Federal Circuit Holds That Company Cannot Use Merger to Avoid Royalty Payments

Abstract

A licensee attempted to split its manufacturing and distribution businesses into separate entities to avoid its royalty obligations. That 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 released the second entity from liability for royalty payments. The Federal Circuit disagreed, finding that general principles of contract law and the text of the relevant statute prevented the manufacturer from harming its contractual partners in the divisive merger.

Background

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

In the years after Hwang’s departure, the H-Pin patents brought Plastronics Socket substantial financial success, accounting for more than $65 million and over half of Plastronics Socket’s revenue. This success, however, incurred 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. Plastronics Socket then integrated those H-Pins into sockets for sale to third parties. Plastronics Socket argued that the divisive merger eliminated its liability for royalties arising from these socket sales.

The Plastronics Decision

Noting that Plastronics’s stated objective for the merger was to “Spin off all the H-pin business into an entity and sell at cost to Plastronics as a master distributor, therefore never worrying about royalties [to Hwang],” the Federal Circuit rejected its arguments. General principles of contract law dictated that a company could not use a merger to negatively affect the rights of parties with which it had contracted.

Texas’ merger statute did not contradict this contract law principle. The statute stated that it did not “abridge any right or rights of any creditor under existing laws.” The Federal Circuit interpreted this language to indicate that one purpose of the statute was to enable mergers that did not negatively affect the rights of parties who had previously contracted with the merging entities. This reading of the statute was further confirmed by the legislative history and bankruptcy court cases interpreting the statute. The court thus found Plastronics liable for the royalties for sales of both H-Pins and sockets with H-Pins by either 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 will likely not countenance the use of such tools to avoid contractual obligations.

Further Information

The Plastronics order can be found here.