Publications

By Mitchell Grossell, Insolvency Lawyer

On December 13, 2018, Bill C-86, a federal omnibus budget bill also known as the Budget Implementation Act, 2018 (the “Bill”),^[1] received Royal Assent by the Governor General of Canada.  This omnibus legislation is over 850 pages in length and addresses topics in income tax, excise tax, money laundering, greenhouse gas emissions pricing and intellectual property.

Corresponding to some of the intellectual property amendments, the Bill amends the Bankruptcy and Insolvency Act (“BIA”)^[2] and the Companies’ Creditors Arrangement Act (“CCAA”)^[3] to clarify the rights of intellectual property users or licensees when intellectual property rights are sold or disposed of or when those rights are disclaimed or resiliated in an insolvency proceeding.

On November 1, 2019, the amendments to the BIA and CCAA came into force.

The Amendments

The amendments to the BIA and CCAA seek to protect the rights of intellectual property users, notwithstanding a sale or disposition of assets in an insolvency or bankruptcy proceeding.  The Bill introduces the following substantively similar language to both insolvency statutes:

If […] the company is a party to an agreement that grants to another party a right to use intellectual property that is included in a sale or disposition, that sale or disposition does not affect that other party’s right to use the intellectual property — including the other party’s right to enforce an exclusive use — during the term of the agreement, including any period for which the other party extends the agreement as of right, as long as the other party continues to perform its obligations under the agreement in relation to the use of the intellectual property.

In the CCAA, this language is added as a new subsection to section 36, which places restrictions on the debtor company when seeking court approval to sell or dispose of property in a proceeding.  In the BIA, this language is added to Parts III (subsection 65.13(9)), IV (section 72.1(1)) and XI (section 246.1(1)) to address a sale or disposition in proposal, bankruptcy and receivership scenarios.

Under the BIA, the Bill extends the same protections to intellectual property users in a disclaimer or resiliation context.  A similar amendment is not required under the CCAA because subsection 32(6) of the CCAA already protects intellectual property users in a disclaimer or resiliation scenario in CCAA proceedings.

New sections 72.1(2) and 246.1(2) of the BIA, in the context of a bankruptcy or receivership, introduces the following substantively similar language:

If the insolvent person or the bankrupt is a party to an agreement that grants to another party a right to use intellectual property, the disclaimer or resiliation of that agreement does not affect that other party’s right to use the intellectual property — including the other party’s right to enforce an exclusive use — during the term of the agreement, including any period for which the other party extends the agreement as of right, as long as the other party continues to perform its obligations under the agreement in relation to the use of the intellectual property.

This language is already captured in the context of a proposal by subsection 65.11(7).

The Disclaimer or Resilitation of Intellectual Property Agreements: Harmonization

Introducing subsections 72.1(2) and 246.1(2) to the BIA is fairly uncontroversial as these sections clarify that intellectual property users’ rights are no different in a bankruptcy or receivership context than in a proposal context.  These amendments bring the intellectual property disclaimer or resiliation provisions in harmony across Canadian insolvency statutes.

From a practical perspective, if an insolvent person or bankrupt owns intellectual property that is being used by a third party user, such intellectual property is likely an asset and may be cash generating.  It is unlikely that the debtor will want to disclaim or resiliate such an agreement unless the debtor believes that it can enter into a better agreement with a new party.  The new amendments to the BIA, coupled with the existing sections in the CCAA and the proposal part of the BIA, have effectively shut the door on a debtor attempting to disclaim an existing intellectual property user agreement in favour of a more lucrative agreement.

Although creditors may have heartburn over the idea that a debtor cannot utilize the disclaimer provisions to maximize value, in a liquidation scenario, the debtor company will likely not exist long enough for any increased revenue stream to make a material difference.  It seems that Parliament has favoured the protection of intellectual property user’s usage rights to any marginal benefit that may be realized by creditors.

The Sale or Disposition of Intellectual Property: SteelCo, a Chilling Example

The protection of usage rights of intellectual property users in a sale or disposition of intellectual property may have material consequences to the maximization of value in an insolvency or bankruptcy proceeding.

The Canadian Intellectual Property Office defines intellectual property as a form of creative effort that can be protected through a patent,^[4] industrial design,^[5] trademark,^[6] or trade secret.^[7]  We will use an example to assist with the analysis and examine the impact of the amendments on an insolvent steel company (“SteelCo”) that is looking to sell certain trade secrets, including the formulas used to manufacture proprietary grades of steel.

Prior to the commencement of insolvency proceedings, SteelCo entered into an intellectual property agreement to allow a third party steel company competing in a different geographical market (“UserCo”) to use SteelCo’s trade secrets and manufacture SteelCo’s proprietary grades of steel.  Due to a downturn in the global steel market, SteelCo enters into insolvency proceedings and commences a sales process in an effort to sell its business to the highest bidder.  One such bidder is a large steel manufacturer (“BidderCo”) that operates in other markets in addition to the market that SteelCo operates in, including the same market that UserCo operates in.  BidderCo is interested in SteelCo’s proprietary grades of steel and is willing to pay top dollar to purchase substantially all of the assets of SteelCo.  However, BidderCo wants to be the exclusive user of the proprietary grades in the market that UserCo operates in.

In this example, the amendments to the BIA and CCAA prevent BidderCo from exclusively using the trade secrets that it bought from SteelCo.  The amendments protect UserCo’s rights to use the trade secrets during the term of the agreement, including any extensions allowed under the agreement, so long as UserCo continues to comply with the terms of the agreement.

This should be concerning to the creditors of SteelCo.  Since the amendments prevent BidderCo from acquiring an exclusive right to use SteelCo’s trade secrets in the UserCo market during the term of the UserCo agreement, BidderCo may reduce its bid on the assets of SteelCo by the value that BidderCo attributes to the exclusive use of the proprietary steel grades.  At an extreme, BidderCo may even decide that it is not worth pursuing the purchase of SteelCo’s assets.

Further, the protection of UserCo’s rights to continue using the trade secrets of SteelCo, despite a sale or disposition of that intellectual property to a purchaser, may disincentivize UserCo from either participating in the sales process or submitting a competitive bid.

The new amendments to the BIA and CCAA may create a chilling effect on the sale of companies with significant intellectual property assets that have been licensed out to third party users.  This should cause concern to creditors because there is the potential for cash to be left on the table, meaning reduced recoveries to creditors.

A review of the current case law on the rights of intellectual property users during the sale or disposition of intellectual property assets did not yield any decisions that analyzed this issue.  It appears that the protections afforded under the amendments to the BIA and CCAA are novel in concept.

Concluding Thoughts

In a sale or disposition context, the new amendments have now introduced differing treatment to intellectual property agreements than other types of agreements, such as a rental or lease agreement where the end user is using property of the debtor company.  If the purchaser purchases substantially all of the assets of the debtor company, but does not assume the rental or lease agreement, the purchaser may take back its purchased property from the end user.  As demonstrated above, the same result cannot hold true due to the new amendments for intellectual property.

Given the shifting value proposition in many industries from tangible to intangible assets, such as intellectual property, it will be interesting to observe the effect that the new amendments to the BIA and CCAA have on sales processes, the solutions that companies and professionals find to minimize any negative effects of the amendments and the application of the new amendments by the Court.