Intellectual Property Transactions: Dealing with Financial Hardship imposed by COVID-19
Very few, if any, commercial enterprises will not be affected by the current COVID-19 pandemic and the measures governments are introducing to combat it. This applies as much to parties to intellectual property arrangements as it does to parties to any other commercial arrangement. However, this article will deal specifically with the issues which are most likely to arise in the context of the licensing of intellectual property rights.
As a general proposition, the terms of the particular intellectual property licence under consideration will govern the extent to which commercial hardship will affect the requirement for observance of the obligations and the exercise of contractual rights under the arrangement. For instance, if the licence contains a hardship clause or a force majeure clause then analysis of the relevant clause to see whether it applies in the present circumstances would be required. We comment further on force majeure clauses here.
Contracts governed by overseas laws: hardship clauses and other provisions
Whilst it is probably fair to say that hardship clauses are relatively uncommon in Australia in domestic contracts, some foreign countries actually provide for contractual hardship in their legislation. In China, for example, the Supreme Court handed down the following direction in the Interpretation of the Supreme People’s Court on Several Issues Concerning the Application of the Contract Law of the People’s Republic of China in 2009:
‘Interpretation (II) Article 26: After the contract was established, where the objective circumstances have major changes that are unforeseeable and not a commercial risk caused by force majeure when entering into the contract, the continued performance of the contract is obviously unfair to one party or the purpose of the contract cannot be achieved, the party can request the People’s Court to modify or terminate the contract. The People’s Court shall determine whether to modify or terminate the contract in accordance with the principle of fairness and the actual situation of the case.’
Other examples of countries which have provisions in their law dealing with changed circumstances leading to hardship include France (Article 1195 of the French Civil Code), Germany and Switzerland. Thus, in all cases it will be important to determine and have regard to the law to which the licence is subject.
The situation regarding circumstances amounting to force majeure is much the same. Some countries, such as China, have provided for force majeure in their contract law. Once again, the questions will be: what law governs the contract; do the current circumstances fit within the statutory provisions; and, are/can the provisions be excluded by the express terms of the licence.
The Vienna Convention on Contracts for the International Sale of Goods
A force majeure provision might also be available to a distressed licensee if the licence qualifies as a contract for the sale of goods between parties which have places of business in different contracting states under the Vienna Convention on Contracts for the International Sale of Goods. This will be rare because the Convention does not apply to contracts ‘… in which the preponderant part of the obligations of the party who furnishes the goods consists in the supply of labour or other services’. In a licence context the main service provided is likely to be the licence itself. However, where the Convention does apply, Article 79 provides that:
‘A party is not liable for a failure to perform any of his obligations if he proves that the failure was due to an impediment beyond his control and that he could not reasonably be expected to have taken the impediment into account at the time of the conclusion of the contract or to have avoided or overcome it or its consequences.’
The other point to note is that the provisions of the Vienna Convention can be excluded by the parties, which is often done.
The Australian position: compliance with terms in IP licences
Australia does not have laws dealing with hardship and force majeure circumstances in commercial contracts, but it does have laws which could affect the enforcement of rights under an intellectual property licensing arrangement.
In the first place, each State and Territory has legislation which deal with the frustration of contracts. We have previously commented on such provisions here. As noted in the article, frustration of a contract occurs where performance of a contract becomes impossible or radically different to that contemplated by the parties as the result of something not caused by a party and the contract does not otherwise deal with that occurrence; for example through a force majeure provision. The threshold for establishing frustration of a contract is high.
Other laws which could affect the enforcement of rights under an intellectual property licensing arrangement are to be found in the Australian Consumer Law (the ACL) in the prohibitions on engaging in unconscionable conduct (section 18) and the imposing of unfair contract terms (section 23).
Unconscionable conduct is a fairly loose concept in law and the ACL does not attempt to define the term. As the Australian Competition and Consumer Commission (ACCC) says in its fact sheet relating to unconscionable conduct:
‘To be considered unconscionable, conduct it must be more than simply unfair—it must be against conscience as judged against the norms of society. Business behaviour may be deemed unconscionable if it is particularly harsh or oppressive, and is beyond hard commercial bargaining.’
The ACL, for current purposes, prohibits a person in trade or commerce in connection with the acquisition or supply of goods or services engaging in conduct that is in all the circumstances unconscionable. The law gives a shopping list of factors which a court is to take into account in determining whether or not conduct is unconscionable and an explanation of parliament’s intention in imposing the prohibition. In particular, the law states that it is the intention of parliament that in considering whether conduct to which a contract relates is unconscionable, the court may consider “…the manner in which and the extent to which the contract is carried out; and is not limited to consideration of the circumstances relating to formation of the contract.” This leaves the way open for an argument to be run that, in exercising certain rights under a contract relating to the acquisition or supply of goods or services, the manner in which that exercise is undertaken is conduct which can be evaluated from the point of view of unconscionability.
The ACL also prohibits the imposition of unfair contract terms in standard form consumer and small business contracts. For present purposes, this article will concentrate on small business contracts.
A standard form contract is basically a contract where one party did not have a realistic opportunity to negotiate the terms.
A small business contract is one which:
- is for the supply of goods or services or the sale or the grant of an interest in land;
- at the time the contract is entered into, at least one party employs fewer than 20 persons; and
- the upfront price payable does not exceed $300,000.00 or, if the contract is for more than 12 months, the upfront price payable under the contract does not exceed $1 million.
Section 24 of the ACL provides that a term of a small business contract is unfair if it causes a significant imbalance in the party’s rights and obligations, is not reasonably necessary to protect the legitimate interests of the advantaged party and would cause detriment if it were applied or relied on. Section 25 of the ACL sets out examples of terms which might be unfair. These include a term which permits one party (but not another party) to terminate the contract, a term that allows one party (but not another party) not to renew a contract and a term which has the effect of allowing one party (but not another party) to avoid or limit performance of the contract.
The prohibition on unfair contract terms assumes greater importance in the current economic environment as it provides a possible argument which could be used by a licensee under financial distress to challenge the exercise of a right of a licensor under a licence. Thus, there are both laws and contractual provisions which could regulate a party’s rights and obligations under a licence agreement depending upon the applicable governing law and the contract provisions respectively.
Payment of royalties
The types of situation which might arise in respect of licences in the current economic conditions are many. However, in the first place, many licences provide for running royalties to be paid by a licensee. In most cases, these would be calculated by reference to production or sales and so a reduced volume of sales by the licensee will mean a corresponding reduction in the required royalty payment. Compliance with that obligation might not create hardship for a licensee for that reason. However, where the reduction in sales means that a licensee does not have the income to cover fixed or unavoidable costs, the licensee might be forced to prioritise who gets paid in full, who gets paid in part or who does not get paid at all. The issue for the licensee is what the consequences of part payment or non-payment of the royalty will be.
In order to answer that question, the first port of call will be the licence agreement itself. If the agreement contains a force majeure clause, then the next step will be to determine whether the clause excuses non-payment of royalties. As a general comment, this is unlikely to be the case unless expressly provided for because most force majeure clauses require that performance must be rendered impossible or hindered by the force majeure event; the courts have long held that inconvenience does not reach this threshold. Thus, even though the COVID-19 pandemic is likely to be a force majeure event, the impact of it might not fall within the ambit of a force majeure clause in this respect.
The situation for a licensee will be compounded if the licence contains minimum royalty obligations or renewal provisions which are conditioned on a specified level of production or sales. However, the good news for a licensee in respect of those provisions might be that compliance with them could be more easily be said to be prevented or hindered by the force majeure event; whether it is the pandemic itself or the Government measures implemented to combat it.
Compliance with other contractual obligations
Other obligations or circumstances which might be affected by the COVID-19 pandemic or the Government measures to combat it would include obligations to remain open for business at certain times as might be the case in a franchise arrangement, inspection obligations, compliance with performance obligations, the provision of services (such as training or repair) to a licensee, continuation of research programs, advertising commitments and, subject to the recent amendments to the Corporations Act 2001 (Cth), avoiding insolvency. In all of these cases, it is conceivable that compliance with these obligations will be at least inconvenient and involve hardship; particularly for a licensee in financial distress. The questions will be whether there is anything in the licence agreement itself or which is implied by the governing law which will excuse performance or full performance of a contractual obligation, whether the contract is frustrated as a matter of the relevant law or whether insistence on compliance by a licensor will involve the exercise of rights under an unfair term or amount to unconscionable conduct or similar laws which might apply in jurisdictions outside Australia.