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Special Feature: Covenant Not to Sue Is Not Discharged in Bankruptcy

Wednesday, March 06, 2013

by Paul Devinsky

The U. S. Court of Appeals for the Third Circuit, equating a covenant not to sue under a patent with a license, has concluded that a trustee in bankruptcy cannot unilaterally reject the covenant as an executory contract. In re Spansion, Case Nos. 11-3323, -3324 (3rd Cir., Dec. 21, 2012) (Scirica, J.).

Spansion and Apple settled a patent dispute at the U.S. International Trade Commission (ITC) regarding flash memory products, with Spansion agreeing to dismiss its case and to refrain from filing related actions. In pertinent part, the agreement stated:

Provided that neither Spansion nor any successor in interest to any of the patents being asserted in the referenced ITC action do not bring an action of any nature asserting any such patent before any legal, judicial, arbitral, administrative, executive or other type of body or tribunal that has, or claims to have, authority to adjudicate such action in whole or in part against Apple or any Apple product, Apple agrees Spansion will not be disbarred as an Apple supplier as a result of the referenced ITC action.

In exchange, Apple agreed that Spansion would remain a primary supplier of certain flash memory “for the life-time of the [Apple] product” and will be considered for future platforms.

Spansion later filed for bankruptcy, and the trustee moved to reject the settlement as an executory contract. Under the normal rule in bankruptcy the debtor (i.e., Spansion) can unilaterally reject executory contracts if it so chooses, and any resulting contract damages will simply be treated as an unsecured debt. However, the Bankruptcy Code includes exception (codified in 11 U.S.C. § 365(n)) whereby a licensee can elect to retain its license rights despite a debtor’s rejection.

If the trustee rejects an executory contract under which the debtor is a licensor of a right to intellectual property, the licensee under such contract may elect . . . (B) to retain its rights . . . under such contract . . . to such intellectual property . . . as such rights existed immediately before the case commenced."

In an appeal of the Bankruptcy Court’s ruling that § 365 did not apply to the covenant (which the Bankruptcy Court concluded was not a license) the district court in Delaware, concluded the settlement agreement was a license and that Apple had the right, under § 365, to retain its rights under the subject patents. Spansion appealed.

On appeal, the question was whether the contract between Spansion and Apple was a license or merely a promise not to sue. The 3rd Circuit affirming the district court, cited to the Supreme Court decision in De Forest Radio (1927): “[A] license ... [is] a mere waiver of the right to sue by the patentee.” Further, the 3rd Circuit, citing to the Federal Circuit TransCore decision (2009) [IP Update, Vol. 12, No. 5], explained that a license need not be a formal grant, but may instead be simply a “consent[ ] to use of the patent.”

The 3rd Circuit concluded that Spansion’s promise to “dismiss the ITC action” and “not re-file the ITC action or another action related to one or more of the same patents against Apple” was a promise not to sue on a patent and therefore a license of patent rights subject to § 365(n).

Practice Note: Presumably, under the Federal Circuit decision in General Protecht Group (2011) [IP Update, Vol. 13, No. 9] the covenant would even extend continuations of the Spansion patents that were the subject of the covenant. Thus, as a consequence of the Spansion bankruptcy and General Protecht decision, Apple ended up with a broader covenant than it originally bargained for and no obligation to continue to use Spansion flash memory in its product.

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