Restructuring

Contributed by Dana Hall
In the day to day litany of bankruptcy decisions discussing deteriorating market conditions, declining output, and corporate greed and malfeasance, it’s not all that often that we read a new case and feel a sense of . . . well, patriotism?  In In re Qimonda AG Bankruptcy Litigation, the United States Bankruptcy Court for the Eastern District of Virginia, rooting its holding in the fundamental U.S. public policies of fostering technological growth and innovation, determined that the protections of section 365(n) of the Bankruptcy Code apply to licensees of a foreign debtor’s U.S. patents.  The court premised its holding on its findings that (a) the balancing of debtor and creditor interests, mandated by a joint reading of sections 1521(a)(7) and 1522 of the Bankruptcy Code, strongly favored the application of section 365(n) with respect to the U.S. patent portfolio of Qimonda, a foreign debtor, and (b) permitting a foreign debtor to use foreign law in a chapter 15 case to non-consensually terminate various U.S. patent licensing agreements would be “manifestly contrary to the public policy of the United States” pursuant to section 1506 of the Bankruptcy Code.
Background
Qimonda, a semiconductor manufacturer, holder of thousands of U.S. patents, and party to several U.S. patent licensing, cross-licensing, and joint venture agreements, commenced insolvency proceedings in Germany in January of 2009.  In July of that same year, the United States Bankruptcy Court for the Eastern District of Virginia granted Qimonda’s insolvency administrator’s petition for recognition of the German proceedings as a foreign main proceeding under chapter 15 of the Bankruptcy Code and simultaneously entered a supplemental order that made certain provisions of the Bankruptcy Code, including section 365, applicable to the chapter 15 case.
After entry of the supplemental order, Qimonda sent letters to various licensees electing, under the German Insolvency Code, not to perform under the license agreements.  In response, various licensees asserted their right to retain licenses for Qimonda’s patents pursuant to section 365(n) of the Bankruptcy Code.  Generally speaking, section 365(n) provides that if a debtor-licensor terminates an intellectual property licensing agreement, the non-debtor licensee may either treat such rejection as a termination of the agreement or, alternatively, retain its rights under the licensing agreement.  As a result, Qimonda asked the bankruptcy court to amend the supplemental order to provide that section 365(n) would only apply in the event that the foreign representative specifically rejected a contract pursuant to section 365, as opposed to the election of non-performance under German law.  After briefing and argument on the issue, the bankruptcy court granted Qimonda’s requested relief.
On appeal, the District Court for the Eastern District of Virginia determined that the bankruptcy court had failed to adequately balance the licensees’ and the debtors’ interests against one another, as required by section 1522 of the Bankruptcy Code, and that the bankruptcy court had failed to determine, as required by section 1506, whether the relief granted was “manifestly contrary” to U.S. public policy.  Accordingly, the district court remanded the proceeding to the bankruptcy court for a determination in accordance with its opinion.
Section 1522 Balancing Test
Although section 365 of the Bankruptcy Code does not automatically apply in a chapter 15 case, section 1521(a)(7) permits a court, in the exercise of its discretion, to grant the relief provided under section 365.  To grant discretionary relief pursuant to section 1521, however, section 1522 of the Bankruptcy Code requires that the bankruptcy court ensure that the interests of creditors and debtors alike are “sufficiently protected.”
On remand, the Qimonda court explained that the “sufficiently protected” standard of section 1522 requires the court to “tailor relief . . . so as to balance the relief granted to the foreign representative and the interests of those affected by such relief.”  In conducting its balancing analysis, the bankruptcy court recognized that technology companies such as the licensees to Qimonda’s patents enter into licensing agreements in order to avoid the threat of patent infringement litigation and the payment of “hold-up premiums.”  The court concluded that the semiconductor industry, in particular, is characterized by the existence of a “patent thicket” in which any semiconductor device may “incorporate technologies covered by a multitude of patents.”  Licensing and cross-licensing agreements give companies “design freedom” to expend resources researching and developing new products without the overhanging concern that a patent holder may later attempt to extort a hold-up premium on account of the innovator’s incorporation of a patented technology into a new product.  The bankruptcy court was unable to quantify the harm that might result to the Qimonda licensees if the court did not mandate the application of section 365(n), but the court recognized that the prospect of infringement litigation posed a “very real” threat to future development and to previous research and development investments that had been made in reliance on the licensing agreements.  Although the bankruptcy court also recognized that its application of section 365(n) to the U.S. patent licensing agreements would decrease the value realized by the Qimonda estate (because Qimonda would be unable to unilaterally terminate the licenses and then seek to re-license the patents for new value), the bankruptcy court determined that the risk of harm to the patent licensees outweighed the harm to the debtors.  Accordingly, the bankruptcy court determined that any right of the debtors to administer any U.S. patents should be subject to the limitations of section 365(n).
Section 1506 Public Policy Concerns
Notwithstanding the court’s more narrow holding under section 1522, the court went on to determine more broadly that a U.S. bankruptcy court’s failure to apply section 365(n) to a chapter 15 debtor’s U.S. patent licensing agreements would be “manifestly contrary” to U.S. public policy.  Although section 1509(b)(3) of the Bankruptcy Code broadly mandates that a United States court grant comity to a foreign representative, section 1506 permits a bankruptcy court to refuse to take an action where such action “would be manifestly contrary to the public policy of the United States.”  Section 365(n) was passed in response to the infamous Lubrizol decision and was motivated in large part by Congressional concern that a failure to protect the rights of licensees in bankruptcy would have the adverse consequence of encouraging would-be licensees to insist on obtaining an assignment instead of a license, thereby decreasing returns to inventors and creating disincentives to research and development.  The licensees in Qimonda focused on a different threat – that the court’s failure to apply section 365(n) to a foreign debtor’s U.S. patent portfolio in chapter 15 would create uncertainty and slow the pace of technological innovation in contravention of the fundamental U.S. public policy of promoting technological innovation and growth.  Accordingly, the bankruptcy court determined that, to the extent that granting comity to German insolvency law would enable a foreign debtor to unilaterally terminate U.S. patent licensing agreements, the court’s failure to grant licensees of such patents the protections of section 365(n) would be manifestly contrary to U.S. public policy.
Weil represents Micron Technology, Inc., one of the licensees of Qimonda AG’s patents discussed in this blog post.