In a case located at the intersection of bankruptcy and IP law, the Third Circuit ruled that, under the terms of a contract, Walt Disney Studios Motion Picture Production and its affiliates did not acquire a perpetual worldwide license to use patents to convert conventional films into 3D.
The story of In re DDMG Estate begins with the 2009 Disney film “G-Force,” which depicted the adventures of a band of highly-trained crime-fighting guinea pigs. Of course, the only thing better than a rodent action-adventure flick is a 3D rodent action-adventure flick—which is why Disney and a company called In Three entered into the contract at the heart of this appeal. Under the contract, In Three was to deliver a “left eye and right eye digital 3D version of 17 minutes of the [G-Force] Picture” to Disney.
The contract granted Disney a “perpetual, irrevocable, fully paid-up, royalty-free, worldwide right and license” to use In Three’s patents “in connection with displaying, developing, enhancing, marketing, distributing …, or otherwise using or exploiting” the completed 17 minutes of converted 3D film. In addition, the contract contained a covenant not to sue, under which In Three agreed that it would not pursue any claim or assert any patents against Disney on the basis of work done for Disney by a third-party vendor. The contract also granted Disney an option to seek an “irrevocable, perpetual, worldwide license” for the 3D conversion patents, if Disney made a formal request and negotiated a licensing fee in good faith.
After converting 17 minutes of G-Force, as the contract required, In Three sold its 3D conversion patents to another entity, DDSG, but did not transfer the G-Force Agreement (which, in any event, contained a clause prohibiting assignment by In Three). DDSG subsequently filed a petition for relief under Chapter 11 of the Bankruptcy Code and moved for the Bankruptcy Court’s approval to sell the patents to RealD, Inc.
Disney objected to the sale, contending that it held a broad perpetual license of the patents. To support its objection, Disney pointed to both the option provision and the covenant not to sue in the G-Force Agreement. Disney argued that it had exercised the option because—before DDSG petitioned for bankruptcy protection—Disney and DDSG engaged in negotiations regarding a license, although those negotiations did not result in agreed-upon license terms. Disney also argued that the covenant not to sue amounted to a broad perpetual license to use the patents in any film. Disney further claimed that its license would be unaffected by DDSG’s “free and clear” sale of the patents in bankruptcy.
The Bankruptcy Court denied Disney’s objection to the sale and its subsequent motion for reconsideration. The decision was affirmed twice, first by the District Court and then by the Third Circuit. Because all three courts followed similar lines of logic, we will skip straight to the Third Circuit’s opinion to see why Disney does not hold the license it claimed to hold.
On appeal to the Third Circuit, Disney abandoned what was perhaps its weaker argument—that it exercised the option and acquired a license by merely negotiating for one. Disney’s argument, that the covenant not to sue amounted to a license, was built on tenets of patent law: specifically, that covenants not to sue are enforceable as patent licenses, and that a license survives the sale of a patent, even a “free and clear” bankruptcy sale. RealD (which, as the purchaser of the patents in bankruptcy, was the real party in interest) countered that the covenant not to sue related only to G-Force and did not grant Disney a broad license.
The Third Circuit declined to decide whether the covenant not to sue amounted to a license, ruling only that “to the extent there was a license to the 3D patents, it was limited to the work performed on G-Force and there was no patent right beyond G-Force to transfer.” That ruling, in turn, rested on principles of California contract law, because the G-Force Agreement contained a California choice of law clause.
Construing the contract as a whole, as required by black-letter contract law, the Third Circuit concluded that the contract related only to G-Force. The Court looked to numerous portions of the contract to support its reasoning. The prefatory language provided that the contract set forth the principal terms of the parties’ agreement “with respect to … ‘G-Force.’” The Agreement contained specific instructions for the delivery of a converted 3D version of 17 minutes of G-Force, including formatting instructions specific to G-Force. The Agreement granted Disney a perpetual, worldwide license—but expressly in conjunction with “displaying, developing, enhancing, marketing, distributing or providing, maintaining, supporting, or otherwise using of exploiting the Picture [i.e., G-Force].” The integration clause at the conclusion of the contract reiterated that the Agreement expressed the parties’ entire understanding with respect to In Three’s “services in connection with [G-Force].”
In light of the ample contractual evidence that the Agreement was about G-Force and only G-Force, the Third Circuit reasoned that it was immaterial that the clause containing the covenant not to sue did not expressly mention G-Force. The scope of the covenant not to sue, the Third Circuit said, was limited to G-Force “when read in conjunction of the other provisions of the G-Force Agreement.” Although two sections of the Agreement looked beyond the G-Force film, those sections—namely, the option to obtain a license to the 3D conversation patents, and a clause contemplating additional future conversion work for Disney by In Three—required the parties to engage in further negotiations and reach separate agreements. According to the Third Circuit, this demonstrated that the G-Force Agreement’s terms were “limited to the G-Force film absent further action and agreement.”
The Third Circuit explained that Disney’s patent-law argument—that RealD acquired the patents subject to Disney’s pre-existing license—assumed too much. For the same reasons that the Court’s contract construction exercise yielded the result that the covenant not to sue applied only to G-Force, the Court reasoned that “Disney’s rights to the 3D patents are limited to G-Force.”
Lastly, the Court rejected Disney’s arguments that two particular clauses of the contract demonstrated that the covenant not to sue would bind future owners of the patents. Although the G-Force Agreement provided that the covenant not to sue would survive the expiration of the Agreement, and that the Agreement would bind In Three’s successors and assigns, yet another clause of the Agreement provided that In Three could not assign its rights and obligations under the Agreement. Therefore, none of the contractual language that Disney pointed to could bind In Three, which was not a party to or an assignee of the G-Force Agreement.
In litigating its objections to the patent sale and the subsequent appeals, Disney attempted to frame its arguments as principles of patent law—that a covenant not to sue is a license, and that the buyer of a patent takes the patent subject to pre-existing licenses. The Third Circuit, however, decided the appeal based on straightforward principles of contract interpretation. It is not enough simply to assert that there is a covenant not to sue with regard to a patent. Under the applicable rules of contract construction, the language of the covenant not to sue must actually grant a license that would permit the would-be licensee to use the patents in the particular way it wishes to use them.