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    Archive for August, 2010

    The Edge of Discretion

    Monday, August 30th, 2010

    The advent of the information age has given rise to economies built not on steel, but on ideas.  It is therefore no surprise that intellectual property assets have assumed an increasingly important component of firm balance sheets – and firm value – throughout advanced economies worldwide.

    And yet, though the value of intellectual property is universally recognized and the rights attaching to it increasingly protected, “knowledge assets” are not always treated in the same manner whenever – and wherever – the firm enters restructuring or liquidation.  The story of Qimonda AG is the story of what happens when one country’s rules governing the treatment of an insolvent firm’s intellectual property collide with those of another.

    Qimonda
    Image via Wikipedia

     As the following post suggests, that story is far from over.

    Quimonda AG’s Insolvency.

    Qimonda AG (Qimonda), a producer of Dynamic Random Access Memory (DRAM) chips, also holds a portfolio of approximately 12,000 patents.  A little more than one-third of this intellectual property originated in the US (i.e., it consists of US patents or pending applications); the balance is of German or other international origin.

    Over a 13-year period, Qimonda entered into a series of joint venture and cross-licensing agreements with a number of semiconductor manufacturers.  Under those agreements, Qimonda and these manufacturers cross-licensed tens of thousands of patents.

    DRAM ece385 illustrative example I drew this w...
    Image via Wikipedia

    During 2007 and 2008, prices for PC-based DRAM technology collapsed.  Despite efforts to restructure, Qimonda entered German insolvency proceedings in January 2009.  The Munich court overseeing the proceeding appointed Dr. Michael Jaffé as Qimonda’s insolvency administrator.

    Subsequently, Dr. Jaffé sought and obtained recognition in the US for Qimonda’s German insolvency proceeding.  Dr. Jaffé also obtained concurrent, discretionary relief making certain sections of the US Bankruptcy Code applicable to Qimonda’s Chapter 15 proceeding.  These sections included Section 365, which governs executory contracts – including licensing agreements.

    Both the German Insolvency Code and the US Bankruptcy Code address the administration of executory contracts.  However, US insolvency practitioners will be aware the US Bankruptcy Code – specifically, section 365(n) – protects the intellectual property licensees of a bankrupt licensor.  Under this subsection, the licensee – at its own option – may preserve its rights under an intellectual property license, despite the bankruptcy trustee’s efforts to reject the license.

    The German Insolvency Code provides no such protection.  Instead, Section 103 of that statute simply provides that the court-appointed insolvency administrator may elect performance of contractual obligations or affirm that they remain unenforceable against the estate by electing non-performance.

    Dr. Jaffé’s Proposed Treatment of Qimonda’s Cross-Licensing Agreements.

    Sometime after obtaining recognition and discretionary relief in Virginia, Dr. Jaffé, acting pursuant to German law, provided notification to certain of Qimonda’s cross-licensing partners of his elected non-performance of Qimonda’s patent cross-licensing agreements.

    Those partners, understandably, protested – and argued further that Section 365(n) (made applicable to Qimonda’s Chapter 15 proceeding at Dr. Jaffé’s own request) now prohibited Dr. Jaffé from electing non-performance.  In response, Dr. Jaffe sought the US Bankruptcy Court’s amendment of his previously-granted relief in order to clarify the basis for his non-performance of the cross-licensing agreements.  Specifically, Dr. Jaffé sought a modification of the prior order to provide that Section 365 (and, therefore, Section 365(n)) would be applicable only in such instances where he sought rejection of agreements pursuant to the US statute.

    The Cross-Licensing Partners’ Appeal.

    Following a hearing held 28 October 2009, US Bankruptcy Court Judge Robert Mayer issued a decision granting Dr. Jaffé’s further request, thereby clearing the way for him to elect non-performance of the cross-licensing agreements under German insolvency law.  Qimonda’s partners promptly appealed to the US District Court for Virginia’s Eastern District, arguing (i) that Section 365 – including Section 365(n) – applies automatically to foreign proceedings recognized under Chapter 15 (and, presumably, may therefore not be “modified” or otherwise trifled with by the Bankruptcy Court in the manner proposed by Dr. Jaffé); and, further (ii) that principles of comity applicable under US case law (and the provisions of Chapter 15) did not require the requested modification of the Bankruptcy Court’s prior order.

    In an appellate decision issued 2 July 2010, US District Judge Thomas Selby (Tim) Ellis III remanded the matter back to Judge Mayer for further clarification of two issues – one factual, one legal.  Along the way, however, Judge Ellis offered several important observations regarding the construction of Sections 1521(a) (governing the provision of “any appropriate relief” to the representative of a recognized foreign proceeding) and 1509(c) (governing a recognized administrator’s requests for comity).

    Section 1521(a).

    A significant portion of Judge Ellis’ 36-page decision is devoted to the conclusion that Section 365 of the US Bankruptcy Code does not apply automatically upon recognition of a foreign “main proceeding.”  This seems unremarkable, given that a simple reading of Section 1520(a) makes only select provisions of the Bankruptcy Code applicable automatically in Chapter 15, and that Section 365 is not among them.  As a result, Section 365 – available to a foreign representative only through specific request pursuant to Section 1521(a) – is susceptible to selective or otherwise limited application by the US Bankruptcy Court.  Indeed, the Bankruptcy Court may determine it does not apply at all.

    Far more interesting is Judge Ellis’ conclusion that Dr. Jaffe’s request had been granted without the requisite balancing test set forth in Section 1522.  That section requires that, upon a request for modification of relief previously granted through Section 1519 or 1521, the Court may so modify only after ensuring that “the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.”  11 U.S.C. §1522(a).  Because the evidence relied upon by the Bankruptcy Court to balance creditors’ interests was “anemic,” Judge Ellis remanded the matter for a more full-bodied factual inquiry.

    Specifically, Judge Ellis directed focus on two primary issues:

    How the application of § 365(n) would unavoidably “splinter” or “shatter” the Qimonda patent portfolio “into many pieces that can never be reconstructed,” thereby diminishing its value and rendering the Qimonda patent portfolio essentially unsalable  (“Left unexplained, in particular, is why this is so, given that the continuation of appellants’ non-exclusive licenses for an unspecified percentage of the Qimonda patent portfolio would preclude neither the sale of the patents themselves nor the grant of additional, non-exclusive licenses.”).

    The nature of the U.S. patents licensed to appellants, and whether cancellation of licenses for those patents would put at risk appellants’ investments in manufacturing or sales facilities in this country for products covered by the U.S. patents (“At best, the Bankruptcy Court stated (i) that the application of dissimilar bankruptcy laws to different portions of Qimonda’s patent portfolio ‘may well be detrimental to parties who are or wish to license patents,’ and (ii) that appellees’ demanding that appellants pay new licensing or royalty fees was an ‘unfortunate but an inevitable result’ of Qimonda’s insolvency . . . . It is not readily apparent why this is so.”).

    Though leaving little doubt that Section 365’s applicability to a Chapter 15 proceeding was entirely within the Bankruptcy Court’s sound discretion, Judge Ellis nevertheless observed that “the Bankruptcy Code nonetheless ‘limits the opportunity for a completely unencumbered new beginning to the honest but unfortunate debtor,’ as ‘statutory provisions governing nondischargeability reflect a congressional decision to exclude from the general policy of discharge certain categories of debts.’”

    Under Judge Ellis’s reading of Sections 1521 (and 1522), a Bankruptcy Court enjoys broad discretion – not only to provide “any appropriate relief” to a foreign representative, but to further amend, modify, or terminate the same relief – provided that the Court engage in the affirmative exercise of articulating why the interests of the debtors and the creditor are protected.

    Section 1509(c).

    Judge Ellis’ treatment of judicial discretion did not end with Section 1521.  On appeal, Qimonda’s cross-licensing partners also called into question the Bankruptcy Court’s decision to grant comity to Dr. Jaffé’s application of German insolvency law to the cross-licensing agreements.

    By contrast to the broad discretionary application of “appropriate relief” under Section 1521, Judge Ellis found that a US Bankruptcy Court’s discretion regarding the comity to be afforded determinations rendered under foreign law and pursuant to Section 1509 is far more limited:

    Section 1509 states, in mandatory terms, that “a court in the United States shall grant comity or cooperation to the foreign representative.” 11 U.S.C. § 1509(b)(3) (emphasis added).  . . .  [U]nder the plain terms of § 1509(b)(3), the Bankruptcy Court lacked general discretion to deny the Foreign Administrator’s request for comity; rather, the Bankruptcy Court could only have refused to defer to German Insolvency Code § 103 on the ground that applying German law, instead of § 365(n), would be “manifestly contrary to the public policy of the United States” under § 1506.  Put another way, §§ 1509(b)(3) and 1506, read in pari materia, provide that comity shall be granted following the U.S. recognition of a foreign proceeding under Chapter 15, subject to the caveat that comity shall not be granted when doing so would contravene fundamental U.S. public policy.

    What sort of foreign relief would “contravene fundamental US public policy?”

    Judge Ellis’ review of decisions addressing the “public policy” exception to Chapter 15’s comity mandate indicated that the focus of this exception is on (i) procedural inequity (e.g., a lack of “due process” as that term is commonly understood by US courts); and (ii) frustration of a US court’s ability to administer the Chapter 15 proceeding and/or severe impingement of a U.S. constitutional or statutory right, particularly if a party continues to enjoy the benefits of the Chapter 15 proceeding (e.g., frustration of the “automatic stay” made applicable upon recognition of Chapter 15).

    However, Judge Ellis further found that – as with the “balancing test” required by Section 1522 – the Bankruptcy Court had not gone far enough in its analysis.

    Congress enacted Section 365(n) in direct response to contrary case law and in order to protect the US-based licensees of intellectual property.  Yet the entire section is subject to modification or amendment in Chapter 15 upon the Bankruptcy Court’s discretion – or not applicable at all.

    In light of these mixed judicial signals, is the protection of Section 365(n) therefore “fundamental?”  Or not?  In granting Dr. Jaffé’s request, the Bankruptcy Court had not explicitly decided this question, so Judge Ellis direct that it do so upon remand.

    What Does It Mean?

    Judge Ellis’ Qimonda decision is significant for its analysis of Sections 1509 and 1522 – it appears to endorse, at least in general terms, the flexibility required of an internationally-oriented recognition statute and the latitude potentially available to recognized foreign representatives.

    However, Judge Ellis’ Qimonda analysis is perhaps most significant for what it doesn’t say.  It leaves unanswered what general factors courts might apply to the “balancing test” of creditors’ and debtors’ interests mandated by Sections 1521 and 1522.  And though it describes the outer bounds of “fundamental US public policy” such that otherwise-mandatory comity ought not to apply to the determinations of non-US tribunals, it does little to address the import (if any) to be derived from Congressional amendments specifically intended to protect the rights (or the interests) of general or special US economic interests.

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    Chapter 15 Round-Up

    Tuesday, August 24th, 2010

    Continued global economic uncertainty and an impending 3d quarter slow-down in the US have translated into active global restructuring in recent months. Some of the 2d and 3d quarter’s more newsworthy cross-border filings include:

    Compania Mexicana de Aviacion – Compania Mexicana de Aviacion, generally known as Mexicana, filed for insolvency in Mexico City and Chapter 15 bankruptcy protection in New York on August 2.

    The airline reportedly made its move after failing to reach a new cost-cutting deal with its unions – it claims Mexicana’s labor costs “are well above the average for the industry at the global level, so a leveling is essential for achieving a restructuring with creditors and the company’s viability.” Mexicana claims it will have to slash 40 percent of pilot and flight attendant jobs, with those remaining with the carrier being asked to take 40 percent pay cuts.

    At the time of filing, the company also reported three of Mexicana’s 64 aircraft already had been seized by the leasing companies that own them.

    Fairfield Sentry Ltd., Fairfield Sigma Ltd. and Fairfield Lambda Ltd. – Three financial services companies, established in 1990 as “feeder funds” for the purpose of investing in Bernard L. Madoff Investment Securities LLC, received joint recognition in Manhattan on July 22 in connection with their respective British Virgin Islands insolvency proceedings.

    As reported by the Daily Deal on July 27, all three entities sold shares to individuals who were neither residents nor citizens of the United States. Such investors also included pension and profit-sharing trusts, charities and other tax-exempt entities. Fairfield Sentry, the largest of the feeder funds, offered its shares in U.S. dollars, while Fairfield Sigma offered shares in Euros and Fairfield Lambda provided them in Swiss francs.

    Bernard Madoff's mugshot
    Image via Wikipedia

     

    Fairfield Lambda was placed into liquidation by the Eastern Caribbean Supreme Court in the High Court of Justice in British Virgin Islands in April 2009 upon application by Commerzbank AG, then known as Dresdner Bank AG. Fairfield Sentry’s and Fairfield Sigma’s liquidations were approved by the same court in July following similar creditor requests.

    Cozumel Caribe SA de CV – The Mexico City-based operator of the 348-room Hotel Park Royal Cozumel resort sought recognition for a previously-commenced concurso mercantil proceeding (filed in the Third District Court of the Mexican State of Quintana Roo) on July 20 in Manhattan.

    Cozumel Caribe blamed its financial woes on declines in Mexican tourism, which has been beleaguered of late by a weak Mexican peso, the outbreak of H1N1 flu virus, and State Department advisories regarding increased crime in Mexico. Cozumel Caribe’s own cash woes were allegedly further compounded by lender CT Investment Management Co.’s alleged failure to withhold tax receipts and funds to cover daily operations.

    Minster Insurance Co. Ltd. – The London insurer and its affiliate, Malvern Insurance Co. Ltd., sought recognition on July 19 in furtherance of its previously-approved solvent scheme of arrangement, made pursuant to Part 26 of the U.K. Companies Act 2006. A hearing to consider the recognition is scheduled for Aug. 27.

    Controladora Comercial Mexicana SAB de CV – The operator of Costco Wholesale Corp. outlets in Mexico, and the country’s third-largest retailer, sought recognition in New York on July 16 in furtherance of its prenegotiated concurso mercantil proceeding in Mexico City.

    As reported by the Daily Deal, CCM will restructure a total of $3.3 billion through its prenegotiated bankruptcy filing, including approximately $2.2 billion worth of derivative obligations owed to J.P. Morgan Chase NA, Barclays Bank plc, Goldman Sachs Group Inc., Bank of America Merrill Lynch, Banco Santander (Mexico) SA, Banco Nacional de Mexico SA and Citibank NA, and $99.4 million in unsecured debt owed to seven unspecified Mexican commercial banks. The restructuring is purportedly supported by 85% of its debt holders.

    CCM’s prenegotiated plan follows an earlier, failed 2008 concurso bid, which subsequently drove the parties to the bargaining table.

    ABC Learning Centres Ltd. – The Australian childcare center operator sought recognition of its voluntary winding up proceeding over the objection of RCS Capital Development LLC.  ABC and RCS are involved in litigation over the development of child care centers in Arizona and Nevada.  In addition to opposing recognition, RCS sought relief from the automatic stay to enter judgment upon a jury verdict rendered in its favor in Arizona, and to assert that judgment as an offset against claims made by ABC in Nevada.

    At a hearing held August 9, Delaware Bankruptcy Judge Kevin Gross took both matters under advisement. As of the date of this writing, no decision has been rendered.

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    A New Type of Government Refund: Criminal Restitution Payments Recoverable as Preferential Transfers

    Sunday, August 15th, 2010

    From the 9th Circuit last week, a decision providing creditors and their representatives with a potentially new source of preferential recoveries: pre-petition criminal restitution payments.

    Seal of the United States Court of Appeals for...
    Image via Wikipedia

     

    Jeffrey and Faye Silverman – electrical contractors – were indicted in 2005 for fraud and underpayment of workers’ compensation insurance premiums.  In March of that year, they paid the California State Compensation Insurance Fund $101,531 in restitution as part of a plea agreement and their court-ordered sentence.  Less than 60 days later, they sought relief under Chapter 7.

    Their trustee sought recovery of the restitution payment from the State Fund under the theory that the payment was a preferential transfer under Section 547(b) of the Bankruptcy Code.

    Both sides moved for summary judgment.  For its part, the State Fund argued that Section 547(b) doesn’t apply to criminal restitution payments, citing Kelly v. Robinson, 479 U.S. 36 (1986) and Becker v. County of Santa Clara (In re Nelson), 91 B.R. 904 (N.D. Cal. 1988).  Kelly held that criminal restitution payments are non-dischargeable under Section 523(a)(7).  Nelson extended Kelly to hold that payments on such non-dischargeable obligations are not recoverable as preferences.

    The Bankruptcy Court for the Central District of California was not persuaded – nor was the District Court, which heard the matter on appeal following entry of summary judgment in the trustee’s favor.

    The Ninth Circuit agreed.  Finding that criminal restitution payments are, in fact, subject to the preference statute, the Ninth Circuit held that State Fund enjoyed no “judicial exception” to Section 547(b)’s reach.  In the 3-judge panel’s view, an obligation’s non-dischargeability is separate and distinct from recovery of its pre-petition payment as a preference.  Further, the restitution payments to State Fund were “to or for the benefit of” State Fund within the contemplation of Section 547(b)(1) - State Fund’s arguments to the contrary notwithstanding.

    The decision is an important one for creditors’ representatives and committees seeking possible additional sources of recovery where the debtor has been attempting to resolve criminal problems pre-petition.

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    DIP Lending in Transition

    Monday, August 9th, 2010

    As the economy lurches forward into an uncertain back half of 2010, the DIP lending market remains in flux.  In a short piece appearing in the Journal of Corporate Renewal last Wednesday, Imran Choudhury and Frank Merola – both of Jeffries & Co., Inc. - offer a concise overview of the factors affecting credit availability and expense over the last two years.

    After a sharp contraction in 2008, Choudry and Merola show how DIP funding has increased – both in terms of deal size and in terms of new money . . .

    and likewise, how spreads have eased during the same period . . . .

    Their walk-away, in light of this data:

    “The overall state of the DIP financing market has changed over the last couple of years as the broader credit markets have changed. Lower yields due to improvements in the overall credit markets have resulted in lower rates in the DIP loan market as well.

    While it is difficult to say precisely what DIP yields will be over the next year or so, it seems very likely that the worst part of the credit cycle is over and DIP yields are not going to reach the same levels as they did in late 2008 and early 2009. Even though yields on DIP loans are not at their peak levels, the loans will still likely be used for . . . strategic reasons—protecting existing debt positions or controlling restructuring processes or acquiring assets through credit bids.”

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    Southern California – America’s Small Business Bankruptcy Leader

    Monday, August 2nd, 2010

    In a globalized business environment, it should be no surprise that some of the more interesting – and better – economic reporting on the US economy now comes from offshore.

    Last month, China’s Xinhua news agency reported that California leads the nation in small-business bankruptcies.  The report – based on data reported by Equifax – covers small business filings under all applicable chapters of the Bankruptcy Code (i.e., Chapters 7, 11, and 13).  The Xinhua report (it broke the story a day before the Orange County Register) is here.

    Equifax’s reporting shows that California remains the most impacted state, with the Los Angeles and Riverside/San Bernardino MSA’s leading the nation in small business bankruptcy flings by a significant margin.  

    The chart below provides a closer look at this trend.

                                                        # of
                     MSA         # of Bankruptcies Bankruptcies  % of Increase
                                        Q1 2009        Q1 2010
        Los Angeles-Long
         Beach-Glendale, CA                899          1035          15.13%
        Riverside-San
         Bernardino-Ontario,
         CA                                663           736          11.01%
        Sacramento-Arden-
         Arcade-Roseville,
         CA                                462           522          12.99%
        Houston-Sugar Land-
         Baytown, TX                       365           399           9.32%
        San Diego-Carlsbad-
         San Marcos, CA                    345           387          12.17%
        Portland-Vancouver-
         Beaverton, OR-WA                  276           386          39.86%
        Denver-Aurora, CO                  304           382          25.66%
        Santa Ana-Anaheim-
         Irvine, CA                        359           370           3.06%
        California -Rest of
         State                             233           335          43.78%
        Phoenix-Mesa-
         Scottsdale, AZ                    234           327          39.74%
        Dallas-Plano-
         Irving, TX                        348           323          -7.18%
        Chicago-Naperville-
         Joliet, IL                        395           314         -20.51%
        Atlanta-Sandy
         Springs-Marietta,
         GA                                336           304          -9.52%
        Oregon -Rest of
         State                             235           299          27.23%
        ---------------                    ---           ---          -----
        New York-White
         Plains-Wayne, NY-
         NJ                                335           272         -18.80%
        ------------------                 ---           ---         ------

    Inc. Magazine picked up the story last week, commenting that “no area has been insulated from the recession and the economy clearly isn’t rebounding quickly enough.”

    No kidding.

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