Historically software developers have wrestled with how to protect their rights in software. Ideas, processes and methods can only be protected by either patenting them if they otherwise meet the requirements for obtaining a patent, or by keeping them secret. If products have a short shelf life, seeking a patent is not usually an economically sound approach, because the cost and time to obtain the patent outweigh the benefits. On the other hand, if software has a long shelf life, and easily can be reverse engineered, owners sometimes consider trying to obtain a patent. Copyright law only protects the way the idea or process is expressed. While it is possible to register the copyright in software and still keep the trade secret portion of the source code secret, the copyright registration will not protect the underlying idea or process. Accordingly, most software developers and sellers have sought to protect their trade secrets and rights in the software by licensing the software under an agreement of strict confidentiality with limits on use, where the software owner retains ownership rights in the software. The theory behind this approach is that the licensee then only has a limited right to use the software, is normally not allowed to reverse engineer the software, and is normally not allowed to resell or sublicense the software except under similar confidentiality, ownership, and use restrictions and with the permission of the owner. Sounds good, right? Well, the concept works unless a court says otherwise, which is exactly what some courts have determined in recent times.
While historically courts have honored the characterization of transacting parties of the distribution of software as a license transaction, more recently courts have, under certain circumstances, concluded that the "economic realities" of the transaction make it in actuality a "sale" of the software, despite characterization in a license agreement to the contrary. (See, for example, Softman Products Co., LLC v. Adobe Systems Inc., 171 F. Supp.2d 1075 (U.S.D.C. C.D. Cal. 2001); Vernor v. Autodesk, Inc., 2009 WL 3187613 (U.S.D.C. W.D. Wash. 2009)). By treating the license as a sale of the copy of the software, the courts conclude that the so-called "first sale doctrine" applies under the copyright law. That doctrine, embodied in Section 109 of the United States Code (17 U.S.C. ยง 109(a)), provides that (with some exceptions) the owner of a particular copy of a copyrighted work is entitled to, without the authority of the copyright owner, sell or otherwise dispose of the possession of that copy. The owner of the copy also may publicly display the copy either directly, or by the projection of no more than one image at a time, to viewers present at the place where the copy is located. Therefore, the licensee, as owner of the copy, may sell or transfer possession of that copy (although most likely the licensee cannot legally make derivative works or multiple copies of its own copy). The consequence is that potentially a third party competitor transferee could acquire ownership of the copy without the license restrictions. Accordingly, any license restrictions on reverse engineering would not apply to a third party who acquires the copy by virtue of a sale rather than by a license. Note that Section 109(b) (with some exceptions) expressly prohibits the owner of the copy of the computer program to dispose of the copy for direct or indirect commercial advantage by rental, lease or lending of the program.
While specific court decisions are not binding on courts in other jurisdictions, they nevertheless represent a potential trend in how software is treated for purposes of determining ownership, at least of the copy provided to a licensee. The following are some of the factors that courts would consider tend towards a finding of a sale, rather than a license:
1. The license runs for an indefinite or unlimited term with no provisions for expiration or renewal
2. The license agreement contains no provision for the return of the software upon the happening of certain events or expiration of a certain period of time
3. The licensor does not reserve title in the software, including in the particular copy of the software
4. The licensee obtains a single copy of the software with documentation, for a single price
5. The licensee pays the price at the time of the transaction, and this one time payment constitutes the entire payment for the "license"
6. The licensee pays full value for the software and accepts the risk that the software might be damaged or lost
7. There is no prohibition in the license agreement, or requirement to obtain permission, with regard to subsequent transfers of the software copy
8. Use restrictions in the license agreement have the primary purpose of protecting intangible copyrights, such as the right to make copies of, distribute, or make derivative works of, the underlying work, rather than preserve and protect ownership rights in both the software and the copy of the program provided to the licensee
The lessons to be learned by software developers and licensors from these cases are:
1. Make sure that you clearly retain all ownership and proprietary rights in the software copy, as well as in the copyrights
2. Place term limits on the license, with renewal options (as opposed to an indefinite or perpetual license term)
3. Even in the case of a perpetual license, make sure there are grounds for termination of the license agreement and return of the copy licensed
4. Spread payments out over time, and characterize them as royalties (and, if feasible, have the royalties dependent upon variables rather than fixed payments)
5. Make sure that clearly defined limits and restrictions are placed on the rights of use, transfer, and sublicensing, both as to the copies themselves and as to copyrights
6. Make sure that there is no right granted to "sell" or "resell" the software
7. Include provisions that avoid placing all the risk of loss or damage on the licensee
8. Avoid terms like "resellers" and "reselling" ("distributor" and "licensing" would be preferable terms)
There is a clear risk, particularly with off the shelf software and boilerplate click through and shrink wrap license agreements, that the licensee of the software will be deemed under the law to be the owner of that copy of the software. The consequence of such a conclusion is that the licensee/owner will have the right to sell or transfer possession of the copy, potentially even to a competitor of licensor who is not bound by the license terms (including any license restrictions on reverse engineering). While this risk cannot be avoided absolutely, there are steps that can be taken to minimize the risk, such as requiring return of the copy at the end of the term or otherwise upon termination of the license, imposing a fixed term on the license, and providing for serial royalty payments. A carefully crafted software license agreement will go a long way towards minimizing the first sale doctrine risk.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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