In a case of first impression that has important implications for parties who acquire intellectual property rights under international license agreements, the U.S. Bankruptcy Court for the Eastern District of Virginia held that the protections of Section 365(n) of the U.S. Bankruptcy Code applied to licensees of U.S. patents in a Chapter 15 case, despite the fact that those protection were not available under the foreign law applicable to the foreign debtor.   In re Qimonda AG, Case No. 09-14766 (Bankr. E.D. Va., Oct. 28, 2011) (Mitchell, Bankruptcy J.). 

Qimonda AG, a German semiconductor memory device manufacturer, filed for bankruptcy in Germany in January 2009.   Debtor Qimonda’s assets included approximately 4,000 U.S. patents and 6000 foreign patents, mostly relating to computer memory and semiconductor process technology.   Key manufacturers of semiconductor (DRAM and flash) memory devices held non-exclusive licenses under the Qimonda’s patents as a part of various royalty-free, cross-licensing, licensing and joint-development arrangements.   

The German court-appointed insolvency administrator then petitioned to the Virginia bankruptcy court under Chapter 15 of the U.S. Bankruptcy Code   for recognition of the German bankruptcy proceeding.  Chapter 15 allows a foreign debtor’s representative to commence a proceeding in a United States bankruptcy court to administer U.S. assets of a debtor’s estate.  The Virginia court granted the petition, making the U.S. bankruptcy laws, including § 365 of the U.S. Bankruptcy Code, applicable to the proceeding.  Section 365 provides an important safeguard to licensees, i.e., if a debtor rejects an existing intellectual property license (one qualifying as an “executory contract”), then the licensee has the right to elect to terminate the license or continue to exercise its rights for the remaining term of the license. 

As part of liquidating Qimonda’s assets for the benefit of the creditors, the German bankruptcy administrator found that Qimonda’s patent license agreements were no longer favorable to Qimonda and thus proposed to relicense Qimonda’s patents under new royalty-bearing agreements at reasonable and non-discriminatory royalty rates.   Accordingly, the administrator notified Qimonda’s various licensees that they were “non-performing” as required under German law in order to terminate the licenses and also filed a motion with the Virginia bankruptcy court to clarify that § 365(n) did not apply if such rights were exercised under German law.   (German law does not contain any protections equivalent to those in § 365 of the U.S. Bankruptcy Code.)  Several of Qimonda’s licensees opposed the motion, arguing that the licensees would then be subject to infringement claims.  The bankruptcy court granted the German bankruptcy administrator’s motion, and Qimonda’s licensees appealed to a U.S. district court.  The district court affirmed-in-part, but remanded the case to determine whether the licensees would be “sufficiently protected” if § 365(n) did not apply and whether restricting the applicability of § 365(n) was “manifestly contrary to the public policy of the United States.”     

On remand, the bankruptcy court balanced the interests of the debtor and the licensees to determine if the licensees’ interests were sufficiently protected.  Testifying that the semiconductor industry is characterized by a “patent thicket,” the licensees explained that entering into cross-licensing, licensing and joint-development agreements provided them with freedom to operate.  Without the protection of § 365(n), however, and the resulting return to uncertainty, investment to build fabrication plants and an increase the “hurdle rate,” the initial threshold required to proceed with product development, are significantly effected, the licensees testified.  Economic experts testifying on behalf of the German bankruptcy administrator argued that there was no reason to believe that the licensees’ research and development would be affected by a decision that § 365(n) does not apply.  First, the economic experts explained that the administrator was committed to re-licensing the patent portfolios for reasonable and non-discriminating royalties (a small percentage of the manufacturers R&D annual budget, which was estimated to be approximately 3.6 percent).  Second, changing the cross-license agreements from one in which non-monetary value flows in both directions to one in which the licensees pay cash would change the form of the agreement, but not the value.  Third, the economic experts testified that design freedom provided by the cross-license agreements would not be completely realized because the industry is still the subject of frequent patent disputes.  Finally, § 365(n) would only preserve the U.S. patent licenses and not licenses to the foreign patents, which would need to be the subject of a new license.

Ultimately, the bankruptcy court ruled that § 365(n) applies to the Chapter 15 proceeding to extent that U.S. patent licenses are involved.   Addressing the first issue raised by the district court for remand, whether the licensees would be “sufficiently protected” if § 365(n) did not apply, the bankruptcy court held that balancing the debtor and creditor interests weighed in favor of imposing the restrictions of § 365(n) on the German bankruptcy administrator.   The court noted that the application of § 365(n) results in less value to the bankrupt estate, the U.S. patents can still be licensed to parties not yet licensees and to the extent permitted by German law, the administrator will still be able to fully monetize the non-U.S. patents.  In contrast,  without § 265(n) protection, Qimonda’s licensees would suffer greater hardship because they had made substantial investments in U.S. research and manufacturing facilities in reliance on the freedom to operate provided by the licenses.   

Concerning the second issue raised by the district court for remand, whether restricting the applicability of § 365(n) was “manifestly contrary to the public policy of the United States,” the bankruptcy court determined that declining to apply § 365(n) in the context of the semiconductor industry would adversely threaten U.S. public policy favoring technological innovation.  The court was persuaded by testimony that the resulting uncertainty resulting from the failure to apply § 365(n) would slow the pace of innovation, to the detriment of the U.S. economy, “severely impinging” on an important statutory protection accorded licensees of U.S. patents, thus undermining fundamental U.S. public policy promoting technological innovation.  Therefore, the bankruptcy court concluded that to the extent German law would allow cancellation of the U.S. patent licenses that would be manifestly contrary to U.S. public policy.

Practice Note:   While the decision establishes precedent that § 365 applies to Chapter 15, it is hard to determine to what extent the decision will apply to other Chapter 15 proceedings.   Given the magnitude of the industry, the large number of patents involved, the number of affected parties and amount of investment, future courts may limit the case’s applicability.  Time will tell.toby