Column

Not Just the Best Policy, but Now the Law: The Impact of the Duty of Honest Contractual Performance on Intellectual Property License Agreements

The Supreme Court of Canada recently decided a contractual dispute, Bhasin v. Hrynew, involving businesses selling educational savings plans (ESPs). In doing so, the Court recognized a duty of honest contractual performance. While the Bhasin decision did not concern intellectual property, the Court’s ruling has implications for all contracts, including intellectual property (IP) licensing agreements.

Previously, Canadian law was divided as to whether parties to a contract were required to discharge their contractual obligations honestly or whether the duty of good faith only applied to specific types of contracts, e.g. employment agreements. The Supreme Court’s ruling in Bhasin recognizes that a duty of honest performance applies to all contracts. This duty requires parties to be honest and reasonable with each other regarding the performance of their respective contractual obligations, and prohibits conduct that is capricious or arbitrary. The parties cannot agree to contract out of this duty.

The Bhasin case is particularly applicable to renewable IP licenses because it concerned a renewable contract. Bhasin was a dealer of ESPs provided by Canadian American Financial Corp (Can-Am). Bhasin and Can-Am had a dealership contract with a three (3) year term that would automatically renew in the absence of six (6) months written notice that the contract would not renew. Can-Am wanted to restructure its business and repeatedly mislead Bhasin about issues regarding the business. Can-Am then threatened to terminate the agreement and subsequently gave notice of non-renewal to Bhasin.

Bhasin lost the value of his business because the ESPs were no longer unavailable from Can-Am. The Court found for Bhasin, assessing damages as the value of Bhasin’s business at the time the contract was terminated.

The Bhasin decision applies to IP license agreements, including those that are renewable, and particularly to circumstances where the licensee could lose access to the licensed IP and consequently its ability to operate its business. Consequently, IP licensors must be careful to act honestly and in good faith, otherwise they may be liable for damages based on the business value lost in addition to other remedies that may be available to the licensee. Conversely, licensees must also act honesty, e.g. by accurately reporting royalties owed to the licensor, otherwise they could be found in breach of the duty as well as breach of their royalty reporting obligations under the license.

Comments

  1. Bhasin will certainly apply to IP license agreements, and many IP disputes generally (it has already been plead in several cases I am litigating). The full impact will be interesting to see, and you have certainly highlighted an area where it is likely to have greater impact than most.

    Another interesting questions that may come up with some IP licenses… do you now have an obligation to report potential challenges in the validity or strength of the underlying IP assets to licensees? Should office action rejections be forwarded? with or without commentary? an opinion proffered by a potentially infringing third party arguing invalidity? a negative decision in a foreign jurisdiction on a related right?

    On another note, while you correctly cite the judgement for the principle that you can’t contract out of the duty of good faith, I think there are steps that can be taken to reduce the potentially negative impact of the decision. This may be achieved by setting out the parties expectations more explicitly and also by removing potential areas where one parties actions could lead the other to argue there was bad faith.

    For example, if the dealership agreement was scheduled to simply expire after three years, and any renewal possibility left to be negotiated as a new contract in the future, it would be far harder for the dealership to argue a duty of good faith required notice that the parties would not be entering into a new contract in the future.

    While removing the renewal language from the contract might seem like a big change during negotiation, it would seem to have little impact on their likely intentions at the time of negotiations, namely that the term would be for 3 years, and any extension was subject to a veto by the Dealer).

    Alternatively, if there was a desire to have automatic renewals subject to some discretion, enumerating points which could give rise to the veto rights and any advance notice provisions may diminish the uncertainty caused by the duty of good faith. (The duty of good faith being a duty to the good faith in the performance of the contract as agreed by the parties, and not a general duty owed to the other party).