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Unintended Consequences

Unintended Consequences

December 31, 2009
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" What happens to software licenses upon a merger or reorganization? "

A recent opinion from the U.S. Court of Appeals for the Sixth Circuit (Cincom Systems Inc. v. Novelis Corp, 92 U.S.P.Q.2d 1085 (6th Cir. 2009)), serves as a strong reminder to those web-based businesses that have licensed code, scripts, and other software, to carefully consider the impact of federal intellectual property laws on the transferability of these items when selling or purchasing your business.

The curious result in the Cincom case was an award of almost $500,000 to a software vendor as damages for copyright infringement, despite a state merger statute that allowed assets held by a party to automatically vest in a successor company. The vendor succeeded in being paid twice for the same software, on the same machine, in the same building, essentially because the name over the customer's door had changed. A complete copy of the Court's decision may be found online.

The facts in Cincom involve Alcan Rolled Products Division (Alcan Ohio), an Ohio corporation wholly owned by Alcan, Inc., that licensed certain software from Cincom Systems, Inc. pursuant to the terms of a license agreement. The agreement provided that the license was "non-exclusive and non[-] transferable" and did not permit Alcan Ohio to "transfer its rights or obligations under [the license agreement] without the prior written approval of Cincom." The license agreement also required that the software be used only on one specific computer in Alcan Ohio's Oswego, New York, facility. It also indentified Ohio law as controlling the matter.

After completion of the internal reorganization, the software remained on the same computer in New York, but in a plant now owned by the successor company, Novelis. Alcan Ohio/Novelis never attempted to obtain Cincom's written approval to continue to use the software before or after the restructuring, presumably assuming that such approval was unnecessary in the context of an internal reshuffling that did not change the physical location or expand the use of the software.

Ohio's merger statute provided that "[t]he surviving or new entity possesses all assets and property of every description, and every interest in the assets and property ... all of which are vested in the surviving new corporation without further act or deed." Notably, the merger law had been changed before creation of the license agreement to replace language that all property shall be deemed "[t]ransferred to" the surviving corporation without further act or deed.

Cincom sued Novelis, alleging that Alcan Ohio had violated the Cincom license by transferring the license to Novelis without consent, making Novelis an infringer whose use of the copyrighted software was unauthorized by Cincom as the copyright owner. Novelis countered that the license contained no indication of intent to prohibit the license from moving between related parties as part of an internal corporate reorganization, and that Ohio's removal of the words "transferred to" from the merger statute required a finding that there had been no "transfer" of the license. The District Court disagreed, and determined that the series of mergers effected a prohibited transfer of the license. Novelis appealed.

The Court of Appeals characterized the zone of conflict between federal intellectual property law and state corporation law as one of the limited situations requiring "judicial creation of some federal rule of common law." It further observed that courts had previously articulated the need for a uniform rule that patent licenses are "personal" and "non-transferable" in the absence of agreement expressly authorizing the assignment, and extended that patent principle to Cincom's copyrights in the software. In short, despite the fact that Ohio state law would allow a successor to assume the license, like other assets of the predecessor company, without express authorization, the court determined that Ohio must yield to the "federal common law" that it found to prohibit such transfers.

After determining that a transfer without express authorization from Cincom would be impermissible, the court then determined that Alcan Ohio did make such a transfer when Novelis continued using the software — on the same computer in the same location — without first obtaining Cincom's permission to do so, and awarded damages for copyright infringement in an amount stipulated by the parties (based on standard fees for a new license).

This decision is only controlling within the 6th Circuit (comprising Ohio, Kentucky, Michigan, and Tennessee), however there are very few judicial opinions on this topic and other courts may find the Cincom holding persuasive. Right or wrong, however, it offers two cautionary lessons:

  • Assignment and permitted-user clauses in license agreements for software and other intellectual property must be drafted with particular care, because courts are likely to treat intellectual property as a unique asset category entitled to special federal protection.
  • Intellectual property due diligence, including a review of key software license and assignment provisions, is essential even in the context of a restructuring that may affect the corporate identity of the original licensee.

If your company is considering a merger, whether with a third party or for internal reorganization purposes, it is important that your intellectual property contracts be carefully reviewed and analyzed to determine if the merger may have an effect on the surviving entity's ability to use the intellectual property at issue. Without a clear understanding of that matter, you may find that you have inadvertently lost some of the benefits the merger was intended to provide.

Daniel Pepper is founder and managing member of Pepper Law Group, LLC, a boutique law firm in Somerville, New Jersey. For more information, visit www.adultwebsitelawyer.com.


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