Recent Decisions in Bankruptcy Court

Types : Alerts

Third Circuit Finds Covenant Not to Sue in Patent Settlement is a License that Cannot be Rejected under Bankruptcy Code Section 365(n)

In a recent decision, the Third Circuit Court of Appeals determined that a covenant not to sue incorporated in  a patent dispute settlement is a license that cannot be rejected by a trustee in bankruptcy.  In re Spansion, 2012 WL 6634899 (3d. Cir. 2012).

Spansion settled a patent dispute before the U.S. International Trade Commission (ITC) over flash memory products with Apple before it filed for chapter 11 in Delaware.  As part of the settlement, the parties agreed if Spansion or its successors refrained from bringing any further such action before the ITC, it would remain an exclusive flash memory products supplier to Apple.

When Spansion filed for bankruptcy, the trustee viewed the settlement as an executory contract and sought to reject it, which Spansion was authorized to do under section 365 of the Bankruptcy Code.  Apple, however, asserted that an exception to this rejection right controlled the settlement under section 365(n), which allows a licensee to retain its license rights with respect to a license of intellectual property regardless of a debtor’s unilateral rejection of the contract.

The bankruptcy court found the 365(n) exception not applicable to the covenant not to sue.  The district court disagreed and ruled in favor of Apple on appeal, finding that the covenant not to sue under the settlement agreement was a license of intellectual property, and as a result Apple maintained its rights under the patents.

On appeal to the Third Circuit by Spansion, at issue was whether the settlement granted Apple a license of the flash memory products or whether it was merely a contractual agreement not to sue.  Agreeing with the District Court, the Court found that Spansion’s agreement to end the patent dispute and not pursue any further action before the ITC was a promise not to sue on a patent, which resulted in a license of Spansion’s patent rights to Apple subject to the 365(n) exception to rejection.  Accordingly, Apple maintained its license rights with respect to the Spansion products.

Given the Third Circuit’s ruling, licensees of intellectual property may be able to retain their rights not only under their license agreements, but also in connection with pre-petition settlements.  Licensees therefore need to be wary of language in the settlement seeking to accept these license rights to ensure that they are protected in the event of a bankruptcy.

Delaware Bankruptcy Court Upholds Post-Petition Plan Support Agreement

Under normal circumstances, chapter 11 debtors are required to obtain the court’s authorization before they solicit acceptance of a plan of reorganization by obtaining approval of a disclosure statement which must contain adequate information to allow a creditor to make an informed decision with respect to acceptance of the plan.  This process, required under Bankruptcy Code section 1125, can be expensive and cumbersome, especially if the debtor must contend with multiple objections as to the adequacy of the information disclosed.  To get around this, a trend has developed in which creditors sign to plan support agreements.  For the most part, this has been done in the pre-petition time frame where a debtor seeks approval of a pre-packaged plan on an expedited basis.  Recently, however, a trend has developed in which debtors are circulating and obtaining plan support agreements, often referred to as “lock-up agreements,” before obtaining court approval to solicit plan acceptance.  Such agreements have been criticized as a means to circumvent the statutory requirements for plan solicitation.  Some courts, however, have found that proceeding in this manner is efficient and promotes a debtor’s reorganization.

At least one case in the District of Delaware has approved of this process in the case of In re Indianapolis Downs LLC, 2013 WL 395137 (D. Del. 2013).  There, the debtor, a “racino,” entered into a lock-up agreement with several of the largest creditors which bound the creditors to vote for approval of the debtor’s plan of reorganization before the disclosure statement was approved.  Certain parties who did not approve of the plan sought to have the assenting creditors votes designated (disallowed) arguing that the lock-up agreement violated the required solicitation process.

The court disagreed, noting that doing so would be a harsh penalty in the absence of wrongful conduct or bad faith.  Further, the creditors to the lock-up agreement were part of the plan process and the debtor had provided them with enough information to obtain broad support of the plan.  The court also found that his was not contrary to section 1125 of the Bankruptcy Code, which was enacted to prohibit the solicitation of votes from creditors who had not received enough information to make an informed decision about supporting a plan.  Under these facts, the court found that the lock-up agreement did not violate the solicitation procedures set forth in section 1125 of the Bankruptcy Code and the plan was approved.

The Indianapolis Downs case suggests that bankruptcy solicitation may occur outside the statutory framework of section 1125 if the creditors are adequately informed and have been engaged in the plan formulation process.  It should be noted, however, that this decision was reached based upon the specific facts and circumstances involved in the case.  Other courts, including some in the District of Delaware, have found otherwise.  Nevertheless, Indianapolis Downs suggests that in modern bankruptcy practice efficiency may trump the formal solicitation process under the right circumstances.