to take. The court in the GOFI  case overlooked these points and the case is open to criticism on this score. But more importantly, perhaps, this aspect of the decision serves to underscore the unforgivably patchwork nature of Canada’s insolvency laws. The rules governing disclaimer of contracts should be the same across the board both in the interests of consistency and to discourage forum shopping (picking and choosing between insolvency regimes to take advantage of discrepancies between the regimes).

3.      Asset sales and licensee’s rights
As it happens, the receiver in the GOFI  case did not seek to disclaim the licence agreement. Instead, it applied to the court for approval to sell the intellectual property (a patent) free and clear of the licence. BIA, s.65.13 governs asset sales in BIA commercial proposal proceedings and CCAA, s.36 is a parallel provision applicable in CCAA proceedings. There is no corresponding provision for receiverships, but the courts have developed a similar set of criteria for approving asset sales in a receivership, including a requirement that, in deciding whether to approve a sale, the court should take account of third party interests.[13] In the GOFI  case, the court held that even though the licensee had no proprietary interest in the patent, it did have a contractual right (presumably in the form of a damages claim) which it was entitled to pursue against the sale proceeds.[14] The court framed the question in terms of whether it would be unfair to permit this right to be extinguished and on the facts of the case, it concluded that this question should be answered in the negative. Specifically, the court found that the licensor and licensee companies were both, in effect, alter egos of the same human actor (Dr Goodenowe) and that Goodenowe had years previously bargained away the licensee’s rights.

This conclusion seems plausible as far as it goes, but it must be stressed that it turns on the particular facts of the case. Furthermore, even if the facts had been different and the court had found in the licensee’s  favour, on the court’s own reasoning this would have served only to keep alive the licensee’s  claim for damages and the claim, being a provable one, would be poor compensation for loss of the licence.   In this connection, the policy considerations are the same as in the context of disclaimers:  an order approving the sale free and clear of the licence would be detrimental to the licensee’s reliance interest and, if the licence is central to the licensee’s business, it might trigger the licensee’s own insolvency. Furthermore, the risk that the licence may be defeasible in the licensor’s insolvency proceedings could have a significantly chilling effect on intellectual property licensing activity at large. In this respect, too, the  GOFI  case points to the incoherence of the Canadian insolvency laws: it makes no sense to enact provisions aimed at giving effect to these policies in the disclaimer context, but to leave the licensee exposed to the very same risk in the context of asset sales.

In the GOFI  case,  the court overlooks the possible application of the registration and priority rules in the Patent Act.[15] At least until recent amendments, the Patent Act clearly required exclusive licences to be registered[16] and it further provided that that an “assignment” was void against a subsequent assignee unless registered.[17] It was unclear  (1) whether “assignment” included an exclusive licence;  (2) if so, whether the provision meant that the holder of a registered licence had priority over a subsequent purchaser of the patent; and (3) if not, what the governing priority rule might be.[18] The disputed agreement in the GOFI  case was a non-exclusive licence and, as such, it was clearly not registrable. But it is still not clear how the priorities should be determined.  Poolman v. Eiffel Productions [19] suggests that the federal intellectual property registration provisions do not establish priority regimes and that priorities between competing interests in intellectual property are subject to provincial law, not federal law. 

On the other hand, the correctness of Poolman has been doubted. For example Professor Vaver argues that the federal statutes do determine priorities, at least as between registrable interests, and that there is no room for the application of provincial laws.[20] But Vaver’s reading of the provisions leaves open the question of how to determine the priorities where one or more of the competing interests is an unregistrable interest.[21]  Perhaps the answer is that, at least in the case of a non-exclusive licence,  the licensee has no proprietary claim and so no question of priorities arises.  In any event, to the extent that federal laws apply to determine priorities between competing interests in intellectual property, they should be equally relevant inside and outside insolvency proceedings. This means that, in considering third party interests when deciding whether to approve an asset sale in insolvency proceedings, the court should not confine itself  to asking whether the asset sale is “fair” to the third party; it should also ask whether and, if so, how, the federal intellectual property laws might apply. 

In the broader scheme of things, there is a strong case for reforming the intellectual property laws to establish a modern and comprehensive system for the registration of intellectual property interests and a coherent set of priority rules, along the lines of the provincial Personal Property Security Acts.  If the government were to grasp that nettle, the new priority provisions would clearly be front and centre in any asset sale proceedings involving intellectual property.

Anthony Duggan,
Hon. Frank H. Iacobucci Chair,
Faculty of Law,
University of Toronto


[1] Anthony Duggan and Norman Siebrasse,  The Treatment of Intellectual Property Rights in Insolvency : Report to Industry Canada (September, 2013); “The Protection of Intellectual Property Licences in Insolvency: Lessons from the Nortel  Case [2014]  Annual Review of Insolvency Law  19.
[2] 2016 SKQB 306 (the “GOFI  case”).
[3] RSC 1985, c.B-3 (“BIA”).
[4] RSC 1985, c.C-36 (“CCAA”).
[6] At [21].
[7] At [23], quoting from an unreported judgment of Meschishnick J. in the same proceedings (July 19, 2016) at paras 8-10 which, in turn, cites Bennett on Receiverships  (Toronto: Carswell, 1999) at 341.
[8] Ibid.
[9] (2008) 42 CBR (5th) 125, 2008 CanLII 19227 (Ont. SCJ).
[10] At [18].
[11] As it happens, the receiver did not seek to disclaim the licence agreement, but instead applied for approval to sell the intellectual property free and clear of the licence (see further below).
[12] Duggan and Siebrasse [ARIL],  supra note 1 at 33.
[13] See Toronto-Dominion Bank v. 101142701 Saskatchewan Ltd  2012 SKQB 289, quoted in the GOFI  case at [27].
[14] At [25].
[16] Section 50(2), now replaced by s.49(3).
[17] Section 51, now replaced by s.49(4), replacing “assignment” with “transfer”.
[18] Duggan and Siebrasse [ARIL],  supra  note 1 at 38-46.
[19] (1991) 35 CPR (3d) 384 (Fed.TD).  Poolman  was a copyright case, but its reasoning seems equally applicable in the patents context.
[20] David Vaver, Copyright Law (Toronto: Irwin Law, 2000) at 248.
[21] Duggan and Siebrasse at 45.

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