Second Circuit Case Underscores Limitations on Licensing Claims Involving Copyrighted Software

A licensor of copyrighted software is often faced with two potential pathways for a claim that the copyrighted material was misappropriated: (1) a claim under the Copyright Act or (2) a claim for breach of the licensing agreement. A recent decision from the U.S. Court of Appeals for the Second Circuit, Universal Instruments Corp. v. Micro Systems Engineering, Inc., 924 F.3d 32 (2019), sheds some light on when the Copyright Act might preclude assertion of the contract claims.

The plaintiff in this case, Universal Instruments Corporation (“Universal”), designed and sold an automated system for the handling of medical devices during quality testing to defendant Micro Systems Engineering, Inc. (“MSEI”), pursuant to a purchase agreement (“Purchase Agreement”). MSEI had developed a multi-phase plan to build the system, and Universal had performed its work as part of the first development phase. However, MSEI awarded the second and third phases of the project to a Universal competitor, Missouri Tooling & Automation, Inc. (“MTA”). In implementing phases two and three, MSEI and MTA used computer source code that Universal had provided to MSEI for phase one and modified the code in order to better adapt it to the second and third phases.

Universal believed that its intellectual property was being infringed and brought an action alleging, among other things, that MSEI and MTA had infringed Universal’s copyright in its source code in violation of the Copyright Act and had violated restrictions on the use of its source code in the Purchase Agreement. During the course of a jury trial on these claims, the trial court granted defendants’ motion dismissing these claims, and Universal appealed to the Second Circuit.

Both the trial court and the Second Circuit determined that under the unambiguous language of the Purchase Agreement, MSEI had properly permitted MTA the use of the source code in the second and third phases of the project. Universal then went on to contend that: (1) the alteration of the code for the second and third phases of the project was not permitted under the Copyright Act and (2) the alteration of the code was a breach of contract, in that the alteration was unauthorized under the Purchase Agreement. The Second Circuit rejected the first branch of this argument, determining that the alteration did not violate the Copyright Act because of an affirmative defense under the Copyright Act allowing the owner of the copyright (and MSEI was deemed an owner) to modify a computer program for limited purposes (17 U.S.C. § 117(a)).

This brings us to the breach of contract claim asserted by Universal for alteration of the source code. The Second Circuit did not address the merits of the claim, because it instead determined that the breach of contract claim was preempted by the Copyright Act. The Second Circuit noted that the Act exclusively governs a claim, and preempts it, when the particular work to which the claim is being applied falls within the type of works protected by the Copyright Act, and where the claim seeks to vindicate legal or equitable rights that are equivalent to one of the bundle of exclusive rights already protected by copyright law under 17 U.S.C. § 106— “reproduction, performance, distribution or display.”

The way that a party may avoid preclusion is by claiming a state law remedy not available under the Copyright Act. Typically, a party asserting a breach of contract claim will be seeking damages for breach of the contract, relief which is outside the scope of the Copyright Act and will therefore be permitted to avoid preclusion of its contract claim. However, here, the Second Circuit determined that Universal was not in fact seeking money damages for breach of contract; indeed, it had received all contract payments to which it was entitled. Instead, it was attempting to police and preclude the use of the altered software in phases two and three of the project— of the very type available under the Copyright Act. For this reason, the Second Circuit upheld the trial Court’s dismissal of all breach of contract claims in the case.

This article is intended only as a general discussion of these issues. It is not considered to be legal advice or relied upon. We would be pleased to consider providing additional details or advice about specific situations. For additional information on this topic, please feel free to contact Mark H. Moore, who regularly counsels and litigates for clients in connection with business disputes.