Restructuring

Contributed by Dana Hall
Fully recharged after last week’s Thanksgiving respite, the United States Court of Appeals for the Fourth Circuit this week affirmed a 2011 bankruptcy court decision denying a chapter 15 debtor’s attempts to terminate, under foreign insolvency law, various U.S. patent licensing agreements.  We previously discussed the decision by the United States Bankruptcy Court for the Eastern District of Virginia here.
The decisions in In re Qimonda deal with the ability of a foreign debtor, through its foreign representative in a chapter 15 case, to terminate unilaterally U.S. patent licensing agreements, pursuant to foreign law (in this case, section 103 of the German Insolvency Code).  In Qimonda, the chapter 15 debtor’s foreign representative attempted to terminate licenses of U.S. patents that the debtor had granted to a large number of technology companies.  The licensees objected and argued that the foreign administrator should be bound by the licensee protections included in section 365(n) of the Bankruptcy Code.  The foreign representative argued that, under the German insolvency regime, he was permitted to terminate a debtor’s license agreements, leaving licensees without the benefit of their prepetition agreements.  In contrast, under U.S. bankruptcy laws, the normally broad rejection power granted a trustee or debtor in possession by section 365(a) is limited with respect to certain intellectual property licenses, including U.S. patent licenses, as a result of section 365(n).  Specifically, section 365(n) permits a patent licensee to elect to retain certain rights under its prepetition license despite a debtor’s decision to reject that license.
The foreign representative in Qimonda argued that German laws should apply to the termination of the licenses, while the licensees argued that section 365(n) should apply.  Ultimately, the applicability of section 365(n) hinged on the court’s examination of sections 1506, 1521, and 1522 of the Bankruptcy Code.  Section 1521(a)(7) permits a court, in the exercise of its discretion, to grant a chapter 15 foreign representative “additional relief” above and beyond the limited provisions made applicable by way of sections 1520 and 1521(a)(1)-(6) of the Bankruptcy Code.  Section 1522, however, tempers the broad grant of authority provided in section 1521 by providing that a bankruptcy court may only grant relief under section 1521 if “the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.”  Section 1506 of the Bankruptcy Code further permits a court to refuse to take any action to the extent that doing so would be “manifestly contrary to the public policy of the United States.” 
After a four-day evidentiary hearing, the bankruptcy court in Qimonda held that the balancing of debtor and creditor interests mandated by a joint reading of sections 1521(a)(7) and 1522 of the Bankruptcy Code favored the application of section 365(n) with respect to the U.S. patent portfolio of Qimonda.  The bankruptcy court also found that permitting a debtor to terminate U.S. patent licensing agreements non-consensually pursuant to foreign law would be “manifestly contrary to the public policy of the United States” and would, therefore, implicate section 1506 of the Bankruptcy Code.  The Fourth Circuit, on direct appeal from the bankruptcy court, affirmed the bankruptcy court’s ruling on the first basis and, as a result, did not directly reach the issue of whether the public policy exception provided in section 1506 of the Bankruptcy Code applied to the non-consensual termination of patent licensing agreements.
Qimonda’s foreign representative raised three arguments on appeal, all of which were rejected by the Fourth Circuit.  First, the representative argued that because he had not specifically requested the inclusion of section 365(n) among his “additional” 1521 powers at the outset of the case, the court was not required to undertake a section 1522 balancing analysis with respect to that section.  In other words, because the foreign administrator did not explicitly seek inclusion of section 365 in the court’s 1521 order, his authority to assume or reject should be governed by foreign law.  The Fourth Circuit found that although the administrator had not specifically requested the powers afforded by section 365 of the Bankruptcy Code, he had requested, pursuant to other provisions of section 1521, that the bankruptcy court entrust him broadly with the “administration or realization of all or part of the assets of [Qimonda] within the territorial jurisdiction of the United States” and had specifically included the debtor’s U.S. patent portfolio among the enumerated assets that he sought to control.  Accordingly, the court held that as a prerequisite to granting any relief under section 1521 of the Bankruptcy Code, it was required to ensure sufficient protection of all interested parties pursuant to section 1522 and was entitled to subject such section 1521 relief to whatever conditions the court deemed appropriate, including the incorporation of licensee protections provided under U.S. bankruptcy laws.
Second, the foreign representative argued that the bankruptcy court misinterpreted the requirements of section 1522 of the Bankruptcy Code and that the bankruptcy court was not required to undertake a “balancing” analysis – weighing the interests of the creditors against those of the chapter 15 debtor.  Specifically, the representative argued that section 1522 merely serves as a procedural protection designed to ensure that all creditors are able to participate in the bankruptcy case on an “equal footing.”  According to the representative, the design of chapter 15 mandates that courts defer to foreign law except to the extent that those laws implicate section 1506 of the Bankruptcy Code and are “manifestly contrary to the public policy of the United States.”  In rejecting this argument, the Fourth Circuit focused on the language of the Model Law on Cross-Border Insolvency and its accompanying Guide to Enactment – specifically Article 22 of the Model Law, on which section 1522 of the Bankruptcy Code is based.  The Model Law’s Guide to Enactment specifically contemplated the need for courts to balance between the relief sought by a foreign representative and the interests of the persons affected by such relief, in particular local creditors.  In light of the language of chapter 15 and the Guide to Enactment, the Fourth Circuit found that the bankruptcy court had correctly applied a balancing analysis and that section 1506 merely provided an “additional, more general protection of U.S. interests that may be evaluated apart from the particularized analysis” of section 1522 of the Bankruptcy Code.
Finally, the foreign representative argued that even if a balancing analysis under section 1522 were appropriate, the bankruptcy court’s analysis was flawed because it overstated the potential harm to the licensees.  The Fourth Circuit was, however, persuaded by the bankruptcy court’s comprehensive analysis and found that the bankruptcy court had exercised reasonable discretion in concluding that although application of section 365(n) would invariably reduce the value of the debtor’s U.S. patent portfolio, it would not render it worthless.  The debtor could, for example, continue entering into license agreements with new counterparties.  The licensees, however, stood to lose very substantial research and development investments made in reliance on the licensing agreements.  The Fourth Circuit, like the bankruptcy court, expressed serious concern that permitting a foreign debtor to terminate intellectual property licenses would inject a “dangerous degree of uncertainty into a licensing system that plays a critically important role in the semiconductor industry, as well as other high-tech sectors of the global economy.”  Additionally, as noted in the bankruptcy court’s decision, granting the relief requested by the representative would undermine one of Congress’ primary purposes in enacting section 365(n) – to encourage developers to accept property licenses instead of outright assignments, thereby increasing returns to inventors and creating incentives for research and development.
The decision highlights the interesting tension between the United States’ interests in protecting U.S. creditors and its interest in cooperating with foreign insolvency proceedings.  The decision is a major victory for U.S. patent licensees, but it remains to be seen how other courts will apply the Fourth’s Circuit’s “balancing test” under different circumstances.  At this time, the foreign representative has not yet sought leave to appeal or to have the issue reheard en banc, but we will continue to monitor the docket and provide any updates going forward.
Weil represents Micron Technology, Inc., one of the licensees of Qimonda AG’s patents discussed in this blog post.