Part 2 of 4: Bankruptcy: Crisis for Some,
Opportunity for Others
Michael Cooley, Partner, Gardere Wynne Sewell LLP
In 2009/2010, GSA will bring GSA Forum readers a four-part series analyzing legal issues such as antitrust and bankruptcy. These articles will be written by Gardere Wynne Sewell LLP, one of the Southwest's largest full-service law firms providing legal services to private and public companies and individuals in areas of energy, litigation, corporate, tax, environmental, labor and employment, intellectual property, governmental affairs and financial services.
While GSA does not endorse any particular perspective, we believe whether you agree or disagree, these articles will encourage semiconductor companies and their partners to ask and begin identifying answers to some difficult and challenging questions.
The semiconductor industry—like virtually every other—is
not immune to the challenges of the current economic
climate. In April 2009, All American Semiconductor Inc., a
leading distributor of semiconductors, obtained court approval of a
chapter 11 plan of liquidation. More recent months have seen the
bankruptcy filings of Aviza Technology Inc., a supplier of advanced
semiconductor capital equipment and process technologies, and
Magnachip Semiconductor Ltd, which sells and manufactures wafers
designed and used by other semiconductor companies.
Even healthy companies, however, can be affected by a bankruptcy
filing. The bankruptcy of a key customer or vendor can disrupt a
company's supply chain and, in the case of a bankrupt customer,
create the potential for significant receivables to go uncollected.
Perhaps more critically, licensing rights in intellectual property can
be affected by a bankruptcy filing where the bankrupt entity seeks to
terminate its rights and obligations under license agreements.
While the current outlook may be grim for the economy at large,
the prospects of individual companies vary significantly, and some
companies will continue to perform well despite the larger trends.
For example, the designer retailer's loss may become Walmart's gain
as consumers shop more closely for bargains. As car manufacturers
frequently say, "your mileage may vary." For some companies, this
means finding new strategies to survive in a world of tightening
credit markets and shrinking revenue. For others, the global crisis
presents the chance to capitalize on opportunities that the current
economy provides.
Asset Sales in Bankruptcy
One such area where one company's crisis may be another's opportunity
is in the asset sales that frequently accompany chapter 11 cases.1
Traditionally, chapter 11 of the Bankruptcy Code was designed
to facilitate management's rehabilitation of a troubled company,
while chapter 7 offered a streamlined process for the liquidation
of a business under the supervision of an appointed trustee. In the
modern day, however, companies with every intention of selling all or
substantially all of their assets are filing for bankruptcy protection in
chapter 11 too. The advantage to a company of liquidating in chapter
11 is that it offers management the ability to continue operating the
business in bankruptcy. This, in turn, frequently translates to a more
orderly liquidation process in which the troubled company can be
marketed and sold as an ongoing (and presumably more valuable)
enterprise, rather than as a lifeless assortment of inventory, equipment
and receivables.
Asset sales in chapter 11 have become more commonplace as
companies have resorted to bankruptcy as a means to liquidate,
rather than reorganize, the corporate entity. Commonly referred
to eponymously as "Section 363 sales" (named for the Bankruptcy
Code section from which they arise), they enable the trustee in a
bankruptcy case to sell anything, ranging from a single piece of
equipment to the entire ongoing business enterprise.2 Under the
terms of the Bankruptcy Code, proposed sales are subject to approval
by the bankruptcy court and generally (though not always) conducted
through an auction process in which entities may bid for the assets
offered for sale by a bankrupt debtor.
Most potential buyers fall into two categories: strategic buyers
and financial buyers. A strategic buyer, most typically, is a company
engaged in the same or similar business as the target company. The
strategic buyer will view the acquisition as an opportunity to add
to an existing industry presence or vertically integrate the target
company into its supply chain. A financial buyer, on the other hand,
views the acquisition as an investment. The acquisition may be a one-off
transaction, or the buyer may add it to a portfolio of companies in
a particular industry. Of course, the difference between the two types
of buyers is not always well-defined; for example, a private equity
fund seeking to add a target company to a portfolio of companies
in a similar industry may exhibit attributes of both strategic and
financial buyers.
In the recent semiconductor cases, both Aviza and Magnachip filed their
chapter 11 cases with proposed buyers already lined up. The
proposed acquiror of Aviza, Sumitomo Precision Products Co. Ltd.,
is a diversified equipment manufacturer that makes a semiconductor
manufacturing system that competes with an Aviza system—in other
words, a strategic buyer. In this situation, therefore, the acquisition
will add to Sumitomo's semiconductor business unit and consolidate
competing systems under a single banner.
The proposed buyer of Magnachip's assets, on the other hand,
is a financial buyer. KTB 2007 Private Equity Fund, a Korean
venture capital firm, will add Magnachip's operation to its portfolio
of technology companies, which includes Siltron, a manufacturer of
silicon wafers. As other companies in the semiconductor and related
industries contemplate their options, more opportunities like these
are bound to emerge.
For those companies with available liquidity, Section 363 sales
provide an excellent opportunity to strengthen existing operations
through the strategic acquisition of individual assets or entire business
units. These sales provide the added benefit of having received the
"blessing" of the bankruptcy court, without which a Section 363 sale
cannot be concluded. Bankruptcy court approval, which typically
carries with it findings that the sale was for reasonable value, frequently
also heads off the later possibility that the sale might be challenged
as having been for less than fair value. Such approval also affords the
purchaser the benefit of the safe harbor provisions of Section 363,
which protects the integrity of the sale to a good faith purchaser in
the event the order approving the sale is subsequently appealed. Of
particular value to buyers seeking to acquire entire business units,
such sale orders may also contain provisions limiting or extinguishing
any potential successor liability associated with the acquisition.
Intellectual Property Rights in Bankruptcy
Another key area of concern (and opportunity) arises in connection
with the license of intellectual property rights by or to a bankrupt
entity. Among other powers granted to a debtor in bankruptcy is
the ability to elect whether to "assume" (i.e., retain) or "reject" (i.e.,
terminate) contracts (including licenses) under which substantial
performance remains due by both parties such that termination of
the contract would constitute a material breach excusing performance
by the other party. Such contracts are referred to in Section 365 of
the Bankruptcy Code as "executory contracts," and the Bankruptcy
Code sets forth at length the respective rights of both the debtor and
the nondebtor counterparty based upon whether the debtor elects to
assume or reject the contract.
Briefly stated, when a debtor elects to assume an executory
contract, it cures all outstanding defaults (including payment defaults,
but excluding nonmonetary defaults) and agrees to be bound by the
contract going forward as though the bankruptcy had never occurred.
When a debtor rejects an executory contract, the rejection is treated as
a breach of the contract as of the commencement of the bankruptcy
case, following which the contract may be terminated and the
nondebtor counterparty may assert a claim against the bankruptcy
estate for damages arising from the rejection and resulting breach.
The decision to assume or reject an executory contract is one that
lies within the exercise of a debtor's reasonable business judgment,
and provides a debtor with the ability to divest itself of unprofitable
contracts while preserving profitable relationships and those essential
to the continued operation of the debtor's business. Notably, the
debtor may elect whether to assume or reject the contract even
over objection of the nondebtor counterparty except in limited
circumstances where, for example, either applicable law excuses the
nondebtor party from accepting performance from a third party (e.g.,
franchise agreements) or the contract is a financial accommodation
(e.g., loan, promissory note).
Licenses, including licenses of intellectual property, are generally
considered to be executory contracts and therefore subject to a
debtor's right to assume or reject them subject to the requirements
of the Bankruptcy Code. When a licensee files bankruptcy, therefore,
the licensor (i.e., the nondebtor counterparty) can anticipate that the
debtor licensee will seek either to retain or divest its rights under the
license agreement. Upon the former, assumption of the license will
return the parties essentially to the status quo ante; and upon the
latter, rejection will entitle the licensor to file a claim for damages, if
any, arising from the termination. In many instances, it may reflect
the loss of a royalty stream, but is unlikely to represent a catastrophic
event for the licensor.
More complicated, however, is what happens when the licensor
files bankruptcy and seeks to reject license agreements between itself
and its licensees. From the licensee's perspective, termination of
a license has the potential to be catastrophic, as a licensee's entire
business model may be built around access to the intellectual property
obtained through the license agreement. To protect the licensee in
these situations, the Bankruptcy Code grants the licensee the power
to partially override the debtor licensor's decision to reject the license
and preserve its rights in the underlying intellectual property.
Section 365(n) of the Bankruptcy Code sets forth the rights of a
licensee of intellectual property when the debtor elects to reject an
executory contract under which the debtor is a licensor of intellectual
property. The Bankruptcy Code defines “intellectual property” to
mean—
(A) trade secret,
(B) invention, process, design or plan protected under title 35,
(C) patent invention,
(D) plant variety,
(E) work of authorship protected under title 17,
(F) mask work protected under chapter 9 of title 17.3
The term "mask work" in this context is given the same definition
as provided in chapter 9 of title 17 of the United States Code,4 which
defines mask work as "a series of related images, however fixed or
encoded—"
(A) having or representing the predetermined, three-dimensional
pattern of metallic, insulating or semiconductor material
present or removed from the layers of a semiconductor chip
product; and
(B) in which series the relation of the images to one another is
that each image has the pattern of the surface of one form of
the semiconductor chip product.5
Reading these provisions together, the protections of Section
365(n) will typically extend to the nondebtor licensee under a mask
work license as well as other licenses of intellectual property.
If the debtor licensor elects to reject a license of intellectual
property (say, mask work), the licensee may elect to treat the license
as terminated by such rejection and file a claim in the bankruptcy case
for damages arising from such rejection and termination—in other
words, to effectively acquiesce in the rejection and allow the license to terminate.
Alternatively, Section 365(n) permits the licensee to
retain its rights to the licensed intellectual property as such rights
existed immediately before the commencement of the bankruptcy
case, including exclusivity rights arising under the license.
Upon such an election by the licensee, the Bankruptcy Code
requires the licensor to allow the licensee to exercise its rights as
licensee under the license. Put another way, the nondebtor licensee
can "trump" the debtor's rejection and elect to continue to use the
intellectual property for the duration of the license agreement and
any period for which it may be extended by the licensee as a matter of
right. To the extent provided under the terms of the license agreement,
the licensee may also obtain the underlying intellectual property
(including any embodiment thereof ) from the licensor; however, the
licensee cannot demand specific performance of any other obligations
of the licensor under the license. In return, the licensee is obligated
to continue to make all royalty payments due under such license for
the duration. In this fashion, the Bankruptcy Code preserves the
licensee's ability to retain its right to use the intellectual property
while relieving the licensor of any continuing obligation under the
license agreement (e.g., to provide service, upgrades).
Conclusion
Current market conditions strongly suggest that the current uptick
in significant bankruptcy filings will only continue for the foreseeable
future, and even healthy companies will find themselves implicated
in bankruptcy proceedings as competitors, customers and suppliers
seek to reorganize or liquidate. For the company with a healthy
balance sheet and meaningful cash reserves or other access to capital,
corporate bankruptcies can provide real opportunities for continued
business growth and profits.
About the Author
Michael Cooley is a partner at Gardere Wynne Sewell LLP and a member
of the firm's bankruptcy and business reorganization group. Mr. Cooley has a
comprehensive practice, including complex bankruptcies, workouts, distressed asset
sales and bankruptcy litigation. Although his practice focuses on the representation of
debtors in complex chapter 11 reorganizations and liquidations, Mr. Cooley's clients
also include individual lenders, creditors and prospective buyers in both chapter 7
and chapter 11 cases. Mr. Cooley has written on a variety of subjects relating to
bankruptcy law and is a member of the American Bankruptcy Institute. You can
reach Michael Cooley at 214-999-4824 or mcooley@gardere.com.
References
1 Unless otherwise noted, chapter and section references herein are to the Bankruptcy Code, 11
U.S.C. §§ 101-1532 (2008).
2In a chapter 11 case, absent the appointment of an independent trustee under specified
circumstances, the estate is administered by the debtor acting as trustee and “debtor in possession.”
For convenience, the term “debtor” is used herein to refer to the debtor in its capacity as trustee
and debtor in possession.
3 11 U.S.C. § 101(35A).
4 11 U.S.C. § 101(39).
5 17 U.S.C. § 901(a)(2).
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