Back to the Future (Lubrizol): An Overview of IP & Bankruptcy Issues, Chapter 15, and the Qimonda Chapter 15 Proceeding

B EI JI N G F RAN KFU RT H O N G KO N G LO N D O N L O S AN G ELES MUN ICH N EW YO RK SI N G AP O RE T O KYO W ASH I N G T O N , D C

Back to the Future (Lubrizol):
An Overview of IP & Bankruptcy Issues, Chapter 15,
and the Qimonda Chapter 15 Proceeding
p g
Moderated by: Michael M. Murray
Featuring Presentations by: Blake Reese and Bradley Scott Friedman

May 18, 2010

Presenters

Michael M. Murray Blake Reese
Partner, Intellectual Property/Litigation Associate, Intellectual Property/Litigation
Milbank, Tweed, Hadley & McCloy LLP Milbank, Tweed, Hadley & McCloy LLP
1 Ch
Chase M h tt Pl
Manhattan Plaza
1 Chase Manhattan Plaza
New York, NY 10005
(212) 530-5424 New York, NY 10005
MMurray@milbank.com (212) 530-5496
http://www.milbank.com/en/Attorneys/m-
p y @
BReese@milbank.com
o/Murray_Michael.htm http://www.milbank.com/en/Attorneys/p-
r/Reese_Blake.htm
Bradley Scott Friedman
Associate, Financial Restructuring
Milbank, T
Milb k Tweed, Hadley & M Cl LLP
d H dl McCloy
New York, NY 10005
(212) 530-5846
BFriedman@milbank.com
BFriedman@milbank com
http://www.milbank.com/en/Attorneys/d-
f/Friedman_Bradley.htm
1 The views expressed in the presentation are those of the authors and
may not be attributed to Milbank or its clients.

Roadmap

• (1) Bankruptcy 101
• (2) IP Asset Sales
• (3) The Treatment IP Licenses under
Sections 365 of the Code
• (4) The Qimonda Case
– (i) Chapter 15 of the Code
– (ii) Factual Background
– (iii) Impact
– (iv) Status

• (5)
( ) Q&A
2

Roadmap

– (iii) Impact
– (iv) Status

• (5)
( ) Q&A
3

Why Businesses File for Bankruptcy

• Businesses file for bankruptcy for p
p y protection
from their creditors
• Types of Protection under the Bankruptcy Code
(the “Code”)
( h “C d ”)
– The Automatic Stay;
– Ass me / Reject contracts
Assume
– No ipso facto clauses; and
– Others

4

The Two Business Bankruptcies

• Chapter 7 - pure liquidation

• Chapter 11 – reorganization or
liquidation
li id ti

5

Filing for Protection

• Who: Usually a corporation or related business association

– Voluntary vs. Involuntary
• When: 24/7 365
24/7,

• Where: Venue (try for S.D.N.Y. or Del.)
– Incorporated;
– primary place of business;
– firm’s assets; or
firm s
– affiliate or partner filed

• What: A Petition
6
• Result: Filing the petition = automatic order; creates the
“estate”

The Players in Chapter 11

• The Debtor in Possession (“DIP”)
( DIP )
• The United States Trustee (“Trustee”)
• The Official Committee of Unsecured
Creditors (“Committee”)
• Others:

7

The Automatic Stay – the “Quiet Period”

• Section 362 of the Code provides an
automatic stay (a freeze on):
– Actions/proceedings against the Debtor to recover a
claim that arose before the petition
– Enforcement of pre-petition j g
p p judgments
– Act to obtain possession of property of the estate or to
exercise control over it (includes Contracts and
Licenses)
Li )
– Create / perfect lien against property of the estate

8

Assumption, Rejection, Assignment

• Section 365 of the Code allows for the
assumption or rejection of “executory
contracts
contracts”
• Countryman definition adopted in nearly all
jurisdictions:
j i di ti
– “A contract under which the obligations of both
the bankrupt d the th
th b k t and th other party t the contract
t to th t t
are so far unperformed that the failure of either
to complete performance would constitute a
material breach excusing the performance of the
other.”
9

Assumption, Rejection, Assignment (cont.)

• Assumption: Must cure prepetition
defaults and post petition defaults
• Rejection: “Rejection is Breach”
Rejection Breach
• Assignment – few limitations
– Overrides Anti-assignment agreements
Anti assignment
– Adequate Assurance
– N li bilit post-assignment
No liability t i t
• Debtor has no liability post-assignment

10

The Chapter 11 Proceedings

• Section 341 – Meeting of Creditors
g
• Almost every act is done on motion pursuant
to the Federal Rules of Bankruptcy Procedure
• Adversary Proceedings – Debtor or other
interested party has a separate proceeding in
the same case
• Bar Date, Proofs of Claim, and Resolution
Process
ocess

11

The Plan and Disclosure Statement

• The Plan of Reorganization (“Plan”)
( Plan )
– DIP has an exclusivity period (first 120 Days
plus 18 month extension)
– Generally Includes:
•D i
Designation of creditor classes
ti f dit l
• Explanation of payments
• Other Requirements

• Possibility for competing Plans
• Any party in interest can object
12

The Plan and Disclosure Statement (cont.)

• Solicitation of Votes
– Each class gets a vote
– 2/3 in amount OR more than ½ in number of
creditors in that class votes for Plan
– “Cram-Down”
– Unimpaired claims = deemed to have
accepted
p
• Proponent Can Modify at any point before
confirmation, but generally not after solicitation
• Confirmation and Objections
13

The Plan and Disclosure Statement (cont.)

• Disclosure Statement (“Disclosure”)
( )
– “adequate information”
• Hearing on Disclosure Statement
• Why this slide is second?
• Prof. Baxter: “Only an associate at a law firm
y
would read one of these cover to cover.”

14

Order of Distribution – "Waterfall"

“Surcharge” Against Collateral

“Carve-Out” For Professional Fees in DIP Financing Superpriority
Claims
Priming Lien in DIP Financing

Secured Claims

New Unsecured Debt Superpriority
Claims
Adequate Protection Claims

Priority Claims*
Priority Claims Administrative Claims

Unsecured Claims Wage Claims

Contributions To Employee Benefit
Plans
Equity Claims
Tax Cl i
T Claims

15 * Full list set forth in 11 U.S.C. § 507

Timeline

Traditional Pre-Arranged Pre-Packaged

Case Preparation
Case Preparation Case Preparation
(Time varies) Negotiate Major Terms of Plan Draft and Negotiate Plan
With Creditors
File Petition Plan Solicitation
File Petition
“First Day” and “Second Day” Hearings
File Petition, Plan Disclosure Statement
(Usually a few weeks) “First Day” and “Second Day” Hearings
and Ballots
(Usually a few weeks)
Case Administration
“First Day” Hearing, Disclosure
(Usually 3 to18 months) Case Administration
Statement Hearing & Confirmation
(Usually faster than traditional case)
( y )
Hearing (Usually a week or two)
Plan Proposal
(Debtor’s exclusivity period limited to a Plan Proposal
Plan Confirmation
maximum of 18 months (Usually within a few months of filing)

Exit and Post Confirmation
Plan Solicitation Plan Solicitation
(Time varies)
(limited to a maximum of 180 days after
( y (Usually faster than traditional case)
( y )
plan proposal)
Plan confirmation
Plan confirmation
Exit and Post Confirmation
Exit and Post Confirmation (Time varies)
(Time varies)

16

Roadmap

– (iii) Impact
– (iv) Status

• (5)
( ) Q&A
17

IP Asset Sales

• Business Judgment Rule
• Subject to Liens/other encumbrances
– If Debtor fulfills “ ti and h i ” req’ts,
D bt f lfill “notice d hearing” ’t
sale can proceed subject to encumbrances

18

IP Asset Sales

• Free and Clear (i e not subject to
(i.e.,
encumbrances)
– Debtor must:
• Receive court authority under § 363(b); and
• M t at least one special requirement under §
Meet t l t i l i t d
363(f).

19

Special Requirement - 1

• Non-bankruptcy law permits the sale free
Non bankruptcy
and clear of the license (i.e., Article 9);

20


• The licensee consents (express/implied);
– Implied Consent

21


• The license is in bona fide dispute;
– An objective basis for either a factual or legal
dispute as to the validity of the encumbrance

22


– The licensee could be compelled, in a legal or
equitable proceeding, to accept a monetary
substitute; OR

23


• The proceeds are used to foreclose a lien
where the sale price is sufficient to
discharge all liens
liens.

24

Effect of Finding Free and Clear

• Termination without Rejection: License
j
could be extinguished (i.e., sale could
preclude rejection and thus not invoke
protections under Code)
– An objecting party may be entitled to
adequate protection under § 363(e)
363(e).

25

Effect of Finding Free and Clear (cont.)

• Protection on Appeal
– May not be able to unwind transaction

26

Roadmap

– (iii) Impact
– (iv) Status

• (5)
( ) Q&A
27

The Scenario

• MidTech LLC holds patents directed to p
p pioneering
g
photovoltaic inventions, including novel software that
networks these systems. MidTech’s technology
dominates the market and consumers look for the
SuperSolar® product-line
• BigTech Inc. licenses rights in patents, trademarks,
copyrights, and trade secrets related to technologies
• BigTech builds factories and invests millions based on
its agreement with MidTech BigTech pays all of its
MidTech.
royalties on time.
• MidTech files for Ch. 11 bankruptcy, now what?
p y

28

IP Licenses as Executory Contracts

• Most IP licenses are “executory contracts”
executory contracts
because both parties’ failures to perform
would be considered material breaches
• “Executory contracts” may be (1)
assumed or (2) rejected by Debtor

29

IP Licenses as Executory Contracts (cont.)

• Aim for nonexecutory:
– More like an assignment:
• A b dl written and exclusive li
broadly itt d l i license
• A paid-up, or paid-in-full, license

30

IP Licenses as Executory Contracts (cont.)

• Aim for executory:
– State that failure to perform continuing obligations
constitutes a material breach of the contract excusing
performance by the other party or otherwise define
events constituting a material breach
– Include obligatory provisions

31

Debtor as Licensor –
Debtor Assumes (Continues) License
• Cure all monetary defaults under the agreement
• Pay damages
• Provide adequate assurances of future
performance

32

Debtor Assumes (Continues) License (cont.)
(cont )

• Court approval is required (i e Motion &
(i.e.,
Order approving assumption)
– Breach post-assumption results in damages
post assumption
that would be considered administrative
expenses (
p (rather than unsecured debt from
rejection)

33

Debtor as Licensor --
Debtor Rejects (Discontinues) License
• L EE
L’EE may treat rejection as a pre-petition
pre petition
breach and file a claim OR
• L EE
L’EE retains rights under “intellectual
intellectual
property” license for rest of term and
keeps up with royalty p y
p p y y payments and non-
monetary obligations
– Retention rights enacted in response to Lubrizol
– Includes right to enforce “exclusivity provisions”
– No prospective rights
– Royalties ≠ maintenance, etc.
34

Debtor Rejects (Discontinues) License (cont.)
(cont )
• Definition of “intellectual property” under Code:
intellectual property
– (A) trade secret;
– (B) invention, process, design, or plant protected under
title 35;
– (C) patent application;
– (D) plant variety;
– (E) work of authorship p
( ) p protected under title 17; or
;
– (F) mask work protected under chapter 9 of title 17;
• “IP” excludes trademarks  L’EE can
IP L EE
– (i) file claim, (ii) hold security interest, (iii) put
35
transition period in License Agreement

Rejection and Source Code
• If Debtor-L’OR seeks to reject, L’EE can try to
j , y
enforce obligation to provide Source Code per
Agreement

• Escrow Agreements popular  agent provides
Source Code to L’EE if Debtor-L’OR rejects
j
license

36

L’OR Tips

• Debtor may file Motion to Reject license
as bargaining leverage in negotiations
for new terms that Debtor will assume
assume.
• Worth asking: Is L’EE a prospective
purchaser of the IP?

37

Debtor as Licensor--
L’EE Tips
• In License Agreement:
– Debtor agrees to “assume”
– “IP” is clearly, broadly defined (include foreign
IP
patents)
– Incent Debtor not to reject  load royalties at end of
license
– Allocate payments between royalty and maintenance
– Get and perfect security interests whenever possible
• Assert right to continue under 365(n)

38

The Scenario (cont.)

• MidTech LLC holds patents directed to p
p pioneering
g
photovoltaic inventions, including novel software that
networks these systems. MidTech’s technology
dominates the market and consumers look for the
SuperSolar® product-line
• BigTech Inc. licenses rights in patents, trademarks,
copyrights, and trade secrets related to technologies
• BigTech builds factories and invests millions based on
its agreement with MidTech BigTech pays all of its
MidTech.
royalties on time.
• MidTech files for Ch. 11 bankruptcy, now what?
p y

39

The Scenario (cont.)

• What if, instead, MidTech (L’EE) files for bankruptcy?
, , ( ) p y

40

Debtor as Licensee --
Rejects License

• Reject: License to Debtor discontinues
– Claim for money damages
• R j ti = b
Rejection breach
h
– If a cross-license, L’OR may wish to continue
its license under Debtor patents
patents.

41

Assignment Limitations
• To assign, must assume and thus meet assumption
req’ts
’t
• Choice to assume-and-assign may be subject to non-
assignment provision in license and laws applicable to IP
• Non-exclusive Patent/Copyright Licenses:
– most courts hold non-exclusive patent licenses are non-
p
assignable without consent
– some courts applied reasoning to hold non-exclusive copyright
licenses non-assignable without consent

• Exclusive Patent/Copyright Licenses usually transferable

• Trademark Licenses: nontransferable without consent
42

Assumption When Nonassignable
• If the license is transferable, the Debtor may
y
assume the license

• If the license is not assignable there is a split
assignable,
of authority on whether it may be assumed

43

Courts Split
• Actual Test
– Looks to see if the Debtor actually intends to assign
the “non-transferable” license.
– If so, it cannot assume the license.
– If it has no intent to transfer the license to another
party,
party assuming the license is finefine.
• Hypothetical Test
– Will not allow the Debtor to assume (or continue) the
license, even if no transfer was intended, if law would
preclude transfer.

44

Courts Split (cont )
(cont.)
• Supreme Court on record in denying cert on
p y g
issue stating that it would like to address split,
but when better facts arise See N.C.P.
Marketing Group Inc v BG Star Productions
Group, Inc. v. Productions,
Inc., No. 08-463 (U.S. Mar. 23, 2009).

45

L’EE Tips

• L’EE includes transferability provision
L EE
(consent) in Agreement to keep
“assumption” option open
assumption
• L’EE who wants to assume might consider
filing Chapter 11 in venue that applies
“Actual Test”

46

L’OR Tips
• Non-exclusive licenses over exclusive
Non exclusive
• Define “adequate assurance” that L’EE must
satisfy to support “assumption” of license
y pp p
• Termination provisions with non-bankruptcy
triggers
gg
• Hold security interests in embodiments of IP
held by licensee
• Limit consent to assumption to circumstances
that do not provide change of control

47

Roadmap

– (iii) Impact
– (iv) Status

• (5)
( )Q&A
48

Qimonda --
Chapter 15
• Background:
– Enacted with 2005 Amendments (BAPCPA)
• Purpose
• Chapter 15 Case = Ancillary to cases
brought in the debtors home country

49

Qimonda --
Chapter 15 (cont.)
(cont )
• Foreign Representative (
g p (“FR”)
)
• Commencement
– In principal place of business or assets in U.S. (VA)
– FR must first file a petition in U.S. BUT this DOES
NOT automatically trigger protection
– Order must be entered to invoke protections
• “Foreign Main Proceeding” = case is pending in the country
where the debtor has ‘‘the center of its main interest’’
• During this “Gap Period” the Court can grant provisional
injunction
• Other Aspects of Chapter 15

50

Qimonda --
Background

• Qimonda commenced an insolvency
proceeding in Germany – appointed Dr.
Michael Jaffé as preliminary insolvency
administrator and as FR
• June 15 2009 Dr Jaffé filed a petition for
15, 2009, Dr. Jaffé,
relief under Chapter 15
• J l 22 2009 th B k t C t
July 22, 2009, the Bankruptcy Court
entered an uncontested order of
recognition
iti
51

Qimonda --
Background (cont.)
(cont )
• Same day - order stating that, pursuant to
Chapter 15, ‘‘the following sections [of the
Bankruptcy Code] are also applicable in
p y ] pp
this proceeding: §§ 305-307, 342, 345,
349, 350, 364-366, 503, 504, 546, 551,
558.’’
558 ’’
• About two and a half months later,
Qimonda moved t amend th order t
Qi d d to d the d to
strike the reference to Section 365 or to
limit the application of Section 365
52

Qimonda --
Court’s Order
• Significant licensees objected to motion, as like most
countries’ l
t i ’ laws, GGerman llaw d
does not afford 365( ) lik
t ff d 365(n)-like
protections to licensees

• U.S. Bankruptcy Court granted Qimonda’s motion to
amend, despite:
– Qimonda’s availing itself of U.S. automatic stay provisions in
U.S.
U S bankruptcy court;
– Congress’s clear intent in enacting 365(n) to avoid harsh
“Lubrizol-esque” outcomes
– The Court s earlier order dictating the applicability of 365 in the
Court’s
Ch. 15 case
– Express provisions in at least one of the licenses that called for
the application of 365(n) and New York law
pp ( )

53

Qimonda --
Rationale
• “The principal idea behind chapter 15 is that the
p p p
bankruptcy proceeding be governed in accordance with
the bankruptcy laws of the nation in which the main case
is pending ”
pending.
• “If the patents and patent licenses are dealt with in
accordance with the bankruptcy laws of the various
nations in which the licensees or licensors may be
located or operating, there will be many inconsistent
results.
results In fact the same idea, process or invention may
fact, idea
be dealt with differently depending on which country the
particular ancillary proceeding is brought.”

54

Qimonda --
Impact
• If Qimonda holding becomes widely-accepted,
widely accepted,
beware the following:
– Multinational entity files abroad
– Multinational entity brings Ch. 15 proceeding in U.S.
to allow foreign bankruptcy court control over U.S.
assetst
– U.S. bankruptcy court defers to foreign proceeding
and foreign law on licenses involving U S patents
U.S.
– Debtor gains extraordinary leverage over non-debtor
licensees that are potential infringers
p g

55

Qimonda v. Voda

• Remember Voda v. Cordis:
– “Regardless of the strength of the harmonization
trend … [p]ermitting our district courts to exercise
jurisdiction
j i di ti over i f i
infringement claims b
t l i based on f i
d foreign
patents … would require [the Fed. Cir.] to define the
legal boundaries of a property right granted by
another sovereign and then determine whether there
has been a trespass to that right”

56

Qimonda --
Status
• On appeal to District Court
– Only one amicus brief (supports appellee)
– Oral argument May 14 2010
14,
– Waiting for decision from District Court
– Will likely be further appealed to regional
circuit court

57

Roadmap

– (iii) Impact
– (iv) Status

• (5)
( )Q&A
58

Q&A

Michael M. Murray Blake Reese
Partner, Intellectual Property/Litigation Associate, Intellectual Property/Litigation
Milbank, Tweed, Hadley & McCloy LLP Milbank, Tweed, Hadley & McCloy LLP
1 Ch
Chase M h tt Pl
Manhattan Plaza
New York, NY 10005
(212) 530-5424 New York, NY 10005
MMurray@milbank.com (212) 530-5496
http://www.milbank.com/en/Attorneys/m-
p y @
BReese@milbank.com
o/Murray_Michael.htm http://www.milbank.com/en/Attorneys/p-
r/Reese_Blake.htm
Bradley Scott Friedman
Associate, Financial Restructuring
Milbank, T
Milb k Tweed, Hadley & M Cl LLP
d H dl McCloy
New York, NY 10005
(212) 530-5846
BFriedman@milbank.com
BFriedman@milbank com
http://www.milbank.com/en/Attorneys/d-
f/Friedman_Bradley.htm
59

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