Micro Data Base Systems v. Dharma Systems

Citation: Micro Data Base Sys., Inc. v. Dharma Sys., Inc., 148 F.3d 649 (7th Cir. 1998).

Factual Background
The Internal Revenue Service (“IRS”) requested bids for a contract to improve their computer capabilities. Unisys Government Systems, Inc. (“Unisys”) wanted to submit a bid for the project and made a contract with Micro Data Base Systems, Inc. (“MDBS”) for the provision of a workstation database management system. MDBS then made a contract with Dharma Systems, Inc. (“Dharma”) to adapt its copyrighted software program SQL Access (“SQL”) for use in the system that MDBS would be producing for Unisys.

Under the contract, MDBS agreed to pay a license fee of $125,000 for use of SQL, and an additional $125,000 for professional services (Dharma’s work adapting the program), which was to be paid in three installments. Additionally, Dharma requested that MDBS pay a 25% royalty on the sale of each program in which the SQL software was incorporated. MDBS agreed to this provision and assured Dharma that it would do so, however, it refused to sign the agreement.

MDBS paid Dharma the initial $125,000 license fee, and the first 50,000 payment for the professional services. On November 8, 1994, MDBS paid the second $50,000 payment to Dharma when Dharma shipped the beta version of the SQL program to MDBS. MDBS turned the beta version over Unisys for testing.

In May of 1995, Unisys was awarded the contract with the IRS and requested that MDBS send six copies of the SQL program &mdash; one for it to keep and five to sell to the IRS. MDBS requested the copies from Dharma, but Dharma refused to supply them until MDBS signed the License Agreement. MDBS refused, but “upon its written representation to Dharma that ‘it [MDBS] will not distribute this Component [the SQL program] without [Dharma’s] prior written consent.” Dharma backed down and shipped the disks.

A few weeks later, without receiving Dharma’s consent, MDBS shipped the disks to Unisys. MDBS’s cover letter stated that the shipment was for “acceptance testing” and was not “a distribution.” Unisys notified MDBS that the disks contained several minor defects. MDBS contacted Dharma to have the errors corrected, but Dharma refused to do so until MDBS signed the License Agreement. Despite the defects, Unisys paid MDBS the final $25,000 payment and $413,894 in royalties generated by Unisys’s contract with the IRS. MDBS withheld the $25,000 payment and the royalties from Dharma.

MDBS brought suit against Dharma seeking restitution of $225,000 that it had paid Dharma under the contract. Dharma counterclaimed seeking the $25,000 unpaid final installment for professional services and additional damages for misuse of trade secrets embodied in the SQL software program.

Trial Court Proceedings
The District Court ruled that as a matter of law, when a contract is made through the mail or over the phone, yet performed in one state only, the state law where the contract was performed would govern any contractual dispute that arose during performance. Thus, New Hampshire law (where Dharma was located) would govern the dispute rather than Indiana law (where MDBS was located).

The Court rejected MDBS’s claim and held that MDBS and not Dharma had breached the contract. The Court awarded Dharma $25,000 for the unpaid services rendered and $76,867.50 in compensatory damages for the trade secret violations. The Court further ruled that MDBS was not liable for punitive damages. MDBS appealed.

Appellate Court Proceedings
The Appellate Court affirmed the District Court’s holding.

First, the Court ruled that punitive damages were not proper in this case. The Court reasoned that the Uniform Trade Secrets Act limited the award of punitive damages to cases where the violation of the Act was willful and malicious. Here, punitive damages were not proper because this was “a garden-variety trade secret dispute rather than anything that smacks of willfulness or malice-vague term.”

Second, the Court ruled that Uniform Commercial Code (“UCC”) would govern this transaction since the contract was primarily for the sale of a “good” (the SQL software) rather than a service.

Third, the Court affirmed the District Court’s holding that Dharma was entitled to the $25,000 final payment. MDBS contended that the final payment was not due because the software was never accepted by Unisys. MDBS believed this because Unisys did not explicitly notify MDBS of acceptance. Rather, Unisys notified MDBS and Dharma of the defects in the software.

The Court opined that under the UCC, “goods are deemed accepted if the buyer fails, after having had a reasonable amount of time in which to inspect them, to communicate its rejection to seller.” Here, Unisys received the beta version of the software in November of 1994, and did not complain about the defects until May of 1995.

Additionally, despite the defects, Unisys was still able to sell the software to the IRS- which Unisys would not be permitted to do unless it had purchased the software. Thus the Court held that “this conduct shows both that the defects were not serious enough to permit rejection…and that Unisys in fact accepted it.”

Finally, the Court affirmed the District Court’s award of compensatory damages in Dharma’s favor. The Court reasoned that the damages were a “reasonably foreseeable” consequence of MDBS’s misappropriation. Thus, the damages were proper.