Introduction

On June 2, 2009,  Judge Kevin J. Carey, Chief Judge of the United States Bankruptcy Court for the District of Delaware, issued an opinion in the Spansion bankruptcy finding that the Debtors’ settlement of various patent cases was not the result of the "sound exercise of the Debtors’ business judgment."  Judge Carey’s decision in Spansion is helpful as it provides analysis of what is required in order for a debtor to meet its burden when seeking bankruptcy court approval of a settlement. 

Background

Spansion filed for bankruptcy on March 1, 2009.  Approximately two weeks after filing for bankruptcy,  Spansion entered into a settlement agreement with Samsung Electronics Co. settling two patent infringement cases commenced by Spansion and settling one patent infringement case commenced by Samsung against Spansion.  Pursuant to the parties’ settlement agreement, Samsung agreed to pay Spansion $70 million.

Spansion sought approval of the settlement agreement pursuant to Fed.R.Bankr.P. 9019. In response to Spansion’s settlement motion, an ad hoc consortium of senior secured noteholders (the "Noteholders") filed an objection listing various reasons why the Court should not approve the settlement. After conducting an evidentiary hearing, the Court issued its opinion.

Arguments For and Against the Settlement

Spansion argued that the Court should approve the settlement as it (i) was the product of good faith negotiations; (ii) allowed Spansion to avoid costly and time consuming litigation; (iii) allowed Spansion to avoid naming customers in the patent litigation, potentially harming these relationships; and, (iv) provided Spansion with cash now, instead of waiting years to potentially recover through litigation.

In opposing the settlement, the Noteholders argued that the settlement was both structurally flawed and lacked sufficient information in order for the Noteholders to determine if the settlement amount was fair. Regarding the structural flaws, the Noteholders argued that the settlement provided unbalanced rights to the parties. 

Court’s Analysis

The Court began its analysis by noting that under Key3Media Group, settlements under Fed.R.Bankr.P. 9019 are subject to the sound discretion of the Court.  Key3Media Group, Inc., v. Pulver.com, Inc. (In re Key3Media Group, Inc.), 336 B.R. 87, 92 (Bankr. D. Del. 2005).  Further, the role of the bankruptcy court in reviewing a 9019 motion is to determine whether "the compromise is fair, reasonable and in best interests of the estate."  In re TSIC, Inc., 393 B.R. 71, 78 (Bankr. D. Del. 2008).  In order to make its determination,  the Court applied the Third Circuit’s analysis in Myers v. Martin (In re Martin), 91 F.3d 389, 393 (3d Cir. 1996).  Under Martin, courts should consider the following factors in deciding whether a settlement is in the best interest of the estate:

  1. Probability of success in the underlying litigation;
  2. Difficulties in collection;
  3. Complexity of the litigation involved, including the expense, inconvenience and delay arising from the litigation; and,
  4. Interest of the creditors.

Before applying the factors provided under Martin, the Court noted that it does not have to be convinced that the "settlement is the best possible compromise."  Instead, the Court must decide whether the settlement "is within the reasonable range of litigation possibilities,"  citing In re World Health Alternatives, Inc., 34 B.R. 291, 296 (Bankr. D. Del. 2006).  Further, Debtors carry the burden of persuading the Court that the settlement falls within the reasonable range of settlement possibilities. 

Starting with the first prong of the Martin analysis (probability of success on the merits), the Court noted that its task is to consider the issues presented in the underlying patent litigation and determine whether Spansion’s settlement with Samsung "falls below the lowest point in the range of reasonableness."  The Court found that Spansion had not satisfied the "merits prong" of Martin as evidence presented during the hearing showed that Spansion entered the settlement in order to "negotiate a quick settlement,"  instead of considering the settlement by evaluating the merits of the patent cases.

Turning to the second prong under Martin, difficulties in collection, the Court found that Spansion provided no evidence to suggest that Spansion might have trouble collecting a judgment against Samsung. 

The third prong of the Court’s Martin analysis looked at the complexity of the litigation involved, including the costs and inconvenience caused by the delay.  Citing Nutraquest, the Court recognized that settlements almost always reduce the "complexity and inconvenience of litigation."  Will v. Northwestern Univ. (In re Nutraquest, Inc.), 434 F.3d 639, 645 (3d Cir. 2006).  What is required, however, is a comparison of the complexity of the underlying litigation to the likelihood of success.  Since the Court found Spansion had not presented evidence sufficient to consider a "likelihood of success," the Court could not determine whether the settlement is better than the expense and inconvenience caused by the continuation of the litigation. 

Finally, the Court considered under Martin the "paramount interest of creditors."  Here, the Court found that the Noteholders "vigorously opposed the settlement agreement."  Further, evidence presented at the evidentiary hearing demonstrated that Spansion did not have sufficient information to determine the reasonableness of the patent litigation settlement.

Conclusion

The Spansion decision provides guidance for what is required for a debtor to obtain approval of a litigation settlement.    Here, the Court found it significant that the settlement agreement contained a "perpetual license to Samsung of the Debtor’s future patents."  The Court agreed with the Noteholders that the settlement lacked mutuality between the parties – the agreement appeared to provide more favorable terms to Samsung than Spansion.  The decision does not suggest that settlement agreements must always contain mutual releases between the parties.  Instead, debtors should be prepared to present evidence demonstrating why the settlement is in the best interests of the creditors and that a reasonable determination was made by the debtor that the proposed settlement is preferable to continued litigation expense and delay.