Law Times

PAGE 10 FOCUS March 23, 2009 • Law TiMes Questions remain over IP rights in insolvency process BY GLENN KAUTH Law Times ership following a sale to a new company. I n 2006, a troubled Ontario company called Body Blue Inc. ended a stint in receiv- Among the assets sold for $7 million was a product called PG Free, a deodorant stick market- ing itself as a natural alternative to scents containing the solvent propylene glycol. As part of the sale, it got an approval and vest- ing order transferring the rights of the previous owner, now called Old Body Blue, to a new entity, Body Blue 2006, accord- ing to court documents. There was one problem, how- ever. Another company, Arizo- na-based Herbal Care Systems Inc., claimed it had an exclusive licence from Old Body Blue to manufacture and sell PG Free. So, in 2006, it warned the new entity that it would seek to pro- tect its licence by challenging the vesting order, something it first did in an Arizona court. Body Blue 2006, in turn, sought to veto Herbal Care's claims in an Ontario court by asking a judge to declare that the vesting order had essentially ended the Arizona company's rights to the licence. It turned out, however, that tual agreement as between the parties. Even if the grant to Herbal Care to market and sell were construed as a traditional licence, it is not the case that Herbal Care acquired a prop- erty interest in such a right." The case — and the rights of licensees to continue using intellectual property when the licensor goes bankrupt — is one that lawyers working in corporate restructuring and insolvency have been taking note of. "Forever there's been that concern in insolvency legislation," says Deborah Grieve, a partner with Blaney McMurtry Barristers & Solici- tors LLP in Toronto. "A licence is just a right judge to overturn a past or- der in cases where a party had failed to assert its rights. A further wrinkle in Body Herbal Care was out of luck. Last year, the Ontario Superior Court ruled against the company's argu- ments that the ownership of the licence was in dispute. "At best, Herbal Care had an exclusive li- cence to use the PG Free technol- ogy," Justice Geoffrey Morawetz wrote in Royal Bank of Canada v. Body Blue Inc. in April. "How- ever, even if established, a licence agreement only creates a contrac- DD LT B QtrA-05 OPTabs ad 3/13/09 10:09 AM Page 1 to use something," she adds, noting that a licensee has less leverage in the courts than someone holding a proprie- tary interest in a product. "It's just a contract, and the con- tract can be terminated." The Body Blue case isn't the first time questions over the fate of intellectual property rights have come up during an insol- vency process. When T. Eaton Co. Ltd. filed for protection under the Companies' Credi- tors Arrangement Act a decade ago, a company operating Ea- ton's credit-card business asked the courts to uphold its right to use the famed retailer's trade- mark despite its pending sale to Sears Canada Inc. National Retail Credit Services Co. had a 10-year deal with Eaton's, but the sale to its rival required the retailer to end the arrangement. The judge in that case ruled similarly that a licence doesn't constitute a proprietary right. At the same time, it noted that as 'What this means is if you're a licens- ee, you have to pay very close atten- tion to what's happening with the licensor,' says Susan Beaubien. a mechanism designed to allow companies to restructure, the CCAA does allow them to break contracts. As such, it leaves other parties, such as the holder of a li- cence, with the perhaps unpleas- ant option of having to sue a po- tentially bankrupt company for a breach of contract, the judge pointed out. But in Body Blue, other prob- lems hurt Herbal Care's chances of successfully challenging the vesting order. While Herbal Care informed Body Blue 2006 of its objections in mid-2006, it didn't take any steps to appeal the or- der, Morawetz pointed out in his judgment. It later began an ac- tion in Arizona, but it was Body Blue 2006 that had the issue brought before an Ontario court. As such, Morawetz said he agreed with a previous court ruling that it would be inappropriate for a Dye & Durham is the Largest Supplier of Indexes ruling is a signal to licensees to seek protections in agree- ments with licensors. They can ask, for example, to have the arrangement declared a propri- etary agreement, something that would enhance their rights under any insolvency proceeding. At the same time, the federal Blue was the fact that when the new entity went to court to get the vesting order, Herb- al Care had received no no- tice of it nor had the chance to make any arguments, Morawetz noted. As a result, Ottawa intellectual property lawyer Susan Beaubien says the case puts an added onus on licensees to keep up to date on how the licensor is doing. "What this means is if you're a licensee, you have to pay very close attention to what's happening with the licensor," says Beaubien, a lawyer with Macera & Jarzyna LLP. Grieve, too, notes that the government's recent changes to the CCAA and Bankruptcy and Insolvency Act do go some way to addressing the plight of licensees. In amendments deal- ing with a company's contract obligations, the revamped laws would allow a debtor to disclaim agreements other than certain fi- nancial contracts, leases in which the insolvent company is the lessor, financing arrangements and collective agreements. But the other party can challenge the disclaimer within 15 days, something that would require the court to decide whether al- lowing it is necessary for a viable restructuring. If rejected, the other party can then sue. But the changes go further For example, Grieve says the leg- islation doesn't specify what use of intellectual property means. "What good is use if you don't have the right to use any modi- fications or enhancements to the intellectual property?" she asks, noting a licensee might also be concerned about getting ongoing technical support for the product. As well, it's not yet clear how the changes would affect licences where the company is in receiv- ership rather than undergoing a restructuring under one of the acts. "The new legislation doesn't fully answer the future of licens- ees' rights in insolvency," she says. Beaubien, too, notes the amendments and the Body Blue ruling put an extra onus for law- yers dealing with intellectual prop- erty to exercise due diligence since they in some ways contradict each other. On one hand, the new laws will enhance licensees' rights while on the other, the Body Blue deci- sion limits them — at least in the case of a receivership. Companies will have to heed the court's ver- dict for now while being mindful of the legal changes that will take effect at some point, she notes. "It's all going to come back Questions remain, however. to protect licensees through an exception to the contract pro- visions granting them the right to continue using intellectual property as long as they ful- fill their obligations under the agreement. "It seems to protect the rights of the counterparty exclusive licensee," Grieve says. to how the licence is drafted and what is being granted to the li- censee," she says. Beaubien adds that the issue of intellectual property doesn't always have to create conflicts between a licensee and the buyer of a distressed asset or company. Many new owners are quite hap- py to have a guaranteed revenue stream, she points out. "On the one hand, this may be a good thing . . . because what this is do- ing is protecting the status quo." But questions over licences, pat- ents, and trademarks can get sticky because they essentially dilute the monopoly the new owner would otherwise hold over the intellectual property. As a result, Beaubien ar- gues new protections for licensees shouldn't grant licensees the ability to go even further by sublicensing their rights to someone else. "It shouldn't give you an unfettered right to do what you want with the licence," she says. 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