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Microsoft Corp. v. DAK Indus., Inc.
Court	United States Court of Appeals for the Ninth Circuit
Full case name	Microsoft Corporation v. Dak Industries Incorporated
Decided	October 2, 1995
Citation(s)	66 F.3d 1091
Case history
Prior action(s)	27 Bankr.Ct.Dec. 118 (Denied Microsoft's administrative expense claim)
Court membership
Judge(s) sitting	William A. Fletcher, Melvin T. Brunetti, and Thomas G. Nelson
Case opinions
Buying a lump sum of software was found to be equivalent to buying a lump sum of physical goods when considering the 'economic realities' of the deal, even if it was sold under a license providing a 'permission-to-use' the information property.

Microsoft Corp. v. DAK Indus., Inc. 66 F.3d 1091 (9th Cir 1995) is a court case in which Microsoft contends that in being licensed the rights to sell Microsoft Word (Word) software units, the then bankrupt DAK Industries had been granted permission to use this Intellectual Property and Microsoft was therefore entitled to continued payments post-bankruptcy in the form of royalties for its use. The court disagreed, believing that the 'economic realities' of the agreement in which payments for a certain number of copies of Word were made in the form of installments meant that the agreement should be considered as a 'lump sum sale of software units' even if the agreement was called a license that required 'royalties' instead of 'payments'. Microsoft was therefore unable to claim special interest over the bankruptcy claim as it was a transfer of goods in the form of a sale, making them an unsecured creditor.

Background

DAK Industries, a supplier of computer hardware entered into a License agreement with Microsoft, a software distributer, that would grant DAK the rights to distribute and license copies of Microsoft Word on the computers it sold during the term of the agreement. Microsoft provided a master disk to DAK which would be used to load the Microsoft Word software onto the computers DAK was to distribute. Payment for this license agreement would follow a 'royalty rate' of $55 for each copy of Word that is distributed - however DAK had to make a minimum commitment to Microsoft of $2,750,000 to be paid in 5 installments over 1 year irrespective of the number of copies DAK managed to sell. DAK was therefore entitled to distribute up to 50,000 units, with any additional units attracting an additional $55 charge each. DAK made the first three installments to Microsoft however filed for bankruptcy before completing the remaining payments. After bankruptcy, DAK's debtor continued to sell copies of Microsoft Word without making the remaining payments.

Microsoft alleges that it was entitled to 'administrative expenses' from DAK's debtor in that it should be compensated for the continued use of the license agreement that allowed distribution of the software.

District Court and Bankruptcy Court opinion

Microsoft initially made this claim at the bankruptcy court who denied it on the basis that even though Microsoft had labelled the agreement as royalty payments for continued intellectual property, it was more like installment payments on the sale of goods. This made the debt owed to Microsoft an unsecured claim. On appeal to the district court affirmed this decision stating that Microsoft was not facing any continued expenses in DAK's distribution of Word. Microsoft appealed this decision to the United States Court of Appeals for the Ninth Circuit.

Opinion of the court

The court raised several reasons for why it believed that the 'economic realities' of the deal between Microsoft and DAK indicated that the agreement meant a lump sum sale of software rather than permission to use the Word Intellectual Property:

• The pricing structure in which DAK was required to make a minimum commitment was based on the number of units DAK received from Microsoft rather than a duration of time that DAK could use the Microsoft Word software as would be expected in a rental agreement
• The agreement meant that DAK had to pay entire $2,750,000 even if it only ever sold one copy, and DAK at the time of the agreement was entitled to sell the entire amount agreed to. The court took this to be similar to the purchase of goods on unsecured credit whereby DAK makes a down payment, obtaining the goods and would pay the remainder in instalments. DAK did not have to pay at the time it actually sold a copy of the Word software like one would expect in a rental agreement
• The license agreement effectively gave DAK a 'right to sell' rather than 'permission to use' the Word IP: it sold Word directly to customers rather than using it as part of its business
• DAK's post-bankruptcy use of Word was at no expense to Microsoft - DAK was already allowed to sell 50,000 copies of Word

The court found that simply naming something as a license and denoting the payments as royalties did not in fact make it a license in terms of intellectual property. Furthermore the court found that DAK's sales indicate it did not sell all of the units it was entitled to under the agreement and since Microsoft did not have a business relationship with DAK after bankruptcy granting this claim to Microsoft would be unjust to other unsecured creditors - DAK was required to carry all of the risk of the deal. The court supported the decision of the bankruptcy and district courts to deny Microsoft this claim.

Subsequent developments

Other cases

The idea of courts looking at the 'economic realities' of a deal to decide if a transaction was a sale or a 'license to use' was applied in the case SoftMan Products Co. v. Adobe Systems Inc.. When a consumer purchased Adobe software, they received a single copy for which they paid for in entirety and where the 'license' was valid forever - Adobe argued that consumers were merely given a licence to use the software rather than being sold the software. However the court found that, like in DAK, the nature of this transaction indicates the sale of goods and hence the First sale doctrine would apply. In Universal Music Group v. Augusto, the court looked at the 'economic realities' of the transaction involving UMG distributing promotional music CDs to 'music industry insiders' and found that since UMG provided the CDs with no intention of recovering them, there was a transfer of title. This was despite UMG labeling ('licensing') the CDs with certain constraints on their usage such as limiting resale. Because the constraints on the CDs were not valid, the defendant was able to sell the promotional CDs under the first sale doctrine.

Criticism

In a different interpretation, it is argued that DAK was provided with a non-exclusive license to distribute Word - they were only entitled under the license to use the master disk in order to provide additional copies of Word as per a royalty scheme. DAK was only making the units of Word it needed for the duration that it was allowed to use Microsoft's Word master disk. Any payments made by DAK were merely an advance against potential royalties: a common agreement in book and motion picture licenses. Therefore, contradicting the court's opinion, the way in which DAK was able to sell copies of Word should be seen as permission to use the intellectual property (use of the master disk) rather than a 'sale of goods' in the way a manufacturer sells a given quantity of goods to a reseller and hence Microsoft should have continued to receive royalty payments as per the initial agreement.

See also

• Microsoft litigation
• Software license
• United States v. Wise
• Vernor v. Autodesk, Inc.

External Links

• Carver, Brian W., Why License Agreements Do Not Control Copy Ownership: First Sales and Essential Copies (March 19, 2010). Berkeley Technology Law Journal, SSRN convenience link