It’s an odd case of copyright infringement. The defendant–Novelis Corp.–made no infringing copies, nor did it help anyone else make infringing copies. Instead, the company’s liability sprang from an internal corporate reorganization.

Novelis is organized under the laws of Texas. Before 2003, this subsidiary of Alcan Inc. had a different name (Alcan Rolled Products Division) and was organized under Ohio law.

The reorganization in 2003 was rather routine. However, a software supplier smelled blood. After learning of the corporate change, Cincom Systems Inc. sued for infringement in 2005, alleging that Novelis was possessing and using Cincom software without any right to do so.

Cincom had licensed its software to Alcan Rolled Products back in 1989. The license agreement specified that the Ohio company could “not transfer its rights or obligations under this Agreement without the prior written approval of Cincom.”

Novelis argued there was no transfer. It was engaged in the same business as its Ohio predecessor. It kept the licensed software on the very same company computer in Oswego, N.Y. This was just an internal reorganization.

Cincom argued that Alcan Rolled Products was a different legal entity than Novelis, and Cincom had never approved transferring the software to Novelis. Thus, Novelis had no legal right to possess or use the software–and was guilty of infringement.

A federal district court in Ohio agreed with Cincom, finding that the 2003 reorganization affected a transfer of the license. A unanimous 6th Circuit panel affirmed the ruling Sept. 25.

“The result in [Cincom Sys. Inc. v. Novelis Corp.] should be very troubling to business managers,” says John Rothchild, who teaches copyright law at Wayne State University in Detroit. “[I]t means that whenever there’s a corporate reorganization, there is potential of copyright infringement on a massive scale.”

For many company executives, it’s an unexpected liability. “[T]his will shock a lot of people,” says Jonathan Handel, of counsel at TroyGould.

Tracking a Trend

The Cincom case isn’t a freak outlier. A growing number of software companies, desperate for revenue in tough economic times, are suing their customers for allegedly violating their licensing agreements.

“Plenty of [software] companies are saying, ‘You broke the rules and you owe me money’ on plenty of predicates. For instance, you changed your hardware [on which the software was installed] or you relocated the hardware to a different facility [in violation of the license agreement],” says Henry Jones III, a solo attorney who specializes in software law.

Plaintiffs have filed more than 30 lawsuits of this type, according to Jones. He says this method of squeezing more money from customers has been around a long time, and it has gotten more common lately. “It is now an established tactic of some vendors,” he adds.

However, the software vendors’ legal position is somewhat shaky because of conflicting court rulings. “The right to transfer a physical copy of copyrighted software is vexed and confusing,” Handel says.

Confusion and Conflicts

Part of the confusion arises from the dual nature of software transactions. “There’s both a sale and a license in almost all transactions involving copies of copyrighted software. The license authorizes certain uses of the copyrighted work, and there is a sale of the material object on which the computer program is transmitted,” Rothchild says.

He offers this example: “If you buy a shrink wrapped package with Quicken software in it, there’s a sale of the CD on which the software is contained, but you don’t obtain the copyright in the software. … You get a license to use the software in certain ways. As the owner of the CD, you have the right to resell that CD. But you don’t have the right to make [unauthorized] copies of the software program or to take any other actions that would infringe the exclusive rights of the software owner. This is the point on which many courts have become confused.”

Michael Scott, who teaches IT and IP law at Southwestern Law School in Los Angeles, says that many courts have simply assumed there is a license. In Cincom, for instance, the court never considered if there was a sale, which would have allowed the buyer to transfer the physical copy of the software it had paid for. The court just assumed the software was licensed and ruled that, under federal law, “copyright licenses are unassignable absent express language to the contrary.” Thus, under Cincom, software can never be transferred unless the license specifically allows it.

This conflicts with Vernor v. Autodesk Inc., a Sept. 30, 2009, ruling by a federal district court in Seattle. In Vernor, the court upheld the right of Timothy Vernor to buy packages of Autodesk software from Autodesk customers and then resell the software, even though Autodesk’s software license forbids transferring the software without the company’s permission. The court rejected Autodesk’s assertion that its software is merely licensed, stating that “the use of software copies can be licensed while the copies themselves are sold.” The court found that the copies of software were sold, and so buyers had the right to resell their copies to Vernor, which could in turn resell these copies.

Apples and Oranges

“It is very difficult to reconcile Cincom and Vernor,” says Handel. “The rulings are almost diametrically opposed.”

However, according to Handel, these different rulings may simply reflect the different types of the software involved. “It is apples and oranges,” Jones says.

Vernor concerned relatively inexpensive mass-market software, available through a variety of distribution channels, that came with a non-negotiable shrink wrap license. The software in Cincom was the complete opposite. It had a six-figure price tag, was customized for the user’s specific requirements, was provided directly by the vendor and was provided pursuant to a signed license agreement that was negotiated by both parties to the transaction. Moreover, the Vernor software was paid for in a single transaction, whereas the user in Cincom had to pay a fee each year in order to use the software.

Companies that use software may therefore need to handle mass market software differently than customized, expensive software. Because mass market software may be freely transferable, corporate users might engage in internal reorganizations without fear of infringing the copyrights in such software. But they may need to treat expensive, customized software with far more care.

Legal departments should review their company’s current software license agreements in order to create an inventory of licensing and transfer restrictions, experts warn. This review should be run by a lawyer, Jones says, so it can be covered by attorney-client privilege, thus preventing any embarrassing findings or concerns from being discoverable in litigation.

Corporations need “to better resource and manage their past and future software transactions, and to progress beyond the smug assumptions of legal and commercial safety,” Jones says.

Otherwise, a growing number of software vendors are waiting to pounce. Warns Jones, “[Cincom] is only the tip of the iceberg.”