Whilst conditions in the credit and banking markets might be less tempestuous in Q2 2009 than in recent quarters, there remains the risk of a significant upsurge in both insolvencies and restructurings in the wider economy. It is, therefore, a natural time for practitioners and advisers to be looking ahead. Intellectual property rights (“PRs”’) may not be an obvious candidate for attention, but there is much to be said for re-assessing an asset class which presents some unique issues.
IPRs increasingly embody the inherent - but intangible - value of many business enterprises (as recognised in an earlier article in this publication ((2008) 3 CRI79)). It is certainly no exaggeration to say that in some cases a company’s entire business model may be predicated on the continued right to use IPRs licensed to it. Notwithstanding such potential dependence, there are a number of issues concerning their status (their intangibility for one), protection and how they may be dealt with which impact on the intrinsic or realisable value of IPRs. These issues are brought into particularly sharp relief when insolvency intervenes, whether a disposal of rights is contemplated or their continued availability is central to a successful outcome from any ongoing trading.
IPRS - An essential grounding
The following is a brief refresher on the primary types of “intellectual property”:
- Copyright: a right which protects the form of expression of ideas, rather than the ideas themselves. It is intended to reward authors for the creation of original works and to prevent unauthorised copying. Copyright lasts for a set period, for most works the life of the author plus 70 years and protection arises automatically. The right is not registrable in the UK.
- Design right: gives the owner the exclusive right to reproduce a design for commercial purposes by making articles to that design or by making a design document to enable articles to be made to that design. Such rights can be registered or unregistered (and both national or EU-wide). The UK Intellectual Property Office (“IPO”) and OHIM (for community designs) maintain registers on which assignees, licensees and mortgagees of registered designs can have their interest registered.
- Patent: a right which entitles an inventor to prevent third parties from using his invention without due authorisation. Protection only arises following the grant of a patent. The IPO maintains a register of patents on which assignees, licensees and mortgagees can have their interest registered.
- Trade mark: a mark which distinguishes one trader’s goods or services from another’s and enables customers to recognise particular brands. Trade marks can be registered nationally or across the EU. Once registered, the owner of the mark has a monopoly over its use for the goods or services for which it is registered. Assignees, licensees and mortgagees can have their interest registered at the IPO.
In addition to these principal rights, there are a number of other generally accepted rights. These include confidential information/trade secrets, know how and database rights.
Commercial exploitation of rights is typically manifested through the licensing of user rights. Arrangements range from a bespoke exclusive licence o£ say, a patent through to a non-exclusive, mass market standard form copyright licence, such as a shrink-wrapped, end-user computer software agreement.
The combined effect of the particular characteristics of IPRs, the potentially critical value of such rights to commercial parties, the absence of specific statutory protections in the UK dedicated to IPRs when insolvency impacts upon one party and some difficult concepts produces some issues which are unique to IPRs as an asset class.
Typical scenarios involving IPRS
In the author’s experience, typical scenarios likely to be encountered involving stakeholders concerned with IPRs and key considerations which arise as a result are wide-ranging and include the following:
1. Insolvency practitioner (“IP”) where IPRs are more of a burden than a benefit.
2. IP looking to realise best value from IPRs held within the insolvent company estate:
- the need for due diligence to determine to what extent the IPRs are actually owned or licensed to the insolvent company;
- if the rights are only licensed to the company, consider the need to continue paying licence fees (and possibly arrears) to avoid the lapse of the licence. Is there funding available to the IP to cover this? The licensor may have substantial leverage;
- if the IPRs are owned outright, but are subject to an existing grant of user rights, can the same be freely assigned?
- even though any sale of IPRs will be subject to the usual ‘rights, title and interest’ qualification (and other standard IP protections), will this necessarily protect the IP from claims of conversion/wrongful interference if the IPRs are not owned outright but are sold? Will s234 of the Insolvency Act 1986 (“IA 1986”) assist?
3. Purchaser looking to acquire an insolvent business or assets encompassing IPRs:
- the absence of usual going concern warranties as to title etc, hence the need to carry out appropriate due diligence to determine whether or not all ownership and/or licence rights are in place and freely alienable;
- recognise that determining unregistered rights is particularly difficult;
- have crucial third party rights been terminated or do they remain terminable on the company’s insolvency and/or on other grounds (such as breach of undertakings, notably to pay royalties) ? In the UK, an administration moratorium per se will not prevent termination right being exercised;
- note impact of UK intellectual property legislation. For instance, a buyer of copyright will take subject to an existing licence unless it is a bona fide purchaser for value without notice of the licence;
- the sale agreement should include a broad further assurance obligation on the part of the IP (and the company), perhaps an irrevocable power of attorney from the company and possibly retentions from the purchase price to address these risks.
4. Licensee’s concern to insolvency-proof a license arrangement at the outset, recognising that an unsecured claim against an insolvent licensor may be an entirely hollow remedy if the licensee does not remain free to continue using the licence rights:
- consider whether equitable relief might be available if damages would be an inadequate remedy against an insolvent company so as to force the insolvent licensor (and moreover its IP) to honour the pre-insolvency licence. This is a vexed question in the context of IPRs - it may be relevant whether the licence confers a proprietary or merely a personal right;
- in software development scenarios, a source code deposit or escrow arrangement may be helpful;
- consider a sale/assignment of the underlying IPRs with a licence back to the putative licensor. This may be very unattractive to the owner for control, accounting and cost reasons;
- consider the use of an option to purchase before or at the time of the licensor’s insolvency. However, this may have a number of limitations. Whilst a fair value would need to be paid for the assignment/sale, such an arrangement would still arguably sit ill with the anti-avoidance provisions in the IA 1986 and be challengeable by an IP, particularly if the assignment/sale was at demonstrably less than prevailing market value;
- consider a structure involving the transfer of the IPRs into a clean Spy owned by the licensor which is not permitted to trade (other than to the extent necessary to preserve the IPRs). This should be reasonably bankruptcy remote. The licensee could take a charge over the shares in the SPY as security for the licensor’s licence obligations.
5. Investor in an IPR rich company in financial difficulties considering options to best protect its investment. An insolvency before the development and licensing of a valuable product or technology has been completed could put the entire investment at risk:
- as well as considerations mentioned above, one option would be for the investor to take fixed security over the IPRs together with a “lightweight” floating charge in support of its financial investment. This would allow for the appointment of a fixed charge receiver or administrator (and to “trump” any administration appointment by the company). The investor - or a related party - may consider buying the IPRs (subject to compliance with the fair dealing and self-dealing rules).
Drawing on some of the themes identified in these scenarios, this article will now focus on some of the key issues and potential battlegrounds and will have an eye to the position as it is developing in other common law jurisdictions.
An asset - or a liability?
Whilst an intellectual property “right” would usually be considered an asset, this might not actually be the case. The right-holder may have contractual obligations to maintain or develop a copyright or patent in accordance with a pre-existing licence. Additionally, in order to preserve the value of a patent or trade mark, there may be ongoing registration and prosecution expenses (possibly in multiple jurisdictions).
Where the right-holder is insolvent, it may be concluded that the cost burden outweighs the benefit of the relevant IPRs. The question may then arise whether the IP is entitled to repudiate any pre-insolvency contractual agreements to which the IPRs may be expressed to be subject.
This question commonly arises in the context of bespoke development relationships where the use of products by third parties is made possible through licences granted by developers and the licensees will often be entitled to regular development and upgrades.
The liquidator of the licensor can disclaim any such licence that is onerous by reason of being either unprofitable or unsalable under s178 IA 1986 (but bear in mind the tests recently approved by the Court of Appeal in Squires (Liquidators of SSSL Realisations (2000) Ltd v AIG Europe (UK) Ltd (2006) BCC 233). In practice, any licence obliging the licensor to incur payment or other prospective liabilities will be an onerous contract. A licensee will be entitled to apply for a vesting order under s181 IA 1986. Whilst an administrative receiver is likewise, in principle, entitled to avoid any contract entailing prospective liabilities which interferes with the primary duty he owes to his appointor, neither an administrator nor a supervisor under a company voluntary arrangement or a scheme of arrangement will be able to ignore the contractual liabilities that the subject company may have.
Notwithstanding the application of the caveat emptor maxim, a prudent IP will want to know that there is at least a fair argument that the company has a saleable interest in any IPRs proposed to be sold. Despite only selling such right, title and interest as the company may have, he will usually be pressed by a well-advised buyer to confirm whether he controls an ownership interest or inherits merely a user right (through some form of licence). If he purports to sell something the company doesn’t actually own, s234lA 1986 might come to his assistance (provided he acted reasonably in the disposal), but doubt was expressed on the availability of this protection in Welsh Development Agency v Export Finance Co (1992) BCC 270 in the case of intangible property. There remains the prospect of a challenge from the actual owner(s) in the form of a tortious claim for wrongful interference with property rights.
Where the company had a licence right only, key questions will arise. For instance, if the licence is critical for the company’s ability to operate, will the IP have to pay fees or royalties for the ongoing rights the company needs where non-payment could result in the licence rights being suspended? Will he have sufficient available funds to do so? The IP will look to assign the benefit of such a licence (assuming it is assignable), but will any requisite consent be granted by the licensor?
The acquisition of IPRs from a purchaser’s perspective is fraught with danger as no representations or indemnities will typically be given by the IP. Appropriate due diligence to address these and other important questions may, in practice, prove very difficult to do, especially against a tight timetable. The position will be potentially even more opaque with unregistered rights. In contrast, a degree of protection is afforded copyright purchasers under the Copyright, Design and Patents Act 1988.
Where third-party rights play a part, it should be possible to identify the licensor(s) and investigate the extent to which there are pending payment or other defaults and hence the risk of actionable termination. Unlike in the US where the Bankruptcy Code prohibits one party terminating a contract merely as a result of the other’s insolvency, under English law a counterparty can invoke its contractual termination rights even in an administration. Commercial reality may, however, induce a licensor to decline termination in the hope of having a new counterparty take over the company’s future performance through a novation arrangement. Most standard sale agreements. provide for the IP’s assistance in facilitating the company’s succession to licence arrangements (and others), whether by novation or assignment. The purchaser may want supplemental further assurance and price retention arrangements.
Bullet-proofing IPRS - is it possible?
As previously suggested, the potentially significant value of IPRs, whether in terms of ownership or user rights, cannot be underestimated in today’s rights-orientated business world. Rather than trying to deal with the fallout arising from an insolvency which has happened, is it possible to take pre-emptive action to secure the continued use (or preservation) of business~-critical IPRs?
Take a typical scenario. How can a licensee protect itself against the possible future insolvency of its licensor and the threat of interruption to — or loss of— its contractual usage rights (such as technical support and ongoing developmental upgrades)?
The licensee’s remedy for its losses in such a case would usually be a damages claim. However, an unsecured claim in an insolvent company’s estate is often virtually worthless. An IP will look to realise the licensor’s IPRs and the purchaser may assume the licence as it is, not least because it may still be revenue-producing. However, there is a potential risk that the purchaser will try to take the IPRs free of the pre-existing licence. What can the licensee do in such a case?
Conventional wisdom would look to alternative remedies from the world of equity, but will an injunction or specific performance be available? In one sense, damages against an insolvent company are not an adequate remedy, but equitable remedies in a case like this will be restricted to those with a proprietary interest in the subject matter concerned.
As a matter of English law, it is unclear whether an IPR licence can be anything other than a pure, personal right. Certainly that was what was decided over 100 years ago by the Court of Appeal in Heap v Hartley  Ch D 461, even in the case of an exclusive licence of patent rights: “An exclusive licence ... confers like any other license, no interest or property in the thing” (at 470). Arguably, the better, modern view is that an exclusive licence could in appropriate circumstances found a right which is tantamount to a proprietary interest which, in turn, could enable the grant of an injunction against a purchaser looking to evade pre-existing third party licence rights.
Whilst the position in this country may be uncertain, the jurisprudence is becoming more developed elsewhere and this to some extent informs the analysis here. For instance, the US Bankruptcy Code contains a section specifically designed to protect a licensee which would otherwise be vulnerable to the licensor’s bankruptcy. Section 365(n) confers an exception to the usual rule allowing insolvent debtors to disclaim “executory contracts” in the case of IPR licences by providing that licensees may retain their contractual rights so long as they make all royalty payments when due (without any set off. The licensor is also obliged to provide the licensee with all IPRs and developments to which it is entitled and not to interfere with the licensee’s rights to obtain the same from a third party (such as a source code escrow agent).
Meanwhile, proposed laws in Canada seek to enshrine a licensee’s rights to use intellectual property, including the right to enforce an exclusive use, where a licensor is insolvent (The Bankruptcy and Insolvency Act) or in restructuring (The Companies’ Creditors Arrangement Act). These are designed to override a Canadian trustee’s or receiver’s disclaimer rights, distinguishing the position of a buyer of goods and services (who can mitigate the effects of a non-supply or pre-emptively hedge such risk) from that of a licensee which, given the often unique nature of IPRs, might find sourcing a substitute to be extremely costly or even impossible.
As we are not alone in the UK in wrestling with continuing uncertainties concerning IPRs and the potentially devastating consequences that insolvency can wring on key stakeholders, it is hoped that some of the ideas proposed in the scenarios above will be thought-provoking for practitioners and advisers alike. What is clear is that given such uncertainty, early planning and pre-emptive structuring could be decisive, especially in any scenario where stakeholders are based in multiple jurisdictions.