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

BEIJIN G FRAN KFU RT H O N G KO N G LO N D O N LO S AN G ELES M U N IC H N EW YO RK SI N G APO RE T O KYO WASH I N G T O N , D C

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

and the Qimonda Chapter 15 Proceedingp gModerated by: Michael M. Murray

Featuring Presentations by: Blake Reese and Bradley Scott Friedman

May 18, 2010

Presenters

Michael M. MurrayPartner, Intellectual Property/LitigationMilbank, Tweed, Hadley & McCloy LLP1 Ch M h tt Pl

Blake ReeseAssociate, Intellectual Property/LitigationMilbank, Tweed, Hadley & McCloy LLP

1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5424 MMurray@milbank.comhttp://www.milbank.com/en/Attorneys/m-

1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5496 BReese@milbank.comp y

o/Murray_Michael.htm

Bradley Scott FriedmanAssociate, Financial RestructuringMilb k T d H dl & M Cl LLP

@http://www.milbank.com/en/Attorneys/p-

r/Reese_Blake.htm

Milbank, Tweed, Hadley & McCloy LLP1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5846BFriedman@milbank com

BFriedman@milbank.comhttp://www.milbank.com/en/Attorneys/d-

f/Friedman_Bradley.htmThe views expressed in the presentation are those of the authors and may not be attributed to Milbank or its clients.

Roadmap

• (1) Bankruptcy 101(1) Bankruptcy 101• (2) IP Asset Sales• (3) The Treatment IP Licenses under• (3) The Treatment IP Licenses under

Sections 365 of the Code• (4) The Qimonda Case• (4) The Qimonda Case

– (i) Chapter 15 of the Code– (ii) Factual Background– (iii) Impact– (iv) Status

( ) Q&A22

• (5) Q&A

Roadmap

( ) Q&A33

• (5) Q&A

Why Businesses File for Bankruptcy

• Businesses file for bankruptcy for protection p y pfrom their creditors

• Types of Protection under the Bankruptcy Code ( h “C d ”)(the “Code”)– The Automatic Stay;

Ass me / Reject contracts– Assume / Reject contracts– No ipso facto clauses; and

Others– Others

The Two Business Bankruptcies

• Chapter 7 - pure liquidation

• Chapter 11 – reorganization or li id tiliquidation

Filing for Protection

• Who: Usually a corporation or related business associationWho: Usually a corporation or related business association

– Voluntary vs. Involuntary

• When: 24/7 365• When: 24/7, 365

• Where: Venue (try for S.D.N.Y. or Del.)

– Incorporated;– Incorporated;

– primary place of business;

– firm’s assets; orfirm s assets; or

– affiliate or partner filed

• What: A Petition

• Result: Filing the petition = automatic order; creates the “estate”

The Players in Chapter 11

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

Creditors (“Committee”)• Others:Others:

The Automatic Stay – the “Quiet Period”

• Section 362 of the Code provides anSection 362 of the Code provides an automatic stay (a freeze on):– Actions/proceedings against the Debtor to recover aActions/proceedings against the Debtor to recover a

claim that arose before the petition

– Enforcement of pre-petition judgmentsp p j g

– Act to obtain possession of property of the estate or to exercise control over it (includes Contracts and Li )Licenses)

– Create / perfect lien against property of the estate

Assumption, Rejection, Assignment

• Section 365 of the Code allows for the• Section 365 of the Code allows for the assumption or rejection of “executory contracts”contracts

• Countryman definition adopted in nearly all j i di tijurisdictions:

– “A contract under which the obligations of both th b k t d th th t t th t tthe bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a

to complete performance would constitute a material breach excusing the performance of the other.”

Assumption, Rejection, Assignment (cont.)

• Assumption: Must cure prepetitionAssumption: Must cure prepetition defaults and post petition defaults

• Rejection: “Rejection is Breach”Rejection: Rejection is Breach• Assignment – few limitations

– Overrides Anti-assignment agreementsOverrides Anti assignment agreements– Adequate Assurance

N li bilit t i t– No liability post-assignment• Debtor has no liability post-assignment

The Chapter 11 Proceedings

• Section 341 – Meeting of Creditorsg• 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 casethe same case

• Bar Date, Proofs of Claim, and Resolution Processocess

The Plan and Disclosure Statement

• The Plan of Reorganization (“Plan”)The Plan of Reorganization ( Plan )– DIP has an exclusivity period (first 120 Days

plus 18 month extension)plus 18 month extension)

– Generally Includes:D i ti f dit l• Designation of creditor classes

• Explanation of payments

• Other Requirements

• Possibility for competing Plans

12• Any party in interest can object

The Plan and Disclosure Statement (cont.)

• Solicitation of Votes– Each class gets a vote– 2/3 in amount OR more than ½ in number of2/3 in amount OR more than ½ in number of

creditors in that class votes for Plan– “Cram-Down”– Unimpaired claims = deemed to have

acceptedp• Proponent Can Modify at any point before

confirmation, but generally not after solicitation

• Confirmation and Objections

The Plan and Disclosure Statement (cont.)

• Disclosure Statement (“Disclosure”)( )– “adequate information”

• Hearing on Disclosure StatementHearing 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.”

Order of Distribution – "Waterfall"

“Surcharge” Against Collateral

Superpriority Claims

“Carve-Out” For Professional Fees in DIP Financing

Priming Lien in DIP Financing

Secured Claims

New Unsecured Debt

Adequate Protection Claims

Superpriority Claims

Adequate Protection Claims

Priority Claims

Priority Claims*

Administrative Claims

Unsecured Claims

Equity Claims

Wage Claims

T Cl i

Contributions To Employee Benefit Plans

Tax Claims

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

Timeline

Traditional Pre-PackagedPre-Arranged

Case Preparation(Time varies)

File Petition

Case PreparationDraft and Negotiate Plan

Plan Solicitation

Case PreparationNegotiate Major Terms of Plan

With Creditors

File Petition

Case Administration(Usually 3 to18 months)

“First Day” and “Second Day” Hearings(Usually a few weeks) File Petition, Plan Disclosure Statement

and Ballots

“First Day” Hearing, Disclosure Statement Hearing & Confirmation Hearing (Usually a week or two)

Case Administration(Usually faster than traditional case)

“First Day” and “Second Day” Hearings(Usually a few weeks)

Plan Proposal(Debtor’s exclusivity period limited to a

maximum of 18 months

Plan Solicitation(limited to a maximum of 180 days after

Plan Confirmation

Exit and Post Confirmation(Time varies)

Hearing (Usually a week or two)( y )

Plan Proposal(Usually within a few months of filing)

Plan Solicitation(Usually faster than traditional case)( y

plan proposal)

Plan confirmation

(Time varies)

Roadmap

( ) Q&A1717

• (5) Q&A

IP Asset Sales

• Business Judgment RuleBusiness Judgment Rule• Subject to Liens/other encumbrances

If D bt f lfill “ ti d h i ” ’t– If Debtor fulfills “notice and hearing” req’ts, sale can proceed subject to encumbrances

IP Asset Sales

• Free and Clear (i e not subject toFree and Clear (i.e., not subject to encumbrances)

Debtor must:– Debtor must: • Receive court authority under § 363(b); and

M t t l t i l i t d §• Meet at least one special requirement under §363(f).

Special Requirement - 1

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

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

• The license is in bona fide dispute;The license is in bona fide dispute;– An objective basis for either a factual or legal

dispute as to the validity of the encumbrancedispute as to the validity of the encumbrance

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

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

Effect of Finding Free and Clear

• Termination without Rejection: License jcould be extinguished (i.e., sale couldpreclude rejection and thus not invoke protections under Code)protections under Code)

– An objecting party may be entitled to adequate protection under § 363(e)adequate protection under § 363(e).

Effect of Finding Free and Clear (cont.)

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

Roadmap

( ) Q&A2727

• (5) Q&A

The Scenario

• MidTech LLC holds patents directed to pioneering p p gphotovoltaic inventions, including novel software that networks these systems. MidTech’s technology dominates the market and consumers look for thedominates 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 itsits agreement with MidTech. BigTech pays all of its royalties on time.

• MidTech files for Ch. 11 bankruptcy, now what?

IP Licenses as Executory Contracts

• Most IP licenses are “executory contracts”Most IP licenses are executory contracts because both parties’ failures to perform would be considered material breacheswould be considered material breaches

• “Executory contracts” may be (1) assumed or (2) rejected by Debtorassumed or (2) rejected by Debtor

IP Licenses as Executory Contracts (cont.)

• Aim for nonexecutory:Aim for nonexecutory:– More like an assignment:

A b dl itt d l i li• A broadly written and exclusive license

• A paid-up, or paid-in-full, license

IP Licenses as Executory Contracts (cont.)

• Aim for executory: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– Include obligatory provisions

Debtor as Licensor –Debtor Assumes (Continues) LicenseDebtor Assumes (Continues) License

• Cure all monetary defaults under the agreementCure all monetary defaults under the agreement• Pay damages• Provide adequate assurances of futureProvide adequate assurances of future

performance

Debtor as Licensor –Debtor Assumes (Continues) License (cont )Debtor Assumes (Continues) License (cont.)

• Court approval is required (i e Motion &Court approval is required (i.e., Motion & Order approving assumption)

Breach post assumption results in damages– Breach post-assumption results in damages that would be considered administrative expenses (rather than unsecured debt from p (rejection)

Debtor as Licensor --Debtor Rejects (Discontinues) LicenseDebtor Rejects (Discontinues) License

• L’EE may treat rejection as a pre-petitionL EE may treat rejection as a pre petition breach and file a claim OR

• L’EE retains rights under “intellectualL EE retains rights under intellectual property” license for rest of term and keeps up with royalty payments and non-p p y y p ymonetary obligations

– Retention rights enacted in response to Lubrizol – Includes right to enforce “exclusivity provisions”– No prospective rights

– Royalties ≠ maintenance, etc.

Debtor as Licensor --Debtor Rejects (Discontinues) License (cont )Debtor Rejects (Discontinues) License (cont.)

• Definition of “intellectual property” under Code:Definition of intellectual property under Code:– (A) trade secret;

– (B) invention, process, design, or plant protected under(B) invention, process, design, or plant protected under title 35;

– (C) patent application;

– (D) plant variety;

– (E) work of authorship protected under title 17; or( ) p p ;

– (F) mask work protected under chapter 9 of title 17;

• “IP” excludes trademarks L’EE can

IP excludes trademarks L EE can – (i) file claim, (ii) hold security interest, (iii) put

transition period in License Agreement

Debtor as Licensor --Rejection and Source CodeRejection and Source Code

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

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

Debtor as Licensor –L’OR TipsL’OR Tips

• Debtor may file Motion to Reject licenseDebtor may file Motion to Reject license as bargaining leverage in negotiations for new terms that Debtor will assumefor new terms that Debtor will assume.

• Worth asking: Is L’EE a prospective purchaser of the IP?purchaser of the IP?

Debtor as Licensor--L’EE TipsL’EE Tips

• In License Agreement:In License Agreement:– Debtor agrees to “assume”

– “IP” is clearly, broadly defined (include foreignIP is clearly, broadly defined (include foreign 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)

The Scenario (cont.)

• MidTech LLC holds patents directed to pioneering p p gphotovoltaic inventions, including novel software that networks these systems. MidTech’s technology dominates the market and consumers look for thedominates 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 itsits agreement with MidTech. BigTech pays all of its royalties on time.

• MidTech files for Ch. 11 bankruptcy, now what?

The Scenario (cont.)

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

Debtor as Licensee --Rejects LicenseRejects License

• Reject: License to Debtor discontinuesReject: License to Debtor discontinues– Claim for money damages

R j ti b h• Rejection = breach

– If a cross-license, L’OR may wish to continue its license under Debtor patentsits license under Debtor patents.

Debtor as Licensee --Assignment LimitationsAssignment Limitations

• To assign, must assume and thus meet assumption ’treq’ts

• Choice to assume-and-assign may be subject to non-assignment provision in license and laws applicable to IPassignment 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

Debtor as Licensee --Assumption When NonassignableAssumption When Nonassignable

• If the license is transferable, the Debtor may yassume the license

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

Debtor as Licensee --Courts SplitCourts 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 assuming the license is fineparty, assuming the license is fine.

• Hypothetical Test– Will not allow the Debtor to assume (or continue) theWill not allow the Debtor to assume (or continue) the

license, even if no transfer was intended, if law would preclude transfer.

Debtor as Licensee --Courts Split (cont )Courts Split (cont.)

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

Debtor as Licensee --L’EE TipsL’EE Tips

• L’EE includes transferability provisionL EE includes transferability provision (consent) in Agreement to keep “assumption” option openassumption option open

• L’EE who wants to assume might consider filing Chapter 11 in venue that appliesfiling Chapter 11 in venue that applies “Actual Test”

Debtor as Licensee --L’OR TipsL’OR Tips

• Non-exclusive licenses over exclusiveNon exclusive licenses over exclusive• Define “adequate assurance” that L’EE must

satisfy to support “assumption” of licensey pp p• Termination provisions with non-bankruptcy

triggersgg• Hold security interests in embodiments of IP

held by licensee• Limit consent to assumption to circumstances

that do not provide change of control

Roadmap

( ) Q & A4848

• (5) Q & A

Qimonda --Chapter 15Chapter 15

• Background:Background:– Enacted with 2005 Amendments (BAPCPA)

• Purpose• Purpose• Chapter 15 Case = Ancillary to cases

brought in the debtors home countrybrought in the debtors home country

Qimonda --Chapter 15 (cont )Chapter 15 (cont.)

• Foreign Representative (“FR”)g p ( )• 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– 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

Qimonda --BackgroundBackground

• Qimonda commenced an insolvencyQimonda commenced an insolvency proceeding in Germany – appointed Dr. Michael Jaffé as preliminary insolvencyMichael Jaffé as preliminary insolvency administrator and as FR

• June 15 2009 Dr Jaffé filed a petition for• June 15, 2009, Dr. Jaffé, filed a petition for relief under Chapter 15J l 22 2009 th B k t C t• July 22, 2009, the Bankruptcy Court entered an uncontested order of

recognition

Qimonda --Background (cont )Background (cont.)

• Same day - order stating that, pursuant toSame day order stating that, pursuant to Chapter 15, ‘‘the following sections [of the Bankruptcy Code] are also applicable in p y ] ppthis proceeding: §§ 305-307, 342, 345, 349, 350, 364-366, 503, 504, 546, 551, 558 ’’558.’’

• About two and a half months later, Qi d d t d th d tQimonda moved to amend the order to strike the reference to Section 365 or to limit the application of Section 365

limit the application of Section 365

Qimonda --Court’s OrderCourt’s Order

• Significant licensees objected to motion, as like most t i ’ l G l d t ff d 365( ) likcountries’ laws, German law does not afford 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 bankruptcy court;U.S. bankruptcy court;– Congress’s clear intent in enacting 365(n) to avoid harsh

“Lubrizol-esque” outcomesThe Court’s earlier order dictating the applicability of 365 in the– The Court s earlier order dictating the applicability of 365 in the 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 ( )

Qimonda --RationaleRationale

• “The principal idea behind chapter 15 is that the p p pbankruptcy proceeding be governed in accordance with the bankruptcy laws of the nation in which the main case is pending ”is 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 In fact the same idea process or invention mayresults. In fact, the same idea, process or invention may be dealt with differently depending on which country the particular ancillary proceeding is brought.”

Qimonda --ImpactImpact

• If Qimonda holding becomes widely-accepted,If Qimonda holding becomes 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.

tassets

– U.S. bankruptcy court defers to foreign proceeding and foreign law on licenses involving U S patentsand foreign law on licenses involving U.S. patents

– Debtor gains extraordinary leverage over non-debtor licensees that are potential infringers

Qimonda v. Voda

• Remember Voda v. Cordis:– “Regardless of the strength of the harmonization

trend … [p]ermitting our district courts to exercise j i di ti i f i t l i b d f ijurisdiction over infringement claims based on 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”

Qimonda --StatusStatus

• On appeal to District CourtOn appeal to District Court– Only one amicus brief (supports appellee)

Oral argument May 14 2010– Oral argument May 14, 2010

– Waiting for decision from District Court

– Will likely be further appealed to regional circuit court

Roadmap

( ) Q & A5858

• (5) Q & A

Michael M. MurrayPartner, Intellectual Property/LitigationMilbank, Tweed, Hadley & McCloy LLP1 Ch M h tt Pl

Blake ReeseAssociate, Intellectual Property/LitigationMilbank, Tweed, Hadley & McCloy LLP

1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5424 MMurray@milbank.comhttp://www.milbank.com/en/Attorneys/m-

1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5496 BReese@milbank.comp y

o/Murray_Michael.htm

Bradley Scott FriedmanAssociate, Financial RestructuringMilb k T d H dl & M Cl LLP

@http://www.milbank.com/en/Attorneys/p-

r/Reese_Blake.htm

Milbank, Tweed, Hadley & McCloy LLP1 Chase Manhattan PlazaNew York, NY 10005(212) 530-5846BFriedman@milbank com

BFriedman@milbank.comhttp://www.milbank.com/en/Attorneys/d-

f/Friedman_Bradley.htm

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

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