S.O.S., Inc. v. Payday, Inc., 886 F.2d 1081 (9th Cir. 1989) (full-text).
S.O.S., Inc. specialized in furnishing computer hardware and software to companies that process payroll, ledgers, and accounts receivable. Payday, Inc. provided payroll and financial services to the entertainment industry.
In 1978, S.O.S. acquired from Hagen Systems (not a party to this action) a non-exclusive license to unpublished business software called "Brown Tank." Under this license, S.O.S. could sublicense Brown Tank to end users, but only if Hagen Systems' proprietary and confidential rights in the software were protected. S.O.S. also had the right to prepare derivative works based on Brown Tank.
In 1983, an accountant at Payday, Mike Waldrip, told S.O.S.'s president, Bob Oliver, that Payday wanted to computerize in order to appeal to a prominent client. The initial understanding between the two companies was that S.O.S. would provide the software that Payday would use on Waldrip’s computer instead of installing a computer in its own office.
Oliver at S.O.S. sent Payday a draft contract, and Payday's president signed it, providing for the following: (1) the purchase of a terminal and other hardware to be installed in Payday’s office; (2) the lease of a disk drive and other hardware to be installed at Waldrip’s office. There was also a software agreement.
The software agreement provided in part: “This series of programs is the property of SOS, and Payday is acquiring the right of use, SOS retains all rights of ownership.” There was no discussion in this contract of the terms "copyright" or "trade secrets." The parties did not discuss the meaning of language referring to rights of "ownership" and "use."
The contract was not adequate for Payday's entire business, so the parties modified it in March 1984. Now, Payday was to use S.O.S.’s computer for a monthly fee of $1,500 and in addition, agreed to pay monthly an additional $1,500 against accumulated programming charges. Meanwhile, S.O.S. continued developing programs for Payday as agreed.
Thereafter, two of S.O.S.'s employees left the company, but continued to render services for it. These employees proposed to Payday’s controller, Goodman, that Payday purchase an in-house computer system. Instead, Payday solicited a competing bid from S.O.S. to provide an in-house computer system. One of the employees later went to the S.O.S. office and made a copy of the payroll software and gave it to Payday. They then made an unauthorized entry into S.O.S.’s computer system despite the password changes S.O.S. had made. These employees also committed other unlawful actions. Payday continued to request a copy of the payroll programs from S.O.S. to conceal its software piracy.
Finally, S.O.S. suspected that Payday had copied its programs, and so it registered the payroll programs in October 1985 with the U.S. Copyright Office in anticipation of litigation. Payday continued to modify the payroll programs on its computer. S.O.S. and Payday sued each other.
S.O.S. sued Payday for (1) copyright infringement and pendent state law claims for breach of contract, (2) misappropriation of trade secrets, and (3) account stated. Payday filed several counterclaims under various state law theories, including (a) abuse of process, (b) breach of contract and (c) tortious breach of the covenant of good faith and fair dealing, and sought a declaratory judgment that S.O.S.'s copyright was invalid.
Trial Court Proceedings
The district court dismissed the contract claim on the ground that the contract did not provide for attorney’s fees, which were the only actual damages sought. It dismissed the implied covenant claim on the ground that the contract between the parties did not give rise to the sort of special relationship that would give rise to tort liability.
Appellate Court Proceedings
To prevail on its claim of copyright infringement, S.O.S. must prove: (1) ownership of copyright in the payroll programs, and (2) "copying" of protectible expression by Payday beyond the scope of Payday's license. Payday argued (1) that S.O.S.'s copyright is invalid and (2) that copying and modification of the software by Payday were permitted by the contract. The district court had granted summary judgment to Payday on the second theory, and therefore did not find it necessary to discuss the issue of copyright validity.
The appellate court held that since Payday had a license enabling it to use the payroll programs, it could not infringe S.O.S.’s copyright. Absent a restriction in the contract explicitly disallowing Payday from making modifications, Payday had the unrestricted right to adapt and utilize the program. The court concluded, however, that Payday went beyond the scope of its license when it copied and prepared a modified version of the programs without S.O.S.’s permission. The court remanded on this issue.
Misappropriation of trade secrets
The district court had ruled against S.O.S. on its misappropriation of trade secrets claim against Payday. The facts S.O.S. alleged were basically the same as in its copyright count, with particular attention paid to the way Payday acquired its copy of the software. The misappropriation of trade secrets is when improper means are used to acquire knowledge of the trade secret.
S.O.S. produced evidence that Payday requested a copy of the software from S.O.S., which S.O.S. refused to provide unless some conditions were met. It also produced evidence that Payday obtained a copy through two of S.O.S.’s former employees, who had acquired a copy from the S.O.S. computer without authorization.