Increasing volatility at the intersection of intellectual property and restructuring law

Read our article in the Cayman Financial Review Magazine, eversion 

Recent fireworks between tech giants Apple and Samsung illustrate the intensity of modern battles over intellectual property rights. Even for companies whose business does not so obviously hinge on patent and trademark rights, however, an intellectual property license can be a small but vital lynchpin holding together the non-tech aspects of a company’s traditional manufacturing or other operations.

Two recent cases have stoked long-burning debates about the impact of restructuring proceedings on IP license rights.

The first case exacerbated the potential for conflict in the already tense cross-border context. A Munich manufacturing company, Qimonda AG entered into restructuring proceedings in Germany and later sought and received recognition of the German case as a “foreign main proceeding” in the US Bankruptcy Court for the Eastern District of Virginia. Because one of the primary goals of Qimonda’s restructuring proceedings was to renegotiate and extract further value from its many agreements with patent licensees, its representative specifically requested that a particular aspect of US bankruptcy law be held not to apply to its case.

That specific US bankruptcy law, 11 USC section 365(n), grants special protections to intellectual property licensees whose license agreements are rejected by a licensor like Qimonda in a restructuring proceeding. This very specific provision prevents debtor-licensors from undermining the IP rights of their licensees.

It was inserted into the Bankruptcy Code in direct response to a case that involved a debtor-licensor’s pursuit of a strategy very similar to Qimonda’s. In Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), the court had affirmed this strategy, holding that rejection of an IP license by the debtor-licensor deprives the licensee of any further right to use the licensed intellectual property without a renewed agreement from the debtor-licensor.

Congress acted swiftly to countermand most of the effects of the Lubrizol decision by amending the Bankruptcy Code with the new section 365(n) to specifically preserve IP licensees’ rights to use intellectual property despite the debtor-licensor’s rejection of a license agreement.

Qimonda’s insolvency representative, however, pointed out that German law governed its restructuring, and unlike US law, German law still allowed a debtor-licensor to terminate the rights of IP licensees and renegotiate the license agreements for the benefit of the restructuring entity and its many other creditors.

With its adoption of Chapter 15 on cross-border cases, US bankruptcy law had aligned itself with the “universalist” approach of deferring to the law of the “main” proceeding, which here was in Germany, so the exceptional US law on licensee protection should not apply to this case.

Ordinarily, US bankruptcy courts would be expected to cooperate with and defer to applicable foreign restructuring law, but a narrow safety valve allows for refusal to defer in cases where application of the foreign law would be “manifestly contrary to the public policy of the United States” 11 USC section 1506.

While this public policy exception is designed to be very narrowly construed and cooperation withheld only in extreme and exceptional circumstances, the Bankruptcy Court for the Eastern District of Virginia held that the special US protection for IP licensees represents fundamental US public policy, and deferring to the diametrically opposed German law would be “manifestly contrary” to that fundamental public policy.

Given the hotly disputed nature of the issue, the magnitude of the potential lost revenue to Qimonda’s estate – nearly $50 million, as estimated by Qimonda’s expert – and the gravity of yet another decision by a US bankruptcy court refusing to cooperate with foreign proceedings,* the case was designated for immediate appeal to the Court of Appeals for the Fourth Circuit.

Ironically, this is the same Court of Appeals that nearly thirty years earlier had rendered the Lubrizol decision, the very case that ignited the IP license controversy at issue in Qimonda. The resolution of the Qimonda appeal will have far-reaching impacts on both the value of intellectual property to a reorganizing company, as well as on the reputation of the US bankruptcy courts for complying with the rapidly solidifying worldwide norm of cooperation with and deferral to the law of foreign main restructuring proceedings.

A more recent case has the potential to expand Qimonda-type disputes dramatically. When Congress inserted the special bankruptcy provision protecting IP licensees, it neither confirmed nor disclaimed explicitly the Lubrizol case’s position that a debtor-licensor’s rejection of an intellectual property license vitiates the licensee’s rights.

This past July, another Court of Appeals (for the Seventh Circuit, centred in Chicago) revisited the issue and announced its disagreement with the earlier Lubrizol approach.

In Sunbeam Prods, Inc v Chicago American Mfg, LLC, the court took the relatively unusual step of moving beyond the “equitable” arguments presented to the court below, and it squarely attacked the earlier Lubrizol construction of the effect of rejection of an IP license contract.

The court held that, while the Bankruptcy Code allows a restructuring debtor to reject the burdens of an executory contract such as a license agreement, “nothing about this process implies that any rights of the other contracting party have been vaporised”. Consequently, the court concluded that rejection of an intellectual property license agreement has essentially no impact on the right of the licensee to continue to use the licensed IP rights.

This latest decision rekindles a fundamental debate about the powers of reorganising debtors to restructure their intellectual property licensing arrangements. If the Seventh Circuit’s approach prevails, the special IP-licensee protection provision will be rendered largely superfluous, and US bankruptcy law will continue on a direct collision course with the law of Germany and perhaps other countries whose insolvency law seeks to maximise the value of intellectual property for the restructuring estate.

Qimonda and Sunbeam offer reminders that the Lubrizol debate will not go away quietly, and its impact will likely grow in coming years given the centrality of intellectual property rights in modern knowledge-based economies and the increasing incidence of financial distress among companies relying on IP rights, both as licensors and as licensees.

Though congressional action is unlikely in the current dysfunctional US political climate, the battle lines are now clearly drawn for the courts to alter what has been all but accepted wisdom for decades about the effect of bankruptcy on IP licenses.

 

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Jason Kilborn

Professor Jason Kilborn teaches business and commercial law at John Marshall Law School in Chicago.  His primary focus is on the comparative analysis of insolvency systems for individuals, though his interest extends to international bankruptcy as well. He recently co-authored a book on international co-operation in cross-border insolvency cases, published by Oxford University Press.

Jason Kilborn
Professor of Law
John Marshall Law School, Chicago
315 S. Plymouth Court
Chicago, IL 60604
USA

T: +1 (312) 386 2860+1 (312) 386 2860
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John Marshall Law

Throughout its history, The John Marshall Law School has upheld a tradition of diversity, innovation and opportunity, and has consistently provided an education that combines an understanding of the theory, the philosophy and the practice of law. Founded in 1899, The John Marshall Law School today is proud to be recognized as a dynamic independent law school, promoting excellence in all aspects of legal education.Our seven Centers for Excellence serve as an academic foundation for our students' successes. Their specialized curricula are among the most comprehensive in the country. In addition to our six LL.M. programs-employee benefits, information technology law, intellectual property law, international business and trade law, real estate law and tax law - John Marshall offers its students a joint JD/LLM, JD/MBA (in conjuction with Dominican University), JD/MPA and JD MA (in conjunction with Roosevelt University). Foreign students may elect to earn an LLM in Global Legal Studies.
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