Times might seem right to restructure or consolidate a couple of your affiliate entities. The companies have long been under common ownership. The merger is really simple because state law provides that the surviving company automatically succeeds to the assets of the merging company, right? The tax advisors say it is a "go." So, what is the problem?
As illustrated in Cincom Systems, Inc. v. Novelis Corp., 2009 WL 3048436 (6th Cir. Sept. 25, 2009), a problem might arise from the license terms for software or other copyrighted or patented rights that are used by the merging company. The federal district and appellate courts in Cincom deliver a clear and blunt reminder that copyright and patent licenses are treated differently than other assets when it comes to mergers.
A Tale of Woe
At first glance, the facts may seem innocuous. During 1989, Cincom, a software developer, licensed rights to use certain software programs to Alcan Ohio, Novelis’ predecessor. Cincom was the developer of the software and owned the copyrights to the software.
Several years later, the ultimate corporate parent of Alcan Ohio decided to reorganize and consolidate some of its subsidiaries. As a result, Alcan Ohio was merged into an affiliate which was merged with other affiliates, all under common control of the ultimate parent. The resulting consolidated company was renamed Novelis. These mergers had little or no effect upon operations at the facilities formerly owned and operated under Alcan Ohio. The licensed software continued to operate on the same computer, at the same location, as it had before the merger. Use of the software was not expanded within Novelis. The only difference was that a different legal entity now owned and operated the computer on which the software was installed.
After learning of Alcan Ohio’s merger, Cincom objected to Novelis’ continued use of the software. Cincom noted that the software license provided that "Customer shall not transfer its rights or obligations under this Agreement without the prior written approval of Cincom." In response, Novelis pointed to and relied on state law dealing with mergers to argue that no transfer had taken place.
Cincom then sued Novelis for copyright infringement, alleging that Novelis was using the software without a license because the software license could not pass from Alcan Ohio to Novelis without Cincom’s consent, whether by corporate merger or otherwise.
During the course of litigation, Novelis argued that, because the state merger statute governed what assets passed via merger, state law also ought to determine whether the software license passed from Alcan Ohio to Novelis. Novelis pointed out that the relevant state merger law (as in most states) provides that the surviving company automatically succeeds to the assets of the merging company without any further action by either party. Therefore, according to Novelis, the software license passed automatically from Alcan Ohio to it by operation of law.
Both the U.S. District Court and the Court of Appeals for the Sixth Circuit unequivocally rejected Novelis’ argument. Both courts concluded that the surviving company of a merger does not automatically succeed to the copyright and patent licenses of the merging licensee, unless the copyright or patent licensor gives its express consent. Express consent can be given within the license itself or in a separate document. Here, the license from Cincom included a provision prohibiting assignments without Cincom’s consent. The Sixth Circuit clearly noted that the result would have been the same if the software license had been silent on the point (silence is golden, for the licensor). The only way the result would have been different is if the license had expressly permitted the transfer or assignment or if Cincom had otherwise given its express consent. Novelis, of course, did not seek Cincom’s consent because it did not believe that consent was necessary under state law.
The Sixth Circuit acknowledged that, as a general proposition, state law does govern mergers and state law also apply to licenses—even copyright and patent licenses. However, federal law intrudes just enough to govern and preempt when it comes to the assignment of copyright and patent licenses. This federal intrusion is necessary to protect the integrity of the federal copyright and patent systems. Novelis simply failed to recognize that it needed to secure consent for continued use of Cincom’s software after Alcan Ohio’s merger with an affiliate. The result is probably even more distressing to Novelis because the software, while important to sustain Alcan Ohio’s ongoing operations immediately following the merger, was not central to the merger decision and may have been of only negligible operational significance to Novelis in the long run.
Apart from the cost of litigation, the result was that Novelis was required to again license the software from Cincom, at a cost of more than $400,000.
1. If you are the licensee of patents or copyrights, get the licensor’s express consent to the assignment of the license within the license itself. If a broad consent cannot be obtained, then ask for limited consent to cover transactions that, like the Alcan Ohio merger, result in the transfer or assignment of the license to an affiliated entity owned by or under common ownership or control with the licensee. This should be the standard for licensees. Exceptions to the standard should be noted for easy identification as part of due diligence prior to closing any merger.
2. Yes, intellectual property due diligence is a necessary evil in any merger. All mergers, even "housekeeping" mergers between affiliated entities under common ownership, require a review of the merging entity’s copyright and patent licenses (including software and database licenses) to determine whether they contain express language permitting their assignment and, if any do not, to obtain express consent.
3. If the license is silent on the issue of transfer or assignment, then the licensor’s consent is required (see lesson number 4).
4. If the license is silent or if licensor expressly reserves the unfettered right to approve or reject any proposed transfer or assignment of the license, the licensor’s consent is required. If so, the licensor might be able to hold future transactions hostage by withholding its consent to the assignment, conditioning consent on payment of additional fees or acceptance of new license terms.
The opinions expressed in this bulletin are intended for general guidance only. They are not intended as recommendations for specific situations. As always, readers should consult a qualified attorney for specific legal guidance.