Yesterday the Fourth Circuit issued a decision in Jaffe v. Samsung, et al. regarding the preservation of existing U.S. patent licensing rights that various semiconductor companies had through cross-licensing with Qimonda AG, a German semiconductor manufacturer going through bankruptcy proceedings in Germany.  The decision does not state whether any standard essential patents (SEPs) were at issue, but does discuss issues of a reasonable and non-discriminatory royalty (RAND), patent “holdup” and prejudice to an industry if existing licensing agreements do not follow the patents through bankruptcy.

Qimonda AG had been one of the largest DRAM manufacturers, having thousands of worldwide patents, including about 4,000 U.S. patents.  Qimonda had entered cross-licensing agreements with competitors “to avoid infringement risks caused by the ‘patent thicket’ resulting from the overlapping patent rights of some 420,000 patents in the semiconductor industry.”

In 2009, Qimonda filed for bankruptcy in Germany.  The bankruptcy trustee, Jaffe, sent letters to the cross-licensed companies invoking a provisoin of German bankruptcy law to declare those cross-licenses “no longer enforceable”.  Some licensees responded that they would invoke protections under Section 365(n) of the U.S. bankruptcy code that allows licensees to retain their rights under existing licenses.

The U.S. bankruptcy and district courts were then asked to balance the rights of parties with the United States’ foreign comity obligations.  The district court ultimately ruled that it would preserve the licensee’s Section 365(n) rights as to U.S. patents, which ruling the Fourth Circuit affirmed in its ruling yesterday.

Holdup.  The court explained a “holdup” concern based, not on SEPs, but infringement assertions of patents generally after “sunk costs” in developing a semiconductor product:

The problem of the patent thicket is exacerbated by the enormous costs incurred to bring a new semiconductor product to market.  According to one expert, the price of building a new semiconductor fabrication facility can now exceed $5 billion.  These sunk costs could create a classic “holdup” problem if a new product were ultimately found to infringe someone else’s patent, with the patent’s owner being able to extract a substantially higher royalty after the investment had been made than if a license had been negotiated beforehand. Thus, to avoid this holdup premium and enhance their design freedom, competitors in the semiconductor industry have routinely entered into broad, non-exclusive cross-license agreements with each other, sometimes with the addition of equalizing payments (either up-front payments or so-called running royalties) to account for differences in the size and breadth of the respective patent portfolios.

 RAND.  The Qimonda bankruptcy trustee explained that revocation of existing licenses would include a promise to re-license the patents under a reasonable and non-discriminatory royalty (RAND), to enter good faith negotiations and bring any RAND rate dispute into arbitration proceedings before the World Intellectual Property Organization (WIPO).  The court likened this RAND commitment to those common in technical standard setting organizations (SSOs).  In this instance, the licensor would seek to convert the existing non-monetary cross-licensing terms into a pure monetary RAND rate estimated to give the Qimonda estate about $47 million a year.  In contrast, the existing non-monetary cross-licenses had little value to the bankrupt Qimonda estate since it was no longer in the semiconductor production business.

The licensees responded that, among other things, terminating the existing cross-licenses would “destabiliz[e] the system of licensing that has enabled the extraordinary success of the semiconductor industry” and would have further uncertainty if the patents were sold to another entity that itself goes bankrupt or otherwise does not honor the existing license agreements.  The district court weighed the issues and ruled that the licensees could rely on Section 365(n) to preserve the existing licenses to U.S. patents, and the Fourth Circuit affirmed that ruling as “reasonable.”

The issue of preserving licensing rights through bankruptcy has arisen with standard essential patents (SEPs) as well (see our Rockstar post), though this case illustrates the issue is not unique to SEPs.  This decision does not resolve the issue.  The concurring opinion notes that the decision is only whether the district court’s ruling was a “reasonable” exercise of discretion and not whether the court would reach the same conclusion.  Further, the U.S. government filed an amicus brief in this case seeking to reverse the preservation of licensing rights “on the threshold ground that Section 365(n) cannot constrain the operation of German insolvency law in Germany.”  In contrast, current patent reform legislation seeks to confirm that licensing rights are preserved through bankruptcy (see our November post).