Lasercomb Amer., Inc. v. Reynolds
United States Court of Appeals for the Fourth Circuit
911 F.2d 970 (4th Cir. 1990)

Sprouse, Circuit Judge.

Appellants Larry Holliday and Job Reynolds appeal from a district court judgment holding them liable to appellee Lasercomb America, Inc., for copyright infringement and for fraud, based on appellants’ unauthorized copying and marketing of appellee's software. We affirm in part, reverse in part, and remand for recomputation of damages.

I. Facts and Proceedings Below

Appellants and defendants below are Larry Holliday, president and sole shareholder of Holiday Steel Rule Die Corporation (Holiday Steel), and Job Reynolds, a computer programmer for that company. Appellee is Lasercomb America, Inc. (Lasercomb), the plaintiff below. Holiday Steel and Lasercomb were competitors in the manufacture of steel rule dies that are used to cut and score paper and cardboard for folding into boxes and cartons. Lasercomb developed a software program, Interact, which is the object of the dispute between the parties. Using this program, a designer creates a template of a cardboard cutout on a computer screen and the software directs the mechanized creation of the conforming steel rule die. (This genre of software is called CAD/CAM, which stands for computer-assisted design and computer-assisted manufacture.)

In 1983, before Lasercomb was ready to market its Interact program generally, it licensed four prerelease copies to Holiday Steel which paid $35,000 for the first copy, $17,500 each for the next two copies, and $2,000 for the fourth copy. Lasercomb informed Holiday Steel that it would charge $2,000 for each additional copy Holiday Steel cared to purchase. Apparently ambitious to create for itself an even better deal, Holiday Steel circumvented the protective devices Lasercomb had provided with the software and made three unauthorized copies of Interact which it used on its computer systems. Perhaps buoyed by its success in copying, Holiday Steel then created a software program called PDS-1000, which was almost entirely a direct copy of Interact, and marketed it as its own cad/cam die-making software. These infringing activities were accomplished by Job Reynolds at the direction of Larry Holliday.

There is no question that defendants engaged in unauthorized copying, and the purposefulness of their unlawful action is manifest from their deceptive practices. For example, Lasercomb had asked Holiday Steel to use devices called chronoguards to prevent unauthorized access to Interact. Although defendants had deduced how to circumvent the chronoguards and had removed them from their computers, they represented to Lasercomb that the chronoguards were in use. Another example of subterfuge is Reynolds’ attempt to modify the PDS-1000 program output so it would present a different appearance than the output from Interact.

When Lasercomb discovered Holiday Steel's activities, it registered its copyright in Interact and filed this action against Holiday Steel, Holliday, and Reynolds. Lasercomb claimed copyright infringement, breach of contract, misappropriation of trade secret, false designation of origin, unfair competition, and fraud. Defendants filed a number of counterclaims. The district court entered a preliminary injunction, enjoining defendants from marketing the PDS-1000 software.

The procedural history of this case is complex, with various claims and defenses experiencing both death and resurrection on various pretrial motions and at the bench trial itself. For purposes of this appeal it suffices to say that, ultimately, all of the counterclaims were dismissed; Lasercomb's claims of misappropriation of trade secret, false designation of origin, and unfair competition were dismissed as preempted by the Copyright Act; the court found the defendants liable to Lasercomb for copyright infringement, rejecting their affirmative defenses of misuse of copyright and lack of statutory copyright notice; and the court held for Lasercomb on its claims of breach of contract and fraud.

The district court awarded Lasercomb $105,000 in actual damages for copyright infringement and for fraud, with Holiday Steel, Holliday, and Reynolds jointly and severally liable, plus $10,000 against Holliday and $5,000 against Reynolds as punitive damages on the fraud claim. All defendants were permanently enjoined from publishing and marketing the PDS-1000 software.

Holliday and Reynolds raise several issues on appeal. They do not dispute that they copied Interact, but they contend that Lasercomb is barred from recovery for infringement by its concomitant culpability. They assert that, assuming Lasercomb had a perfected copyright, it impermissibly abused it. This assertion of the misuse of copyright defense is based on language in Lasercomb's standard licensing agreement, restricting licensees from creating any of their own cad/cam die-making software. Appellants also argue that the district court's finding of fraud was erroneously based on facts not alleged in the complaint. Finally, they contend that, even if they are liable, the district court erred in the calculation of damages. We consider these issues seriatim.

II. Misuse of Copyright Defense

A successful defense of misuse of copyright bars a culpable plaintiff from prevailing on an action for infringement of the misused copyright. Here, appellants claim Lasercomb has misused its copyright by including in its standard licensing agreement clauses which prevent the licensee from participating in any manner in the creation of computer-assisted die-making software. The offending paragraphs read:

D. Licensee agrees during the term of this Agreement that it will not permit or suffer its directors, officers and employees, directly or indirectly, to write, develop, produce or sell computer assisted die making software. E. Licensee agrees during the term of this Agreement and for one (1) year after the termination of this Agreement, that it will not write, develop, produce or sell or assist others in the writing, developing, producing or selling computer assisted die making software, directly or indirectly without Lasercomb's prior written consent. Any such activity undertaken without Lasercomb's written consent shall nullify any warranties or agreements of Lasercomb set forth herein.

The term of this Agreement referred to in these clauses is 99 years.

Defendants were not themselves bound by the standard licensing agreement. Lasercomb had sent the agreement to Holiday Steel with a request that it be signed and returned. Larry Holliday, however, decided not to sign the document, and Lasercomb apparently overlooked the fact that the document had not been returned. Although defendants were not party to the restrictions of which they complain, they proved at trial that at least one Interact licensee had entered into the standard agreement, including the anticompetitive language.

The district court rejected the copyright misuse defense for three reasons. First, it noted that defendants had not explicitly agreed to the contract clauses alleged to constitute copyright misuse. Second, it found such a clause is reasonable in light of the delicate and sensitive area of computer software. And, third, it questioned whether such a defense exists. We consider the district court's reasoning in reverse order.

A. Does a Misuse of Copyright Defense Exist?

We agree with the district court that much uncertainty engulfs the misuse of copyright defense. We are persuaded, however, that a misuse of copyright defense is inherent in the law of copyright just as a misuse of patent defense is inherent in patent law.

The misuse of a patent is a potential defense to suit for its infringement, and both the existence and parameters of that body of law are well established. Although there is little case law on the subject, courts from time to time have intimated that the similarity of rationales underlying the law of patents and the law of copyrights argues for a defense to an infringement of copyright based on misuse of the copyright. The origins of patent and copyright law in England, the treatment of these two aspects of intellectual property by the framers of our Constitution, and the later statutory and judicial development of patent and copyright law in this country persuade us that parallel public policies underlie the protection of both types of intellectual property rights. We think these parallel policies call for application of the misuse defense to copyright as well as patent law.

1. Overview

Because of the paucity of precedent in the copyright misuse area, some historical perspective of the elements underlying intellectual property law is helpful to our inquiry. Fortunately, respected treatise authors have captured well the essence of the relevant historical perspective.

During the 16th century, it became common for the English Crown to grant letters patent which gave individuals exclusive rights to produce, import and/or sell given items within the kingdom. These monopolies were granted for such commonplace items as salt, vinegar, and calfskins, to name but a few. The practice of granting monopolies led to widespread abuses, such as shortages and inflated prices for items that would otherwise be easily and cheaply available. Consequently, Parliament passed the Statute of Monopolies, 21 Jac,, ch. 3, § 6 (1623-24), prohibiting the creation of such monopolies by the Crown. An exception was made, however, to permit a patent to be granted for a period of fourteen years to the creator of a new invention.

The rationale for allowing patents for new inventions was and is to encourage their creation for the benefit of society. The monopolies granted by the Crown had been odious because they restrained trade in articles that had previously been a part of the public domain. An invention, however, does not withdraw anything from public traffic; rather, it introduces something new. To encourage and reward inventors for increasing the inventory of useful objects, the government grants them, for a limited time, the right to exclude others from making and selling their inventions.

The development of copyright law in England likewise grew out of a differentiation by Parliament between a monopoly that restricts publication of works and a limited copyright that encourages the efforts of authors. In 16th century England, the Crown granted to the Stationers’ Company the exclusive right to publish and print all published works (apparently to enable censorship of Protestant materials). In the early 1700s, the Stationer's Company petitioned Parliament to recognize that these rights inured to it in perpetuity. Instead, Parliament passed the Statute of Anne, 8 Anne, ch. 19 (1709-10), the first known copyright legislation. That statute gave authors the sole right of publication for up to 28 years. Thus, the English statutory treatment of copyright was similar to that of patent in that it granted the creator a monopoly for a limited time only.

It is significant, we think, that the framers of our Constitution continued the English development of intellectual property law and considered in tandem those property rights protectable by copyrights and those protectable by patents. In giving Congress the power to create copyright and patent laws, the framers combined the two concepts in one clause, stating a unitary purpose, to promote progress. This clause was adopted without debate, and material explaining the intention of the framers is limited. However, a comment in The Federalist No. 43, indicates the public policy behind the grant of copyright and patent powers is essentially the same:

The utility of this power will scarcely be questioned. The copyright of authors has been solemnly adjudged, in Great Britain, to be a right of common law. The right to useful inventions seems with equal reason to belong to the inventors. The public good fully coincides in both cases with the claims of individuals.

Supreme Court comment has likewise equated the public policies of copyright and patent. For example, in Mazer v. Stein, 347 U.S. 201, 219 (1953), the Supreme Court stated:

The economic philosophy behind the clause empowering Congress to grant patents and copyrights is the conviction that encouragement of individual effort by personal gain is the best way to advance public welfare through the talents of authors and inventors in Science and useful Arts. Sacrificial days devoted to such creative activities deserve rewards commensurate with the services rendered.

The philosophy behind copyright, parallel to that discussed above for patent, is that the public benefits from the efforts of authors to introduce new ideas and knowledge into the public domain. To encourage such efforts, society grants authors exclusive rights in their works for a limited time.

2. The Misuse of Patent Defense

Although a patent misuse defense was recognized by the courts as early as 1917, most commentators point to Morton Salt Co. v. G. S. Suppiger, 314 U.S. 488 (1942), as the foundational patent misuse case. In that case, the plaintiff Morton Salt brought suit on the basis that the defendant had infringed Morton's patent in a salt-depositing machine. The salt tablets were not themselves a patented item, but Morton's patent license required that licensees use only salt tablets produced by Morton. Morton was thereby using its patent to restrain competition in the sale of an item which was not within the scope of the patent's privilege. The Supreme Court held that, as a court of equity, it would not aid Morton in protecting its patent when Morton was using that patent in a manner contrary to public policy. The Court stated:

The grant to the inventor of the special privilege of a patent monopoly carries out a public policy adopted by the Constitution and laws of the United States, “to promote the Progress of Science and useful Arts, by securing for limited Times to Inventors the exclusive Right” to their new and useful inventions. But the public policy which includes inventions within the granted monopoly excludes from it all that is not embraced in the invention. It equally forbids the use of the patent to secure an exclusive right or limited monopoly not granted by the Patent Office and which it is contrary to public policy to grant.

Thus, the Supreme Court endorsed misuse of patent as an equitable defense to a suit for infringement of that patent.

Since Morton Salt, the courts have recognized patent misuse as a valid defense and have applied it in a number of cases in which patent owners have attempted to use their patents for price fixing, tie-ins, territorial restrictions, and so forth. The patent misuse defense also has been acknowledged by Congress in the 1988 Patent Misuse Reform Act, 35 U.S.C. § 271(d), which limited but did not eliminate the defense.

3. The Misuse of Copyright Defense

Although the patent misuse defense has been generally recognized since Morton Salt, it has been much less certain whether an analogous copyright misuse defense exists. This uncertainty persists because no United States Supreme Court decision has firmly established a copyright misuse defense in a manner analogous to the establishment of the patent misuse defense by Morton Salt. The few courts considering the issue have split on whether the defense should be recognized, and we have discovered only one case which has actually applied copyright misuse to bar an action for infringement. M. Witmark & Sons v. Jensen, 80 F. Supp. 843 (D. Minn. 1948), appeal dismissed, 177 F.2d 515 (8th Cir. 1949).

We are of the view, however, that since copyright and patent law serve parallel public interests, a misuse defense should apply to infringement actions brought to vindicate either right. As discussed above, the similarity of the policies underlying patent and copyright is great and historically has been consistently recognized. Both patent law and copyright law seek to increase the store of human knowledge and arts by rewarding inventors and authors with the exclusive rights to their works for a limited time. At the same time, the granted monopoly power does not extend to property not covered by the patent or copyright. Morton Salt; cf. Baker v. Selden.

Thus, we are persuaded that the rationale of Morton Salt in establishing the misuse defense applies to copyrights. In the passage from Morton Salt quoted above, the phraseology adapts easily to a copyright context, which we paraphrase here:

The grant to the author of the special privilege of a copyright carries out a public policy adopted by the Constitution and laws of the United States, “to promote the Progress of Science and useful Arts, by securing for limited Times to Authors the exclusive Right” to their original works. But the public policy which includes original works within the granted monopoly excludes from it all that is not embraced in the original expression. It equally forbids the use of the copyright to secure an exclusive right or limited monopoly not granted by the Copyright Office and which it is contrary to public policy to grant.

Having determined that misuse of copyright is a valid defense, analogous to the misuse of patent defense, our next task is to determine whether the defense should have been applied by the district court to bar Lasercomb's infringement action against the defendants in this case.

B. The District Court's Finding that the Anticompetitive Clauses Are Reasonable

In declining to recognize a misuse of copyright defense, the district court found reasonable Lasercomb's attempt to protect its software copyright by using anticompetitive clauses in their licensing agreement. In briefly expressing its reasoning, the court referred to the delicate and sensitive nature of software. It also observed that Lasercomb's president had testified that the noncompete language was negotiable.

If, as it appears, the district court analogized from the rule of reason concept of antitrust law, we think its reliance on that principle was misplaced. Such reliance is, however, understandable. Both the presentation by appellants and the literature tend to intermingle antitrust and misuse defenses.* A patent or copyright is often regarded as a limited monopoly, an exception to the general public policy against restraints of trade. Since antitrust law is the statutory embodiment of that public policy, there is an understandable association of antitrust law with the misuse defense. Certainly, an entity which uses its patent as the means of violating antitrust law is subject to a misuse of patent defense.

*     In the context of copyright, this confusion probably arises at least in part from Broadcast Music, Inc. v. CBS, 441 U.S. 1 (1979). In that case, CBS brought an antitrust suit and also asked for a declaratory judgment that defendant's action constituted misuse of copyright. The Second Circuit first addressed whether there was an antitrust violation, and finding there was, it held that the challenged conduct constituted misuse of copyrights solely on the basis of its finding of unlawful price fixing. The Supreme Court reversed the finding of a Sherman Act antitrust violation, on the basis that the court of appeals had used the wrong standard to evaluate the price fixing, stating: “We reverse that judgment, and the copyright misuse judgment dependent upon it.” Standing alone, this latter sentence seems to imply that copyright misuse depends on a finding of an antitrust violation. In context, however, it is apparent that misuse was linked to antitrust in that case simply as a matter of litigation strategy. Copyright misuse was not asserted as a defense to an infringement suit, and the primary claim was an antitrust claim.

However, Morton Salt held that it is not necessary to prove an antitrust violation in order to successfully assert patent misuse:

It is unnecessary to decide whether respondent has violated the Clayton Act, for we conclude that in any event the maintenance of the present suit to restrain petitioner's manufacture or sale of the alleged infringing machines is contrary to public policy and that the district court rightly dismissed the complaint for want of equity.

So while it is true that the attempted use of a copyright to violate antitrust law probably would give rise to a misuse of copyright defense, the converse is not necessarily true—a misuse need not be a violation of antitrust law in order to comprise an equitable defense to an infringement action. The question is not whether the copyright is being used in a manner violative of antitrust law (such as whether the licensing agreement is reasonable), but whether the copyright is being used in a manner violative of the public policy embodied in the grant of a copyright.

Lasercomb undoubtedly has the right to protect against copying of the Interact code. Its standard licensing agreement, however, goes much further and essentially attempts to suppress any attempt by the licensee to independently implement the idea which Interact expresses. The agreement forbids the licensee to develop or assist in developing any kind of computer-assisted die-making software. If the licensee is a business, it is to prevent all its directors, officers and employees from assisting in any manner to develop computer-assisted die-making software. Although one or another licensee might succeed in negotiating out the noncompete provisions, this does not negate the fact that Lasercomb is attempting to use its copyright in a manner adverse to the public policy embodied in copyright law, and that it has succeeded in doing so with at least one licensee.

The language employed in the Lasercomb agreement is extremely broad. Each time Lasercomb sells its Interact program to a company and obtains that company's agreement to the noncompete language, the company is required to forego utilization of the creative abilities of all its officers, directors and employees in the area of cad/cam die-making software. Of yet greater concern, these creative abilities are withdrawn from the public. The period for which this anticompetitive restraint exists is 99 years, which could be longer than the life of the copyright itself.

We previously have considered the effect of anticompetitive language in a licensing agreement in the context of patent misuse. Compton v. Metal Products, Inc., 453 F.2d 38 (4th Cir. 1971), cert. denied, 406 U.S. 968 (1972). Compton had invented and patented coal auguring equipment. He granted an exclusive license in the patents to Joy Manufacturing, and the license agreement included a provision that Compton would not “engage in any business or activity relating to the manufacture or sale of equipment of the type licensed hereunder” for as long as he was due royalties under the patents. Suit for infringement of the Compton patents was brought against Metal Products, and the district court granted injunctive relief and damages. On appeal we held that relief for the infringement was barred by the misuse defense, stating:

The need of Joy to protect its investment does not outweigh the public's right under our system to expect competition and the benefits which flow therefrom, and the total withdrawal of Compton from the mining machine business everywhere in the world for a period of 20 years unreasonably lessens the competition which the public has a right to expect, and constitutes misuse of the patents.

We think the anticompetitive language in Lasercomb's licensing agreement is at least as egregious as that which led us to bar the infringement action in Compton, and therefore amounts to misuse of its copyright. Again, the analysis necessary to a finding of misuse is similar to but separate from the analysis necessary to a finding of antitrust violation. The misuse arises from Lasercomb's attempt to use its copyright in a particular expression, the Interact software, to control competition in an area outside the copyright, i.e., the idea of computer-assisted die manufacture, regardless of whether such conduct amounts to an antitrust violation.

C. The Effect of Appellants Not Being Party to the Anticompetitive Contract

In its rejection of the copyright misuse defense, the district court emphasized that Holiday Steel was not explicitly party to a licensing agreement containing the offending language. However, again analogizing to patent misuse, the defense of copyright misuse is available even if the defendants themselves have not been injured by the misuse. In Morton Salt, the defendant was not a party to the license requirement that only Morton-produced salt tablets be used with Morton's salt-depositing machine. Nevertheless, suit against defendant for infringement of Morton's patent was barred on public policy grounds. Similarly, in Compton, even though the defendant Metal Products was not a party to the license agreement that restrained competition by Compton, suit against Metal Products was barred because of the public interest in free competition.

Therefore, the fact that appellants here were not parties to one of Lasercomb's standard license agreements is inapposite to their copyright misuse defense. The question is whether Lasercomb is using its copyright in a manner contrary to public policy, which question we have answered in the affirmative. In sum, we find that misuse of copyright is a valid defense, that Lasercomb's anticompetitive clauses in its standard licensing agreement constitute misuse of copyright, and that the defense is available to appellants even though they were not parties to the standard licensing agreement. Holding that Lasercomb should have been barred by the defense of copyright misuse from suing for infringement of its copyright in the Interact program, we reverse the injunction and the award of damages for copyright infringement. (This holding, of course, is not an invalidation of Lasercomb's copyright. Lasercomb is free to bring a suit for infringement once it has purged itself of the misuse.)

Notes

1. The Fourth Circuit cited its Compton decision. See also National Lockwasher Co. v. Garrett Co., 137 F.2d 255 (3d Cir. 1943)(holding it misuse to license lockwasher technology on condition that licensee not utilize competing lockwasher technology not covered by licensor's patent; court characterized conduct as use of “patent monopoly to suppress the manufacture of possible competing goods not covered by its patent”).

The government's antitrust theory in United States v. Microsoft Corp., 56 F.3d 1448 (D.C. Cir. 1995), was that Microsoft monopolized operating system software for X86 personal computers by charging copyright royalties on a per processor basis. This practice allegedly deterred manufacturers from using competing operating system technology, and in effect caused them to refrain from using operating system software of Microsoft's competitors. The alleged effect was to decrease competition in developing operating system software technology.

2. Others have viewed licensing arrangements that discourage development or use of competing technology as more benign. William C. Holmes, Intellectual property and Antitrust Law § 21.03 considers a strict condemnation of such licensing arrangements unwarranted. He argues that they may “generate desirable procompetitive economic benefits,” such as facilitating long–term planning, reducing selling expenses, assurance of supply, protection of purchasers' capital investments, and assuring loyalty in product manufacture or distribution.

The U.S. Dept. of Justice and FTC, Antitrust Guidelines for the Licensing and Acquisition of Intellectual Property (Apr. 6, 1995), reprinted in Trade Reg. Rep. (CCH) ¶ 13,132, § 4.1.1 state that the government believes that such arrangements should be analyzed for antitrust illegality on the basis of whether they harm competition by posing “a significant risk of retarding or restricting the development of new or improved goods or processes.” That in turn may depend on the fraction of the market covered by such restrictions, concentration, difficulty of entry, and similar factors. The Guidelines provide a hypothetical case, Example 8, which describes a license from struggling newcomer NewCo to a license with a small market share in a market where entry is easy and substantial economic justifications for exclusive dealing in the new technology exist. Government challenge of the restriction is therefore said to be unlikely.

The Guidelines discuss likelihood of the Antitrust Division or FTC's mounting an antitrust challenge against a licensing arrangement, not whether there is a misuse. Should the same considerations nonetheless apply in a misuse analysis?

3. For a case quite similar to Lasercomb, see Tamburo v, Calvin, 1995 WL 121539 (N.D. Ill. Mar. 17, 1995). Tamburo, owner of software for tracking dog breeding records, sued Calvin for copyright infringement and Calvin asserted a misuse defense. Tamburo's license prohibited its licensee Calvin from developing any competitive software for 10 years, and contained a liquidated damages provision for $1500 per violation. The court considered the license an a fortiori case of a Lasercomb type of misuse.

Triad Systems Corp. v. Southeastern Express Co.
United States Court of Appeals for the Ninth Circuit
64 F.3d 1330 (9th Cir. 1995), cert. denied, 116 S. Ct. 1015 (1996)

Sneed, Circuit Judge:

Southeastern Express Co. (Southeastern) appeals the district court's grant of a preliminary injunction in favor of Triad Systems Corp. (Triad). The injunction followed a finding that Southeastern was infringing on Triad's software copyrights. The terms of the injunction substantially prohibit Southeastern from servicing Triad computer systems. We affirm the grant of the preliminary injunction against Southeastern.

I. Facts and Proceedings Below

Triad manufactures computers for use by automotive parts stores and designs, sells, and licenses unique software to run its computers. The computer systems enable customers in the automotive parts industry to automate their sales, inventory, and accounting tasks. Southeastern is what is known as an independent service organization (ISO) that services Triad computers. Southeastern and Triad thus compete for the business of servicing and maintaining Triad computers. The crux of Triad's complaint is that Southeastern has infringed on its software copyrights and continues to do so by performing maintenance on Triad computer systems for Triad's licensees.

Triad's copyrighted software includes:

(1) operating system software, which is necessary to run any other program on the computer (OS software);

(2) applications software, which performs the basic functions like accounting and invoicing for the Triad customer; and

(3) utilities, diagnostic, and auxiliary software, which is used by technicians to repair Triad software and hardware (service software).

The OS software and the service software are involved in this dispute.

Triad software customers are subject to three different contractual arrangements. From 1976 to 1985, Triad sold its software outright to customers (Regime 1). Because Regime 1 customers own their software, they have rights under 17 U.S.C. § 117 to make or authorize the making of copies in the operation of their computers. As a result, such copies are noninfringing, even if they are made by Southeastern in the course of servicing Regime 1 customers' computers. Triad therefore concedes that Southeastern cannot be barred from making use of software owned by Regime 1 customers.

In 1986, however, Triad began licensing rather than selling its software (Regime 2). Under Regime 2 agreements, customers may not duplicate the software or allow it to be used by third parties. In 1991, Triad added a requirement that licensees selling their computer systems pay Triad a license transfer fee (Regime 3). Thus, Southeastern's performance of service and maintenance on the computer systems of Regime 2 and 3 customers is at issue. At stake is the business of servicing these systems.

In order to service a Triad computer, the Southeastern technician uses the OS software and the service software in the Triad customer's possession. Triad argues that Southeastern has infringed its software copyrights because copies of the software are made in the computer's random access memory (RAM) when the computer is in use.

Triad filed suit against Southeastern in federal district court in 1992. A year later, while discovery was ongoing, this Circuit decided MAI Sys. Corp. v. Peak Computer, Inc., 991 F.2d 511 (9th Cir. 1993), cert. dismissed, 114 S.Ct. 671 (1994). There we held that the loading of MAI's operating system software into RAM makes a copy under the Copyright Act, and that therefore Peak, an ISO, had infringed MAI's copyright by operating its customers' MAI computers in order to service them.

Following the MAI decision, Triad understandably moved for summary judgment on its copyright infringement claim. Southeastern moved for summary judgment on its fair use and copyright misuse defenses. Both motions were denied. The district court ordered that the trial be bifurcated: Phase One would include Triad's copyright infringement claims, damages, and Southeastern's fair use defense; Phase Two would include Southeastern's copyright misuse defense and any remaining counterclaims.

Phase One proceeded before a jury. At the close of the evidence, the district court granted directed verdicts in favor of Triad on Southeastern's fair use defense to infringement of both the OS software and the service software. Then, the jury found that Southeastern had infringed Triad's software copyrights.

Then, the district court granted Triad's motion for a preliminary injunction. This was a long step forward for Triad. In essence, the injunction bars Southeastern from performing service or maintenance on Triad computer systems that contain licensed software. Under the terms of the injunction, the onus is on Southeastern to determine whether a particular customer's software is subject to a Regime 2 or 3 license agreement. Triad, however, is obligated to provide the license agreement upon the customer's written request; if it fails to do so within ten business days, Southeastern may service the customer's computer without violating the injunction.

A panel of this court stayed the injunction pending this appeal. Phase Two of the trial remains in progress, but the district court has granted summary judgment in favor of Triad on Southeastern's copyright misuse claim. Southeastern timely appeals the preliminary injunction. This court has jurisdiction pursuant to 28 U.S.C. § 1292(a)(1).

II. Discussion

A. Preliminary Injunction

Southeastern, attacking the preliminary injunction, argues that Triad cannot show the possibility of irreparable injury. It also argues that Triad cannot show the likelihood of success on the merits because of Southeastern's meritorious affirmative defenses.

A district court's order granting preliminary injunctive relief is subject to limited review: It will be reversed only where the district court abused its discretion or based its decision on an erroneous legal standard or on clearly erroneous findings of fact. To obtain a preliminary injunction in this case, Triad must show a likelihood of success on the merits of its copyright infringement action and the possibility of irreparable injury.

1. Irreparable Injury

Southeastern first argues that Triad cannot show a threat of irreparable injury sufficient to merit injunctive relief. Southeastern, mindful of the economic stakes involved, argues that Triad will suffer only monetary damages from lost revenues, which are not usually considered irreparable harm because of the availability of an adequate legal remedy.

In a copyright infringement action, however, the rules are somewhat different. A showing of a reasonable likelihood of success on the merits raises a presumption of irreparable harm. Thus, Triad need only show a reasonable likelihood of success on its copyright infringement claim to support the district court's grant of the preliminary injunction.

2. Likelihood of Success on the Merits

To make its required showing of copyright infringement, Triad must prove (1) ownership of the copyrights and (2) copying of an expression protected by those copyrights. Triad has shown both. Its ownership of valid copyrights is apparently not in dispute.

Triad, to show that Southeastern made copies of its protected works, relies on the MAI decision. It is clear that Southeastern's activities are copying for purposes of the Copyright Act under MAI. Because Southeastern's service activities involved copying entire programs, there is no doubt that protected elements of the software were copied. Therefore, Triad has shown a likelihood of success as to its prima facie case.

3. Fair Use

Southeastern argues that, despite Triad's carrying its burden, the preliminary injunction was improper because the district court failed to consider adequately its affirmative defenses of fair use and copyright misuse. Because those defenses are clearly meritorious, Southeastern asserts, Triad cannot show that it is likely to succeed on the merits.

We agree with the district court that the doctrine of fair use does not apply given the facts of this case. The doctrine of fair use allows a holder of the privilege to use copyrighted material in a reasonable manner without the consent of the copyright owner. Southeastern relies on the rationale of Sega Enterprises, Ltd. v. Accolade, Inc., 977 F.2d 1510 (9th Cir. 1992), cert. denied, 113 S. Ct. 1582 (1993), to find that its service activities are a fair use of Triad's copyrighted software.

Sega, however, was a very different case. There, the defendant, Accolade, had made copies of Sega's video game programs in the process of reverse-engineering them solely in order to figure out the requirements for compatibility with Sega's Genesis game console. The functional requirements of compatibility were not protected by copyright, and there was no other method available to Accolade to discover those requirements. This court held that the copying at issue was a fair use. We determined (1) that Accolade had made the copies for a legitimate, essentially non-exploitative purpose, that is, determining the compatibility requirements; (2) that the copying resulted in the proliferation of independent, creative expression, by making Accolade game programs compatible with the Sega Genesis system, an outcome the Copyright Act was intended to promote; and (3) that the copying neither adversely affected the market for Sega's own video games, nor pirated those games, but only used the unprotected elements needed to make its own games compatible.

Southeastern's activities are wholly unlike the reverse-engineering in Sega. Southeastern did not make a minimal use of Triad's programs solely to achieve compatibility with Triad's computers for Southeastern's own creative programs. Rather, Southeastern has invented nothing of its own; its use of Triad's software is, in the district court's words, “neither creative nor transformative and does not provide the marketplace with new creative works.” Southeastern is simply commandeering its customers’ software and using it for the very purpose for which, and in precisely the manner in which, it was designed to be used. As a result, the copies made by Southeastern while servicing Triad computers have undoubtedly diminished the value of Triad's copyright. As the district court reasoned: “If ISOs like Southeastern freely used Triad's copyrighted software on a widespread basis to compete with Triad, this would likely cause a significant adverse impact on Triad's licensing and service revenues and lower returns on its copyrighted software investment.” To allow Southeastern to use Triad's software as it wishes would cause Triad to lose licensing revenues from the ISOs, who have a substantial motivation to obtain access to Triad's software. In short, we detect no appreciable public benefit arising from Southeastern's practice to justify this continuance under the fair use doctrine. We therefore agree with the district court's thoughtful analysis and its rejection of Southeastern's fair use claim.

Southeastern also contends that the district court's analysis was flawed because Triad's copyright does not extend to the service market. We disagree. Triad invented, developed, and marketed its software to enable its customers and its own technicians to service Triad computers. Southeastern is getting a free ride when it uses that software to perform precisely the same service. Triad is entitled to licensing fees from Southeastern and other ISOs that make use of Triad's software in servicing Triad computers. Furthermore, a finding of fair use is unwarranted because the other relevant factors weigh against such a finding. Not only is Southeastern's use of Triad's software entirely commercial in nature, but also both the OS and the service software are protected expression, and Southeastern is copying programs in their entirety.

4. Copyright Misuse

Not surprisingly, we also conclude that Southeastern cannot show that it is likely to prevail on its asserted copyright misuse defense. The district court properly granted summary judgment on this claim in favor of Triad. It found that, unlike the case of Lasercomb America, Inc. v. Reynolds, 911 F.2d 970, 978-79 (4th Cir. 1990), Triad did not attempt to prohibit Southeastern or any other ISO from developing its own service software to compete with Triad. We agree.

[Affirmed as to the foregoing issues.]

Notes

1. Triad's copyrighted software involved in this dispute was: (1) operating system software, which is necessary to run any other program on the computer (OS software); and (2) utilities, diagnostic, and auxiliary software, which technicians use to repair Triad software and hardware (service software). The court did not differentiate in its analysis between the OS software and the service software. Should it have, and if so, why?

2. Consider the court's distinction of Sega. Is it valid, in general? As valid for the OS software as for the service software?

The court states:

To allow Southeastern to use Triad's software as it wishes would cause Triad to lose licensing revenues from the ISOs, who have a substantial motivation to obtain access to Triad's software. In short, we detect no appreciable public benefit arising from Southeastern's practice to justify this continuance under the fair use doctrine.

Comment on this view of the social utility of ISOs. What arguments would you make as counsel for ISOs to show public benefits from their activities and to justify their existence?

3. The court also stated:

Southeastern also contends that the district court's analysis was flawed because Triad's copyright does not extend to the service market. We disagree. Triad invented, developed, and marketed its software to enable its customers and its own technicians to service Triad computers. Southeastern is getting a free ride when it uses that software to perform precisely the same service. Triad is entitled to licensing fees from Southeastern and other ISOs that make use of Triad's software in servicing Triad computers.

Compare this concept of ISOs as free riders with that of Eastman Kodak, below. Do the stated premises of the Triad court's analysis apply to the OS software? Explain how Triad's copyright extends to the service market.

4. What was different in the substance of the Regime 1 and 2 contracts? What changes in Triad's conduct in relation to customers occurred when Regime 2 replaced Regime 1?

As counsel for an ISO, how would you challenge Triad's nomenclature? See, e.g., Straus v. Victor Talking Machine Co., 243 U.S. 490 (1917), for an old–time approach.

5. Explain the court's reasoning that the doctrine of copyright misuse is inapplicable to Triad's use of copyright.

6. Are there other affirmative defenses that you would assert as counsel for an ISO? Consider implied license, non–derogation from grant. Predict the reception that this court of appeals panel would have given these defenses.

7. How does the ruling here apply to free riders in the automobile service industry who attempt to misappropriate the revenues of GM, Ford, and other vendors of computerized ignition, braking, etc. systems, by setting themselves up in the business of repairing such systems for car owners without any authorization from GM, Ford, etc.? What of fly–by–night free riders who want to repair toasters, microwave ovens, and dishwashers operated by means of programmed microprocessors?

a. Advise a client that asks you — How can these pesty swarms of free riders be eliminated in the future?

b. Advise your client, Joe's Pesty Repair Shop, when Joe asks you how to defend against the advice of preceding paragraph a.

DSC Communications Corp. v. DGI Technologies, Inc.
United States Court of Appeals
81 F.3d 597 (5th Cir. 1996)

Garza, Circuit Judge: DSC Communications Corp. (DSC) obtained a preliminary injunction enjoining DGI Technologies, Inc. (DGI) from making removable copies of DSC's copyrighted software. DSC appeals from the granting of this preliminary injunction, arguing that it is too narrowly drawn. Because we hold that the district court did not abuse its discretion in crafting the injunction, we affirm.

Facts

DSC manufactures telephone switching systems (phone switches). DGI manufactures various devices, including microprocessor cards, that are used in DSC phone switches. DSC sued DGI for unfair competition on various grounds, including copyright infringement. DSC obtained a preliminary injunction in that suit, which prohibits DGI from making copies of DSC's copyrighted operating system software that can be removed from DSC's customer's premises. The injunction, however, does not prohibit DGI from making copies of DSC's copyrighted software that cannot be removed from DSC's customer's premises. DSC's appeals from the preliminary injunction, arguing that DGI should also be enjoined from making copies that cannot be removed from DSC's customer's premises.

A phone switch routes long distance telephone calls to their destinations. It consists of three principal components: (1) the switch matrix, which actually routes the telephone calls; (2) the trunk/line interface system, which converts long distance telephone signals into a form and sequence that can be handled by the switch matrix; and (3) a mass storage frame, which contains the software that operates the entire switching system.

Long distance signals must be in digital form and properly sequenced before they can be routed through the switch matrix. The trunk/line interface system converts the data arriving from the long distance telephone line into proper digital form and sequence. The trunk/line interface system is controlled by DSC's copyrighted software when it converts these signals. Once these signals have been “switched”—i.e., routed to their destination—the trunk/line system converts them back into a form in which they can be transmitted through the phone lines to their destination.

The trunk/line interface system is housed in metal cabinets called frames. These frames contain a number of shelves. The front of the shelves is open, and at the back of the shelves is a backpane. Cables carrying incoming telephone signals from the telephone line and outgoing signals to the switch matrix and the telephone lines are attached to the backpane. Groups of printed circuit boards called cards are inserted into the shelves of the frames from the front and connect to the backpane. These cards contain the components that translate the data from the telephone line into a format that can be used by the switch matrix and vice versa.

The principal cards in the frames are microprocessor cards. The microprocessor cards contain firmware, which is software embedded in a memory chip on the card. When a microprocessor card is inserted into the frame, it must boot up. That is, it must download DSC's copyrighted operating system software into its random access memory (RAM). The booting up process is similar to that used in personal computers, which also boot up by downloading operating system software from a floppy disk or hard disk when the computer is turned on or reset. A microprocessor card must download DSC's copyrighted operating system software when it is used in the phone switch.

DSC manufactures the entire phone switch system, and has a copyright on the software used in the phone switch. DSC sells phone switches, but does not sell the software necessary to operate them. Instead, it licenses the software to its customers. One of the customers to whom DSC sold a phone switch and licensed its software is NTS Communications Corp. (NTS). The licensing agreement between DSC and NTS prohibits NTS from copying the software, and only allows NTS to use the software in conjunction with the phone switch purchased from DSC.

DGI is attempting to develop a microprocessor card that can be used in DSC phone switches. Customers would use this card instead of using a DSC-manufactured card. DSC contends that DGI engaged in several acts of copyright infringement in its attempt to develop a microprocessor card. The alleged infringement at issue in this appeal is DGI's copying of DSC's copyrighted operating system software.

Because DSC did not sell its operating system software on the open market, the only way to gain access to the software was to license it from DSC. DGI needed to gain access to DSC's operating system software in order to develop a microprocessor card, because the microprocessor card had to be able to download the software into RAM, and had to be compatible with the software. To obtain access to the operating system software, DGI obtained access to a DSC phone switch owned by NTS. NTS gave DGI permission to use its phone switch to test microprocessor cards. In return for this permission, DGI gave NTS a 10% discount on purchases of DGI cards, shelves and frames. DGI did more than merely test its cards, however. Without NTS's knowledge, it made copies of DSC's copyrighted software, and removed these copies from NTS's premises.

DGI used two methods to copy DSC's copyrighted software. First, it downloaded DSC's operating system into the memory of a DSC microprocessor card, out through a port on that card, and into a laptop computer. Second, DGI modified a DSC microprocessor card by adding chips designed to capture the communications between the card and another microprocessor card from which the operating system software would be obtained and a chip designed to hold and retain information on the downloading function when the microprocessor card was removed. DGI copied DSC's copyrighted operating system software using this modified microprocessor card.

DSC and DGI were already involved in litigation at the time that DGI was copying DSC's operating system software. DSC sued DGI for allegedly misappropriating its trade secrets to develop microprocessor cards for use is DSC's phone switch and for violating the Lanham Act in selling its cards. DGI countersued, alleging that DSC violated antitrust laws, misappropriated DGI's trade secrets, engaged in unfair competition and committed tortious interference with DGI's business relationships. When DSC learned that DGI was copying its operating system software, it amended its complaint to allege copyright infringement, and moved for a preliminary injunction to prevent DGI from continuing to copy, and benefitting from copying, the operating system software.

The district court granted a preliminary injunction, prohibiting DGI from making any copies of DSC's operating system software that could be removed from NTS's premises. However, the injunction did not prohibit DGI from “downloading into dynamic RAM on a microprocessor or test microprocessor card which is incidental to the testing or operating of a compatible [microprocessor] card so long as the copy is not capable of being removed from the customer location and transported to any other location.” In other words, DGI could not continue to make copies of the operating system to take back to its lab and study, but it could test its microprocessor card on NTS's phone switch, even though DSC's operating system software would be downloaded into the microprocessor card's RAM.

Discussion

In order to obtain a preliminary injunction, DSC was required to demonstrate: (1) a substantial likelihood of success on the merits; (2) a substantial threat of irreparable injury if the injunction is not issued; (3) that the threatened injury to DSC outweighs any damage the injunction might cause to DGI; and (4) that the injunction will not disserve the public interest. Because we hold that the district court did not abuse its discretion in implicitly finding that DSC did not have a substantial likelihood of success on the merits in respect of non–removable copies of the operating system software, we affirm the injunction.

DSC claims that it has a substantial likelihood of prevailing on its claim that DGI infringes upon its copyright every time DGI boots up one of its microprocessor cards on a DSC phone switch. When a DGI microprocessor card boots up, DSC's copyrighted operating system software is downloaded into the card's RAM. DSC contends that this downloading constitutes making a copy under copyright law. Therefore, DSC argues, booting up a DGI microprocessor card infringes upon DSC's copyright by making an unauthorized copy of DSC's copyrighted operating system software.

To prevail on its claim of copyright infringement, DSC will have to prove: (1) that it owned a copyright on the operating system software; and (2) that DGI impermissibly copied or otherwise infringed upon that copyright. Further, it will have to overcome DGI's affirmative defenses, including the defense of copyright misuse.

The parties agree that DSC owns a copyright on the operating system software. However, they disagree on whether booting up a DGI microprocessor card constitutes impermissible copying. DSC argues that an impermissible copy is made every time software is loaded onto a computer's RAM. See MAI. Because the licensing agreement between DSC and NTS only allows the software to be booted up on DSC equipment, this copying is not authorized. Therefore, DSC argues, booting up a microprocessor card violates its copyright. DGI does not dispute that a copy is made when the microprocessor cards are booted up. Instead, DGI argues, inter alia, that it is entitled to the defense of copyright misuse.

The district court did not err in implicitly finding that DSC did not have a substantial likelihood of prevailing on the merits because DGI may well prevail on its affirmative defense of copyright misuse. The defense of copyright misuse bars a culpable plaintiff from prevailing on an action for the infringement of the misused copyright. Lasercomb. The defense is a recognition that while copyright law seeks to increase the store of human knowledge and arts by awarding authors with the exclusive rights to their works for a limited time the granted monopoly power does not extend to property not covered by the copyright. Lasercomb.

The copyright misuse defense is analogous to the patent misuse defense. Id. The patent misuse defense was recognized by the Supreme Court in Morton Salt Co. v. G.S. Suppiger, 314 U.S. 488 (1942). In that case, the plaintiff Morton Salt brought suit on the basis that the defendant had infringed upon Morton's patent in a salt-depositing machine. The salt tablets that the machine deposited were not themselves a patented item, but Morton's patent license required that licensees use only salt tablets produced by Morton. Morton was thereby using its patent to restrain competition in the sale of an item that was not within the scope of the patent's privilege. The Supreme Court held that, as a court of equity, it would not aid Morton in protecting its patent when Morton was using that patent in a manner contrary to public policy.

In Lasercomb, the Fourth Circuit extended the rationale behind Morton Salt to copyright misuse. Paraphrasing Morton Salt, the Fourth Circuit stated:

The grant to the author of the special privilege of a copyright carries out a public policy adopted by the Constitution and laws of the United States, “to promote the Progress of Science and useful arts, by securing for limited Times to Authors the exclusive Right” to their original works. But the public policy which includes original works within the granted monopoly excludes from it all that is not embraced in the original expression. It equally forbids the use of the copyright to secure an exclusive right or limited monopoly not granted by the Copyright Office and which is contrary to public policy to grant.

We concur with the Fourth Circuit's characterization of the copyright misuse defense.

DGI may well prevail on the defense of copyright misuse, because DSC seems to be attempting to use its copyright to obtain a patent-like monopoly over unpatented microprocessor cards. Any competing microprocessor card developed for use on DSC phone switches must be compatible with DSC's copyrighted operating system software. In order to ensure that its card is compatible, a competitor such as DGI must test the card on a DSC phone switch. Such a test necessarily involves making a copy of DSC's copyrighted operating system, which copy is downloaded into the card's memory when the card is booted up. If DSC is allowed to prevent such copying, then it can prevent anyone from developing a competing microprocessor card, even though it has not patented the card. The defense of copyright misuse “forbids the use of the copyright to secure an exclusive right or limited monopoly not granted by the Copyright Office,” including a limited monopoly over microprocessor cards. See Lasercomb. Therefore, DGI's asserting the misuse defense could cast substantial doubt on the predictability of success by DSC.

Of course, we do not hold that DGI will successfully avail itself of the copyright misuse defense. After a trial on the merits, the district court may well decide that DSC did not commit copyright misuse, or that DGI cannot avail itself of the defense because it has “unclean hands.” We simply hold that the district court did not abuse its discretion in implicitly holding that DSC did not have a substantial likelihood of success on the merits because — based on the evidence before the district court — DGI may prevail on its misuse to the defense.

Because we hold that the district court did not abuse its discretion in crafting the preliminary injunction, we affirm.

Notes

1. Is it consistent with the rationale of the misuse doctrine to deny the infringer here the right to assert a misuse defense because it has “unclean hands”? Here, DSC wanted to protect the secrecy of its system, and therefore “did not sell its operating system software on the open market.” Hence, “the only way to gain access to the software was to license it from DSC.” Therefore, DGI gave NTS, a DSC licensee, a 10% discount to get NTS to let DGI “test” microprocessor cards that NTS had obtained from DSC.

Assume that DSC sold the cards to NTS subject to a Mallinckrodt–type restriction or one like that in the shrinkwrap license cases, or like that in the MAI case. That is, NTS did not buy the software embedded in the microprocessor cards; DSC merely licensed NTS to use the software subject to restrictions, such as no copying. Thus, the district court says:

DSC...has a copyright on the software used in the phone switch. DSC sells phone switches, but does not sell the software necessary to operate them. Instead, it licenses the software to its customers. ...The licensing agreement between DSC and NTS prohibits NTS from copying the software, and only allows NTS to use the software in conjunction with the phone switch purchased from DSC.

Hence, it may be assumed for purposes of this question that DGI downloaded DSC's operating system software in intentional contravention of the contractual arrangement between DSC and its licensee NTS.

a. Does public policy require that the court ignore or give no legal effect to the DSC–NTS contract, at least insofar as DGI's downloading is concerned? What would Judge Easterbrook (ProCD case) say? Would the Lasercomb court agree? b. What effect on the public interest does it have to treat the DSC–NTS contract as binding DGI not to download the software? To what extent is the sanctity of contracts (Pacta sunt servanda!) a part of public policy or a public interest factor?

c. Suppose that the Fifth Circuit thinks that both DSC and DGI are behaving badly. What does it do? Should there be a principle of comparative naughtiness?

If the Fifth Circuit says, “Unclean! Unclean! We refuse to have anything to do with either of you and your respective arguments!” — does it just reject application of the misuse defense, or does it refuse to take any legal action at all, including refusing to adjudicate the copyright infringement controversy? For a refusal to consider the misuse defense, see Atari Games Corp. v. Nintendo of America, Inc., 975 F.2d 832 (Fed. Cir. 1992).

d. What happens in an antitrust case when both the plaintiff and defendant are naughty persons? See, e.g., Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134 (1968). In General Leaseways, Inc. v. National Truck Leasing Ass'n, 744 F.2d 588, 597 (7th Cir. 1984), the court stated that “whenever some maxim of equity (such as that to get equitable relief you must have clean hands) collides with the objectives of the antitrust laws, the equity maxim must give way.” Is that principle sound? Does it apply here?

e. Is the application of this concept appropriately calibrated in terms of whether legal (damages) or equitable (injunctive) relief is sought? Is an accounting for profits equitable rather than legal in this sense?

2. What is the rationale for the district court in letting DGI test its microprocessor cards on site at NTS but not letting DGI cart the code off to DGI's laboratory for closer study of the code? Why not in for a penny, in for a dollar?

3. Consider the language at the end of the Fifth Circuit's opinion. Is this just a holding of “no abuse of discretion” on the terms of a preliminary injunction? Is there any ruling on the merits of whether the Fifth Circuit takes a different view of the merits of these restrictions than the Triad court did?

4. Should the wideness of distribution of the product or the magnitude of the price make any difference in these cases? Is something you buy off the shelf from a software reatil store different from a product on which the seller and buyer sign actual contracts?

5. The court considers patent–like protection and says:

If DSC is allowed to prevent such copying [downloading operating system software to RAM of microprocessor of card to test card's compatibility], then it can prevent anyone from developing a competing microprocessor card, even though it has not patented the card.

Suppose that the software is patented, àla the PTO's software guidelines. Then what result? Could that be patent misuse, given Roche Prods., Inc. v. Bolar Pharmaceutical Co., 733 F.2d 858 (Fed. Cir.), cert. denied, 469 U.S. 856 (1984)?

Digidyne Corp. v. Data General Corp.
United States Court of Appeals for the Ninth Circuit
734 F.2d 1339 (9th Cir. 1984), cert. denied, 473 U.S. 908 (1985)

Browning, Chief Judge.

The issue presented for review is whether Data General's refusal to license its RDOS operating system software except to purchasers of its NOVA central processing units (CPUs) is an unlawful tying arrangement under § 1 of the Sherman Act, 15 U.S.C. § 1, and § 3 of the Clayton Act, 15 U.S.C. § 14. We conclude that it is.

Background

Defendant Data General manufactures a computer system known as NOVA. The system consists of a NOVA CPU designed to perform a particular “instruction set” or group of tasks, and a copyrighted NOVA operating system called RDOS containing the basic commands for operation of the system. Not all operating systems work with all CPUs. Plaintiffs produce emulator NOVA CPUs designed to perform the NOVA instruction set and thus to make use of defendant's RDOS.

Data General refuses to license its RDOS to anyone who does not also purchase its NOVA CPU. Plaintiffs allege that this constitutes an unlawful tying arrangement; the defendant's RDOS being the tying product, the NOVA instruction set CPU being the tied product.

Plaintiffs filed a number of actions alleging violations of § 1 of the Sherman Act and § 3 of the Clayton Act. The actions were consolidated. The issues of liability and damages were segregated for trial. This appeal is from a judgment on liability.

After extensive discovery, the parties filed cross-motions for summary judgment. The district court denied the motions, but found certain facts to be uncontroverted under FRCP 56(d). Trial, limited to the issue of defendant's economic power, resulted in a jury verdict for plaintiffs. Defendant's motion for judgment n.o.v. or for a new trial was granted. Plaintiffs appealed.

Discussion

Per Se Rule for Tie–Ins

A tying arrangement is illegal if it is shown to restrain competition unreasonably or is illegal per se, without such a showing, if certain prerequisites are met. The prerequisites of per se illegality are: (1) separate products, the purchase of one (tying product) being conditioned on purchase of the other (tied product); (2) sufficient economic power with respect to the tying product to restrain competition appreciably in the tied product; and (3) an effect upon a substantial amount of commerce in the tied product. These prerequisites were satisfied in this case. We therefore do not consider whether competition was in fact unreasonably restrained.

The district court properly granted summary judgment on the first and third of the required elements of a per se violation, holding that on the undisputed facts the NOVA instruction set CPU and defendant's RDOS are separate products and the volume of commerce in NOVA instruction set CPUs tied to the purchase of defendant's RDOS is substantial.

The undisputed facts summarized in the district court's opinion establish that a demand existed for NOVA instruction set CPUs separate from defendant's RDOS, and that each element of the NOVA computer system could have been provided separately and selected separately by customers if defendant had not compelled purchasers to take both.

The remaining element necessary to establish a per se violation — defendant's possession of sufficient economic power with respect to the tying product, defendant's RDOS—was tried to a jury and resolved in plaintiffs' favor. The district court erred in setting aside this verdict or, alternatively, ordering a new trial.

Test of Market Power

One of the purposes of a per se rule is to avoid an incredibly complicated and prolonged economic investigation to determine at large whether a particular restraint has been unreasonable. Although not requiring as extensive an inquiry as would be necessary to determine whether the tie-in violated the general standard of reasonableness, the district court held that plaintiffs could not recover on the alleged tie-ins unless they identified and proved the relevant market for the tying and tied products. The trial that followed focused upon the definition of the relevant markets for the two products, which the district court characterized as the “critical issue,” and consumed 45 days.

The district court recognized that detailed market analysis was not required in a per se tying case prior to United States Steel Corp. v. Fortner Enterprises, Inc., 429 U.S. 610 (Fortner II), but read that opinion as rejecting this approach in favor of a requirement of some degree of market analysis even in a per se case. The court relied particularly upon language in Fortner II, which states the question to be:

whether the seller has the power, within the market for the tying product, to raise prices or to require purchasers to accept burdensome terms that could not be exacted in a completely competitive market. In short, the question is whether the seller has some advantage not shared by his competitors in the market for the tying product.

From the district court's analysis of the asserted deficiencies in plaintiffs' proof, it appears the court read this statement as requiring proof of power to fix the price of the tying product in the whole of the relevant market as defined by the inquiry described in United States v. E.I. du Pont de Nemours & Co., 351 U.S. 377 (1956), a monopolization case. In this the district court erred. Possession by the seller of such monopoly power is sufficient to establish per se illegality, but it is not required.

In its most recent decision on the question the Supreme Court made it clear that a tying arrangement is illegal per se if the seller of the tying product has the capacity to force some buyers to purchase a tied product they do not want or would have preferred to purchase elsewhere. When such forcing occurs competition on the merits in the market for the tied item is restrained. Thus, what is required in a per se case is not power over the whole market for the tying product, but only, as the Court said, a type of market power that has sometimes been referred to as leverage, defined here as a supplier's ability to induce his customers for one product to buy a second product from him that would not be purchased solely on the merit of that second product.

Nor is a restraint on competition that is substantial in terms of the entire market for the tied product required. If only a single purchaser were forced with respect to the purchase of a tied item, the resultant impact on competition would not be sufficient to warrant the concern of antitrust law. Beyond that, however, it need only appear that a substantial volume of commerce is foreclosed, which the court earlier defined as “substantial enough in terms of dollar-volume so as not to be merely de minimis.”

In accordance with these holdings, we review the record not for what it may reveal as to defendant's position in a defined market in which defendant's RDOS was sold, but only to determine whether the jury reasonably could have concluded defendant's RDOS was sufficiently unique and desirable to an appreciable number of buyers to enable defendant to force those buyers also to buy a substantial volume of defendant's NOVA instruction set CPUs they would have preferred not to buy.

Evidence of Lock–In

There was abundant evidence that defendant's RDOS was distinctive and particularly desirable to a substantial number of buyers, and could not be readily produced by other sellers. There was also substantial evidence that defendant's insistence upon licensing its RDOS only to purchasers of defendant's NOVA instruction set CPU, led buyers to purchase defendant's NOVA CPUs who would not have bought them or would have bought them elsewhere absent the tying requirement.

Although expressing some doubt as to the sufficiency of the evidence, the district court assumed defendant's RDOS was superior to competing operating systems and was viewed as uniquely desirable by buyers. We do not share the court's hesitancy about the adequacy of the proof of the strong preference of many customers for RDOS. It was a most popular product. Experts, customers, and even competitors testified to its many advantages over competitive products. Defendant's own officials expressed the same opinion in pre-litigation documents.

Defendant's RDOS has copyright protection. Defendant also claimed the production of RDOS required use of defendant's trade secrets. The RDOS copyright established both the distinctiveness of RDOS and a legal bar to its reproduction by competitors. The requisite economic power is presumed when the tying product is patented or copyrighted.

There is abundant evidence, including testimony of defendant's own executives, customers, and plaintiffs' expert witnesses, that defendant's RDOS could not be reproduced without infringing defendant's copyright and utilizing defendant's trade secrets. Defendant vigorously pursued those who assertedly violated defendant's proprietary rights. Additionally, there was evidence that creating and testing a compatible system would require millions of dollars and years of effort. One of defendant's officers testified that the passage of the time required to reproduce RDOS would render the completed software obsolete.

The power to coerce that RDOS gave the defendant was enhanced by the fact that many of defendant's customers were “locked in” to the use of RDOS. Briefly, defendant sells RDOS and NOVA CPUs primarily to original equipment manufacturers (OEMs) who combine them with application software (a set of instructions that allows the system to accomplish a particular task) to create a complete computer system for resale. Application system software for particular uses is developed by OEMs at substantial expense. Once developed, application software for a particular use may be used by an OEM in producing any number of computer systems for that use for resale to different customers. However, application software is designed to function only with a particular operating system. OEMs who construct their application software to function with defendant's RDOS therefore must purchase an RDOS for each computer system they assemble using that application software. Because of the tying condition, they also must purchase one of defendant's NOVA instruction set CPUs for each such computer system they sell.

An OEM can free itself from this “lock in” only by abandoning its application software compatible with defendant's RDOS, in which it has a substantial investment, or converting the software so that it may be used with another operating system. There was abundant testimony that conversion was not economically feasible.

The defendant argues that “lock-in” is irrelevant in determining its market power because OEMs are aware of the tie when they select an operating system for the computer system they are assembling. At that point, defendant argues, the OEM has made no investment in application software and, as a result, chooses freely among competing systems. This characterization of the market is not accurate. As the evidence in this case establishes, the initial choice is not free of forcing. Defendant's operating system has been shown to be unique as a matter of law and distinctively attractive as a matter of fact. Defendant's initial leverage is magnified by the lock-in. By 1979, 93% of defendant's NOVA CPU sales were made to locked-in customers. These buyers were not only forced to buy defendant's CPUs initially to acquire the operating system they found most attractive, they were thereafter forced to buy defendant's CPUs for their subsequent needs in order to acquire the only operating system they could economically use. Not even a decision by CPU manufacturers to broaden their base and compete in the operating system market would have alleviated the problem, for the locked-in customers were not free to choose among competing operating systems. RDOS was the only operating system that would allow them to realize the benefit of their investment in application software, an investment that in some cases totalled millions of dollars.

OEM testimony confirmed defendant's potential power to coerce arising from the lock-in. For example, one OEM witness testified “[w]ithout [the RDOS operating system] I can't operate”; and another: “economically I was in a position where I had to use RDOS. I had no choice at that point.”

The power arising from the special attraction of RDOS, coupled with the copyright protection, the trade secret barrier, and the lock-in, was evidenced by defendant's minimum equipment configuration (MEC) program. To obtain defendant's RDOS all licensees were required to purchase not only defendant's CPU but also a set quantity of other peripheral hardware, or pay a program license charge. Defendant's national accounts manager accurately referred to the charge as a “penalty.” Customers testified they were forced to buy peripherals from defendant they otherwise would not have purchased. An OEM testified he purchased defendant's fixed disc because he “had to or pay a $5,000 fine.” He also testified he could have bought a superior disc drive for his purposes from another source at half the price. Another customer testified “we've had to take equipment that we either couldn't use, or equipment that, for one reason or another, might, in our opinion, have been best—best obtained from another source.” Still another OEM called the MEC “arbitrary” because it required the purchase of “items of hardware specified in the MEC for certain products that have no functional bearing or are not required, or not used necessarily by the programs themselves.” Defendant's senior vice-president testified the complaints were received from customers about the MEC program “all the time.”

Defendant retained the MEC program despite buyer resistance because, as defendant's president testified, if required to forgo the program defendant would have suffered a loss in revenues. The tie-in of RDOS to defendant's NOVA instruction set CPU was an equally conscious exercise of economic power in one market to gain an advantage in others. As one of defendant's managers wrote in an intra-company memorandum, “[p]rotection from knock-off products still lies in software licensing restrictions.”

The district court properly rejected defendant's argument, vigorously renewed in this court, “that it must bundle its software together with its CPUs in order to recover its substantial investment in software research and development,” and that “it would be unfair to permit emulator-CPU manufacturers to reap the benefits of [defendant's] software [research and development] when they sell their competing CPUs for use with [defendant's] software.”

Defendant's president testified the tie was devised to ensure recovery of RDOS development costs. He testified the decision to tie was made after a competitive manufacturer of NOVA emulator CPUs requested permission to use RDOS. Rather than sell the software separately at a price that would reflect research and development, defendant chose to restrict availability to its own CPU customers, thus restricting competition for the tied product. As the district court said, recovery of investment costs has been explicitly excluded from the narrowly-construed exceptions to the per se rule against tie-ins. Defendant has not shown, nor has it raised a genuine issue of fact with respect to its ability to show at trial, that it is not capable of adopting the less restrictive alternative of restructured prices in order to recoup its investment costs and maintain its incentive for further innovation. In short, defendant must recover the cost of RDOS development by pricing RDOS appropriately, not by tying it to a separate product.

Evidence regarding the potential sources of power with respect to RDOS (copyright, trade secret, and “lock-in”), was submitted to the jury under appropriate instructions. The jury found as a fact that defendant possessed and used the power by means of the tying arrangement to appreciably restrain competition in the market for NOVA instruction set CPUs. The evidence outlined above fully supported the jury's verdict.

Most, although not all, of the trial court's reasons for setting aside the verdict are traceable to the court's view that the legality of a tying arrangement must be tested by the seller's economic power throughout the market for the tying product, and by the relative substantiality of the restraint on competition in the tied product market considered as a whole.

As we have said, the trial court assumed customers regarded RDOS as “uniquely desirable and that it in fact possesses various features which render it superior to other software,” but concluded that plaintiffs had failed to prove that defendant's “competitors were prevented from developing functionally equivalent software.” Conceding that the copyright on RDOS and the trade secrets involved in its creation precluded development by defendant's competitors of “compatible” software, the court held plaintiffs had failed to prove the effect of defendant's copyright and secrets on the development of software “comparable” to RDOS.

The court erroneously imposed the burden of proof on plaintiffs. The RDOS copyright created a presumption of economic power sufficient to render the tying arrangement illegal per se. The burden to rebut the presumption shifted to defendant.

More basically, the court was misled by its conception that power throughout the product market for the tying product was required. The court's concern was whether there were reasonably interchangeable substitutes for RDOS in the operating systems market as a whole, a question of critical importance if the question were whether that market had been monopolized.

The focus of the prohibition against tying arrangements is quite different. The concern is not with the restraint on competition in the tying product but on competition in the market for the tied product. What is required is not monopoly power in the tying product market, but only sufficient power to enable the seller to restrict competition in the tied product. If a seller's product is distinctive, not available from other sources, and sufficiently attractive to some buyers to enable the seller by tying arrangements to foreclose a part of the market for a tied product, the adverse impact on competition in the tied product is not diminished by the fact that other sellers may be selling products similar to the tying product.

The question is not whether other operating systems with which RDOS competed were as good as RDOS or better in the eyes of some buyers, but rather whether RDOS, available only from defendant, was sufficiently attractive to some customers to enable defendant to require those who wished to obtain it also to buy from defendant NOVA instruction set CPUs they might otherwise have purchased from others. As we have seen, evidence of the defendant's possession of such power was ample.

Clearly the availability of “comparable” or “functionally equivalent” operating systems would not have freed “locked-in” OEMs of the pressure, imposed by their investment in application software “compatible” only with RDOS, that compelled them to accede to defendant's condition that they purchase defendant's NOVA CPU in order to obtain RDOS.

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