Covenants Not to Sue Are Licenses in Bankruptcy

The ongoing Kodak bankruptcy has engendered interest in understanding the role of IP-related licenses in bankruptcy.

The recent decision in In re Spansion also merits consideration. There, following settlement of Spansion’s 2008 ITC patent infringement action against Samsung and Apple, Spansion and Apple entered into a letter agreement in February 2009 whereby Spansion agreed to dismiss its ITC action against Apple and promised to refrain from filing future actions relating to its asserted patents. In turn, Apple agreed to not disbar Spansion as a supplier and to consider Spansion for future products. In March 2009, Spansion filed for Chapter 11 bankruptcy in the Bankruptcy Court for the District of Delaware.

Moving under 11 U.S.C. § 365(a), Spansion sought to reject the letter agreement as an “executory contract,” that is, an ongoing contract between a non-debtor (Apple) and a debtor (Spansion). Under § 365(a), a debtor or trustee can reject the contract upon a showing that the contract is burdensome, a relatively easy threshold in most cases. Rejection of an executory contract constitutes a breach (not a termination) of the contract, entitling the non-debtor counter-party to file a claim for damages arising from the rejection of the contract. However, contract rejection claims are unsecured; the non-debtor typically receives little to no payment on such claims.

The Delaware Bankruptcy Court granted Spansion’s motion, and ordered that “the [Letter] Agreement… is hereby rejected; and further ordered that … [service of] this Order upon Apple, Inc. shall constitute adequate written notice of termination thereof (emphasis added).” Apple then elected to retain its rights under the letter agreement pursuant to 11 U.S.C. § 365(n), maintaining that the agreement was a license. Spansion moved to enforce the September Order, arguing that it terminated the letter agreement. After clarifying the Order, the Bankruptcy Court denied Apple’s § 365(n) election, finding the agreement was not a license, and thus § 365(n) did not apply. On appeal, the District Court of Delaware held the agreement was a license because it was a promise not to sue, and held § 365(n) provides for Apple to retain its rights under the patent license.

The Third Circuit, in a non-precedential decision, held that the covenant not to sue in the letter agreement was a license, citing to the Supreme Court’s decision in De Forest Radio Tel. & Tel. Co. v. United States, 273 U.S. 236 (1927) and the Federal Circuit’s decision in TransCore, LP v. Elec. Transactions Consultants Corp., 563 F.3d 1271, 1275-76 (Fed. Cir. 2009). The Third Circuit particularly focused on what the letter agreement authorized, rather than whether the language is couched in terms of a license or a covenant. Accordingly, Apple retains its rights as licensee under § 365(n), regardless of whether Spansion sells the underlying patent rights in its bankruptcy proceeding.