Caveat Licensees And Suppliers When Entering Cross-Border Agreements

Tuesday, October 4, 2011 - 01:00

Knowing how U.S. bankruptcy courts will treat creditors in bankruptcies of cross-border companies should be key to defining the business relationship at the time of entry into a license agreement or contract, well before a bankruptcy ensues. Therefore, licensees should watch closely the outcome of the remanded proceeding on the appeal by Micron Technology, Inc. in In re Qimonda AG, Chapter 15, Case No. 09-14766 (Bankr. E.D. Va. 2009). A pro-debtor result may require licensees to consider modifying standard license terms where, for instance, the licensor holds the licensed U.S. property in a non-U.S. entity, and may require licensees to become more proactive in objecting to the petition of a foreign administrator to open a Chapter 15 proceeding. Additionally, despite the favorable changes in 2005 to the reclamation provisions of the U.S. Bankruptcy Code, challenges by corporate debtors in bankruptcy to reclamation demands should cause vendors to better protect themselves when shipping goods to multiple jurisdictions, since the goods may be used company-wide, across borders, without regard to where the goods were shipped and which country's laws apply. This article examines the changes in the thought process that should be taking place at the time of entry into a license or supply agreement, before bankruptcy becomes an issue.

In Qimonda , in July 2009, at the request of the German foreign administrator of the debtor's estate, the U.S. Bankruptcy Court for the Eastern District of Virginia, Alexandria Division, entered an order that, among other things, authorized the foreign administrator to act in the U.S. on behalf of the German debtor and provided that 11 U.S.C. §365 ("Section 365") is applicable in the case. See Qimonda, Id. [DN57, ¶4]. Two months later, in September 2009, Qimonda AG's licensors asserted their rights under Section 365(n), which allows a licensee whose license is rejected to continue to license the intellectual property under the terms of the existing license, without entitlement to additional improvements to the property, for the entire term of the license and any optional extension period. In response, Qimonda AG moved to amend the bankruptcy court's order to remove any reference to Section 365 or, in the alternative, to provide that Section 365(n) applies only where Qimonda AG rejects a contract pursuant to Section 365. Id. [DN96]. In November 2009, the bankruptcy court modified the order as requested by the debtor, and in its Memorandum Opinion stated that the inclusion of Section 365 was "improvident." Id. [DN178]. The entry of the order was appealed to the District Court for the Eastern District of Virginia. Id. [DN181]. In July 2010, the District Court remanded the decision to the bankruptcy court to adequately balance the interests of the parties under 11 U.S.C. §1522, and determine whether failing to apply Section 365(n) manifestly violates public policy. Id. [DN274]. The bankruptcy judge recused himself from the matter (apparently due to a conflict with a party to the dispute, Id. [DN299]), and the remand resulted in a trial in March 2011 before a different judge. A decision remains pending.

A company may enter into a license agreement encompassing patents in multiple jurisdictions. If the licensed technology or product will be used in manufacturing goods for sale domestically and internationally, it is foreseeable that the licensee will enter one license with each counterparty to manufacture and use the technology worldwide, as opposed to a license for each country the technology will touch. If the license parties are addressing only one patent for one specific technology, the licensee may have the ability to determine precisely where the patent is filed and which country's law will apply in the event of a bankruptcy. However, often licensing arrangements are more complex, as in the case of Qimonda . An agreement encompassing hundreds of licenses for the manufacture, use and sale of technology or know-how in multiple countries cannot be addressed simply. The decision in Qimonda will determine whether in the Eastern District of Virginia a foreign debtor can open an ancillary proceeding under Chapter 15 for the purpose of applying foreign law to dispossess a licensee of its rights under Section 365(n). If a licensee of intellectual property can be deprived of its rights, granted by the U.S. Congress in response to the Fourth Circuit's decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc. (In re Richmond Metal Finishers, Inc.), 756 F.2d 1043 (4th Cir. 1985), then licensees will need to assess whether to (i) amend existing licenses to clarify that U.S. technology or know-how, or intellectual property licensed within the U.S. is governed by U.S. law, and specifically Section 365(n), and (ii) object to a foreign debtor's attempt to open a Chapter 15 case in the U.S. to exercise rights under foreign law to terminate licenses. As described in the Findings of Fact submitted by the licensees in Qimonda, a decision in favor of Qimonda AG may be far reaching and potentially affect the willingness of cross-border entities to share technology and know-how. Id. [DN603]. While Qimonda dealt only with DRAM technology, the results of an anti-365(n) decision in Qimonda may carry over into other types of intellectual property, like drug manufacturing. Pharmaceutical companies also regularly make decisions to invest enormous sums for research worldwide and will need to consider whether the hundreds of millions invested in the research and testing of drugs through the licensing of patented technology or medicine will be placed at risk.

To be safe, licensees of U.S. patents and copyrights or of intellectual property to be licensed within the U.S. should consider including in their license agreements a provision that, in the event of a bankruptcy, U.S. bankruptcy law and the protections afforded by Section 365(n) will apply. While the provision may not be binding upon a bankruptcy judge or administrator, it at least manifests the intent of the parties at the time of entry into the transaction to protect the rights of the licensee. Where many patents in multiple countries are at issue, moving the technology out of one entity and into a joint venture company (with rights of first refusal by the nondebtor), escrowing the technology or know-how, transferring the intellectual property to a U.S. entity subject only to U.S. bankruptcy law, or creating a security interest in intellectual property may lessen the risk. Of course, this presumes that the property can be described easily. Consequences of creating joint ventures (tax and otherwise) and whether the technology is readily transferrable into the U.S., among other things, must also be considered.

Less potentially disastrous, but similarly concerning to one group of creditors, is the ability of a vendor to receive payment for or recover goods delivered to a company with international business units and delivery points. In the U.S., under state law, suppliers have the right to demand the return of goods delivered in accordance with the terms of a contract within a specified period of time. See, e.g., §2-702(2) of the Uniform Commercial Code (requiring the return of product for which the recipient has not paid, upon demand within ten days after receipt). The Bankruptcy Code extends these rights to suppliers in the bankruptcy context. Pursuant to 11 U.S.C. §§ 503(b)(9) and 546(c)(1), a vendor has 20 days from the filing of a petition to demand the return of its goods delivered in the 45 days prior to the filing date and is entitled to an administrative claim for the value of goods delivered in the 20 days prior to the filing date. However, these sections may not be automatically applicable in cases filed under Chapter 15 ( see 11 U.S.C. §1520, and the Qimonda decision). Therefore, as in the 2009 bankruptcy court ruling in Qimonda , a supplier could find itself in the position of not having rights under state law and the Bankruptcy Code that are fundamental to creditors and were created by Congress specifically for the purpose of protecting vendors.

In the cases of In re Nortel Networks, Inc., et al. Chapter 11, Case No. 09-10138 (Bankr. D. Del. 2009) (jointly administered), In re Nortel Networks Corporation, et al. , Chapter 15, Case No. 09-10164 (Bankr. D. Del. 2009) (recognizing Nortel's Canadian proceeding) and In re Nortel Networks UK Limited , Chapter 15, Case No. 09-11972 (Bankr. D. Del. 2009) (recognizing Nortel's U.K. proceeding), vendors doing business with Nortel worldwide suddenly found themselves dealing with different companies and different rules of law once multiple bankruptcies were filed and the walls went up by country. To the extent that a vendor ships goods outside of the U.S. to a delivery point for use by a buyer worldwide, the vendor may not be able to assert reclamation rights in the U.S. or elsewhere for goods used by the buyer within the U.S. (Canada also has a reclamation law though the U.K. does not). Therefore, vendors must ensure at the outset of a contract that they know where their goods are being delivered and used.

Requiring segregation of the goods at the buyer's delivery site in a location identified with the supplier's name will add a further layer of protection regardless of the jurisdiction into which the goods were shipped. Indeed, European countries recognize retention of title in goods for which the buyer has not yet paid. While retention of title may be governed by common law, inclusion of a specific retention of title provision in a contract will create further protection for the vendor (and should be written to entitle the supplier to claim an interest in the proceeds of any sale of the goods to a third party); the concept being that title to the goods does not pass until payment is made; thus, the goods never become an asset of the buyer's estate. Questions of enforcement will arise where the goods have been incorporated into another product from which they cannot easily be separated or where a secured party, without knowledge of the vendor's rights, asserts a lien on assets.

In short, as contract parties expand operations worldwide and develop protocols for use of technology and know-how and for the efficient delivery of supplies to various locations, they need to protect themselves in the event of bankruptcy, when the proverbial music stops. It is not unique to draft contract provisions to address defaults and breach, such as damage provisions and choice of law. Structuring a deal to avoid potentially significant problems created by bankruptcy should become part of the mix. However, contract clauses alone may not provide sufficient protection for non-debtor counterparties, particularly where the laws of a foreign country that diverge substantially from U.S. law may control. Bankruptcy practitioners domestically and internationally should consider how best to protect bargained for contract rights to promote international trade, perhaps with further modifications or clarification to the existing Model Laws adopted as Chapter 15 of the U.S. Bankruptcy Code and by over a dozen countries.

Carren Shulman is a Partner at Sheppard Mullin LLP in the Finance and Bankruptcy practice group and regularly represents creditors in bankruptcy and contract counterparties in protecting their rights.

Please email the author at cshulman@sheppardmullin.com with questions about this article.