Corporate Mergers and the Transferability of Software Licenses

In Cincom Systems, Inc. v. Novelis Corp, the plaintiff licensed database management software to Alcan Ohio, a predecessor of the defendant Novelis. As part of the non-exclusive software license, Alcan Ohio could only place the software on designated computers that the parties specifically listed in a schedule attached to the license, with one of the designated computers located at Alcan's New York facility. Importantly, under the license's anti-assignment clause, Alcan Ohio could not transfer its rights or obligations under the agreement without the licensor's prior written approval. Subsequently, Alcan Ohio underwent a series of mergers as part of an internal corporate restructuring and became Novelis, with Alcan Ohio ceasing to exist. Under state business law, the assets of Alcan Ohio (which included the software license), were immediately vested in the surviving entity, Novelis. However, prior to the merger, Alcan Ohio never received permission from the plaintiff for the transfer of the software license to the newly formed entity, and the software previously licensed to Alcan Ohio remained on the same New York computer, but in a plant now owned by Novelis.

Cincom claimed that the series of mergers leading to the creation of Novelis resulted in an impermissible transfer of the license agreement, and when the defendant used and copied the licensed software, it necessarily infringed upon the plaintiff's copyright. The district court agreed and held that an illegitimate transfer of rights occurred under the software license as a result of a corporate merger, leading to an order stipulating more than $400,000 in damages. See Cincom Systems, Inc. v. Novelis Corp., 2007 WL 128999 (S.D. Ohio Jan. 12, 2007).

On appeal, the Sixth Circuit considered whether the series of internal corporate mergers resulted in an impermissible transfer of the non-transferable software license agreement initially granted to Alcan Ohio. See Cincom Systems, Inc. v. Novelis Corp., 2009 WL 3048436 (6th Cir. Sept. 25, 2009). The appeals court affirmed the district court's granting of summary judgment to the plaintiff-licensor.

The circuit court first expounded on the “complex interaction” of federal and state law that occurs in the interpretation of intellectual property licenses. The court clarified that state contract law governed the interpretation of a license and whether a merger resulted in a transfer, but federal common law governed questions with respect to the assignability of a patent or copyright license. As a general matter, under Sixth Circuit precedent, a non-exclusive intellectual property license is presumed to be non-assignable and nontransferable in the absence of “express provisions to the contrary.” PPG Industries, Inc. v. Guardian Industries, Corp., 597 F.2d 1090, 1095 (6th Cir. 1979); see also Everex Sys., Inc. v. Cadtrak Corp., 89 F.3d 673, 679 (9th Cir. 1996) (federal law must govern to prevent free assignability and to promote creativity). According to the court, absent a federal rule of decision that restricted assignability, state law could transform every licensee into a potential competitor with the patent or copyright holder. Where state law may allow for the transfer of a non-exclusive intellectual property license absent express authorization, it must yield to the federal common law rule prohibiting such unauthorized transfers. PPG, 597 F.2d at 1093. Simply put, the court stated that because this policy was a mandate of federal law, Ohio state corporate law could not override this presumption.

Novelis' principal argument was that the district court misinterpreted Sixth Circuit precedent in PPG Industries, in which the appeals court concluded that a merger resulted in an impermissible transfer of patent license rights, and also overlooked the parties' intent as expressed in the license agreement. The defendant claimed that while the agreement at issue in PPG showed a clear intent to prevent the license from coming into the possession of a competitor, the Cincom license demonstrates no concern with preventing internal corporate reorganizations. See e.g., In re Access Beyond Techs., Inc., 237 B.R. 32, 45 (Bankr. D. Del. 1999) (debtor barred from assigning patent license to competitor of licensor). The court rejected the defendant's argument that PPG could be distinguished based upon the specific intent of the contracting parties, particularly since, as in PPG, the plaintiff in the instant case also granted the defendant a non-exclusive and non-transferable license requiring the express written approval of the grantor prior to any transfer of the license.

Indeed, as the district court commented: “The Sixth Circuit did not suggest that a merger between a parent and subsidiary should be treated differently than one between unrelated entities, and it did not hold that whether a merger results in a transfer of a license agreement depends on proof that the licensor has suffered a certain measure of adverse impact. Cincom, 2007 WL 128999 at *5. Echoing this logic, the Sixth Circuit found the fact that Novelis was not a competitor of the plaintiff to be immaterial and would not outweigh the general rule that a non-exclusive intellectual property license is personal to the licensee and that a direct merger resulting in the transfer of a license in violation of the express terms of the license agreement constitutes infringement. Cincom, 2009 WL 3048436 at *4. In short, the court concluded that only Alcan Ohio was authorized under the agreement and if any other legal entity held the software license without the plaintiff's approval, then that entity had infringed the plaintiff's copyright because a transfer has occurred ' regardless of whether the transfer took place by a particular act of the parties or by operation of state law. Id. at *5.

While PPG involved a patent license, the court stated that the same reasoning was apt for copyright licenses as courts interpreting copyright law quite commonly referred to patent precedent “because of the historic kinship between patent law and copyright law.” As a matter of fact, other courts have applied the same principles as PPG in holding that non-exclusive copyright licenses are presumed to be non-assignable and nontransferable. See e.g., In re Patient Educ. Media, 210 B.R. 237, 242-43 (Bankr. S.D.N.Y. 1997) (under copyright law, a nonexclusive licensee has only a personal and not a property interest in the intellectual property, which “cannot be assigned unless the [intellectual property] owner authorizes the assignment. '”); In re Golden Books Family Entertainment, Inc., 269 B.R. 300, 310 (Bankr. D. Del. 2001) (non-exclusive intellectual property licenses do not give rise to ownership rights and cannot, as a matter of law, be assigned without the consent of the licensor).

Exclusive vs. Non-exclusive Licenses

The Cincom decision also highlights how federal law treats exclusive and non-exclusive license agreements differently. Generally speaking, an exclusive license conveys the exclusive right or some part of the exclusive right to practice the invention or exploit the copyright and grants the right to exclude others from practicing or exploiting the intellectual property at issue. As discussed in Cincom, a non-exclusive license cannot be assigned unless the copyright owner authorizes the assignment. In contrast, an exclusive licensee acquires property rights that the licensor cannot offer to others and thereafter may freely transfer its rights, absent contractual language to the contrary. In re Patient Education Media, Inc., 210 B.R. 237, 242-43 (Bankr. S.D.N.Y. 1997); In re Valley Media, Inc., 279 B.R. 105, 135 (Bankr. D. Del. 2002) (“Exclusive licenses grant the licensee a property right in the copyright that is freely transferable. '”).

However, this demarcation is not entirely clear as there is a circuit split on the issue of the assignability of exclusive copyright licenses. In Gardner v. Nike, Inc., 279 F.3d 774 (9th Cir. 2002), Nike had entered into an exclusive licensing agreement with the original licensee involving a Nike-created cartoon character, but threatened legal action when the licensee assigned its rights to Gardner (who brought a declaratory judgment action seeking a ruling that the transfer of rights to him was permissible). In affirming the district court grant of summary judgment to the licensor, Nike, the Ninth Circuit held that even exclusive copyright licenses are not assignable without the consent of the licensor. Beyond statutory interpretation of the Copyright Act, the Ninth Circuit relied on policy considerations, commenting that placing the burden on the licensee allows the licensor to monitor the use of the copyright and helps to avoid the “troublesome and potentially litigious situations” that might arise from allowing the original licensor to be excluded from the negotiations with a sublicensee. Id. at 781. But see Traicoff v. Digital Media, Inc., 439 F.Supp.2d 872, 877 (S.D. Ind. 2006) (“This court also finds the reasoning in Gardner to be unpersuasive. A natural reading of the [Copyright] Act's language leads to the conclusion that exclusive licensees, as copyright owners of their exclusive rights, are free under the Act to transfer those rights to third parties.”).

Due Diligence and Drafting Concerns

As the Cincom decision illustrates, it is important to address the assignability of intellectual property licenses during the due diligence process of a corporate merger. Regardless of the merits of the merger between the concerned parties, computer software licensors or other similar licensors may have divergent concerns ' whether they be competitive or monetary ' over the prospect of a licensee transferring rights in a license to a new corporate entity or one of the licensor's competitors. Careful due diligence requires that the parties exchange an exhaustive list of intellectual property licenses. Some licenses may have an express anti-assignment clause, while others may have more ambiguous language. Still other licenses might carve out exceptions for transfers due to an assignment by operation of law or by a merger, sale of stock or assets, or by other changes in the licensee's ownership structure. Once examined, counsel can determine to what extent a particular license prohibits transfer, whether a transaction can be fashioned to comply with a license's assignability clause, or whether the consent of the licensor must be obtained. When a non-exclusive software or patent license agreement is silent as to transferability, many practitioners may assume that the agreement is freely assignable; however, as the Cincom decision and other bankruptcy court opinions have made clear, federal common law treats non-exclusive software and patent licenses as non-transferable “bare” licenses, and some circuits may even do the same for exclusive licenses. This should be kept in mind when drafting a license agreement, as silence on the assignability clause could be inviting a failed corporate transaction, or worse, a lawsuit.

Anti-assignment clauses are typically inserted into license agreements to preclude the introduction of an unwanted third party into the parties' relationship, giving the licensor more control over its valuable property and with whom it ultimately does business. In certain instances, courts do not look favorably upon restraints to alienation of property, but in the intellectual property context, federal common law generally precludes the free assignability of intellectual property licenses without the permission of the licensor. Without such a policy, any license granted by a patent or copyright holder could potentially be assigned to the licensor's competitor or another party to whom the copyright or patent owner might be unwilling to license. In the context of software licenses, ordinarily a court will apply state law to contractual disputes, but federal law pre-empts state law concerning questions of copyright law or policy, which include the assignability of non-exclusive agreements.

An interesting question arises when a licensee's corporate status changes due to a merger, such that the assets of the former company automatically transfer to the new, surviving entity. How does a corporate merger and legal transfer of assets affect a license agreement's anti-assignment clause? Recently, the Sixth Circuit held that a software licensee's merger, which, by law, transferred its license rights to the surviving entity, violated the license's express anti-assignment clause, resulting in liability for copyright infringement.

The Cincom Decision

In Cincom Systems, Inc. v. Novelis Corp, the plaintiff licensed database management software to Alcan Ohio, a predecessor of the defendant Novelis. As part of the non-exclusive software license, Alcan Ohio could only place the software on designated computers that the parties specifically listed in a schedule attached to the license, with one of the designated computers located at Alcan's New York facility. Importantly, under the license's anti-assignment clause, Alcan Ohio could not transfer its rights or obligations under the agreement without the licensor's prior written approval. Subsequently, Alcan Ohio underwent a series of mergers as part of an internal corporate restructuring and became Novelis, with Alcan Ohio ceasing to exist. Under state business law, the assets of Alcan Ohio (which included the software license), were immediately vested in the surviving entity, Novelis. However, prior to the merger, Alcan Ohio never received permission from the plaintiff for the transfer of the software license to the newly formed entity, and the software previously licensed to Alcan Ohio remained on the same New York computer, but in a plant now owned by Novelis.

Cincom claimed that the series of mergers leading to the creation of Novelis resulted in an impermissible transfer of the license agreement, and when the defendant used and copied the licensed software, it necessarily infringed upon the plaintiff's copyright. The district court agreed and held that an illegitimate transfer of rights occurred under the software license as a result of a corporate merger, leading to an order stipulating more than $400,000 in damages. See Cincom Systems, Inc. v. Novelis Corp., 2007 WL 128999 (S.D. Ohio Jan. 12, 2007).

On appeal, the Sixth Circuit considered whether the series of internal corporate mergers resulted in an impermissible transfer of the non-transferable software license agreement initially granted to Alcan Ohio. See Cincom Systems, Inc. v. Novelis Corp., 2009 WL 3048436 (6th Cir. Sept. 25, 2009). The appeals court affirmed the district court's granting of summary judgment to the plaintiff-licensor.

The circuit court first expounded on the “complex interaction” of federal and state law that occurs in the interpretation of intellectual property licenses. The court clarified that state contract law governed the interpretation of a license and whether a merger resulted in a transfer, but federal common law governed questions with respect to the assignability of a patent or copyright license. As a general matter, under Sixth Circuit precedent, a non-exclusive intellectual property license is presumed to be non-assignable and nontransferable in the absence of “express provisions to the contrary.” PPG Industries, Inc. v. Guardian Industries, Corp. , 597 F.2d 1090, 1095 (6th Cir. 1979); see also Everex Sys., Inc. v. Cadtrak Corp., 89 F.3d 673, 679 (9th Cir. 1996) (federal law must govern to prevent free assignability and to promote creativity). According to the court, absent a federal rule of decision that restricted assignability, state law could transform every licensee into a potential competitor with the patent or copyright holder. Where state law may allow for the transfer of a non-exclusive intellectual property license absent express authorization, it must yield to the federal common law rule prohibiting such unauthorized transfers. PPG, 597 F.2d at 1093. Simply put, the court stated that because this policy was a mandate of federal law, Ohio state corporate law could not override this presumption.

Novelis' principal argument was that the district court misinterpreted Sixth Circuit precedent in PPG Industries, in which the appeals court concluded that a merger resulted in an impermissible transfer of patent license rights, and also overlooked the parties' intent as expressed in the license agreement. The defendant claimed that while the agreement at issue in PPG showed a clear intent to prevent the license from coming into the possession of a competitor, the Cincom license demonstrates no concern with preventing internal corporate reorganizations. See e.g., In re Access Beyond Techs., Inc., 237 B.R. 32, 45 (Bankr. D. Del. 1999) (debtor barred from assigning patent license to competitor of licensor). The court rejected the defendant's argument that PPG could be distinguished based upon the specific intent of the contracting parties, particularly since, as in PPG, the plaintiff in the instant case also granted the defendant a non-exclusive and non-transferable license requiring the express written approval of the grantor prior to any transfer of the license.

Indeed, as the district court commented: “The Sixth Circuit did not suggest that a merger between a parent and subsidiary should be treated differently than one between unrelated entities, and it did not hold that whether a merger results in a transfer of a license agreement depends on proof that the licensor has suffered a certain measure of adverse impact. Cincom, 2007 WL 128999 at *5. Echoing this logic, the Sixth Circuit found the fact that Novelis was not a competitor of the plaintiff to be immaterial and would not outweigh the general rule that a non-exclusive intellectual property license is personal to the licensee and that a direct merger resulting in the transfer of a license in violation of the express terms of the license agreement constitutes infringement. Cincom, 2009 WL 3048436 at *4. In short, the court concluded that only Alcan Ohio was authorized under the agreement and if any other legal entity held the software license without the plaintiff's approval, then that entity had infringed the plaintiff's copyright because a transfer has occurred ' regardless of whether the transfer took place by a particular act of the parties or by operation of state law. Id. at *5.

While PPG involved a patent license, the court stated that the same reasoning was apt for copyright licenses as courts interpreting copyright law quite commonly referred to patent precedent “because of the historic kinship between patent law and copyright law.” As a matter of fact, other courts have applied the same principles as PPG in holding that non-exclusive copyright licenses are presumed to be non-assignable and nontransferable. See e.g., In re Patient Educ. Media, 210 B.R. 237, 242-43 (Bankr. S.D.N.Y. 1997) (under copyright law, a nonexclusive licensee has only a personal and not a property interest in the intellectual property, which “cannot be assigned unless the [intellectual property] owner authorizes the assignment. '”); In re Golden Books Family Entertainment, Inc., 269 B.R. 300, 310 (Bankr. D. Del. 2001) (non-exclusive intellectual property licenses do not give rise to ownership rights and cannot, as a matter of law, be assigned without the consent of the licensor).

Exclusive vs. Non-exclusive Licenses

The Cincom decision also highlights how federal law treats exclusive and non-exclusive license agreements differently. Generally speaking, an exclusive license conveys the exclusive right or some part of the exclusive right to practice the invention or exploit the copyright and grants the right to exclude others from practicing or exploiting the intellectual property at issue. As discussed in Cincom, a non-exclusive license cannot be assigned unless the copyright owner authorizes the assignment. In contrast, an exclusive licensee acquires property rights that the licensor cannot offer to others and thereafter may freely transfer its rights, absent contractual language to the contrary. In re Patient Education Media, Inc., 210 B.R. 237, 242-43 (Bankr. S.D.N.Y. 1997); In re Valley Media, Inc., 279 B.R. 105, 135 (Bankr. D. Del. 2002) (“Exclusive licenses grant the licensee a property right in the copyright that is freely transferable. '”).

However, this demarcation is not entirely clear as there is a circuit split on the issue of the assignability of exclusive copyright licenses. In Gardner v. Nike, Inc. , 279 F.3d 774 (9th Cir. 2002), Nike had entered into an exclusive licensing agreement with the original licensee involving a Nike-created cartoon character, but threatened legal action when the licensee assigned its rights to Gardner (who brought a declaratory judgment action seeking a ruling that the transfer of rights to him was permissible). In affirming the district court grant of summary judgment to the licensor, Nike, the Ninth Circuit held that even exclusive copyright licenses are not assignable without the consent of the licensor. Beyond statutory interpretation of the Copyright Act, the Ninth Circuit relied on policy considerations, commenting that placing the burden on the licensee allows the licensor to monitor the use of the copyright and helps to avoid the “troublesome and potentially litigious situations” that might arise from allowing the original licensor to be excluded from the negotiations with a sublicensee. Id. at 781. But see Traicoff v. Digital Media, Inc. , 439 F.Supp.2d 872, 877 (S.D. Ind. 2006) (“This court also finds the reasoning in Gardner to be unpersuasive. A natural reading of the [Copyright] Act's language leads to the conclusion that exclusive licensees, as copyright owners of their exclusive rights, are free under the Act to transfer those rights to third parties.”).

Due Diligence and Drafting Concerns

As the Cincom decision illustrates, it is important to address the assignability of intellectual property licenses during the due diligence process of a corporate merger. Regardless of the merits of the merger between the concerned parties, computer software licensors or other similar licensors may have divergent concerns ' whether they be competitive or monetary ' over the prospect of a licensee transferring rights in a license to a new corporate entity or one of the licensor's competitors. Careful due diligence requires that the parties exchange an exhaustive list of intellectual property licenses. Some licenses may have an express anti-assignment clause, while others may have more ambiguous language. Still other licenses might carve out exceptions for transfers due to an assignment by operation of law or by a merger, sale of stock or assets, or by other changes in the licensee's ownership structure. Once examined, counsel can determine to what extent a particular license prohibits transfer, whether a transaction can be fashioned to comply with a license's assignability clause, or whether the consent of the licensor must be obtained. When a non-exclusive software or patent license agreement is silent as to transferability, many practitioners may assume that the agreement is freely assignable; however, as the Cincom decision and other bankruptcy court opinions have made clear, federal common law treats non-exclusive software and patent licenses as non-transferable “bare” licenses, and some circuits may even do the same for exclusive licenses. This should be kept in mind when drafting a license agreement, as silence on the assignability clause could be inviting a failed corporate transaction, or worse, a lawsuit.