We see it all the time. Parties are deep into increasingly tense negotiations as to access to or use of intellectual property or customer lists that seem to go on for months, sometimes years and then the negotiations break down. A year later, the party who was seeking to license the property suddenly is in the market with a similar, if not identical, product and the outraged owner leaps into court.

Which is great for us attorneys, of course, and quite often a sizable verdict is achieved which seems to vindicate the wrath of the owner of the intellectual property and make the litigation worthwhile. Sometimes it is.

But a business like unemotional review of the economics can often demonstrate that, vengeance and ego aside, more money would have been made by a more realistic approach to the licensing in the first place. In short, better business sense may have avoided the fight to the economic benefit of all.

It’s a hard call…and the time to make the call is in the midst of the negotiation where it is hard to know when to hold firm and when to give way a bit. But, as seen below, even the “winning cases” for the plaintiff are not necessarily wins.


A Win or a Loss?

In contrast to litigation, the expense of licensing is relatively minor. This is not to say that it is free. Proper negotiating of license agreements requires a substantial investment of both executive and attorney time. It is not unusual that several weeks or even months of executive and attorney time will be devoted to certain licensing transactions. However, this amount pales in comparison to the months, if not years, normally devoted to litigation.

One case that illustrates this is the Stac Electronics v. Microsoft Corp., No. C-93-0413-ER (Bx) (C.D. Ca. Feb 23, 1994). Stac was the creator of data compression software used on personal computers. In 1992, Stac's gross revenues were approximately $40 million. In comparison, Microsoft's revenues for the same period exceeded $4 billion. Stac's program shrinks the size of files to reduce disk space on a personal computer hard disk. Stac's product, "Stacker" was the leading product in the industry in 1991. The process embodied in the product was patented by Stac. In November of that year, Microsoft approached Stac to license the technology for incorporation into Microsoft's operating system. This sounds like a smart move by both parties, but the story does not end here.

The negotiations continued into 1992, with Stac requesting blanket license fees of four million dollars a month. Microsoft only offered one million dollars a month.

The negotiations ultimately broke down. Microsoft then went off on its own to license similar technology from another company, to enhance it internally, and design around the Stac patent. Microsoft ultimately released in 1992 a new version of its operating system that included data compression abilities. Stac was convinced it was infringement.

In January 1993, Stac sued Microsoft claiming that the data compression process contained in Microsoft's new operating system infringed Stac's patents. The jury agreed, awarding Stac $120 million. (Microsoft was awarded $6.8 million of compensatory and $6.8 million of punitive damages for Stac's misappropriation of Microsoft's trade secrets.)

Stac announced that it spent more than $7 million in this litigation, which only lasted 13 months. It can be assumed that Microsoft, due to its sheer size, spent at least that much, if not more.

This legal action has been heralded as a victory for the little guy over the corporate giant as well as the power, value and appropriateness of patents for software as enforced in our legal system. All this is true.

However, this case actually seems to demonstrate that negotiations of a license should have continued. It must be noted that the $120 million award does not conform to the damages theories presented at trial. Nonetheless, it is not that far off from the numbers being negotiated by the parties prior to litigation. For example, $4 million (as requested by Stac in negotiations) times 24 months (from February 1992 to February 1994) equals $96 million. $120 million minus $14 million equals $106. Stac and Microsoft settled their dispute in 1994 with Microsoft making a $40 million investment in Stac and Stac licensing its software and patents to Microsoft for use in its MS-DOS operating system.

Another interesting note is that much of the litigation regarding scope of use involves Computer Associates International, Inc. CA is the largest mainframe software vendor in the world (IBM is larger but also sells hardware). Strangely, no CA case against a licensee has ever reached a verdict. Apparently, the negotiations between CA and a licensee regarding changed or expanded scope of use break down, litigation ensues, then, sometime later, cooler heads prevail, and a new license arrangement is negotiated and closed. (Caldwell, Bruce, "Software Disputes - - GTE joins the list of licensees in legal tussles with CA", InformationWeek, April 19, 1994, p. 19.) Although the terms of each deal are confidential, the settlement announcements usually indicate the execution of a new or revised scope of use license coupled with an undisclosed fee. The moral of these stories is that neither party appears to recognize the uncertainty of judicial determination of their alleged infringement/licensing dispute. The license agreement acknowledges certain intellectual property rights, but allows business judgment to mete out the result.

Two software cases involving fair use determinations also involved efforts by the alleged infringer to license the works. In Sega Enterprises Ltd v. Accolade, Inc., 977 F.2d 1510 (9th Cir. 1992), an independent game developer, Accolade, sought to create video games for the Sega home video game system. Accolade explored the possibility of entering into a licensing agreement with Sega, but abandoned the effort because the license agreement would have required that Sega be the exclusive manufacturer of all games produced by Accolade. Id. at 1514. Due to that excessive restriction, Accolade "reverse engineered" Sega's video game program to discover the requirements to make games that would work on Sega's video game machine. The new software written by Accolade only embodied the ideas of Sega's software, not the expressions. Even though the reverse engineering effort required intermediate copying of Sega's copyrighted works, the Ninth Circuit found that such copying was fair use. Had Sega not had such a restrictive license, it might have had the benefit of revenues from Accolade.

In Atari Games Corp v. Nintendo of America, Inc., 975 F. 2d 832 (Fed. Cir. 1992), Atari...wished to make games for the Nintendo video game system. Atari became a licensee of Nintendo's software to allow Atari to make games that were compatible with the Nintendo system. The license terms strictly controlled Atari's access to Nintendo's software by only giving Atari the Nintendo software after it was physically placed in chips that Atari had difficulty in analyzing. Moreover, the license restricted Atari to five new games a year, and restricted licensing Atari's games on competitive video game systems for two years after sale of Atari's Nintendo gave version. Due to these restrictions Atari reverse engineered Nintendo's software to reveal the code necessary to make Nintendo compatible games. The Federal Circuit also found that intermediate copying of a program as part of a reverse engineering effort to reveal the "ideas" contained in Nintendo's video game machine was appropriate. However, unlike Accolade, after reverse engineering, Atari produced its own software that was substantially similar to Nintendo's. The court found that the substantial similarity was a copyright infringement.

Notwithstanding the consistency in the findings of fair use, this decision again represents, albeit to a lesser extent, that a licensing opportunity, as an alternative to litigating, was lost.


Licensing As a Realistic Alternative

The computer industry is the epitome of a dynamic industry. Technology will change; software use will change and the intellectual property law regarding software will change. A lesson can be learned from the litigation in both the computer and the entertainment industry: Recognize the unpredictability of litigation and factor it into decisions to license.

However, simple licensing is not the complete answer. The drafting of software licenses will always present a challenge. The vendor must balance the pressure to accommodate a licensee/user by providing broad grants with the desire to maintain the vendor's future revenue streams through restrictions on use. Users must acquire software to perform the requested functions, yet have flexibility to adapt the use to changes in corporate structure, meet competition and take advantages of new technology. The user must also not receive an excessive windfall due to the mere change in operation or improved hardware technology.

The license must accommodate both parties' needs. The license represents a static transaction, yet must reflect the dynamic in use.

For other types of licenses, the same criteria would apply though the extremely short shelf life of the product may alter the balance of issues. The international nature of software development and ease of transfer also makes software license agreements perhaps the most volatile and dangerous area of licensing.

But all products and concepts licensed face the same underlying cost benefit analysis and reason may require taking less on the fees and avoiding the danger and expense of prolonged litigation. The pen of the drafter may not be mightier than the sword of the litigator, but its results can be more predictable.