The U.S. Court of Appeals for the Third Circuit recently affirmed its expansive definition of what constitutes an intellectual property license in In re Spansion, 2012 U.S. App. LEXIS 26131 (3d. Cir. Dec. 21, 2012). The Third Circuit clarified that a license need not be expressly labeled as such or formally grant intellectual property rights, but instead is a mere waiver by the holder of intellectual property of its right to sue. From a bankruptcy perspective, the characterization of an agreement that contains a covenant not to sue for intellectual property infringement as a license is significant, because the Bankruptcy Code allows an intellectual property licensee to retain its rights under a license notwithstanding rejection of the license by the debtor-licensor.

Background

In November 2008, Spansion Inc. filed a patent infringement complaint concerning its flash memory products against Samsung and Apple with the International Trade Commission. In a letter agreement dated February 10, 2009, between Spansion and Apple, Spansion agreed to dismiss the ITC action against Apple and promised to refrain from filing future actions related to those patents. In exchange, Apple agreed to continue using Spansion as a supplier, and to consider Spansion for future products if certain conditions were met.

On March 1, 2009, before it had taken steps to dismiss the ITC action against Apple as called for in the letter agreement, Spansion filed a Chapter 11 bankruptcy petition in the U.S. Bankruptcy Court for the District of Delaware. Spansion then moved to reject the letter agreement as an executory contract pursuant to Section 365(a) of the Bankruptcy Code. Spansion made a business determination that there would be greater value in suing Apple than in securing Apple’s continued business. The Bankruptcy Court granted the motion to reject. As the pending motion to reject and the specter of renewed litigation hardly fostered warm mutual feelings, Apple and Spansion ceased doing business with one another. Apple, however, filed a notice stating its election to retain its rights under the letter agreement, contending that the agreement was a license pursuant to Section 365(n) of the Bankruptcy Code.

Section 365(n) of the Bankruptcy Code provides that if the trustee or debtor-in-possession rejects an executory contract under which the debtor is a licensor of a right to intellectual property, the licensee has two options. One is that the licensee may elect to treat such contract as terminated if such rejection amounts to a breach that would entitle the licensee to treat the contract as terminated by virtue of its own terms, applicable nonbankruptcy law, or an agreement by the licensee with another entity. Alternatively, the licensee may elect to retain its rights to the intellectual property under the contract and any supplementary agreements, as such rights existed immediately before the bankruptcy case commenced, for the duration of the contract and any period for which the licensee has a right to extend the contract under nonbankruptcy law.

The Bankruptcy Court denied Apple’s Section 365(n) election, holding that the agreement was not a license to which Section 365(n) could apply. On appeal, the U.S. District Court for the District of Delaware overturned the ruling of the Bankruptcy Court and held that the agreement was a license because it was a promise not to sue, and accordingly Section 365(n) permitted Apple to retain its rights under the patent license, most notably the benefit of the covenant by Spansion not to sue for infringement of its patents.

Broad Definition of License

The Third Circuit affirmed the holding of the District Court that the letter agreement between Spansion and Apple was an intellectual property license. According to the court, a license is a “mere waiver of the right to sue by the patentee,” quoting De Forest Radio Tel. v. United States, 273 U.S. 236, 242 (1927). A license need not be a formal grant, but is instead a “consent to the use of the patent in making or using it, or selling it … and a defense to an action for a tort.” The inquiry into what qualifies as a license focuses on what the agreement authorizes, not whether the agreement is identified as a license or a covenant not to sue. Effectively, the two are equivalent. (See TransCore v. Elec. Transaction Consultants, 563 F.3d 1271, 1275-76 (Fed. Cir. 2009).)

In the letter agreement at issue, Spansion had promised “to dismiss the ITC action against Apple, and not re-file the ITC action or another action related to one or more of the same patents against Apple.” This, clearly, was a promise not to sue Apple for its use of Spansion’s patented products. In the view of the Third Circuit, no further inquiry was required – the letter agreement is a license.

The Third Circuit further held that the cessation of business between Spansion and Apple during the bankruptcy case did not preclude Apple from continuing to enjoy the benefit of the covenant not to sue. Section 365(n) allows a licensee to retain its rights as such rights existed immediately before the bankruptcy case commenced. The fact that all business between Spansion and Apple ceased after Spansion filed for bankruptcy was irrelevant to the Section 365(n) analysis. The letter agreement is a license, so Apple had the right to retain its licensing rights as they existed upon the commencement of the Spansion bankruptcy case.

Observations

The reaffirmation by the Third Circuit that a license is a mere waiver of the right to sue has significance that transcends bankruptcy concerns, to be sure. From a bankruptcy perspective, however, the case is illuminating for several reasons.

First, it highlights the fact that when we speak of “rejection” of an agreement by a debtor in bankruptcy, it is not to say that the agreement has necessarily been terminated. In bankruptcy, a rejection under Section 365 of the Bankruptcy Code is equivalent to a breach, not termination. By rejecting a contract, the debtor obtains relief from its obligation to continue performing under the contract, with the damages from such nonperformance treated as a pre-petition unsecured claim. While rejection may also ultimately lead to termination of a contract on account of the debtor’s nonperformance, this is not necessarily so, and it is not to the debtor solely to decide.

This brings us to the second point. The effect of rejection depends on the nature of the agreement at issue. In Section 365 of the Bankruptcy Code, Congress extended special protections to certain categories of contract parties who may stand to suffer especially severe hardships if their rights could be denied through rejection. Intellectual property licensees are one example, as seen here in the Spansion case. Similarly, a real property licensee may treat a rejected lease as terminated, but in the alternative it may choose to retain its rights to real property, including rights of use, possession and quiet enjoyment, under the lease for the duration of the lease term and any applicable renewal terms.

For this reason, how a given contract or lease is characterized may prove critical in determining the rights of the parties in bankruptcy following a rejection. This lesson is demonstrated in Spansion, where the treatment of the letter agreement in question as an intellectual property license likely spared Apple from significant litigation.

Eric Scherling is a member of Cozen O’Connor, where he practices in the firm’s bankruptcy, insolvency and restructuring practice group. He may be reached at 215-665-2042 or escherling@cozen.com.