Fourth Circuit Upholds Extension of U.S. Bankruptcy Code Protections to Intellectual Property Licensees in Chapter 15 Case

Business Restructuring, Creditors’ Rights & Bankruptcy Update

Date: December 12, 2013

The United States Court of Appeals for the Fourth Circuit recently affirmed the bankruptcy court decision in the Qimonda AG chapter 15 bankruptcy case,1 providing that holders of intellectual property licenses based on U.S. patents are entitled to the special protections contained in 11 U.S.C. § 365(n).2 In so doing, the court bolstered the rights of U.S. intellectual property licensees whose agreements might otherwise be vulnerable to termination in a cross-border insolvency proceeding.

Background

Qimonda AG (Debtor), a German manufacturer of semiconductors, filed an insolvency proceeding in Munich, Germany in January 2009. The German court appointed Dr. Michael Jaffé (Administrator) to serve as the Debtor’s insolvency administrator and to wind up the Debtor’s affairs and sell its assets. The Debtor’s most valuable assets were its roughly 10,000 patents, about 4,000 of which were issued in the United States.

As a significant portion of the Debtor’s assets consisted of U.S. patents, the Administrator filed an application in the U.S. Bankruptcy Court for the Eastern District of Virginia (Bankruptcy Court) requesting recognition of the German insolvency proceeding and various forms of relief under chapter 15 of the Bankruptcy Code. The Bankruptcy Court approved the application, entering an order naming the Administrator as the exclusive representative of Qimonda AG in the United States and providing that several sections of the Bankruptcy Code would apply to the U.S. ancillary proceeding, including § 365.

The Debtor, like most other companies in the semiconductor business, was party to numerous cross-license agreements allowing designated entities to use its patents. Shortly after filing the chapter 15 petition, the Administrator sent notices to the entities that had entered into license agreements with the Debtor relating to its U.S. patents, informing them that he was terminating the license agreements pursuant to § 103 of the German Insolvency Code.3 A number of U.S. licensees protested, asserting that under § 365(n) of the Bankruptcy Code, the Administrator could not terminate the licenses, and several licensees (Objecting Licensees) filed a formal objection with the Bankruptcy Court.

The Bankruptcy Court’s Decision

Relying on two sections of chapter 15 of the U.S. Bankruptcy Code, the Bankruptcy Court ruled that the Objecting Licensees were entitled to the protections of§ 365(n) with respect to the Debtor’s U.S. patents.

The Bankruptcy Court first looked to § 1522(a)4 and found that it was required to balance the Debtor’s interests against the Objecting Licensees’ interests to determine whether § 365(n) should be made applicable to the administration of the Debtor’s chapter 15 case. After weighing the potential harm to both sides, the court was persuaded that if it did not require the Administrator to abide by § 365(n), it would create a “very real” risk to the substantial investment the licensees had collectively made in research and manufacturing facilities in the United States, an investment primarily made in reliance on the design freedom provided by the cross-license agreements.5 While the Bankruptcy Court acknowledged the Debtor’s estate would realize a higher recovery if the Administrator were able to terminate the license agreements, the court was not persuaded this interest outweighed the damages the Objecting Licensees would incur if § 365(n) were held not to apply.

As a separate rationale for its holding, the Bankruptcy Court determined that the relief sought by the Administrator would violate § 1506 of the Bankruptcy Code, which allows a court to refuse to apply a foreign jurisdiction’s law if application of that law “would be manifestly contrary to the public policy of the United States.”6 The court, noting that Congress created § 365(n) to protect “American technological development” and promote innovation, concluded it would be contrary to American public policy to deny the Objecting Licensees these protections.7

The Fourth Circuit’s Decision

The Administrator appealed and asked the district court to certify a direct appeal to the Fourth Circuit. The district court agreed these issues were appropriate for a direct appeal; the Fourth Circuit concurred and authorized the direct appeal.8

The Administrator made three arguments to the Fourth Circuit in support of his contention that the Bankruptcy Court erred in holding that under § 1522(a) he had to abide by § 365(n) with respect to licenses relating to the Debtor’s U.S. patents. Specifically, he argued that the Bankruptcy Court erred in even considering § 1522(a) since that section only applies to relief requested by the foreign administrator and he had never requested relief under § 365(n).9 Also, he asserted the Bankruptcy Court utilized the wrong test when it balanced the Debtor’s interests against those of the Objecting Licensees. Finally, the Administrator argued that the Bankruptcy Court overestimated the risk of harm to the Objecting Licensees.

The Fourth Circuit was not persuaded by the Administrator’s arguments. The court disagreed that the Bankruptcy Court erred in considering § 1522(a) and stated that the Administrator’s interpretation of that section was too narrow. Additionally, while acknowledging the Administrator’s interpretation of the balancing test contained in § 1522(a) was plausible, the court held that the test employed by the lower court was more logical and better captured the intent of Congress and the drafters of the United Nations Commission on International Trade Law (UNCITRAL) Model Law on Cross–Border Insolvency.10 Finally, the Fourth Circuit determined that the Bankruptcy Court reasonably weighed both the Debtor’s and the Objecting Licensees’ interests and thus refused to overturn the Bankruptcy Court’s decision to extend the protections contained in § 365(n) to the holders of license agreements involving the Debtor’s U.S. patents.

Since the Fourth Circuit affirmed the Bankruptcy Court’s holding on the grounds that it correctly interpreted § 1522(a), the Fourth Circuit did not directly address the Bankruptcy Court’s alternative rationale that denying the Objecting Licensees the protections contained in § 365(n) would be manifestly contrary to U.S. public policy. However, in the last section of the opinion the court intimated it agreed with the Bankruptcy Court’s conclusion on this point.11

Future Implications for Licensees

The Fourth Circuit decision will have a significant impact on chapter 15 cases in which the debtor’s estate includes U.S. patents subject to cross-license agreements. The decision will undoubtedly strengthen the position of intellectual property licensees in their negotiations with the debtor. The case also stands as strong authority for the proposition that the interests of U.S. creditors must be “sufficiently protected,” which is an easier standard to satisfy than establishing that another country’s law is “manifestly contrary” to U.S. public policy.

There are, however, several important limitations and unanswered questions from the Qimonda case. First, both the Bankruptcy Court and the Fourth Circuit were careful to limit their holdings to the territorial jurisdiction of the United States.

Second, since the Fourth Circuit did not reach a decision on the public policy question, a debtor may still be able to prevail if it can convince a court that the facts in its case should lead to a different result under § 1522(a). Thus, both debtors and intellectual property licensees should be prepared to present evidence demonstrating their respective interests are entitled to greater weight in the § 1522(a) analysis. However, this argument could become moot if courts conclude that disregarding an objecting licensee’s § 365(n) rights is manifestly contrary to U.S. public policy and thus cannot be enforced under § 1506.

Finally, it is unclear whether other circuits will follow the Fourth Circuit’s decision.12 It is worth noting the United States appeared as amicus curiae, arguing the Bankruptcy Court overstepped its authority.13 While the Fourth Circuit disagreed, other jurisdictions could reach a different conclusion.

Important questions remain, but the Fourth Circuit’s decision represents a significant victory for parties with intellectual property licenses based on U.S. patents.

FOR MORE INFORMATION

For more information on these and other cross-border insolvency, intellectual property, and restructuring and bankruptcy issues, please contact:

Alan R. Lepene
216.566.5520
Alan.Lepene@ThompsonHine.com

William H. Schrag
212.908.3961
William.Schrag@ThompsonHine.com

Jim Henderson
216.566.5731
James.Henderson@ThompsonHine.com

Curtis L. Tuggle
216.566.5904
Curtis.Tuggle@ThompsonHine.com

Andrew L. Turscak, Jr.
216.566.5617
Andrew.Turscak@ThompsonHine.com

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1See Jaffé v. Samsung Electronics Co. Ltd., 2013 U.S. App. LEXIS 24041 (4th Cir. Dec. 3, 2013).

2Section 365(n) grants intellectual property licensees special protections, including restrictions upon a debtor’s ability to unilaterally terminate intellectual property license agreements. See 11 U.S.C. § 365(n).

3Id. at *12. As the Fourth Circuit explained, § 103 of the German Insolvency Code is similar to Bankruptcy Code § 365, in that it allows an insolvency administrator to decide whether a debtor will continue to perform under its executory contracts. However, § 103 does not provide a German intellectual property licensee with the same protections afforded to a U.S. intellectual property licensee under § 365(n).

4Under § 1522(a) a court may grant the type of relief a debtor requests only “if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.” 11 U.S.C. § 1522(a).

5Jaffe, 2013 U.S. App. LEXIS 24041 at *20.

611 U.S.C. § 1506.

7Jaffe, 2013 U.S. App. LEXIS 24041 at *21.

8Id. at *22.

9Id. at *28. However, it is interesting to note that at the outset of the chapter 15 case, the Administrator sought a supplemental order making Code § 365 applicable, which the Administrator subsequently moved to delete in its entirety. Id. at *11–12.

10Id. at *35-36. As noted by the Fourth Circuit, chapter 15 is based on the UNCITRAL Model Law on Cross-Border Insolvency.

11Id. at *48-51. Judge Wynn, in a short concurrence, refused to join this section of the opinion because he felt the discussion was “unnecessary dictum.”

12The Fourth Circuit stated that it was joining the Fifth Circuit, which one year earlier had similarly interpreted § 1522(a). See In re Vitro S.A.B. de C.V., 701 F.3d 1031 (5th Cir. 2012).

13Id. at *29-30 n. 3. Specifically, the United States was concerned that the Bankruptcy Court was attempting to “superimpose Section 365(n) on the operation of German insolvency law in a German proceeding.” However, the Fourth Circuit took the view that the Bankruptcy Court’s holding was limited to patents issued by the United States and to the territorial jurisdiction of the United States.