Amicus Curiae Brief — Lubrizol Enterprises, Inc. v. Canfield

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o~ Supreme Court, U.S.

3) FILED

No. 85-863 cc 19 1985

JOSEPH F. SPANIOL, UR.

IN THE CLERK 2

Supreme Court of the United States

OCTOBER TERM, 1985

LUBRIZOL ENTERPRISES, INC.,

Petitioner,

ROBERT A. CANFIELD, BANKRUPTCY TRUSTEE

FOR RICHMOND METAL FINISHERS, INC.,

Respondent.

On Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Fourth Circuit

BRIEF AMICUS CURIAE FOR

COMPUTER AND BUSINESS EQUIPMENT

MANUFACTURERS ASSOCIATION (CBEMA)

IN SUPPORT OF THE PETITIONER

BEST AVAILABLE COPY |

JOHN S. VOORHEES

ANN I. KILLILEA

(Counsel of Record)

HOowREY & SIMON

1730 Pennsylvania Ave., N.W.

Washington, D.C. 20006

(202) 783-0800

Attorneys for Computer

and Business Equipment

Manufacturers Association

(CBEMA), Amicus Curiae

AIRE OT AY ANT SS et AT ENR eR

WILSON - Epes PRINTING Co., INC. - 789-OC96 - WASHINGTON, D.C. 20001

TABLE OF CONTENTS

Page

INTEREST OF THE AMICUS CURIAE ....................... 2

STATEMENT OF THE CASE .......20.22....2...----s--seeeeeee 4

SUMMARY OF ARGUMENT .......0W0-.-2...-.-.ee eee 4

ERLE E I A OTTO CE SOT 5

I. This Court Should Grant The Writ To Prevent

The Fourth Circuit’s Decision From Adversely

Affecting The Entire Structure Of The Informa-

tion Processing Industry, Its Manner Of Doing

Business, Its Users And The Public At Large...... 5

II. This Court Should Grant The Writ To Prevent

The Arbitrary And Inequitable Deprivation Of

A TIED TE cicvewseescchasdcqeacoraeQodiqemtineeinntcnne 7

A. This Court Should Grant The Writ To Pro-

tect A Licensee’s Reasonable Expectation

That Completed Performance Under A Con-

tract Cannet Be Undone ................................... 7

B. This Court Should Grant The Writ To Pro-

tect Against The Arbitrary Characterization

Of All Licensing Agreements As Executory

I i il 8

C. This Court Should Grant The Writ To Ensure

That Equitable Considerations Are Not

Eliminated From A Vital] Part of the Bank-

I IIE pesicictetnsoncesicnnecsiemisheomasningnteae es 10

6 ae a LINC Oy are eT 12

TABLE OF AUTHORITIES

Cases: . Page

In re Gladding Corp., 22 Bankr. 632 (Bankr. D.

Blom. BOGS .ncccicivcncisnitcdatasitichaenean 9

In re Petur U.S.A. Instrument Co., 35 Bankr. 561

(Bamker. WDD. Wait. RERBBD snccnicecccincesssesesccntesit 9,11, 12

N.L.R.B. v. Bildisco & Bildisco, 104 S.Ct. 1188

CIGD a caneissecesinssntnsinicctesnatietiaipneeiniadiaaasamaenan 9

Codes:

12 U.3.6. 6 OG CRBD socccccctsicccoereneeaenl passim

Law Reviews:

Countryman, Executory Contracts in Bankruptcy:

Part I, 57 Minn. L. Rev. 489 (1978) ..................... 10

Countryman, Executory Contracts in Bankruptcy:

Part II, 58 Minn. L. Rev. 479 (1974) ..................... 9

IN THE

Supreme Court of the United States

OCTOBER TERM, 1985

No. 85-863

LUBRIZOL ENTERPRISES, INC.,

Petitioner,

Vv.

ROBERT A. CANFIELD, BANKRUPTCY TRUSTEE

FOR RICHMOND METAL FINISHERS, INC.,

Respondent.

On Petition for a Writ of Certiorari to the

United States Court of Appeals

for the Fourth Circuit

BRIEF AMICUS CURIAE FOR

COMPUTER AND BUSINESS EQUIPMENT

MANUFACTURERS ASSOCIATION (CBEMA)

IN SUPPORT OF THE PETITIONER

Computer and Business Equipment Manufacturers As-

sociation (“CBEMA”) submits this brief as amicus

curiae in support of Lubrizol Enterprises, Inc.’s (“Lu-

brizol”) Petition for A Writ of Certiorari to the United

States Court of Appeals For the Fourth Circuit filed on

November 19, 1985. Pursuant to Rule 36.1 of the Rules

of the Supreme Court of the United States, this brief is

submitted with the written consent ad the parties filed

simultaneously with the Clerk.

INTEREST OF THE AMICUS CURIAE

CBEMA, formerly known as the Business Equipment

Manufacturers Association, is the trade association

which has represented the computer and business equip-

ment industry since 1916. The companies comprising the

current CBEMA membership include the nation’s lead-

ing manufacturers of computers, telecommunications and

business equipment and related supplies and services.

CBEMA is the leading spokesman for the computer and

business equipment industry, representing some 34 com-

panies,’ both large and small, having an estimated com-

bined sales of over $135 billion. Member companies of

the association include both hardware and software man-

ufacturers and provide over 1.2 million job opportunities

throughout the United States. While product lines of

member companies vary widely, the following list is il-

lustrative: electronic computers, computer software in-

cluding programs, computer input and output devices,

computer storage devices, support services, telecommunica-

tions equipment, optical character readers, addressing ma-

chines, accounting machines, bookkeeping machines, office

1 The following companies are members of CBEMA; 3M; Amdahl

Corporation; AMP Incorporated; Apple Computer, Inc.; AT&T;

Bell & Howell; Burroughs Corporation; Control Data Corporation;

Dictaphone Corporation; Digital Equipment Corporation; Eastman

Kodak Company; GF Furniture Systems, Inc.; Harris/Lanier;

Hewlett-Packard Company; Honeywell Information Systems, Inc.;

IBM Corporation; ICL, Incorporated; Information Handling Serv-

ices; Micro Switch, a Honeywell Division; AM International, Inc.;

NCR Corporation; Panasonic Industrial Company; Philips Business

Systems, Inc.; Prime Computer, Inc.; Royal Business Machines,

Inc.; Sanders Associates, Inc.; SMA Corporation; Sony Corpora-

tion of America; Tektronix, Inc.; Terminal Data Corporation;

Texas Instruments Incorporated; UARCO Incorporated; Visual

Technology Corporation; and Xerox Corporation.

copying machines, and supplies and services for these

products.

CBEMA companies have consistently been forerunners

in developing information processing technology. In addi-

tion, they have contributed greatly to the present signifi-

cant status and role of information processing in modern

society and the international competitiveness of the United

States in this industry. The extent to which such products

and services can be utilized effectively depends in great

measure on the ability of CBEMA companies to engage

in licensing transactions, either as licensor or licensee, for

the use of new technology and know-how.

These member companies are continuously involved in

licensing transactions, either as licensor or licensee, for

the transfer of intellectual property related to the hard-

ware and software products which they manufacture, use

or market. Licensing is particularly crucial in the soft-

ware segment of the industry since in today’s market-

place, software is usually copyrighted so that transactions

are accomplished most frequently by licenses rather than

by sales. Whether the user is an individual or an organi-

zation, the transfer of computer software is accomplished

not by direct sale but pursuant to a license to use.

Licensing transactions may take many forms. They

may be transactions which provide needed financing to

small innovative enterprises. They may involve multi-

tiered licenses of technology with a number of entities.

Whatever the form, licensing is one of the principal

methods of technology transfer throughout the world. Li-

censing, therefore, must remain a predictable and safe

business transaction.

The subject matter of the present case is one of great

significance for the CBEMA membership. These compa-

nies are vitally concerned with the protection of licensing

agreements, since licensing is a central business practice

of the industry. The Fourth Circuit’s decision adversely

impacts upon both the immediate and the future planning

of CBEMA companies with respect to the ways and means

of transferring intellectual property. The transfer of in-

tellectual property is necessary for promoting the use of

information processing products, for research and devel-

opment and for many other aspects of the information

processing industry. The Fourth Circuit’s decision in-

evitably affects the future growth and development of

the information processing industry in the United States,

and has even a greater impact on the vast segments of

our society which use and receive the benefits of this

technology.

STATEMENT OF THE CASE

The facts and proceedings below are fully set forth in

the Petition For A Writ Of Certiorari To The United

States Court of Appeals For The Fourth Circuit filed by

Petitioner Lubrizol Enterprises, Inc., on November 19,

1985.

SUMMARY OF ARGUMENT

The question of whether § 365 of tse Bankruptcy Code,

11 U.S.C. § 365,? authorizes the bankruptcy court, on re-

quest of the debtor, to rescind all contractual obligations

divesting the nondebtor of property it had already ac-

quired under the contract prior to the bankruptcy filing

is one which the Supreme Court should resolve now.

The language of § 365 and equitable principles nor-

mally relied upon in bankruptcy point powerfully in one

direction. The holding below points in the other. Every-

day contractual relationships are now in jeopardy be-

cause, under the Fourth Circuit’s erroneous interpreta-

tion of § 365, each party fears that the other party will

file for bankruptcy and seek complete recission of the

performance rendered prior to the bankruptcy.

2 The statute at issue here, Bankruptcy Reform Act of 1978, § 365,

11 U.S.C. § 365 (1982), is reprinted in the Appendix to the Petition

for a Writ of Certiorari to the United States Court of Appeals for

the Fourth Circuit filed November 19, 1985 at 48a-49a (“Petition

for Certiorari”). The statute will be referred to as § 365.

The Fourth Circuit has erred (1) by deciding that con-

tracts are “executory” based solely on continuing, but in-

significant and unburdensome, obligations between the

parties and (2) by subjecting the nondebtor, who in this

case is the licensee, to arbitrary and unfair results with-

out taking into account equitable considerations.

This Court should eliminate the error caused by the

Fourth Circuit’s decision and restore the predictability

so needed to maintain viable contractual relationships in

today’s business climate.

ARGUMENT

REASONS FOR GRANTING THE WRIT

I. This Court Should Grant The Writ To Prevent The

Fourth Circuit’s Decision From Adversely Affecting

The Entire Structure Of The 'nformation Processing

Industry, Its Manner Of Doing Business, Its Users

And The Public At Large

This case is not merely an isolated dispute between

two parties. It has broad-scale implications for the entire

information processing industry. If the Fourth Circuit’s

decision is permitted to stand unreviewed, licensing con-

tracts are now a risky, unpredictable and undesireable

means of transferring new technology and know-how in

the computer industry. Licensing has been an indispen-

sable part of everyday business for CBEMA’s member-

ship, for the information processing industry and for in-

formation processing users as a whole. The latter com-

prise virtually the entire business base of the industrial

world.

As it stands now, the Fourth Circuit has held that, if

a court finds a contract to be “executory,” the licensor *

8 This brief deals with a dispute involving a technology licensor’s

bankruptcy proceeding. All references, therefore, to licensor refer

to the debtor, and all references to licensee refer to the non-debtor.

having filed for bankruptcy has unfettered and unques-

tioned ability to cancel all obligations under the contract,

and even to recoup transfers of property made prior to

the filing of the petition for bankruptcy. This decision

leaves the licensee helpless to protect its rights to prop-

erty transferred prior to the licensor’s bankruptcy peti-

tion.*

Without review by this Court, many adverse ramifica-

tions affecting this industry will flow from the Fourth

Circuit’s decision. Among the most apparent are:

* Investment in and plans for the development of

innovative technology will be stunted and may

never come to fruition. Without a licensee’s mar-

keting and development, new ideas may never sur-

face in the marketplace or be exploited for the

benefit of the industry or the public.

* The benefits of much technological innovation will be

lost and an industry, whose existence depends on

fast-developing technology, will be injured.

* Companies may seek to circumvent the “executory”

nature of a licensing contract and enter only those

contracts that cannot be found by the courts te be

“executory.” For example, a licensee may be

forced to make all royalty payments at the com-

mencement of the contract. For many companies,

such payments would be too costly and will in-

hibit their desire to license the technology.

* The cost of doing business will increase in order

for licensees to cover the enormous risks of licensing

technology in good faith and later losing all rights

to such technology pursuant to § 365.

The Fourth Circuit’s decision, as it stands, will influ-

ence far more than a dispute between Lubrizol and the

*The Fourth Circuit decision, reported at 756 F.2d 1043 (4th

Cir. 1985), is reprinted in the Appendix to the Petition for Certio-

rari at la-10a.

bankrupt; it will exert an adverse impact on the every-

day business transactions of the entire information proc-

essing industry.

Il. This Court Should Grant The Writ To Prevent The

Arbitrary And Inequitable Deprivation Of The

Licensee’s Rights

A. This Court Should Grant The Writ Teo Protect A

Licensee’s Reasonable Expectation That Completed

Performance Under A Contract Cannot Be Undone

The Fourth Circuit’s decision, as it stands, will cause

drastic consequences for the licensee relying on its agree-

ment with the licensor to make use of certain software

technology. For example, a licensee may have obtained

the use of a licensor’s software for the purpose of de-

veloping and maintaining a much needed bookkeeping

system for its business. The licensing agreement may

provide that the licensor must update the bookkeeping

software on a periodic basis while the licensee must make

ongoing payments. The licensor may file for bankruptcy

many years later. Based on the Fourth Circuit’s erroneous

interpretation of § 365, the licensor will succeed in its

bid to convince the bankruptcy court that the ' -ensing

agreement constitutes an executory contract. Under the

Fourth Circuit’s decision, the licensor is relieved of all

past and future obligations under the licensing agree-

ment. The iicensee, therefore, will lose its right to use

the bookkeeping software on which its business now de-

pends. This result, by itself, could force a licensee into

dire straits.

Another situation exemplifies the gross inequities re-

sulting from the Fourth Circuit’s decision. A_ licensor

may own a patent on a unique manufacturing process

which it agrees that the licensee may use. The licensing

agreement may provide that the licensor is obligated to

sue any companies infringing on the patent and that the

licensee is obligated to make ongoing payments. In order

to accommodate the unique process, the licensee may be

forced to make massive capital expenditures. The licensor

subsequently may file for bankruptcy and, pursuant to

§ 365, convince the bankruptcy court to reject all its obli-

gations under the licensing agreement because the licen-

sor’s promise to sue the infringers made the agreement

“executory” in nature. Under the Fourth Circuit’s deci-

sion, the licensee would lose not only its right to make use

ofthe manufacturing process but also the capital expendi-

tures that the licensee made in reliance on the agreement.

The ripple effects of such a loss on the licensee’s business

could force the licensee into bankruptcy or, at best, into

severe economic hardship.

This Court should grant the writ in order to review

two premises underlying the Fourth Circuit’s decision

which lead to such inequitable results: first, whether any

or all licenses are properly viewed as per se executory;

and second, whether courts may continue to “ely on equi-

table considerations to prevent an arbitrary and inequi-

table deprivation of the licensee’s rights when consider-

ing whether to assume or reject contractual obligations

under § 365.

B. This Court Should Grant The Writ To Protect

Against The Arbitrary Characterization Of All

Licensing Agreements As Executory Contracts

Most future obligations in technology licensing agree-

ments are insignificant compared to the accomplished

transfer of intellectual property, and in fact are de min-

imis in nature. They place no real affirmative burdens

on the parties and should not trigger the drastic results

that, based on the Fourth Circuit’s decision, flow from

the designation of “executory” contract.

The Fourth Cireuit’s decision depriving the licensee of

the property it acquired from the debtor prior to the

latter’s filing for bankruptcy turned entirely upon a

characterization of the contract as “executory” under

§ 365. Even where any future obligations under the

agreement are merely insignificant and contingent, the

debtor under the Fourth Circuit’s decision is given an

automatic right to rescind all contractual obligations per-

formed before it filed for bankruptcy.

Congress did not expressly define the term “executory

contract” as used in the Bankruptcy Code. No statutory

definition, therefore, can be mechanically applied for the

purpose of rejecting the contract. See In re Petur U.S.A.

Instrument Co., 35 Bankr. 561, 563 (Bankr. W.D. Wash.

1983) (“The Code does not define the term ‘executory

contract’”). Rather, the analysis of whether a contract

is executory is judicially-fashioned and should not re-

sult in arbitrary and inequitable decisions.’ As the court

recognized in In re Gladding Corp., 22 Bankr. 632, 635

Bankr. D. Mass. 1982) :

It seems clear, at least to this court, that bankruptcy

courts should not be bound by static definitions of

what is an executory contract, but should strive to

satisfy the purposes of the Act in conjunction with

the goals of the debtor (or trustee), in order that

equity may be served.

Because the term “executory contract” is not defined

in the statute, courts, including the Fourth Circuit in this

case, have looked to Professor Countryman’s article on the

matter. A careful reading of the entire Countryman arti-

cle, however, reveals that Professor Countryman did not

view licenses as per se executory contracts. Countryman,

Executory Contracts in Bankruptcy: Part II, 58 Minn.

L. Rev. 479, 502 (1974) (“Where there is no express

undertaking by the licensor [to supply goods or services],

the agreement with the licensee may not be executory

because the licensor may have full performed merely by

executing the license agreement’’).

The Fourth Circuit’s decision, in contrast, assumes that

all licenses are fundamentally executory. If the Fourth

Circuit’s decision is not reviewed by this Court, debtors

will acquire a new right to rescind all past contractual

5 This Court in an entirely different context recognized that

whether or not a contract is executory depends on the facts of each

individual case. N.L.R.B. v. Bildisco & Bildisco, 104 S.Ct. 1188

(1984).

obligations merely because the contract is deemed to be

executory.

The conclusion that a contract is executory is based

upon the premise that a negative covenant—a promise

not to take an action—is just as executory as an affirma-

tive covenant. This conclusion, however, is at odds with

the history of the treatment of contracts in bankruptcy.

The concept underlying § 365 grows out of the well-placed

desire to relieve a bankruptcy trustee or debtor-in-posses-

sion of ongoing burdensome obligations. See Countryman,

Executory Contracts in Bankruptcy: Part I, 57 Minn. L.

Rev. 439, 440-47 (1973). To equate negative covenants

—which generate no burden for the obligor—with affirm-

ative covenants in applying § 365 rejection rights, how-

ever, results in an unjust enrichment of the bankruptcy

estate for which there is no evidence of congressional

intent.

Once the Fourth Circuit mechanically decided that the

licensing agreement was “executory,” Lubrizol as the

licensee was guaranted to lose. This Court should grant

review of this matter to examine the Fourth Circuit’s

assumption that all licensing agreements are necessarily

executory contracts and to prevent the destabilizing con-

sequences for business transactions that flow from that

characterization.

C. This Court Should Grant The Writ To Ensure That

Equitable Considerations Are Not Eliminated From

A Vital Part Of The Bankruptcy Process

Relying on a static definition of executory contract, the

Fourth Circuit applied an arbitrary and mechanized ap-

proach to licensing contracts under § 365.° Having de-

6 The requirement of § 365(a) that the trustee’s assumption or

rejection of an executory contract be “subject to the court’s ap-

proval” dictates a non-mechanical approach to issues involved in

executory contracts. The court must be active in determining what

is, and is not, an executory contract and in disposing fairly of those

arrangements found to be executory in nature.

cided that the contract was executory, the Fourth Circuit

deferred totally to the licensor’s decision that it would be

advantageous to terminate al! rights granted under the

agreement. Based on the »vusiness judgment rule, the

court created an insurmountable burden for the licensee

by defining the issue as “whether the decision of the

debtor [licensor] that rejection will be advantageous is —

so manifestly unreasonable that it could not be based

on scund business judgment, but only on bad faith, or

whim or caprice.” ’ The court underscored the difficulty

faced by the licensee seeking to protect its interests by

stating that this determination is “reviewable up the line

under the clearly erroneous standard.” *®

The Fourth Circuit’s decision has made it virtually im-

possible for a licensee to protect its rights in property,

in this case technological know-how, transferred by the

licensor prior to its bankruptcy. As if to underscore the

licensor’s complete discretion to eradicate all pre-petition

obligations under the licensing agreement, the court held

that “equitable considerations” had no place in the court’s

decision.*® Rather, the Fourth Circuit stated that licensees

“share the general hazards created by § 365 for all busi-

ness entities dealing with potential bankrupts. .. .”

In direct contrast with this approach is Jn re Petur

U.S.A. Instrument Co., 35 Bankr. 561 (Bankr. W.D.

Wash. 1983), where the court balanced the equities of

both parties in denying the debtor’s motion to reject an

executory contract. Despite its agreement with the debtor

that the contract was executory and that rejection of the

contract would be in its best interests, the court engaged

in an independent evaluation of the effect of rejection on

7 Petition for Certiorari, Appendix at 7a.

8 Id.

® Td. at 9a.

10 Td. at 10a.

both parties. In doing so, the court refused merely to

rubber-stamp the business judgment of the debtor. The

court’s major concern was that if it upheld the rejection

of the contract, the non-debtor would be forced out of

business. 35 Bankr. at 563. The court stated:

Counsel for the debtor has cited a number of cases

involving rejection in which harm has resulted to the

non-debtor parties. ... But here we are not only

dealing with harm resulting from a mere disap-

pointment of legitimate expectations. Rather we are

dealing with the actual ruination of an otherwise

profitable, successful and ongoing business. Equity

will not permit such a result.

35 Bankr. at 564 (citations omitted). Looking to equity

for assistance, the court properly weighed the business

judgment of the debtor against the adverse effects of

rejecting the contract on the non-debtor. As the court

stated in In re Petur U.S.A. Instrument Co., “[i]t is

well-established that bankruptcy proceedings are equita-

ble in their nature.” 35 Bankr. at 563.

The Fourth Circuit refused to consider the inequitable

effects of its decision on the licensee. This Court should

grant review in this case to ensure that equitable con-

siderations remain a viable part of the decision as to

whether to assume or reject contractual obligations under

§ 365.

CONCLUSION

CBEMA respectfully requests that the petition of

Lubrizol Enterprises, Inc. be granted (1) to prevent the

arbitrary and inequitable deprivation of a licensee’s rights

to property transferred prior to the debtor’s filing for

bankruptcy, and (2) to correct an erroneous interpreta-

tation of § 365 that will disrupt substantially the predict-

ability of commercial transactions, especially in the infor-

mation processing industry. The Fourth Circuit’s decision

should be reviewed and reversed to prevent major un-

eae ce

certainty and serious inequity from arising out of good

faith business transactions.

Respectfully submitted,