In late December 2022, the United States District Court for the District of Delaware issued an opinion affirming the Mallinckrodt¹ bankruptcy court’s November 2021 decision that the debtor could discharge certain post-petition, post-confirmation royalty obligations for the sale of Acthar Gel.

As background, in 2001, Mallinckrodt and Sanofi-aventis U.S. LLC (“Sanofi”) executed an Asset Purchase Agreement (the “APA”) under which Sanofi sold Mallinckrodt certain intellectual property relating to Acthar Gel, a therapeutic treatment for inflammatory and autoimmune conditions. As a component of the purchase price, Mallinckrodt agreed to pay Sanofi annual royalties equal to 1% of all Mallinckodt’s net sales of Acthar Gel that exceeded $10,000,000 per year.

On October 12, 2020, Mallinckrodt filed for chapter 11 bankruptcy protection in the United States Bankruptcy Court for the District of Delaware. One year later, Sanofi filed a motion for a determination that Mallinckrodt could not discharge the royalty payment obligations under the APA in its chapter 11 cases. On November 11, 2021, the Bankruptcy Court held that the APA was not executory, but that claims for post-petition breaches of the APA, including for Mallinckrodt’s failure to pay any royalties to Sanofi, constituted pre-petition unsecured claims that are dischargeable upon confirmation of Mallinckrodt’s chapter 11 plan.

Sanofi appealed the Bankruptcy Court’s ruling. On appeal to the District Court, Third Circuit Judge Thomas L. Ambro, sitting by designation, focused on two questions: (1) are Sanofi’s claims for post-petition royalties dischargeable in Mallinckrodt’s bankruptcy because they were contingent claims that arose when the APA was executed pre-prepetition; and (2) alternatively, does Sanofi retain a property interest in the Acthar Gel intellectual property requiring Mallinckrodt to pay royalties when it sells the Acthar Gel post-petition and post-confirmation?

In its analysis of the first issue, the District Court began with a textual examination of section 1141(d)(1)(A) of the Bankruptcy Code, which provides that a plan of reorganization “discharges the debtor from any debt that arose before the date of such confirmation.”² The Bankruptcy Code defines “debt” as a “liability on a claim” and, in turn, a “claim” as a “right to payment whether or not such right is reduced to judgment, liquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured.”³ Despite the clarity of the statutory text, the District Court engaged in a survey of case law regarding the dischargeability of unliquidated or contingent future claims. Summarizing the patchwork of answers among the circuits, the District Court concluded, unsurprisingly, that “context is important.”⁴ Here, the District Court held that Sanofi sold full title to the intellectual property in exchange for a right to future contingent payments and, accordingly, assumed the risk of Mallinckrodt’s future distress and dischargeability of such claims in bankruptcy.

Regarding the second question, the District Court declined to adopt Sanofi’s theory that future royalty obligations survived confirmation because Sanofi retained a property interest in the intellectual property that was not severable by bankruptcy. Sanofi argued that the language in the APA providing that the sale of the intellectual property was “subject to the terms and conditions of the [APA],” including the royalty obligations, created a property interest similar to a covenant “running with the land.” The Court swiftly disagreed, finding that even if such a property right in intellectual property could theoretically be created, the boilerplate language of the APA did not do so.

Entities selling their intellectual property in the wake of Mallinckrodt should make efforts to bolster their creditor status with respect to purchasers in the event they file for bankruptcy. As the Court pointed out in its conclusion, any question of fundamental fairness is two-sided: while it may be arguably unfair to allow a purchaser to continue to sell an entity’s intellectual property without paying royalties, allowing royalties to survive discharge in contravention of the Bankruptcy Code would bestow sellers with “special treatment over other unsecured creditors for which [the sellers] did not bargain.”⁵ Sellers should instead heed the Court’s suggestion that they protect themselves by either (a) taking a security interest in the assets sold to secure royalty payments, (b) structure the transaction as a license rather than a purchase, or (c) form a joint venture to retain part ownership of the assets.⁶ Sellers that fail to do so may unfortunately find that their royalties are no match for the “fresh start” provided by the Bankruptcy Code.

FOOTNOTES

1. Sanofi-Aventis U.S. LLC v. Mallinckrodt plc, Civ. No. 21-1636-TLA (D. Del. Dec. 20, 2022)

2. 11 U.S.C. § 1141(d)(1)(A).

3. 11 U.S.C. §§ 101(12); 101(5).

4. Opinion at 8.

5. Id. at 11.

6. Id.