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A short-sighted software vendor move: Sue a customer to force a re-buy after an internal corporate reorganization

I wouldn’t want to be the software-vendor account rep trying to up-sell this customer — not after the vendor successfully sued the customer to force it to spend nearly $500K to re-buy its license after an internal corporate reorganization.

The software license agreement included an assignment-consent requirement

Here’s what happened, according to the appeals court in Cincom Sys., Inc. v. Novelis Corp., No. 07-4142 (6th Cir. Sept. 25, 2009) (affirming summary judgment in favor of vendor). I’ve added emphasis and extra paragraphing below:

Cincom is an Ohio-based corporation that develops, licenses, and services software for its corporate customers. The rights to use two of Cincom’s most popular software offerings form the basis of the current dispute.

SUPRA© [sic; should be ®] is a database management program that allows a corporation to manage millions of records. MANTIS© [sic; ®] is a fourth-generation application development system, i.e., a computer language that allows a corporation’s software professionals to develop computer programs that allow the corporation’s operations to function more smoothly. …

Rather than sell the computer programs themselves, Cincom only sells licenses that allow its customers to use the two programs for an annual fee.

On July 5, 1989, Cincom agreed to license SUPRA© and MANTIS© to Alcan Rolled Products Division (“Alcan Ohio”), an Ohio-based corporation that would later become known as Novelis.

The license Cincom issued listed “Alcan Rolled products [sic] Division” as the “Customer” and granted to Alcan Ohio “a non-exclusive and nontransferable license” to use Cincom’s software. (License at 1.) …

Alcan Ohio could only place the software on designated computers that the parties specifically listed in a schedule attached to the license. (License at 1.) Alcan Ohio listed the designated computer as one located at its facility in Oswego, New York.

The license agreement closed by noting that Ohio law would govern its terms and that Alcan Ohio could “not transfer its rights or obligations under this Agreement without the prior written approval of Cincom.” (License at 3.)

The customer did an internal corporate reorganization

Then came the internal corporate reorganizations, which amounted to reincorporating the customer in Texas (it was originally an Ohio corporation) and changing the name:

Before the commencement of Alcan Ohio’s internal reorganization, Alcan Ohio was a wholly-owned subsidiary of Alcan, Inc., a Canadian corporation.

On May 15, 2003, Alcan Ohio created a separate corporation known as Alcan of Texas (“Alcan Texas”), organized under the laws of Texas.

Alcan Texas, like Alcan Ohio, was also a wholly-owned subsidiary of the Canadian parent corporation Alcan, Inc.

On July 30, 2003, Alcan Ohio merged into Alcan Texas, with Alcan Texas remaining as the surviving corporate entity.

The next day, Alcan Texas simultaneously merged into itself and its three Texas subsidiaries.

As a result, the former rolled products division of Alcan Ohio became a subsidiary of Alcan Texas known as Alcan Fabrication Corporation.

In September 2003, Alcan Fabrication Corporation changed its name to Alcan Aluminum Corporation. A final name change occurred on January 1, 2005, when Alcan Aluminum Corporation changed its name to its current appellation, Novelis.

So what was the net effect? Not much, really:

Thus, as of January 2005, the software Alcan Ohio licensed from Cincom remained on the same computer in Oswego, New York, but in a plant now owned by an entity named Novelis. [DCT COMMENT: For all practical purposes and most legal ones, the “entity named Novelis” was one and the same as the original licensee, Alcan Ohio.]

Alcan Ohio never sought or obtained Cincom’s written approval to continue to use the SUPRA© and MANTIS© software before restructuring its rolled products division.

The vendor sued, and forced the customer to re-buy its license

When the vendor learned of the corporate reorganization, it filed suit, alleging that the customer’s actions violated the license agreement.

The trial court granted summary judgment that, under the federal law governing patent- and copyright licenses, the customer’s internal corporate reorganization transactions constituted a “transfer” of the software license which the license agreement prohibited without the vendor’s consent.

(Under state law, other types of property are deemed automatically vested in the ‘surviving’ corporation, but federal law controls for patent- and copyright licenses.)

The vendor and the customer stipulated that the vendor’s monetary damages were $459,530.00 — which (surprise, surprise) was equal to the amount of the initial licensing fee. See id., slip op. at 3-4.

On appeal, the Sixth Circuit affirmed, explaining that:

… Allowing state law to permit the free assignability of patent or copyright licenses would “undermine the reward that encourages invention.” This is because any entity desiring to acquire a license could approach either the original inventor or one of the inventor’s licensees. Absent a federal rule of decision, state law would transform every licensee into a potential competitor with the patent or copyright holder. In such a world, the holder of a patent or copyright would be understandably unwilling to license the efforts of his work, thereby preventing potentially more efficient uses of the invention by others.

… where state law would allow for the transfer of a license absent express authorization, state law must yield to the federal common law rule prohibiting such unauthorized transfers.

See id., slip op. at 6-7 (citations and internal quotation marks omitted).

This vendor was penny-wise but pound-foolish

It’s totally understandable that a software vendor would want to impose an assignment-consent requirement in a license agreement, in order to keep its software, and the trade secrets therein, out of the hands of competitors.

And it’s also understandable that the vendor would want the ability to consent even to a transfer involving an internal reorganization by the customer — otherwise, the customer might transfer its obligations to a worthless shell corporation.

But that doesn’t mean the vendor has to seize on a customer’s corporate reorganization as an opportunity to extract extra revenue from the customer.

You can bet that this customer is looking around for ways to ditch the vendor.

And if the vendor has competitors (and who doesn’t?), one of those competitors may well be offering a rip-out-and-replace deal, in which the customer gets the competitor’s software for free in return for an agreement to pay maintenance for X — years.

(See also: Assignment-consent provisions in the Notebook.)