The South Bay Law Firm Law Blog highlights developing trends in bankruptcy law and practice. Our aim is to provide general commentary on this evolving practice specialty.

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      Bankruptcy and Insolvency News and Analysis Week Ending October 21, 2016
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    Bankruptcy and Insolvency News and Analysis Week Ending October 14, 2016

    A Chip Too Far


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    Nearly 16 months ago, this blog covered the story of Qimonda AG – a German chip manufacturer whose cross-border liquidation created waves on both sides of the Atlantic.  As noted in that prior post, Qimonda’s insolvency proceeding illustrates what can happen when one country’s rules governing the treatment of an insolvent firm’s intellectual property assets collide with those of another.

    But what can happen is not always what does happen.

    As a liquidating entity, Qimonda’s primary assets were its portfolio of patents, licensed to other firms under a series of cross-licensing agreements.  Though not completely settled law in Germany, patent cross-licenses are widely viewed by German practitioners as executory agreements.  Such agreements are automatically unenforceable unless the insolvency administrator (the functional equivalent of a trustee under US bankruptcy law) affirmatively elects to perform the contracts.  In practice, to avoid any implied election of performance, an insolvency administrator will usually send a letter of non-performance to the counter-party.  Consistent with this practice, Qimonda’s administrator had issued non-performance letters to a number of licensees in connection with his proposed disposition with Qimonda’s patents, which were the company’s most valuable remaining asset following a decision to liquidate.  The business strategy was to maximize the value of Qimonda’s patents by canceling, then re-negotiating, the company’s patent licenses with Qimonda’s original licensees.

    In response, the licensees asserted rights with respect to Qimonda’s US patents under Bankruptcy Code section 365(n), which – contrary to German law – specifically protects the rights of patent licensees in the event of a licensor’s bankruptcy.  Qimonda’s recognition under Chapter 15 of the Bankruptcy Code had made Section 365 “applicable” to the company’s ancillary proceedings in the US.

    Qimonda’s administrator sought the Bankruptcy Court’s elimination or restriction of Section 365’s applicability to the company’s US patents, in light of his proposed disposition of the patents under conflicting German insolvency law.  The Bankruptcy Court restricted 365(n)’s applicability, but the District Court remanded on appeal for a determination of whether doing so was “manifestly contrary to the public policy of the United States” and whether the licensees would be “sufficiently protected” if Section 365(n) did not apply.

    After four days of evidentiary hearings and one day of argument, the Bankruptcy Court concluded that:

    – Chapter 15 of the US Bankruptcy Code, which is rooted in considerations of comity and deference to the decisions of foreign tribunals, is nevertheless limited by the “sufficient[] protect[ion] of creditors’ interests.”  Moreover, any relief requested by a foreign representative seeking recognition and relief in the US under this statute is further limited when granting such relief “would be manifestly contrary to the public policy of the United States.”

    – The protections afforded patent licensees by Section 365(n) have their origins in Congressional reaction to the Fourth Circuit’s decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), a decision involving the debtor’s rejection of a fully paid-up license to a non-bankrupt licensee for use of the debtor’s metal coating technology.  Most disturbingly for Congress, the Lubrizol court found that rejection under Section 365(a) effectively prohibited the licensee’s continued receipt of specific performance under the agreement, even if that remedy would otherwise be available under a  breach of this type of contract.  Congress’ answer to the Lubrizol decision was to pass the “Intellectual Property Licenses Act of 1987,” which included the licensee protections of Section 365(n).  According to the Congressional history behind the statute, adoption of the legislation was intended to “immediately remove [the threat of license rejection] and its attendant threat to American [t]echnology and will further clarify that Congress never intended for Section 365 to be so applied.”

    – Though the nature of patent cross-licensing made it difficult – if not impossible – for the parties to establish whether the cancellation of licenses for specific patents would put at risk the licensees’ investment in manufacturing or sales facilities in the US for products covered by US patents, the administrator’s threat of infringement litigation following cancellation of Qimonda’s patent licenses was as damaging to licensees as an actual finding of infringement of specific patents.  This risk, balanced against the loss in value to Qimonda’s patent portfolio, warranted the application of Section 365(n) to the administrators disposition of the company’s US patents.

    – Application of the German insolvency law as an exercise of comity would “severely impinge[] . . . a U.S. statutory . . . right such that deferring to German law would defeat ‘the most fundamental policies and purposes’ of such right[].'”  For the Bankruptcy Court, the question of whether or not Section 365(n) was intended to protect a “fundamental” US policy was an extremely close one.  But “[a]lthough [technological] innovation [in the US] would obviously not come to a grinding halt if licenses to U.S. patents could e cancelled in a foreign insolvency proceeding, . . . the resulting uncertainty would nevertheless slow the pace of innovation, to the detriment of the U.S. economy.”  As a result, the failure to apply Section 365(n) to Qimonda’s US patent portfolio “would ‘severely impinge’ an important statutory protection accorded licensees of U.S. patents and thereby undermine a fundamental U.S. public policy promoting technological innovation” – and as such, deferring to German law would be “manifestly contrary to U.S. public policy.”

    The Bankruptcy Court’s most recent decision is available here.

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