Today, the federal jury in the Oracle vs. SAP case awarded Oracle $1.3 billion (yes, with a “B”) in damages for copyright infringement by SAP’s TomorrowNow subidiary. This massive award demonstrates once again the critical nature of “due diligence” in merger transactions. SAP admitted to copyright infringement, so the amount of the damages was the only issue. SAP had suggested $40,000,000 and Oracle demanded $1.65 billion. Recently, Reuters reported that SAP had agreed to pay Oracle $120,000,000 for Oracle’s agreement not to seek punitive damages. (for transparency purposes, we do work for Oracle but were not involved in this litigation).  

The challenges of “due diligence” in mergers is discussed in a 2004 Harvard Business Review article “The Secrets of Great Due Diligence http://hbswk.hbs.edu/archive/4104.html. As the article notes:

Deal making is glamorous; due diligence is not. That simple statement goes a long way toward explaining why so many companies have made so many acquisitions that have produced so little value. Although big companies often make a show of carefully analyzing the size and scope of a deal in question—assembling large teams and spending pots of money—the fact is, the momentum of the transaction is hard to resist once senior management has the target in its sights. Due diligence all too often becomes an exercise in verifying the target’s financial statements rather than conducting a fair analysis of the deal’s strategic logic and the acquirer’s ability to realize value from it. Seldom does the process lead managers to kill potential acquisitions, even when the deals are deeply flawed. [...]

The nature of TomorrowNow’s business should have required extra care because TomorrowNow provided third party “maintenance services” for Oracle software. These services are fraught with risk: such companies are strongly tempted to use the software and tools of the company for whose products they are providing maintenance and particular care must be taken to ensure that they resist that temptation.

With the increase in mergers and acquisitions, this case stand as a warning of the importance of careful intellectual property due diligence. The lessons for acquiring companies are:

1.  Intellectual property due diligence is now of greater importance

2.  Copyright liability may be as high as patent liability

3.  Take particular care with business models based on third party intellectual property rights

4.  Determine how third party software use (both open source and commercial) is managed (the answer “ad hoc” is not a good one)

5.  Be prepared to walk away if the problem is significant or fix it prior to closing

The lessons for companies being acquired are:

1. Review your intellectual property ownership as well as use of third party intellectual property rights because acquiring companies are going to much more attentive to these issues

2. Fix any issues that you identify prior to entering merger discussions: many problems can be fixed given enough time, but you won’t have time once you start the merger process

3. Adopt a policy on the use of third party software (including both open source and commercial) to avoid these problems and because acquirors (and your customers) will be asking about it.

The recent series of open source projects who are working to integrate with proprietary software (such as the driver for Microsoft’s Kinect and Apache’s Harmony project relating to Java) demonstrates the difficulty the copyright analysis of these types of interaction. Some guidance is available from England: the recent decision in the case of SAS v. WPL provides some guidance. SAS challenged the established view as to the limits of copyright protection for computer programs. However the decision this summer is not final because the court has referred interpretation of certain provisions of the copyright law to the European Court of Justice (”ECJ”).  http://www.bailii.org/ew/cases/EWHC/Ch/2010/1829.html#para332.

Kit Burden, one of my London colleagues, explained that in 2004 and 2007 the English courts confirmed that competitors are free to study how software works in order to write a program mimicking its functionality.  The courts also said that programming languages themselves, and any software interfaces, fall outside of the scope of copyright protection.

SAS, a major player in the analytical software, is challenging this view.  It does so following the actions of WPL, a smaller software house.  WPL studied SAS’s software, wrote its own software (there was no suggestion that SAS’s source code had been copied), tested its software by running it on SAS’s Learning Edition products, and then offered it to customers as a cheaper, alternative to SAS’s product with much of the same functionality.     

SAS’s arguments are essentially:

·         that WPL breached copyright in SAS’s software both indirectly (by studying SAS’s software and SAS’s manuals in order to develop software which would function in the same way) and directly (by using SAS’s Learning Edition to test this new WPL software - in breach of license) and

·         that WPL breached copyright in SAS’s manuals in the way that it used them to develop its own software and, more straightforwardly, simply because WPL’s user manual is so similar to SAS’s user manual 

The English court’s judgment was handed down in the last week of July.  Both sides claim some success. 

The judge did agree that the two user manuals were too similar; WPL will rewrite them. 

However he remained unconvinced as to SAS’s other, more significant, arguments.  On balance, he believes the earlier decisions of the English courts were correct - that programming languages, interfaces and functionality do all fall outside of the protection of copyright.  He also believes that the breached license term was void and unenforceable.  On this analysis, WPL is in the clear. 

However, there remains some doubt.  The judge agrees that interpretation of the relevant legislation is not clear cut and has asked the ECJ for guidance. 

Given the potential to broaden copyright protection to include functionality, “look and feel” and so on, the industry will be closely monitoring this referral.  That said, the ECJ’s opinion is not expected soon. These issues will continue to arise as proprietary software and open source software become more integrated.