Source: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-cand-3_06-cv-00364/USCOURTS-cand-3_06-cv-00364-2/pdf.json

Nature of Suit Code: 422
Nature of Suit: Bankruptcy Appeals Rule 28 USC 158
Cause of Action: 28:0158 Notice of Appeal re Bankruptcy Matter (BAP)

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United States District Court

For the Northern District of California

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1 Western Digital, as the purchaser of substantially all of

Read-Rite's assets, has agreed to serve as Read-Rite's attorney in

fact for the purposes of the present dispute. 

UNITED STATES DISTRICT COURT

NORTHERN DISTRICT OF CALIFORNIA

In re:

Read-Rite Corporation, a Delaware

corporation,

Debtor.

 

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No. C-06-0364 SC

Bankruptcy No. 03-43576 N7

ORDER AFFIRMING THE

BANKRUPTCY COURT'S

FINDINGS OF FACT AND

CONCLUSIONS OF LAW

I. INTRODUCTION

This appeal is before the Court following the December 20,

2005 decision of the Bankruptcy Court sustaining the objection of

Appellee Western Digital Corporation1 ("Appellee" or "Western

Digital") to the election of Appellant Seagate Technology Holdings 

("Appellant" or "Holdings") to retain, pursuant to 11 U.S.C. 

§ 365(n)(1)(B), any rights it may have had under a non-exclusive

patent cross-license agreement between the parties. For the

reasons set forth herein, the Order of the Bankruptcy Court is

hereby AFFIRMED.

//

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II. BACKGROUND

The facts are virtually undisputed. Read-Rite was one of

three major suppliers of magnetic recording heads for the hard

disk drive and tape drive markets. See Appellants' Appendix Ex. B

at 2. Seagate Technology Inc. (hereinafter referred to as Old

Seagate) was a manufacturer of hard disk drives and was a customer

of Read-Rite. Id. On December 31, 1994, Read-Rite and Old

Seagate entered into a cross-licensing agreement ("1994 Agreement"

or "Cross-Licensing Agreement") whereby each party agreed to grant

the other certain non-exclusive licenses to use its patented

technology. Id.

By 1999, it became clear that Old Seagate's value as a

company was not being assessed according to its business, but

rather according to the successes and failures of Veritas

Corporation ("Veritas"). This was because Old Seagate owned a 20%

shareholder interest in Veritas, which interest was valued at $10

billion and evidently outweighed the total value of Old Seagate's

disk drive business. Id. Old Seagate therefore sought to unhinge

its fate from that of Veritas, yet was unable to do so in a

straightforward manner without incurring $6 billion in tax

liabilities. Id. Old Seagate therefore devised a highly complex

series of corporate spinoff and leveraged buyout transactions

which, when completed, would "unlock Old Seagate's assets,

minimize tax liabilities and reward both companies' shareholders." 

Id. This is what the parties refer to as the "going private

transaction." The Bankruptcy Court described it thus:

The steps transforming Seagate's corporate structure...must

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be spread forth in order to comprehend the problems they

caused under the 1994 agreement with Read-Rite. The first

steps occurred in June 2000, with the formation of a

subsidiary called Seagate Technology LLC ["LLC"]. Over 95%

of the stock in this subsidiary was owned by Old Seagate, and

the remainder was owned by one of Old Seagate's wholly-owned

subsidiaries, Quinta. On that same date, Old Seagate

transferred all of its intellectual property to LLC. Next,

on August 10, 2000 Old Seagate formed a wholly-owned

subsidiary known as New SAC...New SAC in turn formed whollyowned subsidiary Holdings, which formed wholly-owned

subsidiary Seagate Technology HDD Holdings ["HDD"], which

formed wholly-owned subsidiary Seagate Technology U.S.

Holdings ["U.S. Holdings"]. New SAC, Holdings, and HDD were

incorporated in the Cayman Islands, while U.S. Holdings was

incorporated in Delaware. The deal was fully consummated on

November 22, 2000, when the following occurred: Old Seagate

sold New SAC to new investors and former management of Old

Seagate; HDD purchased Old Seagate's interest in Quinta; and

U.S. Holdings purchased Old Seagate's 95% interest in LLC. 

Thus, Holdings...owned the assets of Old Seagate through its

100% ownership of HDD, and through HDD's 100% ownership of

U.S. Holdings and Quinta. 

Id. at 2-3. 

The parties to the 1994 Agreement clearly understood the

business realities that cause corporations to avail themselves of

the panoply of options with respect to structuring a corporate

family. Accordingly, section 3.1 of the 1994 Agreement grants the

parties the right to issue sublicenses to their subsidiaries. 

Section 1.6 of the 1994 Agreement defines a subsidiary as any

entity

more than fifty percent (50%) of whose outstanding shares or

securities...are now or hereafter, owned or controlled,

directly or indirectly, by a party hereto, but such

corporation, company, or other entity shall be deemed a

Subsidiary only so long as such ownership or control

exists...

Appellee's Appendix Ex. P at 2.

Section 3.1 provides that "[a]ny license granted to a

Subsidiary shall terminate on the date such subsidiary ceases to

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be a Subsidiary." Id. at 4. However, a subsidiary that ceases to

be a Subsidiary under section 1.6 nonetheless has the right to

obtain a replacement license if it receives written approval from

its parent, requests the replacement license within 180 days of

the date on which it ceased to exist as a Subsidiary, and meets

the conditions set forth in section 3.2. As is relevant to this

case, that section requires an entity requesting a replacement

license to have all of the following: 

3.2.1. a line of marketable products; 

3.2.2. patents or intellectual property relating to the line

of marketable products; 

3.2.3. tangible assets at least equivalent in value to the

lesser of twenty-five million U.S. dollars ($25,000,000) or

twenty percent (20%) of the total assets of the party of

which it was formerly a subsidiary; and 

3.2.4. at the time of entry into such licence agreement, it

is not a corporation, company, or other entity who has...more

than fifty percent (50%) of its shares or securities...[owned

or controlled by a third party]. 

See id. Following the going private transaction, Holdings was not in

a position to obtain a sublicense as a subsidiary under section

1.6, but rather had to meet the criteria detailed in section 3 if

it was to be entitled to a replacement license. To that end, on

May 18, 2001 Holdings requested by certified letter an operating

subsidiary license from Read-Rite. See Appellant's Appendix Ex.

E. Read-Rite ultimately concluded that Holdings was not entitled

to an operating subsidiary sublicense, and thereafter entered

bankruptcy proceedings under Chapter 7 of the Bankruptcy Code. 

Pursuant to 11 U.S.C. § 365(n)(1)(B), Holdings moved to elect

to retain rights it claimed it had by virtue of its purported

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compliance with section 3 of the 1994 Agreement. Western Digital

objected to that election, and the Bankruptcy Court sustained the

objection, finding that (1) Holdings had not demonstrated that the

original party to the Cross-Licensing Agreement, Old Seagate,

consented to Holdings's request for a replacement license as

required by section 3.2; (2) Holdings did not "have" a line of

marketable products as required by section 3.2.1; (3) Holdings was

100% owned by New SAC, therefore violating section 3.2.4; (4) the

doctrine of forfeiture was inapplicable to Holdings's position in

this case; (5) Holdings is not entitled to an implied license

under the federal patent law doctrine of equitable estoppel; and

(6) Read-Rite did not waive its right to enforce its patents. See

Appellant's Appendix Ex. B at 4-10. The Bankruptcy Court

accordingly sustained Western Digital's objection to Holdings's

election under section 365(n)(1)(B). Holdings timely filed this

appeal.

III. STANDARD OF REVIEW

 In reviewing appeals from Bankruptcy Court decisions,

District Courts must apply a clearly erroneous standard to the

findings of fact and review de novo the Bankruptcy Court's

conclusions of law. In re Lazar, 83 F.3d 306, 309 (9th Cir.

1996). The Bankruptcy Court's decision with respect to

Appellant's equitable defenses is reviewed for abuse of

discretion. A.C. Aukerman Co. v. R.I. Chaides Construction Co.,

960 F.2d 1020, 1028 (Fed. Cir. 1992).

//

// 

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IV. DISCUSSION

Appellant's arguments essentially fall into two categories:

(1) the Bankruptcy Court erred in determining that Holdings was

not entitled to a replacement license under the 1994 Agreement

both because a reasonable interpretation of the agreement

demonstrates that Holdings qualified as an operating subsidiary,

and because even if the plain language did not clearly dictate

that Holdings met the definition of an operating subsidiary,

California's law of contractual interpretation applies to avoid

construing contracts in a manner that results in forfeiture,

which, Holdings contends, is precisely what will happen if the

interpretation of the Bankruptcy Court is upheld; and (2) even if

Holdings does not have the right to receive a replacement license

under the 1994 Agreement, the Court should find that Holdings is

nonetheless entitled to a license under the doctrines of implied

license or waiver.

A. Appellant's Right to a Replacement License Under the

Cross-Licensing Agreement

Holdings may elect to preserve its right to a license under

11 U.S.C. § 365 only if it actually possessed rights under an

executory contract at the time Read-Rite entered bankruptcy. 

11 U.S.C. § 365(n)(1)(B). Since Holdings was created some six

years after the formation of the 1994 Agreement, and because

Holdings does not qualify as a subsidiary of the original party to

the agreement, its right to a license under the 1994 Agreement is

entirely contingent upon whether Holdings satisfied the

requirements of section 3, including meeting the definition of an

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2

 In addition to qualifying as an operating subsidiary, a

party seeking a replacement license under section 3 of the 1994

Agreement was required to receive written authorization from its

parent company, and was required to request the replacement license

in writing within 180 days from the date on which it ceased to be a

subsidiary. The Bankruptcy Court found, and the parties do not

dispute, that Holdings satisfied the latter condition when, on May

18, 2001, 177 days after ceasing to be a subsidiary of Old Seagate,

Holdings sent its written request for a replacement license to

patent counsel for Read-Rite. As for the requirement that Holdings

receive written permission from its parent company, the Bankruptcy

Court was dubious that Holdings had actually received such written

notice, yet did not expressly make such a finding, as the

Bankruptcy Court found numerous other points on which to base its

conclusion that Holdings was not entitled to a replacement license. 

For that reason, and because this Court similarly finds resolution

of that question unnecessary to the outcome of the Court's review

of the Bankruptcy Court's decision, no opinion is expressed as to

the question of whether the statements made by Holdings' parent in

various corporate filings were sufficient to constitute written

consent to seek a replacement license under section 3.

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"Operating Subsidiary."2 

Because the parties do not dispute that Holdings satisfied

section 3.2.2, and seem to assume that Holdings satisfied section

3.2.3, the question of whether Holdings met the definition of an

operating subsidiary boils down to whether: (1) Holdings has a

line of marketable products by virtue of its 100% ownership of

HDD, which in turn owned 100% of U.S. Holdings, which controlled

LLC, the entity that operated Old Seagate's disk drive business;

and (2) whether Holdings has more than 50% of its outstanding

shares owned or controlled by a third party.

As to the first question, the Court finds that Holdings did

not have a line of marketable products. The Bankruptcy Court

reasoned that a straightforward application of the 1994 Agreement

yielded the inevitable conclusion that Holdings did not have a

line of marketable products. See Appellant's Appendix Ex. B at 5-

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3 More than anyone, perhaps, Old Seagate was aware of the

kinds of permutations its corporate structure might undergo one day

in response to the myriad pressures of business and regulation, and

was thus in the best position to insert language in the CrossLicense Agreement that would guarantee its ability to freely obtain

replacement licenses for its operating subsidiaries, even where

such subsidiaries are mere holding companies. That Old Seagate was

unable or unwilling to insert such language in the 1994 Agreement

is therefore evidence that, at the time of formation, the parties

did not mutually intend that a former subsidiary be deemed to

"have" a line of marketable products via indirect ownership of the

outstanding shares of a company that operates a line of marketable

products. 

-8-

6. Rather, Holdings was aptly named - it was, after all, a

holding company - but it did not directly own anything aside from

100% of the shares of HDD. Further, whereas the 1994 Agreement

evidences the willingness of the parties to modify contractual

terms with the clause "directly or indirectly," see Appellee's

Appendix Ex. P at 2 section 1.6.1, absence of such a clause in

section 3.2 gives rise to the inference that the parties did not

intend attenuated control of a company that operated a line of

marketable products to suffice to meet the requirements of section

3.2.1. The Court finds this reasoning sound, and adopts it as

supporting its finding on this point.3

However, there is another, equally compelling reason

supporting the Court's finding. Under the logic championed by

Holdings, there are at least six entities that could be deemed to

"have" a line of marketable products: LLC, as the entity that

controls Old Seagate's disk drive business; U.S. Holdings, as the

entity that controls LLC; HDD, as the entity that owns 100% of the

shares of U.S. Holdings; Holdings, as the entity that owns 100% of

the shares of HDD; New SAC, as the entity that owns 100% of the

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shares of Holdings, and the investors in New SAC, as the

individuals who actually control New SAC (as Holdings argues with

respect to question of which entity owns or controls Holdings for

the purposes of section 3.2.4). Certainly the 1994 Agreement does

not contemplate any one of several different entities all "having"

the same disk drive business, apparently depending merely on who

is asking and what the consequences are. An interpretation of a

contract that yields plainly absurd results is to be avoided, and

the Court therefore rejects Holdings's argument on this point.

The Bankruptcy Court found another compelling reason

supporting its finding that Holdings did not qualify as an

operating subsidiary under the cross-licensing agreement. Under

section 3.2.4, an entity must not have more than 50% of its

outstanding shares owned or controlled by a third party if it is

to qualify as an operating subsidiary. See Appellee's Appendix

Ex. P at 4. The Bankruptcy Court found that Holdings was unable

to satisfy this condition because it was a wholly owned subsidiary

of New SAC. See Appellant's Appendix Ex. B at 5-6. The Court

agrees with this finding, and rejects Holdings's argument that the

Court should look past New SAC's 100% ownership of Holdings and

find that the individual investors who own New SAC - none of whom

own more than 50% of the shares of New SAC - are the entities that

actually own or control Holdings. 

Nothing in the 1994 Agreement suggests that the parties

intended that the requirements of section 3.2.4 apply differently

depending on whether the entity that controls the outstanding

shares of the operating subsidiary is a small, private company or

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4 Appellant argues that its suggested method for determining

who actually owns or controls a company seeking a replacement

license - that is, looking past the entity that immediately owns

the company to the investors in the parent company - applies where

an operating subsidiary is owned or controlled by an intermediate

holding company like New SAC, but should not apply where the parent

company is a large, publicly traded corporation. See Appellant's

Reply Brief at 10. This methodology is necessary to Holdings'

argument because if its suggested interpretation of the

requirements of section 3.2.4 were implemented in all scenarios, a

publicly traded competitor would likely also satisfy the 50%

ownership condition because it is unlikely that any single investor

would own more than 50% of the outstanding shares, a result the

parties agree would be anathema to the purpose of the change of

control provisions of the 1994 Agreement. 

-10-

a large, publicly traded corporation.4 Yet it is precisely this

interpretation that Holdings urges, and indeed, is essential to a

finding that Holdings satisfied the ownership provisions of

section 3.2.4. The Court finds that while this interpretation

might represent what Appellant wishes the 1994 Agreement spelled

out, it enjoys no support outside of Appellant's own self-serving

logic. Nothing in the Cross-Licensing Agreement even remotely

suggests that the definition of an operating subsidiary should be

applied in significantly different ways depending on the corporate

structure of the parent company. Accordingly, the Court rejects

this interpretation and finds that Holdings did not meet the

definition of an operating subsidiary when it sought a replacement

license in 2001. 

As for Appellant's argument that California law of contract

interpretation mandates construing the Cross-Licensing Agreement

in such a way as to avoid causing one of the parties to suffer a

forfeiture, the Court agrees with the reasoning of the Bankruptcy

Court, which found that the law against forfeiture was

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inapplicable to the facts of this case, and that even if it was

implicated, forfeiture law did not mandate a finding that Holdings

qualified as an operating subsidiary. See Appellant's Appendix

Ex. B at 6-8.

The Court affirms these findings of the Bankruptcy Court. 

The Court finds that the law of forfeiture does not apply to save

a party from suffering a loss of rights where the only reasonable

interpretation of a contract dictates that result. See Troughton

v. Eakle, 58 Cal. App. 161, 173 (Cal. Ct. App. 1922); cf.

Milenbach v. C.I.R., 318 F.3d 924, 937 (9th Cir. 2003) ("Where

there are two possible interpretations of a contract, one that

leads to forfeiture and one that avoids it, California law

requires adoption of the interpretation that avoids forfeiture, if

at all possible."). Because the Court does not find that there is

any other reasonable construction of the 1994 Agreement except for

the one detailed above, the law against forfeitures is not

implicated. Even if forfeiture law is applicable, that law does

not operate to allow a court to rewrite the contract or adopt an

unnatural construction of its terms. See Universal Sales Corp. v.

Cal. Press Mfg. Co., 20 Cal. 2d 751, 771 (Cal. 1942); Kitchen v.

Ballard, 192 Cal. 384, 390 (Cal. 1923). Accordingly, Appellant's

arguments on this point are rejected and the Bankruptcy Court's

findings are affirmed.

B. Holdings's Right to Equitable Relief

Holdings argues in the alternative that the Bankruptcy Court

erred in finding that Holdings did not qualify for an implied

license under the doctrine of equitable estoppel. 

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To establish a right to an implied license under the patent

law doctrine of equitable estoppel, a party must prove that

(1) the patentee, through statements or conduct, gave an

affirmative grant of consent or permission to make, use, or

sell to the alleged infringer; (2) the alleged infringer

relied on that statement or conduct; and (3) the alleged

infringer would, therefore, be materially prejudiced if the

patentee is allowed to proceed with its claim...The first

element requires the patentee to communicate that “the

accused infringer will not be disturbed by the plaintiff

patentee in the activities in which the former is currently

engaged.” Thus, for this form of estoppel, the alleged

infringer must have knowledge of the patentee and its patent

and must reasonably infer that the patentee acquiesced to the

allegedly infringing activity for some time. 

Winbond Electronics Corp. v. Int'l Trade Com'n, 262 F.3d 1363,

1374 (Fed. Cir. 2001). 

Holdings argues that Appellee's silence in response to a

series of four communications from Old Seagate to Read-Rite both

prior to and after the going private transaction indicated to

Appellant that Read-Rite would acquiesce to Holdings's use of the

patents under the 1994 Agreement. See Appellant's Brief at 20-24. 

The first two of those communications - in October 2000 and

January 2001 - evidently informed Read-Rite that Old Seagate

intended to assign the Cross-License Agreement to LLC. Id. at 21. 

Read-Rite apparently did not respond to these communications. Id. 

In May 2001, Holdings wrote to Read-Rite to formally request a

replacement license under section 3 of the 1994 Agreement, and did

not receive a response from Read-Rite. Id. Holdings followed

that request with a letter in September 2001 noting Read-Rite's

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failure to respond to the May 2001 request. Id. Prior to sending

the September 2001 letter, Holdings phoned Read-Rite to inquire as

to the status of the replacement license, and was told by counsel

for Read-Rite that a new legal team was in place and no decision

regarding the replacement license would be made until a review of

all documents could take place. See Appellant's Appendix Ex. B at

5. Read-Rite eventually objected to Holdings' license request in

November 2002. See Appellant's Brief at 21.

The Court finds Holdings's argument on this point

unpersuasive and affirms the holding of the Bankruptcy Court

rejecting Holdings's claim for an implied license. To interpret

Read-Rite's silence as an indication that it did not intend to

enforce its patents would be unreasonable, and is therefore

incapable of supporting an argument asserting a right to an

implied license. 

Old Seagate's October 2000 letter informing Read-Rite of its

intention to assign the 1994 Agreement to LLC did not mention

Holdings and does not indicate in any way that Old Seagate would

be relying on Read-Rite's willingness to grant a license to the

entity that eventually came to control the disk drive business. 

See Appellant's Appendix Ex. E. Rather, the letter indicates only

that Old Seagate was planning on assigning its rights and

obligations under the 1994 Agreement to LLC as a part of the going

private transaction. Id. However, the 1994 Agreement expressly

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limits the manner in which parties may make assignments under the

agreement, and therefore Read-Rite would be justified in believing

that Old Seagate would comply with section 9.1 of the 1994

Agreement if it indeed intended to participate in a valid

assignment. 

Furthermore, following the May 2001 letter formally

requesting a replacement license, Holdings was informed that ReadRite would not take action on the request until after its new

legal team had an opportunity to review all pertinent documents. 

How Holdings could genuinely have formed the belief that Read-Rite

would not object to Holdings's use of Read-Rite's patented

technology from the communications between the parties is beyond

comprehension. At the very least, the Court finds that ReadRite's conduct with respect to the communications between the

parties did not create a reasonable inference that it would not

object to Holdings's use of its patented technology.

The Court finds that the determination of the Bankruptcy

Court that Holdings did not demonstrate that it relied on ReadRite's silence to its detriment did not constitute an abuse of

discretion and is therefore affirmed.

With respect to the question of whether Appellant could

demonstrate reliance on Read-Rite's silence, the Bankruptcy Court

found that the structure of the going private transaction was

"already a fait accompli" by the time Old Seagate sought ReadCase 3:06-cv-00364-SC Document 39 Filed 05/05/06 Page 14 of 17
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Rite's approval. Appellant's Appendix Ex. B at 9. According to

the Bankruptcy Court, Appellant was relying on "unilateral

expectations or at most, reasonable hopes that Read-Rite's

approval would be forthcoming, nonwithstanding their failure to

meet the requirements under the cross-licensing agreement. ReadRite's conduct played no part in Seagate's actions." Id.

Appellant argues that the Bankruptcy Court erred in finding

that Holdings did not establish that it relied on Read-Rite's

silence to its detriment, because, Holdings contends, it

"expand[ed] its control of LLC's infringing disk drive business

during the Debtor's two-year period of inaction." Id. at 24.

This Court finds that the Bankruptcy Court's findings with

respect to whether Appellant actually relied on Read-Rite's

conduct are not clearly erroneous, and that the Bankruptcy Court's

declination to award Holdings an implied license under the

equitable estoppel doctrine was not an abuse of discretion. That

finding is therefore affirmed.

Finally, with respect to Holdings's argument that Read-Rite

waived its right to enforce its patents by failing to respond to

Old Seagate's and Holdings's communications, the Bankruptcy Court

found that Appellant had failed to provide any evidence of waiver

whatsoever, much less "clear and convincing" evidence, and that

Holdings was therefore not entitled to a license under that

theory. See Appellant's Appendix, Ex. B at 9-10.

Case 3:06-cv-00364-SC Document 39 Filed 05/05/06 Page 15 of 17
United States District Court

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Holdings argues that the Bankruptcy Court erred in applying

the "clear and convincing" standard for proof of waiver, and that,

where the right to effect a forfeiture is involved, "slight

evidence of waiver of a right to compel forfeiture is sufficient." 

Appellant's Brief at 26. Holdings asserts that Read-Rite's

silence is more than sufficient to meet the "slight evidence of

waiver" standard. Id.

The Court disagrees. Given the Court's interpretation of the

1994 Agreement finding that the facts of this case do not involve

a forfeiture, the "slight evidence of waiver" test is

inapplicable. However, even if it were applicable, the Bankruptcy

Court expressly found that there was "absolutely no

evidence...that Read-Rite intended to give up its right to enforce

the terms of the cross licensing agreement when it failed to

respond to Holdings's letters." Appellant's Appendix Ex. B at 10. 

The Court finds that this finding of fact is not clearly

erroneous, and therefore affirms the finding of the Bankruptcy

Court that Holdings is not entitled to a replacement license under

a theory that Read-Rite waived its right to enforce its patents.

//

//

//

//

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United States District Court

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V. CONCLUSION

For the reasons set forth above, the order of the Bankruptcy

Court sustaining Appellee's objection to Appellant's election

under 11 U.S.C. § 365(n)(1)(B) is AFFIRMED.

IT IS SO ORDERED.

Dated: May 5, 2006 ____________________________

UNITED STATES DISTRICT JUDGE 

 

Case 3:06-cv-00364-SC Document 39 Filed 05/05/06 Page 17 of 17