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If you negotiate software-distribution or -reseller agreements for "the channel," you'll want to know about the Ninth Circuit decision in Adobe Sys., Inc. v. Christenson, No. 12‑17371 (9th Cir. Dec. 30, 2015). In that case:

• One Joshua Christenson owned a now-defunct company that bought up unsold copies of Adobe Photoshop software from third-party distributors and offered the copies for sale to the public via a Web site.

• Adobe sued Christenson and his company, claiming that his sales infringed Adobe's exclusive right, under 17 U.S.C. § 106(3), to distribute copies of its software.

• "In the face of an otherwise slam dunk copyright violation," see Adobe, slip op. at 10, Christenson pled a first-sale defense, namely that he had lawfully acquired genuine copies of Adobe's software from Adobe distributors, and therefore he had the right to resell those copies under 17 U.S.C § 109.

The first-sale doctrine is long-established; in an earlier case, the Supreme Court explained that "once the copyright owner places a copyrighted item in the stream of commerce by selling it, he has exhausted his exclusive statutory right to control its distribution." Adobe, slip op. at 10 (citation and internal quotation marks omitted).

Here, "Christenson offered invoices to document his purchases of legitimate Adobe software from various suppliers. Nothing on those invoices suggests that he was other than a legitimate purchaser of the software. … Christenson discharged his burden with respect to the first sale defense." Id. at 16.

• Adobe, of course, objected to Christenson's first-sale defense: It countered that it licensed its software, as opposed to selling copies of it, and therefore the first-sale defense did not apply.

As the Ninth Circuit explained, "[a]s early as 1908, the Supreme Court recognized that a sale creates a defense to a copyright claim while a license does not." Id. (citation omitted).

The appeals court noted the prevalence of licenses, as opposed to sales, in software distribution: "In practice, because the first sale doctrine does not apply to a licensee, licensing arrangements enable software companies to restrict initial licensees of software from selling their licensed copies of the software to downstream users." Id. at 13 (internal quotation marks and citations omitted).

• The problem for Adobe was that it did not show that it licensed its software as opposed to selling it.

The Ninth Circuit said that "[i]n an ordinary case, Adobe would [have] produce[d] specific license agreements and we would ... determine ... whether downstream customers were bound by a restrictive license agreement such that they [were] not entitled to the first sale doctrine." Id. at 17 (citation and internal quotation marks omitted).

It's not that Adobe didn't try to introduce evidence of its license-agreement arrangements with its distributors: The district court excluded Adobe's evidence on that point as a sanction for discovery violations. See id. at 17-18.

The appeals court affirmed summary judgment dismissing Adobe's copyright claim against Christenson. (It also affirmed dismissal of a trademark-infringement claim on grounds of nominative fair use.)

Drafting lesson: This is a narrow, substantive lesson for those who draft sales-channel distribution agreements for software companies: Be sure to include appropriate license language (which I won't go into here).

Last week's SIGA v. PharmAthene case provides a reminder that an agreement to negotiate in good faith might well be enforceable, and that breaching the agreement could be expensive:

  • SIGA, the financially-troubled developer of an experimental smallpox drug, needed cash.
  • The drug developer approached a potential rescuer, PharmAthene, about merging.
  • The parties signed a detailed, non-binding term sheet in which the drug developer and its rescuer would enter into a "partnership"; in that partnership, the drug developer would eventually merge with the rescuer — but not before first licensing the smallpox drug to the rescuer (because the parties' previous merger discussions had been unsuccessful).
  • To provide the drug developer with some much-needed immediate cash, the parties also signed a separate bridge-loan agreement. Among other things, that agreement obligated the parties to negotiate in good faith a license agreement, in accordance with the detailed economic provisions set forth in the term sheet, if the merger agreement were to be terminated.
  • The parties then turned their attention to the merger agreement itself; they eventually negotiated and signed the formal merger agreement, which likewise included an obligation to negotiate the license agreement in good faith if the merger failed to go through.
  • After that, though, the drug developer got several items of good news: It was awarded a substantial financial grant from the National Institute of Allergy and Infectious Disease; its initial clinical trials of its new smallpox drug went very well; and it received a sizable contract from the National Institutes of Health, one rich enough to fund future development of the smallpox drug.
  • The drug developer, concluding that it no longer needed to be rescued after all, terminated the merger agreement with its would-be rescuer. (The merger agreement gave the drug developer a termination right because the merger had not been completed on or before a drop-dead date, due to the SEC's delay in approving a proxy statement.)
  • The jilted rescuer informed the drug developer that the rescuer was ready to sign a license agreement for the new smallpox drug in accordance with the economic provisions of the now-abandoned term sheet.
  • The drug developer, though, insisted on drastically re-trading the economics of the deal. (The ingrates ....)
  • The rescuer sued the drug developer for breach of its contractual commitment to negotiate a license agreement for the new smallpox drug in good faith.

So what happened? Last week, the Delaware supreme court affirmed the Chancery Court's award of $113 million against the drug developer for breach of its obligation to negotiate the license agreement in good faith. See SIGA Technologies, Inc. v. PharmaThene, Inc., No. 2627-VCP (Del. Dec. 23, 2015).

A California court recently enforced a contract clause prohibiting extrinsic evidence (a.k.a. parol evidence) from being admitted into evidence to help construe the contract. See Hot Rods, LLC, v. Northrop Grumman Sys. Corp., No. G049953 (Cal. App. 4th Dist. Dec. 7, 2015) (reversing and remanding damages award).

The extrinsic-evidence prohibition language was in the contract's entire-agreement provision (a.k.a. "integration clause" a.k.a. "zipper clause"), as follows:

The Parties further intend that this Agreement constitutes the complete and exclusive statement of its terms and that no extrinsic evidence whatsoever may be introduced in any judicial proceedings involving this Agreement.

Id., slip op. at 9 (emphasis added, internal quotation marks omitted). Rejecting Hot Rod's public-policy arguments, the appellate court agreed with Northrop Grumman that a referee in the court below erred by admitting extrinsic evidence to interpret the parties' agreement. See id., slip op. at 12.

CAUTION: A party that asks for such provision might be setting a trap for itself — imagine a judge's reaction if that party later changed its mind and sought to offer extrinsic evidence to support its preferred interpretation of the contract after all.

I'm adding the following language to the Common Draft collection, even though I doubt I'd ever recommend that a client use it:

The parties desire that extrinsic evidence not be considered in determining the meaning of this Agreement, or any provision of it, in any judicial- or arbitral proceeding; each party agrees not to offer any such evidence for that purpose.

(Notice how the phrasing is more deferential to the courts, and also how there's an express covenant not to offer extrinsic evidence, so that doing so would constitute a separate breach of the agreement.)

Contract lesson from case about cow udders

The case is Roskop Dairy, L.L.C., v. GEA Farm Technologies, Inc., No. S-14-115 (Neb. Dec. 4, 2015). Long story short:

  • After installing an automated milking system, a dairy farm started experiencing problems with its cows (many of the cows started suffering mastitis).
  • The dairy owner blamed the provider of the milking system.

After a battle of experts in the trial court, the supreme court upheld summary judgment that the mastitis problems were in fact caused by:

  • poor hygiene practices by dairy-farm workers, e.g., handling teats with bare hands instead of gloved hands and using the same towels to wipe off multiple cows' teats, which can transmit bacteria from sick cows to healthy ones; and
  • poor maintenance of the milking system, e.g., allowing vacuum vents on the udder clamps to become clogged (which apparently happens most often with manure).

I read the case thinking there might be a contract-drafting lesson there, but I didn't find one — other than to keep in mind that when things go wrong, people will often:

  • assume that correlation equals causation; and
  • point fingers at any available scapegoat, with suppliers of automated systems often being convenient targets.

Contract drafters will be interested in Severn Peanut Co. v. Industrial Fumigant Co., No. 15-1063 (4th Cir. Dec. 2, 2015): The court of appeals upheld summary judgment in favor of a fumigation company, which had caused millions of dollars of damage to a customer's peanut-storage dome. The court found that the service agreement's exclusion of consequential damages precluded the damages sought by the customer and its insurance company. The court focused in part on the following language:

• "Severn and IFC are sophisticated commercial entities who entered into an arm’s length transaction." Id., slip op. at 8.

DCT comment: This is likely to be worth putting into the limitation-of-liability provisions where it will be immediately seen by a reader, instead of far away in the general provisions (where an overzealous drafter might delete it as surplusage).

• "Their contract specified that '[t]he amounts payable by [Severn] [which was about $8,000] are not sufficient to warrant IFC assuming any risk of incidental or consequential damages,' including risks to several itemized categories of damages: 'property, product, equipment, downtime, or loss of business.'” Id. at 8-9 (non-italicized alteration marks by the court).

DCT comment: I like this plain, direct approach more than the curent Common Draft version, which says in part that "Each party acknowledges that this Agreement's limitations of liability are material provisions of this Agreement, and that absent those limitations of liability, one or both of the parties would have declined to enter into this Agreement on the economic- and other terms stated in it." I think I'll incorporate something like this into the next Common Draft release.

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