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Trade Creditor Strategies

I was pleased to join Adrienne Walker from Mintz and Lindsay Zahradka Milne from Bernstein Shur on a business panel  yesterday hosted by Massachusetts Continuing Legal Education.   Our focus was on strategies for trade creditors to obtain  (and keep) payment in light of  issues arising in recent financial meltdowns including Sports Authority, Toys R Us, Sears,  Papa Gino’s and many other distressed companies.

We covered a lot of territory in a short amount of time with thoughtful insights and commentary from the audience.  Topics included  maximizing lien rights, obtaining critical vendor status, risks associated with post-petition administrative claim recoveries,  the value of reclamation claims, recent consignment issues, and minimizing preference exposure.

My focus was on lien issues which included the practicality of obtaining and perfecting a security interest under Article 9 of the Uniform Commercial Code.  The discussion also covered various non Article 9 liens including judgment liens, state statutory liens (including mechanics liens) and federal statutory liens (including the Perishable Agriculture Commodities Act).

My top takeaways for trade creditors from the session:

  •  Be Proactive:   Trade creditors who actively monitor and manage receivables are best positioned to avoid the pain of a customer’s financial distress.   Understand the reality that a customer’s  filing could completely extinguish all amounts owed and could also result in the forced return of certain funds paid to the creditor before filing as a “preference.”   Avoid putting off dealing with the unpleasantness of a customer issue; rather make it a priority to protect your right to payment.

 

  • Explore Lien Rights Early:   Creditors often explore lien rights only after experiencing non-payment.  A better strategy is to consider the possibility of lien rights at the outset of a business relationship.   Establishing lien rights requires strict compliance with detailed statutory elements such as those created by Article 9 of the UCC or other statutes.   If lien rights are important, take the time to ensure that the lien is properly created and not subject to attack.

 

  •  Understand Consignment:    Some trade vendors believe that shipping goods to a customer “on consignment” can insulate the vendor from any financial issues of the customer.   However, the law of consignment is highly complex drawing from both the common law and operative provisions of the Uniform Commercial Code enacted by the states.   If you intend to be protected by a consignment relationship, it is imperative that the relationship withstand judicial scrutiny.   Two decisions (available here)  issued on November 26 2018  in the Sports Authority case drill down into these issues and provide a sense of the complexities that can arise.

 

  • Treat DIPs with Care:  “DIP” stands for “debtor in possession” — the term used to describe a company that has filed for chapter 11 relief.    Conventional wisdom teaches that supplying a company in chapter 11 (a DIP) offers some protection to a creditor as claims arising from amounts due post-petition constitute “administrative expense claims” and not just mere “general unsecured claims” (the term given to amounts due for obligations arising pre-petition).   In Toys R Us, however, vendors holding millions of dollars in “admin” claims faced the prospect of no payment whatsoever given the retailer’s cessation of restructuring efforts and implementation of a liquidation.  Although a settlement was reached which provided some payment to holders of admin claims, the recovery was nowhere near 100 percent.   In short, before supplying any company operating in chapter 11, be careful to understand the dynamics of the case and the practical ability to compel payment.

 

  • Understand Preference Risk:    A trade creditor that receives payment in the 90 day period before a customer’s bankruptcy filing is at risk of having that payment examined and potentially challenged as an “avoidable preference.”   There are several defenses available to a trade creditor to defend against such an action.   The best defenses rest on good facts.  Thus, it is imperative that a creditor obtaining payment from a financially distressed firm do so with an eye towards strengthening available defenses in case of a later challenge.    Our session highlighted several recent decisions impacting the ordinary course of business defense, subsequent new value defense and other theories.   The time to think  about such issues is well before a preference lawsuit is filed.

In sum, the opportunity to collaborate with Adrienne and Lindsay was terrific.  The conference also included an excellent presentation on non-judicial options for restructuring and sales as well as an insightful judicial forum.

 

Building Resilient Businesses — Fall 2018 Collaborations

As noted on the About page, this blog focuses on essential aspects of building resilient businesses:   protecting assets, navigating change, solving problems, and getting deals done effectively.

Key components of resiliency are awareness and openness to change.  Denial is absolutely not a strategy.   Resilient business keep  pace with innovation, think strategically,  exercise sound judgment, rely on core values  and build  effective teams.

This Fall has offered numerous opportunities to connect with others on topics at the intersection of technology and  finance – each fundamental to any resilient business.   This post  highlights a few recent and upcoming events/writings  and provides links to those interested in exploring further.

  • In late September, I was pleased to attend a TMA Global Executive Board meeting in connection with the 2018 TMA Annual Conference.   Plenty  of interesting discussions there — but I particularly enjoyed the keynote from Frits van Paasschen, who held the CEO position at  Coors then Starwood and several senior positions at other global companies before that.   He  authored The Disruptors’ Feast — which carries the apt subtitle “How to avoid being devoured in today’s rapidly changing global economy.”   Based on his remarks, I very much look forward to reading the book.
  • This summer, I received an invitation from the American Bar Association Law Practice Division to serve on the board of its Legal Technology Resource Center (LTRC).   The LTRC is focused on  providing legal technology guidance and resources for the efficient and effective practice of law.  Guidance is provided through a technology blog, regular webinars,  various publications and a dedicated website — Law Technology Today.  As  technology continues to evolve rapidly, I look forward to working with the LTRC team who I enjoyed meeting earlier this month.
  • Coming up next week on October 23,  I will join Silvia De Sousa of Thomson Dorman Sweatman LLP in Winnipeg and Kiriakoula Hatzikiriakos of the National Bank of Canada in Montreal (who recently published Secured Lending in Intellectual Property) to present a webinar sponsored by the Canadian Bar Association focused on Secured Transactions in Domain Names & Websites  As has been proven time and again, websites and domain names can be sources of value for companies and creditors — but critical to unlocking that value is successfully navigating various legal issues and understanding cross-border implications.
  • Each year, Massachusetts Continuing Legal Education hosts a New England Bankruptcy Law Conference.   This year, I will join Adrienne Walker from Mintz and Lindsay Zahradka Milne from Bernstein Shur on a business panel focused on trade creditor issues.  With stories of significant trade creditor issues emanating from the Toys R Us case and similar situations, a discussion focused on  practical tools for trade creditors is timely.
  • Finally,  the 2018 Norton Annual Survey of Bankruptcy Law  was published this Fall.  The book contains my chapter analyzing technology and intellectual property issues  in distressed circumstances — including a discussion of the Tempnology case which was the subject of  an earlier blog post here.   Since that blog post in early September,  activity before the Supreme Court has continued with petitioner Mission Product Holding filing a reply brief on September 25 arguing that the High Court should grant review and resolve the question of whether rejection requires termination of a licensee’s rights.   Stay tuned.

In sum, the Fall has offered some interesting opportunities to collaborate with others in  thinking through effective solutions for companies dealing with rapid change.   Technology, finance, and disruption are sure to remain constant partners going forward.

Filing Urges Supreme Court To Decline Review of Case Involving Trademark Rights After License Rejection

Although there has been much attention on the Supreme Court this week, a filing made earlier  today  will draw little popular notice.  Yet, the filing could have significant impact on whether the Court decides to accept a case this term which would impact the rights of trademark licensors and trademark licensees.

The filing  was made by Tempnology, LLC in opposition to a petition for a writ of certiorari filed by Mission Products Holdings, Inc. in June 2018.  Mission filed the petition to  seek Supreme Court review of a  January, 2018 opinion from the United States Court of Appeals for the First Circuit.   In that decision, the First Circuit determined that Mission, a licensee, retained no rights to continue to use trademarks previously licensed from Tempnology upon the rejection of the  license agreement by Tempnology in its chapter 11 proceeding.  See here for a copy of the petition for writ of certiorari along with a brief in support filed this summer by The International Trademark Association and another brief  in support from a  group of law professors.

The litigation over the trademark rights has been brewing for quite some time.  I wrote about the First Circuit decision in January 2018 as a LinkedIn article here and wrote about the Bankruptcy Appellate Panel opinion which proceeded that for the American Bankruptcy Institute Journal here (co-authored with Andrew Hellman).   For the past three years, I have included discussion of the issues in chapters contributed to the Norton Annual Survey of Bankruptcy Law (2018 edition due out soon, 2017 edition, and 2016 edition).

In seeking Supreme Court review of the First Circuit decision, Mission  emphasized the existence of a circuit split with the Seventh Circuit’s reasoning in Sunbeam Products Inc. v. Chicago American Manufacturing LLC, which held that although rejection constitutes a breach of contract, rejection does not terminate a trademark license or strip the nondebtor licensee of its post-breach rights under applicable nonbankruptcy law.  The First Circuit’s 2-1 decision  specifically rejected the Seventh Circuit’s reasoning in  Sunbeam.

Today’s filing acknowledges the existence of the circuit split but urges the Court to deny review on three fundamental grounds:

  • “First, the Petition overstates the depth and duration of the circuit split by attempting to recast the issue as implicating all types of intellectual property rights including patents. That way, according to the Petition, a 1985 Fourth Circuit decision on patent rights, Lubrizol Enters., Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), gets swept into the calculus. But not only is Lubrizol a patent case, the issues it raised were squarely addressed by Congress and put to bed in 1988 by the enactment of 11 U.S.C. § 365(n)(1).”
  • “That brings us to the second, perhaps more fundamental, reason that the Court should deny the Petition: Congressional intent. In passing section 365(n)(1) to address issues raised by the decision in Lubrizol, Congress expressly considered the impact of rejection under the then-new statute on other intellectual property rights such as patents, but deliberately chose not to include trademarks at that time, given the disparate and complex issues involving trademarks. Instead, the legislative history reflects that Congress intended to leave issues involving trademarks for further development and evolution in the courts. At the Court of Appeals level, that exploration has only just begun. In the three decades since the enactment of section 365(n)(1), this issue has only arisen a handful of times and only twice at the Court of Appeals. Until the issues are further fleshed out by other Courts of Appeals, it would be premature for the United States Supreme Court to step in and terminate the judicial developments that Congress envisioned.”
  • “Third, even assuming a single split of circuit authority warrants the attention of this Court, the present case is not the proper vehicle for the Court to resolve these complex issues. This case is a particularly poor choice for the Supreme Court to forestall either bankruptcy court evolution of the law or appropriate legislative action to try to create new standards, because key points such as the burdens on the debtor of the continued policing of the trademark, the debtor’s balancing of those costs versus any benefits derived from that effort, and the impact of a “stranding” of the trademark were the mark to become “abandoned,” were not litigated on a developed evidentiary record below. If the Court were to take up this abstract question on such a thin evidentiary record, that would likely lead either to new standards based largely on speculation, or a further remand for fleshing out the evidence. Far better to await further development of the issues involving trademark licenses in courts as Congress expressly intended or to allow Congress to address the issue as it also contemplated.”

 If the Supreme Court declines review of the First Circuit decision, then confusion will continue to reign about trademark rights in the event of license rejection by a debtor licensor.   Although greater clarity might come someday through Congressional action or a future case finding its way to the Supreme Court neither of those paths seem likely at the moment.  Well drafted license agreements tailored to the needs of the parties and monitored carefully can help save parties years of litigation given the current legal uncertainty.

A Visionary for Financial Literacy

Last week, I had the privilege of joining with other volunteers to help provide financial literacy training  for a group of high school students interning this summer with the judicial branch.

Those students followed in the footsteps of thousands of other high school students in Massachusetts who have participated in the  M. Ellen Carpenter Financial Literacy Program.  The program,  established in 2004, is run as a joint venture  between the United States Bankruptcy Court for the District of  Massachusetts and the Boston Bar Association.   The BBA maintains a collection of articles and photos describing the impact of the program over the years on its Beyond the Billable blog here.  The program is funded by a generous grant from the Charles P. Normandin Fund.

A scroll through those pages makes it clear that the  program would not be able to flourish each year without a dedicated group of  court personnel, bar association staff, and professionals.  Without the vision and dedication of the program’s namesake, however,  the program likely would not exist at all.

M. Ellen Carpenter, who was elected President of the Boston Bar Association in 2004, was an accomplished insolvency attorney.  After her election,  she sought out ways to highlight the substantial pro bono work, educational efforts, and public outreach of the bankruptcy bar.   Together with
then Chief Judge Joan N. Feeney of the Bankruptcy Court,  they decided to develop a course focused on teaching high school students basic financial literacy skills.

Ellen took action immediately to ensure the vision was realized.   She  appointed a task force, chaired by Boston attorney Janet Bostwick.    This effort  produced  a  program that has run ever since — with appropriate updating along the way — but with the same basic structure:  three in-school sessions taught by volunteer lawyers focused on  budgeting,  use of credit cards, and strategies for large purchases.

The final session of the course, named “Consequences” is held at the federal bankruptcy court.  Students have the opportunity to meet with judges, court personnel, and  lawyers to participate in mock hearings based on a typical case of an individual debtor.   That is followed by a discussion of the lessons learned as well as the role of the judicial system generally.

Ellen had a monumental role in envisioning and creating the program.  Tragically, she  passed away suddenly in December of 2006.  The program was soon thereafter named in her honor.  Although today there are many organizations offering financial literacy programs, the program she helped design was one of the first in the nation and remains a model program benefiting thousands.   Volunteers for the program, as well as participants, can thank Ellen for her impact in building a  program teaching students  responsible financial decision making.

 

All Inn

The Pine Street Inn recently held a graduation ceremony to honor individuals who have completed the Inn’s job training program.  Both the Boston Globe and Boston Herald captured photos.  The Inn has been offering the training program for 20 years with approximately 200 people enrolling this past year.   Those completing the program have the opportunity to participate in a graduation ceremony like the one recently held.  For many, it is the only type of  commencement ever celebrated.

The Inn’s website includes additional information about the jobs training program — together with other targeted initiatives  including housing, street outreach, veteran services, recovery services, homeless court assistance and advocacy.  All these programs are in support of the Inn’s mission of partnering with homeless individuals to find solutions.

Last year, I was fortunate to attend a breakfast event for the Inn where I heard a beneficiary of the Inn’s services speak.   The story shared was quite impressive.  Simply put, the support provided by the Inn, combined with the individual’s  hard work and dedication,  allowed her to move forward with dignity and hope.  A short video from that event posted online called “Many Roads Home” tells the story of how the Inn is working to get people off the streets, out of shelters and into housing.

Homelessness is an intractable issue and obviously not one that can be solved with any easy answers.   The good work of the  Inn (and its long-time president Lyndia Downie and committed board, officers, staff, sponsors and supporters) is a shining example of resiliency, helping people navigating change and finding solutions.  For those reasons, I thought this short post about the Inn fit nicely within the theme of highlighting forward thinkers and problem solvers.

In that regard, it is worth noting that this Spring the Globe ran an article about Richard Ring, whose 48 year-long career in advocating for homeless issues includes many years leading the Inn earlier in his career.  At a time when people’s perception of homelessness was quite different, he was instrumental in building awareness, helping to set strategy, and exhibiting ceaseless devotion to the topic.

Perhaps someday, there will be no need for the Inn.  In the meanwhile, those served and the greater community can be very grateful.   The Inn details out numerous ways to donate in support of its mission at this page and other ways to support this mission and get involved at this page. 

 

 

 

 

 

 

 

 

 

 

 

 

A Cautionary Tale For Sublicensees

Law 360 recently published the following analysis I contributed concerning ongoing patent infringement litigation involving four patents licensed by Sirius. Any party currently sublicensing technology or thinking of doing so should understand the issues that Sirius has confronted in litigation brought by the master licensor of the patents at stake.

In a venue not that far away — just south of New Jersey — Sirius Radio has been defending itself against a patent infringement suit that deserves the attention of any party that has ever sublicensed rights or is thinking of doing so. Sirius fully paid for an irrevocable sublicense of certain patents. Moreover, Sirius has been using the technology for approximately 20 years. Yet, it has been accused of infringement by the master licensor that granted rights to the sublicensor that licensed to Sirius. The nuance to the story is that the sublicensor commenced bankruptcy, which resulted in a rejection of the license between the master licensor and sublicensor. That development led to the master licensor contending that Sirius’ rights under its sublicense were forfeited as a result of that rejection.

On March 29, 2018, U.S. Magistrate Judge Sherry Fallon issued a decision in the litigation that is sure to be welcome news to any sublicensee.[1] Specifically, the decision recommends dismissal of the suit. The decision alone does not put the matter to rest, however. Rather, the decision takes the form of a report and recommendation to the U.S. District Court for the District of Delaware, which will have to determine whether to adopt the report and dismiss the case or reject the report and let the litigation continue. No matter the determination of the district court, an appeal to the U.S. Court of Appeals for the Third Circuit could of course follow. In other words, this litigation is sure to have at least one sequel beyond Magistrate Judge Fallon’s recent determination.

The Delaware Litigation

The facts are relatively straightforward. Plaintiff Fraunhofer-Gesellschaft Zur Förderung der angewandten Forschung e.V. developed patented multicarrier modulation technology (the “MCM IP”) to four patents for use in satellite radio broadcasting. Thereafter, Fraunhofer licensed the MCM IP to WorldSpace International Network Inc. (the “MCM license”).

WorkSpace in turn granted a sublicense, on an irrevocable basis, to a firm that later merged to become Sirius Satellite Radio, and which used the sublicensed technology to develop its own technology.

WorldSpace subsequently commenced a Chapter 11 proceeding under the U.S. Bankruptcy Code. During the course of those proceedings, the bankruptcy court approved a settlement agreement under which Sirius paid WorldSpace funds in full satisfaction of all sums owed under the sublicense agreement.

Eventually, the Chapter 11 proceeding was converted to a Chapter 7 liquidation proceeding, in which the trustee did not move to assume the MCM license for the benefit of the estate, resulting in automatic rejection of the MCM license.

Approximately three years later, Fraunhofer notified Sirius of its position that Sirius was infringing. Fraunhofer alleged that the rejection of the MCM license in the WorldSpace bankruptcy proceeding operated to deny Sirius any continuing rights under its sublicense.

As noted above, the magistrate judge disagreed, concluding that the rejection of the MCM license in bankruptcy did not impact the continuation of the irrevocable sublicense previously granted to Sirius by WorldSpace. To support this conclusion, the magistrate judge relied on a Seventh Circuit opinion[2] holding that “[w]here a sub-licensee has lived up to the terms of the license it is inequitable that his license should be revoked because the main licensee has failed to do the same, especially where the sub-licensee has made extensive investments on the strengths of his license.”

The magistrate judge rejected Fraunhofer’s arguments, which were based on decisions issued in the context of nonresidential real property that when a lease is deemed rejected pursuant to Section 365(d)(4) of the Bankruptcy Code, subleases associated with the property must also be deemed rejected because the rights of the sublessee are extinguished when the rights of a debtor are extinguished with respect to the property.[3]

Implications

Although the determination of the magistrate judge should be welcome news for any sublicensee, no such party should believe that the decision paves a clear path forward. As noted, the decision will be reviewed by the district court and then will be subject to the normal opportunities for appeal. Fraunhofer instituted suit against Sirius in February 2017, and oral argument on the motion to dismiss was heard in August 2017, with the magistrate judge’s determination issued in late March 2018. No matter the ultimate outcome of this particular litigation, Sirius has experienced the burden of more than a year of litigation expense and uncertainty with the guarantee of more to follow.

Thus, although sublicensees should keep an eye open for future developments in this case, sublicensees should also consider obtaining contractual certainty at the time of entering into a sublicense agreement. Specifically, a sublicensee should consider obtaining the affirmative consent of the master licensor that the sublicenee’s rights under the sublicense shall continue despite the rejection of the master license agreement in bankruptcy or in the event of any termination of the master license. This same approach should also be used by subleases of real property leases to avoid the draconian result imposed by the case law relied on by Fraunhofer noted above.

Moreover, a sublicensee whose licensor commences bankruptcy should pay close attention to the proceedings and take appropriate action to preserve its rights and position itself to guard against similar attacks. In the case of Sirius, for example, the opportunity should have existed in the WorldSpace bankruptcy proceeding to explore potentially acquiring the MCM license from the bankruptcy trustee rather than just allowing that license to be rejected in the proceeding. In short, sublicensees should anticipate the exact scenario that Sirius confronts and then craft binding contractual provisions to address as well as monitor legal proceedings affecting the validity of the rights granted by the sublicensor. Both of those steps should provide more control and certainty at a cheaper cost than defending litigation from a master licensor lodging an infringement attack.

Notes

[1] Fraunhofer-Gesellschaft Zur Förderung Der Angewandten Forschung E.V., Plaintiff, v. Sirius XM Radio Inc. (Civil Action No. 17-184-JFB-SRF).

[2] Rhone Poulenc Agro SA v. DeKalb Genetics Corp., 284 F.3d 1323, 1332 n.7 (Fed. Cir. 2002)

[3] In Chatlos Systems Inc. v. Kaplan, 147 B.R. 96, 100 (D. Del. 1992), aff’d sub nom In re TIE Commc’ns Inc., 998 F.2d 1005 (3d Cir. 1993).