In a United States bankruptcy case, licensees of intellectual property are granted certain protections under Bankruptcy Code section 365(n) if a debtor rejects (terminates) the license. These protections, however, are not guaranteed when the debtor licensor is subject to a foreign insolvency proceeding. Nevertheless, as previously reported in the February 2012 issue of the International Restructuring Newswire, the United States Bankruptcy Court for the Eastern District of Virginia awarded these section 365(n) protections on US patents licensed by a debtor whose German insolvency proceeding was recognized under Chapter 15. The Fourth Circuit recently affirmed the bankruptcy court’s decision, and licensees across the US are breathing easier. See Jaffé v. Samsung Electronics Co., Ltd., 2013 WL 6388591 (4th Cir. Dec. 3, 2013).

Background

Qimonda AG, a German manufacturer of semiconductor devices, filed for insolvency in Germany in January 2009. Qimonda had approximately 10,000 patents, 4,000 of which were US patents. Consistent with industry practice, the patents were subject to cross-license agreements with other semiconductor manufacturers to avoid the risk of infringement claims resulting from the industry’s “patent thicket.”

Dr. Michael Jaffé, the estate’s German insolvency administrator (akin to a US bankruptcy trustee) filed a Chapter 15 petition seeking recognition of the German insolvency proceeding as a foreign main proceeding, which would result in a stay enjoining actions against Qimonda and its assets in the US. In addition, Jaffé sought discretionary relief under section 1521 of the Bankruptcy Code, including an order entrusting him with the administration or realization of Qimonda’s assets in the US. Ultimately, the bankruptcy court granted recognition to the German insolvency proceeding and issued a “Supplemental Order” pursuant to which Jaffé was, among other things, granted authority to administer Qimonda’s assets in the US.

Thereafter, Jaffé declared that the licenses under Qimonda’s patents were “no longer enforceable” pursuant to section 103 of the German Insolvency Code, which permits a German insolvency administrator to cease performing a debtor’s executory contracts. In response to Jaffé’s efforts to terminate Qimonda’s licenses, certain licensees took the position that they could retain their rights to the patents under section 365(n). Jaffé challenged the application of section 365(n) protections to contracts terminated under German law, rather than rejected the Bankruptcy Code.

After a quick appeal to the district court and then a four-day evidentiary hearing by the bankruptcy court, the bankruptcy court ultimately concluded that the balancing of the interests of all interested parties required making section 365(n) applicable to Qimonda’s licenses of US patents. Otherwise, the licensees would risk losing substantial investments made on the basis of the US patents and the cross-license arrangements. Moreover, permitting termination of the licenses under German law would be manifestly contrary to US public policy favoring innovation to the extent it would cause licensees of US patents to lose their rights. Jaffé appealed, and the Fourth Circuit agreed to directly consider the case.

Fourth Circuit’s Rationale

On appeal, Jaffé argued that the bankruptcy court erred by adopting a balancing test to determine whether creditor licensees should have the benefit of section 365(n) protections in a chapter 15 case. According to Jaffé, the licensees were “sufficiently protected” under section 1522 so long as they were able to participate in the German insolvency proceeding. The Fourth Circuit disagreed, noting that section 1522 requires the court to protect both creditors and the debtor. “And because the interests of the creditors and the interests of the debtor are often antagonistic, as they are here, providing protection to one side might well come at some expense to the other.” Thus, a balancing test considering the relative harms and benefits to the different parties was appropriate.

Jaffé also contended the bankruptcy court placed too much weight on the risk of loss to the licensees. Indeed, according to Jaffé, he had minimized the licensee’s risk by offering to re-license Qimonda’s US patents to the licensees at a reasonable and nondiscriminatory royalty rate. The Fourth Circuit was not persuaded by that argument. According to the Fourth Circuit, the bankruptcy court recognized that the application of section 365(n) would reduce the value of Qimonda’s patents by preventing Jaffé from monetizing the licensed US patents after termination. The imposition of application of section 365(n), however, would not burden Jaffé. It would instead “merely limit his ability—and, importantly, the ability of the patents’ subsequent owners—to bring infringement actions against the very entities that Qimonda had previously promised not to sue.” The Fourth Circuit ultimately concluded that the bankruptcy court’s analysis was “comprehensive and eminently reasonable” and therefore refrained from disturbing the bankruptcy court’s decision to apply section 365(n) to Qimonda’s US patents.

Conclusion

In affirming the bankruptcy court’s decision, the Fourth Circuit agreed that the bankruptcy court properly considered whether the interests of the creditors, the debtor and other interested parties were sufficiently protected under section 1522 in determining whether to grant discretionary relief under section 1521. In this instance, the balance of the interests weighed in favor of granting licensees the protections of section 365(n), principally because of the implications on the patent thicket.

If enacted as currently drafted, the Innovation Act, a bill currently before Congress, would remove such discretion from the bankruptcy court in a Chapter 15 case. Pursuant to the Innovation Act, section 1522 would be amended to provide that section 365(n) applies to all Chapter 15 cases and that upon rejection or repudiation of an executory contract by foreign representative “under which the debtor is a licensor of intellectual property, the licensee under such contract shall be entitled to make the election and exercise the rights described in section 365(n).” Fingers crossed, licensees!