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Licensing Strategies in the Global Marketplace

Note: These materials were prepared in connection with a presentation before a Massachusetts Continuing Legal Education Seminar.

I. The “classic” software license was one copy for one “machine”, i.e., CPU.

A. Often specifies the CPU serial number.
B. Software “comes to rest” at the licensee.
C. Well-plowed ground and well-documented.

II. What are the “New Frontiers”?

A. Changes from the classic format with respect to:

1. Scope of Right to Use (e.g. Network).

2. New Methods of Pricing and Revenue Generation(e.g., Enterprise Licensing, Run-Time; Time Zone limitations).

3. New Ways to Use Software (Objects, Tools, “Widgets”).

4. New Mechanisms to Reach the Intermediate Licensee (Developer) or End User (CD-ROM, Information Brokerage; Internet as the Channel of Distribution).

5. The year’s hottest topic: Cheap, “Web-ready” “mini-programs” to be furnished over the Internet on an as-needed, when needed basis.

B. Attendant Licensing Legal Issues:

1. Difficulty in Defining Permitted Scope of Use.

2. The move to Shrink Wrap.

3. The move away from Shrink Wrap ( no license).

4. Electronic “contracting” (See VII and VII, infra ).

5. Taxation.

6. Other.

a. Copyright Misuse.

III. New Technology (some, not so new, but widespread availability is new) drives the changes:

A. Microcomputers enable and create perceived “need” to copy.

1. PC’s “empower” the non-technician to easily copy.

2. Home and laptop computers create need for multiple installations for the same user.

B. Networks make software actually (if not legally ) available to many users.

1. through use of software installed on others’ machines (temporary use).

2. through ease of copying to permanent storage to machines on (or off – e.g., home) the network.

3. Through “floating” among servers in different time zones.

C. New types of applications require licensing to aid proliferation within the organization if they are to achieve their full potential: (e.g., e-mail, “groupware”).

D. Object oriented programming (see VII below), widgets and tools (see V below) means the primary source of revenue for the software vendor (licensor) is in the middle (i.e., the developer) not the end (i.e., the end user) of the distribution chain.

E. “Information Superhighway”, Internet and their precursors (on-line services, private BBS) provide new distribution channels, often removing use of any hard-copy license (shrink-wrap or signed) from the process.

F. Java and other systems provide a basis for “applets”, which in turn have re-kindled ideas regarding “renting” of software, an “as-needed, when-needed.”

G. Java and others provide a basis for “platform-independent” software.

H. In all the above

1. Licensees/users seek to reduce burdens of administration needed to get the necessary copies and rights to use in the hands of the users (with concomitant reduction in risk of liability for infringement), while reducing fees,

2. while licensors seek ways to

a. satisfy users while still maximizing revenues, and

b. maximize revenue through control and/or pricing.

IV. Multiple Users: Of Networks and Other Enterprise Licensing

A. Issue that runs through all licensing today: Must recognize that all CPUs may be “network accessible”.

1. Where “is” the software: Must consider that installation “on” a particular machine may become meaningless, as network software creates a single network “drive” using many separate storage units on a network.

2. Also, software may be shifted among servers in different time zones, to enable 24 hour “use.”

a. Results in more actual users, without increase in concurrent users.

b. Microsoft and others are reported to have instituted new license procedures to prohibit this loophole.

c. McAfee and other metering software vendors sold metering software to utilize this loophole.

3. Note, however, that there may be many different types of CPUs on a network, with different levels of power, so the issue may be more complex than just granting the right to use a particular version of a particular application (e.g. a word processor for DOS) on compatible or identical linked computers.

4. Need for licensor to

a. control illicit copies;

b. obtain payment for use on additional/different platforms; and

c. get appropriate support fees (and to ensure proper support and distribution of quality documentation, as well).

5. Problem of defining the “network” when a fee per server is charged: LANs of a large company may interlink through “gateways”.

6. Of course, a vendor could license a network or multiple users merely by selling multiple “per CPU” licenses – leaving the user with the task of ascertaining that it has enough licenses in place at all times, and perhaps causing the user to pay for a number of users far in excess of its average use.

B. “Classic” network licensing techniques:

1. Limit maximum number of “concurrent” users;

a. Maximum number who may potentially use:

(1) May be less than number of terminals

(a) particularly if use “license manager” software to technologically enforce the limit.

b. Maximum number who are actually using at any point in time:

(1) Requires a logging process.

(2) Windows: Each terminal has an icon for the application – is that “in use”?

c. Can’t track home or laptop usage – must provide for separately.

d. Terminology:

(1) “Floating Network License”: The number of users is fixed but usage “floats” among the terminals.

(2) “LANpacks”: License to use copy installed on server, on up to X terminals.

2. Per “seat” (typically, the users are software developers):

a. Different charges for different platforms (e.g. charge for Brand X workstation is different than for use on Brand Y).

b. Specific machine (not just number of users) is licensed.

c. Per named user (Oracle, Microsoft, and others have adopted or reportedly are considering.)

3. Per server: Number of users is not necessarily a factor;

a. But price will probably be based on evaluation of number of users for a given server.

b. License may provide for periodic re-evaluation.

4. Site Licensing:

a. In microcomputer software industry, site licensing was an early departure from “one copy per CPU”.

b. Often includes:

(1) Quantity discount

(2)Right of user to make copies

(3)Cap on the licensee’s liability for unauthorized copies.

c. Controls may include:

(1)Prohibit the licensee from copying documentation.

(a)Must order from vendor – additional check on number of copies in use.

(2) I.D. number on each copy; tied to a particular employee.

(3)Reports and audits.

d. Problems:

(1) Risk for vendor if users/cpus unlimited (not get paid full value).

(2) Risk for licensee of liability for exceeding limits, if set.

(3) Need to periodically re-visit limits and charges, and have license fee for term of years, not indefinite.

C. Enterprise Licensing.

1. Solves problem of tracking specific CPUs and/or specific sites, in a corporate environments where many/all machines may be linked, and permanent memory is diffused.

2. Charge for the use , while remove barriers to use.

3. Price can be tied to, e.g.,;

a. Overall MIPs capacity of the enterprise.

b. per server.

c. use (how often; maximum possible concurrent users; other).

4. If pricing is not tied to a fixed metric, devices (usually implemented in software) are required to measure the metric (e.g., amount of use, no. of actual users).

a. Some are commercially available.

5. There are presently some initiatives for industry standard systems for measurement (method of pricing would still be at individual vendor’s discretion).

6. Typically assumes periodic license fee, not single payment.

a. Need for on-going support and maintenance may necessarily create a mechanism for on-going payments even if one-time license fee were to be used.

7. May limit purposes for which the software is used (e.g. prohibit processing data for third parties).

D. Groupware (Shared Files, facilitates working in groups – edit, comment, update, share data);

a. Can be considered a sub-set of network licensing.

E. All above: A “log on” or “splash screen” notice in the software, noting need for appropriate authorization, is recommended.

V. Licensing of Developers’ Tools and Environments

A. Broadly speaking, “tools” refer to software (sold by the “Tool Vendor”) that speeds the tasks of the programmer (the “Application Developer”) developing a product (the “Application”) (which will ultimately be obtained by an “End User”) by, among other things, providing “libraries” of functions that can be utilized in lieu of preparing new code to carry out the function.

1. Includes such things as Languages, Libraries of functions (e.g. mathematical calculations, interfaces to communications), computer-aided software engineering products (CASE), and software developer “toolkits” (“SDKs”) for Windows, Motif and the like.

2. Pricing is generally “one-time” fee for use of the Tool plus “run time” charge for right to sell copies of the resulting Application. Run time charges are typically a fixed charge per copy of the Application, with quantity discounts.

B. Again broadly speaking, the end result is that portions of the Tool Vendor’s code are integrated into the Application developed by the Application Developer.

1. Thus, licenses to third party End Users of copies of the Application necessarily entail distribution of portions of the code of the Tool Vendor.

C. Exposure for the Tool Vendor:

1. Need to prevent Application Developer from creating a competing tool (how much of the original Tool can be incorporated into the Application?)

2. No direct contractual relationship with the End User, thus Tool Vendor has no direct contractual control over use or copying by the End User, and no direct contract limitations on claims for damages by the End User.

D. Exposure for Application Developer:

1. Determining scope of rights to copy and distribute the resulting application.

2. Bankruptcy proceedings for the Tool Vendor may result in termination of Application Developer’s license to use the Tool under Trustee’s rights to reject under Bankruptcy Code sec. 365. Even if sec. 365(n) applies so as to allow Application Developer to keep license rights, this will not apply if Tool Vendor itself is a sub-licensee of a (bankrupt) developer.

E. (Partial) solutions in the process of licensing the Tool from the Tool Vendor to the Application Developer:

1. Rights in the Tool Vendor’s code: License terms (Tool Vendor to Application Developer):

a. Right to incorporate Tool Vendor’s code into the Application, to extent this is the result of the process of using the Tool.

b. License requires that Tool Vendor’s code be so “bound” to rest of Application code that End User cannot derive the Vendor Code.

2. Assurance to Tool Vendor that the Application will not be a competitor of the Tool:

a. General prohibition against this in license grant.

b. Grant of license limited to creation of a specific application, the general functional description of which is reviewed by Tool Vendor and specified in the license grant.

3. Specify terms of Application Developer’s license to End-User:

a. Prohibit reverse-engineering the Application to derive the Tool Vendor’s code.

b. Require disclaimer of liability and warranty of the Tool Vendor .

(1) Downside: Calls End User’s attention to the Tool Vendor

4. Counsel for Application Developers must carefully consider both implementation of 365(n) and “back up” licenses directly with ultimate source of the Tool.

5. Other liability: Require the Application Developer to indemnify the Tool Vendor against any claims arising from the Application.

6. Quaere : Why should Tool Vendors get indemnification from their licensees (the Application Developers) when Application Developers (outside of medical device applications) typically do not get indemnification from their end-users?

a. Is the “merging” of Tool Vendor’s product into Application a sufficient reason?

b. Tool Vendors have a particularly strong need for insurance. Even if Application Developer provides indemnification, that’s only as solid as the company is. Bear in mind that insurance companies are regulated and supposed to be around for a long time.

F. Issues:

1. Many tools are very low cost, and thus necessarily licensed by shrink wrap. See below re the questionable enforceability of shrink wrap provisions.

a. Consider particularly the tenuous reliance on shrink wrap to seek to affirmatively impose a potentially onerous indemnification obligation on the Application Vendor.

2. Even high-cost Applications are being sold by shrink-wrap contracts, as dropping prices and margins push Application Vendors to avoid the overhead and delay attendant on negotiation of written contracts.

a. Application Vendors therefore may resist clauses requiring written agreements with End Users, creating a tension between Tool Vendor’s desire for the certainty of a written commitment by the End User on reverse engineering and limits of liability and the Application Vendor’s practical requirements for accomplishing sales.

G. Representative Clauses;

GRANT OF LICENSE. Licensor grants to Licensee a nonexclusive right (the “License”) to use and modify the copies of the Licensor software provided to Licensee (the “Product”) on a single computer (i.e., with a single CPU or network node, where only one user at a time is technically able to use the Product) for the purpose of developing other programs, resulting from the combination of Licensee’s code linked with portions of the compiled code of the Product (an “Application”). Licensee may physically transfer the Product from one computer to another provided that the Product is used on only one computer at a time. Licensor reserves all rights not expressly granted to Licensee.

DISTRIBUTION. (a) Licensee may distribute copies of any Application provided that the Application is structured so that users cannot gain access to individual object code modules of particular routines in the Product, or to source code of the original or modified Product or any portion. (b) Licensee may not distribute any part of the original or modified Product, alone or as part of any software product that would compete with the Product, without the express written permission of Licensor. (c) Notwithstanding the foregoing, Licensee may distribute portions of the Product in Applications for the explicit purpose of dynamic linking during runtime, provided that Licensee does not distribute Product header files, .x and .xx files, source code, or documentation. The license for each Application must provide (i) an acknowledgment of the inclusion of Run Time portions of Licensor’s code; (ii)an exclusion of liability on the part of Licensor and an agreement to look solely to Licensee for damages relate to the Application; (iii) and an acknowledgment that Licensor is an intended third-party beneficiary of the license agreement and has the right to bring actions against the end user in its own name. (d) Any Application must contain a sufficient copyright notice to afford Licensee copyright protection under the laws of the country in which the Application is distributed, and contain Licensor’s copyright notice.

VI. Widget (and CD-ROM distribution).

A. “Widget”: An icon – term is best know in “Motif” (Motif is the graphical user interface (“GUI”) for the X-Windows – Unix environment.) Many Widgets are application programs in themselves.

B. Need for “Catalog Shopping”: Put code for many widgets on a CD-ROM in a catalog. Customer calls in orders and gives credit number; in return, receives “unlocking” code for Widgets ordered.

C. Licensing issues: The issues set out under Tools are generally applicable for widgets.

1. Complicating factors: Single package (one CD-ROM) with many included vendors, coupled with low license fees, makes anything other than “shrink wrap” impractical; with attendant risks from not having Application Developer sign the a license agreement with use and liability limits.

VII. The Electronic Distribution Channel

A. Shareware: No longer the exclusive domain of the advocates of “free” software. At least one major vendor of anti-virus software appears to have adopted on-line distribution as its primary marketing channel. Downloads are specified by on-line contract to be authorized for trial use for five days, after which the user must “register” (and pay for) a license.

B. Electronic Interchange: The “Information Brokerage”.

1. A concept developed by The Object Management Group, Inc. Currently in planning stage.

2. Partakes of certain aspects of CD-ROM distribution of widgets, and on-line distribution, but goes far beyond.

3. To be a depository of software components and object classes (libraries) coupled with a fully electronic distribution means.

4. Functions (briefly summarized):

a. Suppliers “list” their objects on the Brokerage

b. Users can “browse” electronically.

c. Prices can be “asked” and “bid”.

d. The Brokerage can collect a percentage of transactions, as well as a registration fee from suppliers.

e. Delivery could be by encrypted CD-ROMs, delivered periodically to buyers; but eventually, listing and distribution should be via computer networks (private BBS; Internet).

f. Licensing could be by the Brokerage’s model, or individual deals.

g. Difficulties in implementing this project are illustrative of on-line distribution issues generally: Objects are always in source form; thus, difficult to track usage and assure payment of royalties.

VIII. “Click Wrap”:

Attempts by on-line distributors and publishers to limit liability to user and to control right of downloaders to use and redistribute.

A. Typically, “splash screen” notice, or “library” file with label such as “License.doc” or “Terms of Use”. See sample attached.

B. Mass-market on-line services have little choice but to use.

C. Interesting to note that those who deal with users who are attorneys (e.g. Counsel Connect) require physical, signed agreement from the users.

D. Several states have implemented an “Electronic Signature Act” to validate on-line signatures. See Section X, infra .

IX. Shrink Wrap Evolution:

A. Before we leave “paper” licenses entirely behind, we should consider the latest thinking on shrink wrap.

B. Why bother? General:

1. As competitive pressures push down prices (and margins), vendors are impelled to move from detailed, multi-page license agreements, with their attendant negotiation costs, to shrink-wrap.

2. Why stop there? Of all the products (movies, videos, books, paintings, sculpture, plays, poems, phonorecords) for which copyright is the primary legal means of intellectual property protection, why is software alone provided to the end user with a “license”?

C. Why Bother? Copyright:

1. Cases holding that statutes which purport to validate shrink wraps are pre-empted by the Federal Copyright Act (e.g., Vault Corp. v. Quaid Software Ltd. , 847 F.2d 255 (5th Cir. 1988) perhaps create a misleading focus:

a. Isn’t the point that for the copyright owner, a unilateral statement of permission to make certain use of a copy of the copyrighted work (e.g., “You may use this copy on only a single computer at a time”; “Licensee may permit use of the Program by not more than 5 simultaneous users) will not work a forfeiture of the copyright?

2. Section 117 of Copyright Act gives the owner (not licensee ) of a copy certain inherent rights (load into the memory of a machine). A sale of a copy of a copyrighted work is a “first sale” which exhausts the copyright owner’s rights to control further sales (though it does not exhaust the rights to control copying).

a. How often would either of these matter? Section 117 rights appear to be only those minimally needed to run a program, and the number of sales lost due to users re-selling their copies must be small (especially compared to outright illicit copying).

D. Why bother? Warranty:

1. As to warranties and limits of liability, everything from toasters to cars are sold with warranties and disclaimers which may become part of the “basis of the bargain”.

2. Battle of the Forms – The Vendor Loses:

a. Where the “buyer” has submitted its own order terms, and does not see the shrink wrap until after delivery, the software vendor’s disclaimer or limitation of warranties will likely fall, as “additional terms” which would “materially alter” the terms of the offer. See Step-Saver Data Systems, Inc. v. Wyse Technology and the Sortware Link, Inc .,993 F.2d 91 (3rd Cir. 1991).

3. Of course, there is always a “Massachusetts Rule”:

a. While Gylptal Inc. v. Engelhard Corp. (reported at 21 M.L.W. 47 (1st Cir. 1992) would seem to support Step-Saver , supra , the seller in Gylptal appears to have delivered its terms after the sale of the goods. Roto-Lith, Ltd. v. F.P. Bartlett & Co.,Inc., 297 F.2d 497 (1st Cir. 1962) holds that material alteration by seller’s terms works a counter-offer , which the buyer then accepts by taking delivery, and Gylptal appears to leave this holding untouched when (as would be the case with a shrink-wrap license) the seller’s terms arrive with the goods.

4. Practice trend: Vendors separate “license” (use) terms and warranty terms, even to extent of putting all warranty terms on a separate card.

a. Doesn’t seem to bear on UCC 2-207 issues, but might help warranty terms survive if “license” found otherwise invalid or unenforceable.

5. Case Law on the Enforceability of Shrink-wrap Agreements

a. In ProCD, Incorporated v. Zeidenberg , 86 F.3d 1447 (7 th Cir. 1996), the district court held that the shrink-wrap agreement was an ineffective attempt to modify the conditions of the sale, when the consumer purchased a CD with the agreement inside the packaging. The Seventh Circuit overturned the lower court, finding that the terms were enforceable unless objectionable on other grounds. Specifically, the court found that the terms inside a box of software bind consumers who use the software after an opportunity to read the terms and reject them by returning the product. In Hill v. Gateway 2000, Inc. ,105 F. 3d 1147 (7th7 Cir.1997), the Seventh Circuit reiterated this position with respect to hardware agreements inside boxes.

b. In Morgan Laboratories, Inc. v. Micro Data Base Systems, Inc. , 41 U.S.P.Q. 2d 1850 (N.D. Cal.1997), the parties to a software license had a “no modification unless in writing” clause in a previous agreement. The court found, in the Motion to Dismiss for Improper Venue, that the earlier agreement precluded any attempt to modify the contract, including possible modification issues presented by the shrink-wrap license.

E. Tax issues.

1. States can argue that “license” means the “licensor” has personal property in the state, subject to personal property tax.

2. Countries take position that local distributor’s payments to foreign vendor for “licenses” are “royalties”, subject to withholding from payments to the vendor.

a. At least one major vendor now casts its shrink wrap as a “Software Agreement”, which specifies how “you” may ” use ” the software: The word “license” is studiously avoided.

X. Digital Signatures.

Digital Signatures may turn out to be a powerful new way to bind online licensing agreements. They provide a secure and reliable means of documenting the transaction, without resorting to paper. Both business and government are making substantial investments into an infrastructure that enables users to create viable contracts online.

A. May be used to prove the existence of both a writing and a signature, as required by the Statute of Frauds, and other statutes.

B. Legislation

1. To date, 29 U.S. states have enacted, proposed or drafted legislation seeking to satisfy signature requirements with “electronic indications of intent.”

2. Germany has passed legislation; legislation is pending elsewhere in Europe and beyond (Malaysia, South America, etc.).

a. 10 U.S. states specify digital signature (also called “asymmetric ” or “public key” encryption) technology. These states, following the Utah model, define the infrastructure within which the technology operates. Specifically, the statutes (as opposed to agency regulations) provide for state approval of certification authorities. The statutes further address the liability of certification authorities, in the event of a dispute, when a contract is signed with a digital signature.

b. The remaining states have taken a technology-neutral approach, as have the United Nations Commission on International Trade Law (“UNCITRAL”) and the drafters of the UCC. See attached copy of the UNCITRAL draft.

C. Public key encryption.
PKE is comprised of three basic functions:

1. First, the message or data being signed is run through a program, which assigns a small number to the larger amount of data in the message.

a. This is called the hash function . Should even one comma in the message be changed, the hash number, or “message digest,” will be different.

b. When the sender and recipient run the same software over the same message, they should get the same message digest. If they do, they have a high degree of certainty that the message itself has not been tampered with in transit, over the network.

2. Second, the sender encrypts the message digest with his or her private key.

a. The rightful holder of the private key has substantial responsibility, under state statutory liability models such as Utah’s, for maintaining the ‘integrity’ or possession of the private key.

(1) Evidence of requisite care implies some activity such as protecting the key with a password, or storing it on a smart-card, or other hardware device.

b. The recipient then opens, or decrypts, the message when received, using a specially matched key called the “public key.”

c. While only one entity has a copy of the private key, the public key can be made available to anyone the sender wishes to communicate securely with.

d. Anyone with the public key can decrypt messages encrypted with the sender’s private key. However, messages encrypted with a public key can only be decrypted using the matching private key.

(1) The entire message may be encrypted as well, for greater privacy, however, this consumes substantial computing resources.

3. The third and last function is the process of certification.

a. Banks, the U.S. Post Office, and others are getting into the business of providing certificates which testify to the identity of a private key holder.

b. These certificates travel with the digitally signed messages under the new email standard, X.509v3.

c. Functioning much like notaries public, certification authorities will likely offer a tiered system of certification. A low-liability certificate, for small transactions, for example, might only require a notarized letter in order for a certificate to be issued. A high security certificate might require the applicant, or “subscriber” to appear in person bearing multiple forms of identification.

D. It is easy to manipulate the apparent origin and return address of an email address. This three-function-system provides ‘ authentication ‘ or some level of assurance as to the identity of the sender, because the sender will have certified his or her identity to the certification authority, which has in turn generated a certificate that travels with the message.

E. When both parties to an agreement obtain the same message digest, or hash, this provides solid evidence, in the event of a dispute, that the terms of a contract were received accurately, i.e. that every character was received as transmitted. This is referred to as the ” non-repudiation ” function, as the parties are prevented from claiming that they did not agree to some part of the agreement after the fact.

F. Ultimately, a secure system like this will enable users to take advantage of the benefits of on-line commerce (speed, reach), without the limits of standard licensing agreements such as click- and shrink-wrap.

XI. New Developments relating to “Scope of Right to Use” Provisions in License Agreements

A. Brief Background:

1. Generally, Scope of Right to Use provisions restrict the manner in which software may be used by licensee, including:

a. type of hardware.

b. class/number of users.

c. place of use.

d. type of use (e.g., internal business purposes versus services for third parties).

e. right to make copies or allow access by third parties.

2. Breach of Scope of Right to Use provisions have been found to constitute copyright infringement, breach of contract and misappropriation of trade secrets.

3. Recent Illustrative Decisions:

a. Licensee of software is not the “owner” of the licensed copy and possesses only the limited rights contained in the license. C.f. Advanced Computer Services of Michigan, Inc. v. MAI Systems Corp. , 845 F.Supp. 356 (E.D. Va. 1994).

(1) The MAI software licenses prohibited the licensees from allowing third parties access to the software. Although the software licensees were not parties to this suit, the court stated that by allowing the plaintiff independent service organizations (ISOs) access to the MAI software, the licensees breached their license. This breach constituted a copyright infringement by the licensees.

(2) The court found that the ISOs’ inducement of the MAI licensees to allow them access to the MAI programs constituted contributory infringement of MAI’s copyrights.

(3) The court also found that the ISO’s had directly infringed MAI’s copyrights by loading the software into RAM at the licensees’ sites. The court stated that “where a copy program is loaded into RAM and maintained there for minutes or longer, the RAM representation of the program is sufficiently “fixed” to constitute a “copy” under the [Copyright] Act.” Id . at 363.

4. If a third party acquires software from a licensee of the software in violation of the licensee’s agreement, the third party may be liable for copyright infringement, even if the third party uses the software in compliance with the original license agreement. See Microsoft Corporation v. Harmony Computers & Electronics, Inc. , 846 F.S.upp.208(E.D. N.Y. 1994).

a. In granting a preliminary injunction to enjoin the distribution of Microsoft products, the court stated that “if the defendants purchased their [Microsoft] Products from Microsoft licensees who were acting outside the scope of their licenses by selling the Products stand-alone, any distribution of the Products by defendants, whether within the scope of [Microsoft’s] license agreement or not, would constitute copyright infringement.”

b. The court also stated that Microsoft’s claim that the defendants’ exceeded the scope of the Microsoft license agreement stated a claim for copyright infringement, not breach of contract, since the defendants were not parties to a license agreement with Microsoft. Id . AT 214.

5. Unauthorized use of computer programs may constitute a misappropriation of trade secrets as well as copyright infringement, and may not be preempted by federal law. See The Gates Rubber Co. v. Bando Chemical Industries, Ltd. , 9 F.3d 823 (10th Cir. 1993).

a. ” Federal law will preempt ‘a state created right if that right may be abridged by an act which, in and of itself, would infringe one of the exclusive rights’ established by federal law.” Id . at 847, citing G.S. Rasmussen & Assoc. v. Kalitta Flying Service, Inc. , 958 F.2d 896, 904 (9th Cir. 1992), cert. denied , 508 U.S. 959(1993).

b. However, if a state law claim requires an extra element not subsumed within a federal claim, the state action will not be preempted. Id . In GatesRubber Co., Inc , proof of a breach of trust or confidence was required to establish a claim for misappropriation of trade secrets under the Colorado Uniform Trade Secret Act. The breach of a duty of trust or confidence distinguished the trade secret cause of action from the copyright infringement claim. Accordingly, such a state law claim arising from the unauthorized used of a computer program would not be preempted by federal copyright law.

XII. “Technolocks”

A. Ultimately, technology may outpace legal efforts to lock up content on the web.

B. See attached article, ” Using Technology to Protect Intellectual Property Rights.

XII. Related Legislation

A. Database

1. EU Directive on Databases. See text of Directive, attached.

a. The Directive of the European Parliament and of the Council of 11 March 1996 on the Legal Protection of Databases (1996 OJ L 77), provides 15 year sui generis protection for electronic and conventional databases.

b. The Directive features a Feist-like originality requirement, whereby databases must “by reason of the selection or arrangement of their contents . . . constitute the author’s own intellectual creation.” This requirement is higher than the existing UK requirements. Id . art. 3(1).

c. Unfair extraction right allows the 15 year term to start again with each update of the database. Id. art. 10(1-3).

(1) Applies to electronic as well as conventional databases. Id. art. 1(1-2).

(2) Member states are required to bring their national laws into conformance by January, 1998. Id . art. 16(1).

d. Recommendation : Carefully document how the database is created, to demonstrate selection, arrangement, and a high level of originality. If you are Pro-CD, it may make sense to license your now copyrightable work in the EU.

2. International. The U.S.-proposed international treaty for the sui generis protection of databases was defeated at the December, 1996 World Intellectual Property Organization (WIPO) Diplomatic Conference. A compromise could take years.

3. National . House Judiciary Chairman Moorehead’s proposed “Database Investment and Intellectual Property Antipiracy Act of 1996” (HR 3531) died in committee last year; reintroduction of similar legislation is widely expected in 1997.

B. UCC Article 2b – Licenses

1. Status. The March 21, 1997 revision to proposed UCC Art. 2b have been put up for comment. [The draft is available electronically in its entirety at http://www.law.uh.edu/ucc2b/]. The next committee meeting is at the end of May; the summer draft will be presented to the Commissioners at the August annual meeting.

2. Effect.
Most notably, the current draft addresses the following issues:

a. Addresses the use of mass-market licenses and standard forms. U.C.C. § 2B-203. Click- and shrink-wrap licenses would be legally binding. U.C.C. § 2B-308(a). Licensors must first have the opportunity to reject the license and obtain a refund. U.C.C. § 2B-112(c); see id. § 2B-114(a, b). The terms may not legally objectionable on other grounds. U.C.C. § 2B-109(a,b).

b. Logic bombs, or self-help remedies which allow a licensor to shut down a program, are acceptable provided they are disclosed up front to the licensee. U.C.C. § 2B-314(a).

c. Implied warranty of information. Requires that a licensor exercise “reasonable care and workmanlike effort” to prevent inaccuracies in information provided. U.C.C. § 2B-404(a).

d. Perfect tender rule. The Art. 2 perfect tender rule allows a buyer to reject the sale if the seller doesn’t meet the exact terms and conditions of the sale. Art. 2B replaces the perfect tender rule with “substantial conformance” between the product and the license. U.C.C. § 2B-601(b).

e. Statute of frauds. 2B allows electronic indications of intent to legally bind parties under certain conditions.

f. Consumer protection. Many are concerned that the balance of consumer protection versus market risk is not quite right yet.

C. Copyright.

1. The World Intellectual Property Organization (“WIPO”) Diplomatic Conference in Geneva has adopted two treaties that attempt to resolve critical copyright and liability issues created by the Internet, namely the WIPO Copyright Treaty and the WIPO Performances and Phonograms Treaty.

2. See attached article, ” World Intellectual Property Organization Adopts Cyberspace Treaties .”

XIV. Copyright Misuse – The Trap for the Unwary:

A. Doctrine was first successfully used as a defense in a software license case in Lasercomb America, Inc. v. Reynolds , 911 F.2d 970 (4th Cir. 1990). Provision in vendor’s standard license agreement prohibiting licensee from developing and selling a product competitive to licensor’s, for up to 1 year after term, held to be copyright misuse, and a valid defense for infringer whose license did not contain the clause.

1. Court based decision on “public policy”; a finding of an anti-trust violation was not required.

2. Subsequent cases have considered the basis to be antitrust violation or having some correlation with antitrust, but independently existing.

B. While the defense has since been raised by infringers on a regular basis, there has been little case law adding clarity to the scope and application of the doctrine in software licensing, with most reported litigation focusing on procedural questions such as motions to strike the defense.

1. To date, outside of Lasercomb , the doctrine has been upheld primarily in cases of egregious conduct not directly tied to license language. ( See , e.g. , qad, inc. v. ALN Assoc. ,781 F.S. upp.561 (N.D. Ill. 1992), finding copyright misuse where party asserted a claim to portions of a program it had in fact copied from a third party). This issue was not addressed on appeal.

2. Third party service providers have raised the defense a number of times, when sued for copyright infringement by the licensor of the software for which they are providing service. See Triad Sys. Corp. v. Southeastern Express Co. , 31 USPQ2d 1239(N.D. Cal. 1994); Advanced Computer Services of Michigan, v. MAI Systems Corp. , 845 F. Supp. 356 (E.D. Va. 1994). The courts have generally been supportive of the licensor’s right to selectively license its software.

3. Recently, however, the Fifth Circuit, in DSC Comm. Corp. v. DGI Technologies, Inc . , 81 F.3d 597 (5 th Cir. 1996), refused to broaden the scope of a narrowly drawn preliminary injunction. In DSC , the defendant was enjoined from downloading DSC’s copyrighted OS software and removing it from the premises of DSC’s licensee, NTS, in accordance with the terms of the DSC/NTS license. However, the court refused to enjoin DGI from downloading the OS in order to test its own microprocessor card for compatibility. The court suggested that DGI may prevail on its copyright misuse theory, because “DSC seems to be attempting to use its copyright to obtain a patent-like monopoly over unpatented microprocessor cards.”

4. The Fourth Circuit, in the ongoing In Re: Independent Service Organizations Antitrust Litigation 910 F.Supp. 137(D. Kan. 1995), and 955 F.Supp. 1317(D.Kan.1997), plaintiffs allege that Xerox Corp.’s high licensing fees for servicing materials were designed to perpetuate monopolistic behavior. The court expressed doubt as to whether “excessive pricing alone constitutes copyright misuse.” 910 F.Supp. at 1543

XV. Developments

A. Income tax considerations in selling information, services and products over the Internet.

1. Federal income tax issues.

a. To what extent can existing income tax principles be applied to electronic commerce?

Tax officials in several countries are currently assessing the extent to which taxing income generated through electronic commerce will require new approaches and concepts. The Treasury Department issued a discussion paper November 21, 1996, in which it identified some of the issues. This paper is available on the Treasury Department’s Web home page, http://www.ustreas.gov. To the extent possible, Treasury intends to tax income from electronic commerce the same as that from traditional commercial channels. Consistent with that objective, recently-issued proposed regulations providing tests for the classification of income from transactions involving computer programs (as royalty or sales income) specifically state that the same rules apply regardless of the physical or electronic medium in which a computer program is transferred. Treasury has indicated, however, that new rules might be required to deal with innovations such as electronic cash transactions, and such administrative issues as auditing electronic transactions, and enforcing information reporting and withholding tax requirements where the parties to transactions are increasingly numerous and unsophisticated.

b. What jurisdictional issues does electronic commerce raise?

Identifying which country or countries have jurisdiction to tax transactions occurring on the Internet is one of the key issues identified by Treasury. A foreign person can conduct extensive business with U.S. customers without having a physical presence in the U.S. and, under current rules, presumably without being subject to U.S. income tax. It is possible, however, that the IRS could take the position that using a computer server located in the U.S. is sufficient to create a U.S. trade or business. Of course, if the foreign business has U.S. employees or agents who conduct marketing or support services, it is likely that there is a U.S. trade or business. If a tax treaty applies, the U.S. will not tax a foreign business unless it has a “permanent establishment” here. Generally, the maintenance of facilities solely for the storage, display or delivery of goods is not sufficient to create a permanent establishment. For this purpose, a computer might be the equivalent of a warehouse in the case of a business that sells information.

B. State income tax jurisdictional issues.

Public Law 86-272 protects a company from income tax in a state if the only business activity within the state is the solicitation of orders for sales of tangible personal property, where the orders are accepted outside the state and are filled by shipment from outside the state. Sales or licenses of intangible property, and the provision of services (including information and other Internet-based services), are not protected under this law.

The South Carolina Supreme Court has held that the physical presence requirement of Quill Corp. , discussed below, applies only to sales and use tax jurisdiction, not income tax jurisdiction. In Geoffrey, Inc. v. South Carolina Tax Commission , 313 S.C. 15,437 S.E.2d 13, cert. denied. 510 U.S. 992 (1993), South Carolina found jurisdiction to tax a corporation whose only income was from the licensing of the “Toys ‘R’ Us” trademark, based on the corporation’s economic presence in South Carolina, and on its licensing of intangibles for use in South Carolina, and its accounts receivable and franchise in that state. Encouraged by the Supreme Court’s refusal to grant certiorari, several other states have indicated that they are considering applying the Geoffrey tests to require income tax filings by corporations having purposeful economic presence and intangible property within the state. These tests could conceivably be used to assert jurisdiction over Internet-based companies which have no physical presence in the taxing state (and which are not protected by Public Law 86-272). Massachusetts announced in Department of Revenue Directive 96-2 that a foreign corporation is subject to corporate excise tax where it purposefully (e.g., under a contract) earns revenue from intangible property that is used in Massachusetts, including under a license or franchise, unless its economic presence in Massachusetts is de minimis. For purposes of applying the protection of Public Law 86-272 to this directive, a license of canned software “transferred on a tangible medium” to be used for a purpose other than commercial reproduction will be treated as the sale of tangible property, not the license of intangible property. Electronically-transmitted software is not included in this express exemption, so there is a risk that licensing electronically-delivered software to Massachusetts customers could subject the seller to Massachusetts corporate excise tax.

C. Sales and Use and VAT tax considerations in selling and distributing canned software and other products over the Internet.

1. Sales and Use Taxes.

a. Is software delivered by telecommunication taxable?

States vary in their treatment of canned software delivered electronically. Some states (including California and Massachusetts) do not impose sales tax on software transmitted electronically. Some states regard software transmitted electronically to be intangible property, even though software delivered on a disk would be taxable. Other states, however, have either found software to be tangible property, and therefore taxable, or have adapted their laws or regulations to specifically cover electronic transmission. For an example of a modern statute, see Section 63-3616(a)(i) of the Idaho Code: “Computer software is deemed to be tangible personal property for purposes of [the sales and use tax] regardless of the method by which title, possession or right to use the software is transferred to the user.” The Idaho Sales and Use Tax Regulations specifically state that there is a taxable sale even though the software is delivered by remote telecommunications directly to or through the purchaser’s computer. Pennsylvania specifically taxes the license of electronically delivered software as the sale of a service.

b. Is electronically delivered software a model for the taxation of other electronically delivered products?

Presumably, it would be difficult for a state that does not tax computer software that is delivered electronically because it is not “tangible property” to distinguish the electronic delivery of music, videos or information. Of course, if a state treats electronically delivered software as tangible property, it probably will similarly treat music, magazines, photos and videos that are downloaded by the customer. States that tax electronic or computer services generally tax on-line information retrieval services, and may regard providing products electronically as a taxable service.

c. When are Internet-related services taxable?

Some states impose a tax on value-added services as part of their telecommunications tax on the transmission of information. Texas, for example, includes email services and Internet (and bulletin board) access as taxable telecommunications services. New York, on the other hand, recently announced that Internet access and certain services, including email and communications or navigation software that is provided as part of the access will not be subject to sales tax. States which tax computer or data processing services may impose tax on such services as creating or maintaining a Web page.

d. Does advertising and selling goods via the Internet give a state sales and use tax jurisdiction over the seller?

Under the tests of Quill Corp. v. North Dakota , 504 U.S. 298 (1992), the Commerce Clause would prevent a state from enforcing its use tax against a corporation whose only nexus with the state is advertising on the Internet and selling products to residents of the state (whether delivery is electronic, as in the case of downloaded software, or physical, as by mail). Some sort of physical presence in the state is required. Use of a computer server located in a state may provide the required physical presence. New York recently announced that it would not assert sales tax jurisdiction solely because an out-of-state company advertises on a New York server or through a New York Internet service provider. Texas, however, does impose sales tax on information services where the computer server is located in Texas.

2. VAT.

Computer software is subject to tax upon import in most countries having a VAT or similar tax on the sale of goods or services. In some countries, the VAT is imposed on the value of the carrier medium (e.g., disc or tape), only. However, the full value of the software may be taxed as a service, where it isn’t taxed as goods.

The tax is usually collected by the customs officials at the same time any tariff is collected. Where a seller or service-provider has no physical presence in a country, and no goods go through customs, the country would ordinarily not be able to enforce a requirement that the seller collect VAT. So, when computer software is sold and transmitted over the Internet from a foreign country to an end user, the sale may escape the VAT.

To avoid tax loss in this situation, the customer may be required to pay the VAT, under what is usually called a “reverse charge” procedure. For example, the U.K. treats software sold and delivered via telecommunications as a service, rather than as goods, causing the reverse charge procedures to come into play. Under these procedures, where the provider of a service is outside the U.K., the customer must pay the VAT. However, this reverse charge procedure only applies to business or VAT-registered customers, so Internet software vendors may have a cost advantage when selling to end users for personal, not business use.

An approach used by some countries is to require customers to withhold VAT on payments to out-of-country service providers. Germany and the Russian Federation, for example, require such withholding in certain cases. When selling to customers who are required to withhold VAT, a vendor may want to gross up the sales price or separately invoice the tax.

The sale and electronic delivery of music, photographs, magazines, and videos over the Internet would presumably be treated the same as the sale and electronic delivery of software in those countries that impose a VAT on the sale of those items.

XVI. Employment Agreements.

A. Former Soviet Union and other “second world” countries continue to develop as a source of low-cost, highly-qualified programmers ( see supra re transfer of software among time zones).

B. Issues continue to develop of: which country’s law governs ownership of developments (employer or employee?); “off-hours” development.