Federal Circuit argues company cannot use merger to avoid royalty payments – Contracts and Commercial Law

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Summary

A licensee attempted to split its manufacturing and distribution operations into separate entities to avoid its royalty obligations. This manufacturing entity manufactured the patented products and then sold them at cost to the second entity for incorporation into the commercial product. The manufacturer argued that this structure relieved the second entity of the responsibility for paying the royalties. The Federal Circuit disagreed, finding that general principles of contract law and the text of the relevant statute prevented the manufacturer from injuring its contracting partners in the merger that delivered them.

Background

Electronics companies use spring pins in combination with sockets to test semiconductor chips. Improving on the then-standard machined spring pins, Dong Weon Hwang developed a type of spring pin in 2004 called H-Pin that could be stamped, allowing it to be manufactured faster and more cheaply. He licensed the technology to Plastronics Socket, granting it the joint right to practice the technology covered by the H-Pins patents in exchange for a 3% royalty on sales of H-Pins and sockets containing H-Pins, among other considerations.

In the years following Hwang’s departure, the H-Pin patents brought Plastronics Socket substantial financial success, accounting for over $65 million and more than half of Plastronics Socket’s revenue. This success, however, resulted in significant royalty obligations to Hwang. In 2012, Plastronics Socket executed a divisive merger under Texas law to create Plastronics H-Pin. Plastronics Socket assigned all rights and obligations under the Royalty Agreement to Plastronics H-Pin, which would produce the H-Pins and sell them at cost to Plastronics Socket as its sole customer. Socket Plastronics then integrated these H-Pins into sockets for sale to third parties. Plastronics Socket argued that the spin-off merger eliminated its liability for royalties arising from such socket sales.

The Plastronics Decision

Noting that Plastronics’ stated purpose for the merger was to “separate all H-pin business into one entity and sell at cost to Plastronics as the master distributor, thus without worrying about royalties [to Hwang]”, the Federal Circuit rejected his arguments. General principles of contract law stated that a company could not use a merger to adversely affect the rights of the parties with whom it had contracted.

Texas merger law did not contradict this principle of contract law. The law stated that it did not “restrict any right or rights of a creditor under existing laws”. The Federal Circuit interpreted this language to indicate that one of the purposes of the law was to permit mergers that did not adversely affect the rights of parties who had previously entered into a contract with the merging entities. This reading of the law has been confirmed by legislative history and bankruptcy court cases interpreting the law. The court therefore found Plastronics liable for royalties for sales of H-Pins and sockets with H-Pins by Plastronics Socket or Plastronics H-Pin.

Strategy and conclusion

While a corporate restructuring may appear to be a useful tool to evade royalty obligations, courts are unlikely to approve of the use of such tools to evade contractual obligations.

Further information

The Plastronics the command can be found here.

The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.

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