Fourth Circuit Affirms Application of Section 365(n) to Ensure Patent Licensees Sufficiently Protected in Granting Relief to Foreign Representative

by Dechert LLP
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The Court of Appeals for the Fourth Circuit, in Jaffe v. Samsung Elecs. Co., Ltd.,1 recently held that a U.S. bankruptcy court is not required under principles of comity to blindly apply foreign law to assets located in the U.S. of a foreign debtor whose principal insolvency proceeding is outside the U.S. Instead, bankruptcy courts must balance the interests of the affected U.S. parties with the those of the foreign debtor. In this case, the balancing required the application of U.S. law to the foreign debtor’s U.S. assets, not German law as applied in the foreign proceeding. Absent the application of U.S. law, German law would have governed some 4,000 U.S. patent licenses rendering them unenforceable. Application of section 365(n) of the U.S. Bankruptcy Code, on the other hand, limits the debtor’s ability to unilaterally reject licenses of the debtor's intellectual property by giving licensees the option to retain their rights under the licenses.2 The Court in Jaffe determined that, in granting discretionary relief to a foreign representative under section 1521(a)(5) of the Bankruptcy Code, a Bankruptcy Court is required to balance the interests of affected U.S. entities against the interests of the foreign debtor in order to consider whether such U.S. entities are “sufficiently protected” under section 1522(a) of the Bankruptcy Code.3 The Fourth Circuit also held in the Jaffe case that, in balancing such interests, the Bankruptcy Court properly required, as sufficient protection of the objecting patent licensees, the application of section 365(n) of the U.S. Bankruptcy Code prior to entrusting the U.S. patents to the foreign representative.4

Factual Background

In 2009, Qimonda AG, a German semiconductor manufacturing corporation, filed for insolvency in Munich. Qimonda’s principal assets consisted of some 10,000 patents, including 4,000 U.S. patents. These patents were largely subject to cross-license agreements with Qimonda’s competitors, a practice that the court noted is common in the semiconductor industry due to infringement risks that could otherwise arise from overlapping patents. Qimonda’s German insolvency administrator and the foreign representative in the U.S. chapter 15 case, Michael Jaffe, filed an application in the U.S. Bankruptcy Court for the Eastern District of Virginia asking that the German proceeding be recognized in the United States and that discretionary relief be granted to him under section 1521 of the Bankruptcy Code to allow him to be entrusted with the administration of Qimonda’s U.S. assets. Jaffe then notified the licensees of Qimonda’s patents under the cross-licensing agreements that they were no longer enforceable and that he intended to replace the existing licenses with licenses paid for with cash rather than in-kind treatment. Many of the licensees objected to this treatment.

The Bankruptcy Court’s Decision

Following a four day hearing on the licensees’ objections, the Bankruptcy Court ultimately conditioned the foreign representative’s request to be entrusted with Qimonda’s U.S. patents on the requirement that he afford the licensees the same protection as they would receive under Bankruptcy Code section 365(n). The court based its decision on two separate sections of chapter 15. First, section 1522(a) states that the court may grant discretionary relief “only if the interests of the creditors and other interested entities, including the debtor, are sufficiently protected.”5 Second, section 1506 permits a court to refuse to take an action that would be “manifestly contrary to the public policy of the United States.”6 The foreign representative appealed the judgment directly to the Circuit Court.

The Fourth Circuit’s Affirmance

A three-Judge panel of the Fourth Circuit held that the sufficient protection inquiry under section 1522 requires a “particularized balancing analysis” that considers the interests of all interested parties, including the debtor, and weighs them against each other.7 To that end, the panel affirmed the Bankruptcy Court’s decision, agreeing that it was reasonable to limit the foreign representative’s powers based on evidence before it of the economic harm and instability that would befall the semiconductor industry if the foreign representative could unilaterally reject the cross-licensing agreements. In its decision, the panel confirmed that section 1522 must be employed as a substantive test of interested parties’ rights rather than as a mere procedural safeguard to ensure they can participate in the distributions under the foreign proceeding.8 The panel also noted that section 1506 should serve as “an additional, more general protection of U.S. interests,” and agreed with the Bankruptcy Court that U.S. policy, as reflected in 365(n), favored intellectual property agreements such as the cross-licensing contracts.9 Two of the three Judges on the panel went on to state that while it is sufficient for the court to affirm the Bankruptcy Court’s findings under section 1522(a), the Court is necessarily furthering the public policy that underlies section 365(n) of the Bankruptcy Code.10

Implications

The Fourth Circuit’s decision is an important addition to an on-going debate over the level of deference that U.S. courts will give to foreign bankruptcies. While the Fourth Circuit’s affirmance is a victory for the U.S. patent licensees in this case, the decision confirms that while the application of section 1522(a) of the Bankruptcy Code establishes a substantive requirement, the “sufficient protection” standard of section 1522(a) is an inherently fact-based standard requiring a balancing test. For this reason, broader lessons from the decision on what will constitute sufficient protection in other chapter 15 cases may be difficult to draw.

While case law interpreting chapter 15 continues to develop—especially at the circuit level—Jaffe may be viewed as in line with certain recent cases that, although reaching differing results, have applied U.S. law and standards to a foreign representative’s request for relief under foreign law. Jaffe expressly joins the Fifth Circuit’s Vitro decision which applied U.S. law to deny enforcement of a Mexican-Court approved plan of reorganization on the basis that it would have impermissibly granted releases to non-debtor third parties.11 In addition, the Delaware Bankruptcy Court recently applied the standards of section 363 of the Bankruptcy Code in considering whether to approve an asset sale by Elpida which had previously been approved by a Japanese court.12 Further, in the Sino Forest case the Bankruptcy Court for the Southern District of New York recently distinguished Vitro and applied prior case law from the Second Circuit and the Southern District Bankruptcy Court in deciding and approving an uncontested motion to enforce a Canadian-Court approved global settlement in a CCAA proceeding that included releases of non-debtor third parties.13

Footnotes

1 2003 WL 26478864 (4th Cir. Dec. 3, 2013).

2 Id. at *1.

3 Id. at *2.

4 Id. at *2.

5 11 U.S.C § 1522(a) (2012).

6 11 U.S.C § 1506 (2012).

7 Id. at *12.

8 2003 WL 26478864 at *10-11.

9 Id. at *12.

10 Id. at *15. While concurring in the judgment, one Judge declined to join this part of the opinion writing separately to express that the court’s only task was to determine the reasonableness of the Bankruptcy Court decision before it, and thus the discussion that went beyond the lower court’s decision was mere dictum.

11 See In re Vitro S.A.B. de C.V., 701 F.3d 1031 (5th Cir. 2012).

12 See In re Elpida Memory, Inc., 2012 WL 6090194 (Bankr. D. Del. Nov. 20, 2012).

13 See In re Sino-Forest Corp., 2013 WL 6154114 (Bankr. S.D.N.Y. Nov. 25, 2013).

 

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