Monday, April 06, 2009

Settlement disagreement leads to copyright, trade secret and false advertising claims

SimplexGrinnell LP v. Integrated Systems & Power, Inc., 2009 WL 857504 (S.D.N.Y.)

The plaintiff, SG, sells and services commercial fire safety systems. Defendant ISPI doesn’t make its own fire safety systems, but services them. They compete in New York and New Jersey. Often, customers will contract with SG to install a fire alarm system, but retain ISPI to service and maintain it. Before 2002, the parties had a close business relationship—ISPI originated in 1987 as a local service company for SG’s predecessor. But in 2002, they parted ways, and ISPI filed for Chapter 11 bankruptcy. ISPI instituted an adversary proceeding against SG, alleging breach of contract and various business torts. In 2004, the parties agreed on a settlement, which required SG to pay over a million dollars to ISPI and voided all prior agreeements between them. However, SG was required to sell ISPI service parts, including patches and fixes, for its then-existing customer base at list price. It also required SG to provide ISPI with certain forms of technical support.

The basic question in the case was whether the software used to program and configure two systems, the 4100 and 4100U, were covered by the settlement. With both systems, the software can run through a laptop or an on-site network computer; in either case, a software key (dongle) must be attached to the computer for the programs to run. Each time a program is run, it’s loaded into RAM, where it remains while a technician configures the system; this can take minutes or hours.

There are multiple revisions for each program—4100 has revisions 8 and 9, and 4100 goes from revision 10 to revision 12. And each revision has a number of versions: approximately 50 for 4100U. The particular version of the program must match the particular fire system panel installed. Dongles, however, are not version- or revision-specific: a given dongle works on all SG programs. (Query: why no DMCA claim?)

SG didn’t dispute that ISPI could use the 4100 program to service customers on its customer list. And the court concluded that the 4100U program was also a service part. Among other things, the settlement agreement defined “service parts” as items that used a six-digit product identification number, as both 4100 and 4100U programs did and do, and SG repeatedly sent ISPI price lists for “service parts,” pursuant to the settlement, that included the programs. And the programs are necessary to perform various fire system functions, making them service parts within the plain meaning of the term. The dongles were also service parts, despite SG’s attempts to claim otherwise, even if they contained proprietary information.

SG registered copyrights one version each of revisions 8 through 11 of the 4100 and 4100U programs. The registrations are from 2005; it’s also applied to register one revision of version 12, with an application filed in 2008.

ISPI had access to program disks, and later to a SG website to download revisions and updates. ISPI didn’t limit its use of the programs to servicing customers on the settlement customer list. At some point in 2005 or 2006, SG cut off ISPI’s website access, and denied ISPI’s request for new versions, but never sought to have ISPI return the software it possessed. In 2006, SG wrote to two of ISPI’s new customers, telling them that there was no authorized servicer other than SG itself. SG also denied ISPI’s request to buy dongles specifically for two customers on the existing customer list; SG argued unsuccessfully that the dongles were trade secrets, not service parts.

A preliminary issue was the effect of SG’s registrations. In the Second Circuit, registration of a work doesn’t confer jurisdiction over claims of infringement in derivative works. Each new version of SG’s program is a separate derivative work, as set forth in SG’s registrations themselves. Thus, the court only had jurisdiction over claims that ISPI infringed the registered revisions (not, of course, including the revision whose registration is still pending).

The court concluded that ISPI was infringing SG’s copyrights when it used the software with new customers, but not when it used the software with preexisting customers. Each use of the program creates a copy in RAM (the recent 2nd Circuit Cartoon Network case supported the idea that retention in RAM for a few minutes, as here, sufficed), implicating the reproduction right. In some cases, new customers had the appropriate program and dongle installed on their onsite computers; in other cases, ISPI serviced new customers by bringing in a laptop with the appropriate software already installed. In either case, the court concluded, ISPI was infringing.

The court denied SG’s contention that ISPI was only authorized to use versions and revisions existing at the time of settlement, even if the customers on the list changed their systems and therefore needed new software. The settlement agreement didn’t limit ISPI to the systems existing at the time of the agreement; it put a limit on the parties ISPI had a right to service (and a right to get parts from SG for), not the equipment they used.

Thus, SG could refuse to sell service parts to ISPI for the use of other customers; and SG could assert copyright and trade secret rights against ISPI’s use of the parts for new customers, even if ISPI legitimately acquired the parts. (Query how first sale fits into this; but it’s not clear that the software or the dongles are among the service parts available on the resale market.) The court also rejected ISPI’s arguments that ISPI was licensed to use the programs more broadly and that SG was estopped from claiming infringement.

ISPI promoted itself in emails and letters to potential clients as the only company other than SG that had the necessary software to program SG panels. It stated that it used factory parts, had factory-trained technicians, and once said that it had “direct access to parts and support from the factory.” ISPI could obtain SG parts through other companies, even without direct access. Many of its service technicians were previously employed or trained by SG.

Neither party showed any damages from the other’s conduct. SG wasn’t entitled to statutory damages; it didn’t initially seek damages at all in its complaint, and its allegations of copyright infringement were at first limited to two customers on the settlement list; the incidents for which it sought damages were technically beyond the scope of the present action. Even were that not so, SG could only show a couple of instances of infringement of the registered versions, and it meet its burden of showing that its registrations predated the infringement, so statutory damages were unavailable.

Likewise, SG wasn’t entitled to costs and attorneys’ fees; it largely failed to establish specific acts of infringement, and the case was really about interpretation of the bankruptcy settlement, as to which each side prevailed in part. The most equitable solution was for each party to bear its own costs.

The court found that SG was entitled to an injunction against copyright infringement. Irreparable injury could be presumed from infringement; the evidence suggested ISPI would continue to infringe absent an injunction; ISPI had identified no hardship beyond the hardship of loss of ability to engage in unauthorized conduct and the resulting loss of business; and there was no public interest at stake, because SG could continue to service and maintain fire alarm systems that ISPI couldn’t. The injunction, however, would only extend to the particular versions of the programs over which the court had proper subject matter jurisdiction. The Second Circuit doesn’t allow the kind of general prophylactic injunction that other circuits do. (Query whether this rule will fall along with the Second Circuit’s ruling rejecting the Tasini settlement, when the Supreme Court does reverse.) SG’s remedy for other infringements is to register the other versions. The court’s ruling on the dongle will also preclude unauthorized use of the programs.

So: the dongles contain a trade secret, and ISPI misappropriated it as applied to new customers; for customers on the existing customer list, there was no misappropriation because ISPI was entitled to use the dongles. The court held that the dongles are trade secrets. They’re kept secret, even though they’re sometimes left at customer sites, because they are only provided to authorized users and are not available to the public at large. (Are any measures taken against reverse engineering, whether contractual or technical? This analysis seems rather brisk to me, sensitized as I am by Elizabeth Rowe’s recent presentation on trade secrets.)

ISPI misappropriated the dongles; it didn’t really argue the point, instead arguing that it was entitled to use them to service all customers. Its use for new customers was in breach of a confidential duty—it was provided the dongles for use attendant to authorized functions, first as SG’s agent and later pursuant to the settlement. The court also concluded that there was no copyright preemption, because breach of duty is an extra element. The rationale for finding no preemption, the court thought, was “nicely underscored” by the facts here, because the primary claims of copyright infringement were “largely irremediable.” (I would think this is a rationale for finding preemption—if the infringement were irremediable because of expiration of the limitations period, for example, then the court should be clear that a state-law cause of action shouldn’t resurrect what’s actually a copyright claim; lack of subject matter jurisdiction for failure to register is the same type of barrier. This isn’t to say that the trade secret claim should be preempted—though I do wonder whether the DMCA should factor into that analysis—but that the court’s extra reason is not as helpful as it thinks.) Trade secret is uniquely valuable for computer programmers precisely because it protects ideas, processes and systems that copyright can’t.

The court therefore enjoined unauthorized use of the dongles. (Given SG’s recalcitrance on providing any software updates or dongles, I would think ISPI’s also entitled to an injunction allowing it to purchase same for old customers, but maybe ISPI didn’t ask for that.) The court did need to revisit irreparable injury, because recent circuit precedent suggests that damages will often be a complete remedy in trade secret case when there is no danger of further dissemination and the only possible injury is loss of sales to a competitor. The misappropriator who uses a trade secret to profit will often have the same interest as the the owner in avoiding further dissemination. But the court found that here, the interest in preventing copyright infringement of unregistered versions was sufficient to justify a finding of irreparable injury.

SG also alleged unfair competition in violation of the Lanham Act and state law. The court rejected ISPI’s argument for copyright preemption, because false designation of origin and false advertising aren’t rights equivalent to a copyright right. But SG lost the §43(a)(1)(A) claim, which seemed to be that ISPI misled customers into thinking it was a full and complete substitute for SG. Improperly marketing a product by creating a false impression of a link between the plaintiff’s product and the defendant’s product, those, is actionable as false advertising; it’s not a representation that defendant’s product originated with plaintiff’s.

ISPI’s claims that it had “direct access to parts and support from the factory” and “all the software necessary for programming” was only true for old customers, but false by necessary implication for new customers. They’re material statements, and the second one was made broadly to many potential customers; the first was only made to one New Jersey customer, which (1) wasn’t enough to constitute commercial advertising or promotion under the Lanham Act and (2) didn’t violate New York law because it was directed at New Jersey (which kind of sounds like a New Jersey joke).

ISPI’s claim to have “factory trained technicians” was not literally false, even though SG argued that their training was out of date. Nothing in the ads suggested that the training was the most up-to-date. Nor was the alleged misrepresentation shown to be material; the testimony was that most expertise comes from doing the job.

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