November 22, 2011

Bankruptcy Ruling Favors IP Licensees in Cross-Border Transactions

In the Chapter 15 bankruptcy case of Qimonda AG, a manufacturer of semiconductor memory devices with headquarters in Munich, Germany, the U.S. Bankruptcy Court for the Eastern District of Virginia refused to permit a German Insolvency Administrator to apply German law to abrogate intellectual property license agreements and deprive licensees of the option to retain their rights.  The court held that the licensee protection afforded by section 365(n) of the Bankruptcy Code represented a fundamental public policy of the United States and, accordingly, blocked the Insolvency Administrator from eliminating it.  In addition, the court found that the benefits to be gained by the Insolvency Administrator from voiding the license agreements were outweighed by the harm caused to the licensees, which violated the balancing of interests test under Chapter 15.  The ruling is a significant victory for intellectual property licensees involved in cross-border insolvencies. 

Chapter 15

Chapter 15 of the Bankruptcy Code permits representatives of foreign insolvency proceedings to seek recognition of such proceedings from U.S. courts and, upon recognition, to request specified types of relief.  The bankruptcy court can refuse to take any action if it would be “manifestly contrary to the public policy of the United States”1 or if the interests of the debtor, creditors and other interested parties are not “sufficiently protected.”2

Section 365(n)

When dealing with a license of intellectual property, the traditional power of a trustee or debtor-in-possession in a U.S. bankruptcy case to reject such contracts is circumscribed by section 365(n) of the Bankruptcy Code, which gives the licensee a choice:  the licensee either can treat the licensing contract as terminated by the rejection or the licensee can retain its rights under the license so long as it continues to pay any required royalty payments. 

The Case

In Qimonda, the debtor, Qimonda AG, filed a proceeding in German insolvency court in January 2009.  Dr. Michael Jaffe, the court-appointed Insolvency Administrator in the German proceeding, then successfully petitioned the U.S. Bankruptcy Court for recognition of the German proceeding as a “foreign main proceeding” under Chapter 15.  When an order recognizing a foreign main proceeding is entered, certain provisions of the Bankruptcy Code (but not section 365) apply to the Chapter 15 case automatically (e.g., the automatic stay) while other provisions are made applicable only with court approval.  In Qimonda, the Bankruptcy Court issued an order (the “Supplemental Order”) that made section 365 applicable to the Chapter 15 proceeding.

Under German insolvency law, contracts that have not been fully performed are automatically unenforceable unless the Insolvency Administrator elects to perform.  To negate any inference that he elected to perform, Dr.  Jaffe sent letters to Qimonda’s patent licensees notifying them that he would not perform, effectively terminating the licensees’ rights. Licensees, including Intel, IBM, Micron and several major non-U.S. companies, responded by asserting their rights under section 365(n).  Jaffe then asked the Bankruptcy Court to modify the Supplemental Order by removing section 365 from the list of applicable Bankruptcy Code provisions.  The Bankruptcy Court granted Jaffe’s request and ordered that section 365 would be applicable only to the extent that Jaffe invoked section 365 to reject contracts.  In other words, where Jaffe was exercising Qimonda’s rights under German insolvency law, the intellectual property licensees would not be protected by section 365(n).  The licensees appealed the Bankruptcy Court’s modified order. 

On appeal, the U.S. District Court for the Eastern District of Virginia remanded the case back to the Bankruptcy Court for more specific findings with respect to the public policy and balancing tests mandated by sections 1506 and 1522 of the Bankruptcy Code.

The Decision

On remand, the Bankruptcy Court considered evidence regarding the semiconductor market, Qimonda’s patent portfolio and the possible broader market implications of denying section 365(n) protection.  The court found, among other things, that the semiconductor industry is characterized by a “patent thicket,” where any given semiconductor device may incorporate technologies covered by a multitude of patents not owned by the device’s manufacturer. 

Pursuant to the District Court’s remand directive, the Bankruptcy Court focused on two questions:  (i) whether the licensees were “sufficiently protected” if they were not afforded section 365(n) protection and (ii) whether applying German insolvency law to deny patent licensees the protection of section 365(n) was “manifestly contrary” to the public policy of the United States.

Considering the first question, the court noted, on the one hand, that denying section 365(n) protection to the objecting licensees and forcing them to re-license Qimonda’s U.S. patents would result in significantly more revenue for the German insolvency estate.  On the other hand, even if section 365(n) applied to protect U.S. licenses, Qimonda’s patent portfolio would retain significant value since it consisted mostly of non-U.S. patent licenses, which Jaffe would be free to re-license. Denying section 365(n) protection would impose a significant burden on licensees that had already made significant investments in their technology and manufacturing infrastructure in reliance on the licenses they held from Qimonda.  In light of these factors, the court concluded that to “sufficiently protect” the interests at stake, section 365(n) should apply to Qimonda’s Chapter 15 proceeding.

In considering the second question – whether the failure of German insolvency law to protect the patent licensees was “manifestly contrary” to U.S. public policy – the court identified the “public policy favoring technological innovation” as the public policy to be protected.  In the remand decision, the District Court explained that Congress’s use of the word “manifestly” in section 1506 “substantially limits” the public policy exception to the most fundamental policies of the United States.3  The Bankruptcy Court ruled that section 365(n) met this rigorous standard.

Our Take

While the Bankruptcy Court was persuaded that section 365(n) and the protection of intellectual property licensees implicated a fundamental policy, this conclusion may be questionable.  If section 365(n) implicated such a fundamental public policy, Congress could have required that section 365(n) apply in every Chapter 15 case.  Since it did not, other courts may not agree that protecting innovation by protecting licensees rises to the level of a “most fundamental policy.”

While the “sufficient protection” prong of the decision seems appropriate in Qimonda’s circumstances, it is difficult to predict whether other courts will conclude that the Section 1522 balancing test mandates application of section 365(n) to all intellectual property licenses.  The Bankruptcy Court’s decision was based on specific findings regarding the semiconductor industry, its “patent thicket” and the limited detriment to the German estate.  In different circumstances, the harm to the foreign estate from protecting the licensee might outweigh the harm to the licensee itself. At a minimum, the ruling counsels that intellectual property licensees involved in Chapter 15 cases should specifically seek to have section 365(n) made applicable.     

Qimonda leaves open the question of whether a licensee of a debtor-licensor involved in a foreign insolvency proceeding would otherwise be able to obtain protection of its license rights were no Chapter 15 case commenced.  Would a non-bankruptcy court protect the licensee based on a fundamental policy favoring technological innovation when the sole statutory basis – section 365(n) – only applies in a bankruptcy case?  The Quimonda decision lays the groundwork for a licensee to claim public policy protection outside of the bankruptcy court context, but whether a non-bankruptcy court would agree remains to be seen.

1 11 U.S.C. §1506.

2 11 U.S.C. §1522(a).

3 In re Qimonda AG Bankr. Lit., 433 B.R. 547, 567-69 (E.D. Va. 2010).