In re Diomed Inc.

• Decision Date: 15 September 2008
• Docket Number: No. 08-40749-JBR.,08-40749-JBR.
• Citation: 394 B.R. 260
• Parties: In re DIOMED INC., et al., Debtors.
• Court: U.S. Bankruptcy Court — District of Massachusetts

394 B.R. 260

In re DIOMED INC., et al., Debtors.

No. 08-40749-JBR.

United States Bankruptcy Court, D. Massachusetts.

September 15, 2008.

COPYRIGHT MATERIAL OMITTED

Lisa E. Herrington, Choate, Hall & Stewart LLP, Douglas R. Gooding, Boston, MA, Mark E. Freedlander, McGuirewoods LLP, James E. Van Horn, Ronald W. Crouch, Pittsburgh, PA, Edward Marriot, Rupert Connell, Fladgate LLP, London W1K6DJ, Jared R. Clark, Bingham McCutchen LLP, New York, NY, for Debtors.

MEMORANDUM OF DECISION ON APPLICATION OF ENDOLASER ASSOCIATES, L.L.C. FOR ALLOWANCE AND PAYMENT OF ADMINISTRATIVE EXPENSE CLAIM PURSUANT TO 11 U.S.C. §§ 503(a), 503(b) AND 507(a)(2)

JOEL B. ROSENTHAL, Bankruptcy Judge.

This matter came before the Court for hearing on the Application of Endolaser Associates, L.L.C. for Allowance of Administrative Expense Claim pursuant to 11 U.S.C. §§ 503(a), 503(b) and 507(a)(2) [docket #328] and the objections of the Debtors [docket #356] and Creditors' Committee [docket # 357]. Endolaser asserts an administrative claim of approximately $2.33 million while the Debtors and Creditors' Committee disagree as to the amount, and with respect to most of the claim, the classification of the claim as administrative. Upon consideration of the arguments raised by the parties at the hearing and in their pleadings¹ and for the reasons set forth herein, the Application is allowed in part and denied in part. A portion of the claim, namely that arising from rejection of the License Agreement, may be allowed as a general unsecured claim if Endolaser is able to establish that such claim is part of the rejection damages. The amount of the claim, both the administrative expense and the unsecured portions, will be determined at a later evidentiary hearing if the parties are unable to resolve that dispute.

FACTS

The facts are not in dispute but, as far as the Court can determine, present a scenario caused by the intersection of bankruptcy and patent law not addressed in any published decision. In July 2003 the Debtor, Diomed, Inc., entered into a license agreement with Endolaser whereby Diomed received an exclusive license, including the sole right to issue sublicenses, of Endolaser's undivided interest in U.S. Patent No. 6,398,777 (the "777 Patent"),² which is used in the manufacturing of products for endovenous laser treatment of varicose veins, in exchange for a lump sum payment and the obligation to make periodic royalty payments. See License Agreement at ¶ 5. Diomed was to use "commercially reasonable efforts to actively market and sell Licensed Products...." See License Agreement at ¶ 3.1. The License Agreement also conferred on Diomed the sole right to enforce the 777 Patent, including discretion whether to bring infringement actions and the right to settle such actions. See License Agreement at ¶ 4.6. Diomed subsequently purchased the remaining undivided interest in the 777 Patent from its holder, Dr. Robert Min.³ In 2004 Diomed sued AngioDynamics, Inc. ("Angio") and Vascular Solutions, Inc. ("VSI") for infringement of the 777 Patent in the United States District Court for the District of Massachusetts and obtained jury verdicts of $9.71 million and $4.975 against Angio and VSI respectively. Angio and VSI were also permanently enjoined from infringing on the 777 Patent. Angio and VSI both appealed. On March 14, 2008 (the "Petition Date"), approximately one month before oral arguments were to be heard in the appeal, Diomed and Diomed Holdings, Inc. (the "Debtors") filed voluntary petitions for reorganization pursuant to Chapter 11 of the United States Bankruptcy Code.

Shortly after the Petition Date Diomed filed a Motion to Approve Compromise with Angio (docket # 67), which was approved, without objection, on April 2, 2008. Under the compromise the judgment against Angio was reduced to $7 million and Angio dismissed its appeal. On April 8, 2008 Diomed filed a Motion to Approve Compromise with VSI (docket # 137), which was approved, without objection, on April 16, 2008. Pursuant to the VSI compromise the judgment against VSI was reduced to $3,586,478 and the remainder of the appeal was dismissed. The permanent injunction prohibiting Angio and VSI from infringing on the 777 Patent remained in effect after the compromises, however.

The License Agreement provides that Endolaser shall share in the settlement proceeds. Specifically the License Agreement calls for Endolaser to receive 25% of the settlement proceeds minus all Patent Litigation Costs and applicable Interest Factors, both as defined in the License Agreement. See License Agreement at ¶ 5. Diomed has not tendered and Endolaser has not received any portion of the settlement proceeds.

On April 9, 2008 the Debtors filed a Motion to Sell (docket # 149), which proposed to sell substantially all of the Debtors' assets to Angio. Among the items that Angio was to receive was

[a]n agreement executed by Sellers in form and substance reasonably satisfactory to the parties: (i) granting Buyer the right of first refusal with respect to the sale of the 777 Patent and the exclusive license with respect thereto; (ii) a release and agreement not to sue or otherwise file legal actions against Buyer for infringement of the 777 Patent, which shall be binding upon the Sellers' successors and assigns; and (iii) releasing the injunction imposed against Buyer in the District Court of Massachusetts relating to litigation between Buyers and Sellers over the 777 Patent....

Asset Purchase Agreement, dated April 9, 2008 (the "APA") at Section 3.2(k). Endolaser objected (docket # 269 and # 288) on the grounds that the APA, especially Section 3.2(k) was a thinly disguised attempt to transfer ownership and control of the exclusive license of the 777 Patent to Angio without assuming and assigning the License Agreement.⁴ At the first hearing on the Motion to Sell, held on May 28, 2008, the Court agreed and advised the parties it would not approve the sale as contemplated but urged the parties to resolve the dispute. When the parties were unable to reach a resolution, the Debtors and Angio filed an amendment to Section 3.2(k) of the Asset Purchase Agreement (docket # 292) whereby the sale was restructured to provide Angio with "a non-exclusive, worldwide, perpetual, fully paid-up, royalty free license under Diomed's undivided ownership interest in the 777 Patent and all foreign counterparts...." Amended Section 3.2(k) also required the Debtors to cooperate with Angio "in all actions deemed reasonably necessary" by Angio to vacate the permanent injunction. At the same time the Debtors filed an emergency motion to reject the License Agreement (docket # 290) "in conjunction with the sale" of their assets.⁵ Both motions were allowed on June 2, 2008 with some modifications, including the deletion of the word "worldwide" from amended Section 3.2(k).⁶ At the express request of Endolaser,⁷ to which the Debtors and Angio acquiesced, the Motion to Reject License Agreement was allowed and became effective before the sale was consummated. Endolaser also agreed not to oppose the dissolution of the permanent injunction as to Angio and expressly reserved its rights to assert its monetary claims under the License Agreement before this Court.

ENDOLASER'S ADMINISTRATIVE CLAIM

Endolaser now seeks allowance and payment of an administrative claim, which consists of four separate components. First, Endolaser seeks an administrative claim for royalties for the use of the 777 Patent in products that were sold postpetition but prior to the rejection of the License Agreement (the "Prerejection Royalty Claim"). Second, Endolaser alleges an administrative claim for royalties for the bulk sale of products using the 777 Patent, which were sold to Angio as part of the sale of substantially all of the Debtors' assets (the "Bulk Inventory Royalty Claim"). Third, Endolaser seeks administrative treatment for its claim to a portion of the net settlement proceeds derived from the Angio and VSI settlements (the "Settlement Proceeds Claim"). Finally, Endolaser alleges an administrative claim for damages it avers resulted from Diomed's agreement to cooperate with Angio in having the permanent injunction released (the "Permanent Injunction Release Claim").

DISCUSSION

Endolaser asserts a claim pursuant to 11 U.S.C. §§ 503(a),⁸ 503(b)(1)(A), and 507(a)(2).⁹ It is the application of § 503(b) that determines whether Endolaser has an administrative claim. That section provides in pertinent part:

After notice and a hearing, there shall be allowed administrative expenses, other than claims allowed under section 502(f) of this title, including—

(1)(A) the actual, necessary costs and expenses of preserving the estate....

As the party asserting the administrative claim, Endolaser bears the burden of satisfying each element of § 503(a)(2)(B) by a preponderance of the evidence. Woburn Assoc. v. Kahn (In re Hemingway Transport, Inc.), 954 F.2d 1, 5 (1st Cir.1992). Citing to the pre-Bankruptcy Code case of Cramer v. Mammoth Mart, Inc. (In re Mammoth Mart, Inc.), 536 F.2d 950 (1st Cir.1976), the Hemingway court instructed that generally

a request for priority payment of an administrative expense pursuant to Bankruptcy Code § 503(a) may qualify if (1) the right to payment arose from a postpetition transaction with the debtor estate, rather than from a prepetition transaction with the debtor, and (2) the consideration supporting the right to payment was beneficial to the estate of the debtor.

Hemingway, 954 F.2d at 5. See also In re PYXSYS, 288 B.R. 309 (Bankr.D.Mass. 2003).¹⁰ "The traditional presumption favoring ratable distribution among all holders of unsecured claims counsels strict construction of the Bankruptcy Code provisions governing requests for priority payment of administrative expenses." Hemingway, 954 F.2d at 4-5. Nevertheless, as one of the primary purposes of § 503(b)(1)(A) is to encourage parties to do business with a debtor...