Software Repossession: Technological Novelty or Corporate Terrorism?

The following paper will take a recent and controversial topic that previously did not have a legal opinion issued and form such an opinion. The actual case was settled out of court, but had this case gotten to trial, the following scenario would have likely taken place . . .

Revlon Group, Inc. v. Logisticon, Inc

Superior Court of Santa Clara County
State of California
April 16, 1991, Decided
OPINION BY: David D. Johnston, Fictional Judge

Background Information (Facts)

Revlon, the plaintiff, entered into a contract with Logisticon, defendant in this action where Logisticon was to prepare an inventory control and accounting customized software package that would electronically track and disperse inventory shipments utilizing proprietary source code (human readable) developed by Logisticon.

Logisticon prepared the software, installed and utilized by Revlon during the last half of 1990. Revlon had paid a total of $420,000 in progress payments toward a final delivery price of $600,000. An additional phase of another $600,000 was not contractual obligated, but was left as an option.

During the software delivery and installation phases certain minor problems or "bugs" were detected but did not substantially impair day to day operations or prevent the shipping of products and the electronic processing of orders.

On October 9, 1990, Revlon informed Logisticon that payment of the final $180,000 will not be made until all the software "bugs" are resolved and added the additional condition that the proprietary source code be delivered to Revlon. Revlon claimed that the software did not generate sales receipts or update inventory records properly.¹ Notice was also given that the follow on option of the second phase of the contract would not be exercised.

Had Revlon received the source code for which they had not originally contractually provided for, their own software staff could have completed phase two of the original contract. The defendant has identified the value of the proprietary software as worth several million dollars.

At 2:30 AM on the morning of October 16, 1990, Logisticon electronically "repossessed" the inventory control and accounting software that they had developed for Revlon. This consisted of the executable (machine readable) code. After several months of fruitless negotiations, Logisticon resorted to what they referred to as electronically repossessing software resident in Revlon's computer system. Logisticon used telephone lines and called up the Revlon computer with the access code given to them by Revlon. This crippled Revlon's warehouse distribution centers for three days in Edison, N.J. and Phoenix, Arizona until Logisticon restored the software.² Workers were idled at the warehouses and product shipments and sales were delayed amounting to $20 million. Revlon sued Logisticon for breach of contract, misappropriation of trade secrets and trespassing. Logisticon then cross-filed for breach of contract and damages.

Findings of Fact by the "Court"

The "Court" finds that a valid software design contract with a lease agreement of the software including a security interest did exist. [Since the actual contract was not available to this fictional court, typical contract terms involving a software lease are included as Exhibit A]. Many commercial software contracts provide that this type of agreement be automatically terminated either at the end of development effort if the software is not accepted or if any provisions of the license agreement are breached. The original program or partial reproductions are often required to be returned immediately upon termination or cancellation of these types of agreements.³ Government contracts, on the other hand, almost always provide for the contracting government agency to retain the rights to the software so that a new contractor will be able to pick up where the terminated contractor left off⁴, especially in Defense Department contracts.

Secondly, Revlon is found to have negotiated to the point of impasse by requiring the source code in addition to already possessing the executable code (machine readable) before further payment is made.

Minor "bugs" did exist in the software requiring correction by Logisticon. Logisticon did indeed remove the executable code from the storage disks of Revlon's computer system by electronic means through their authorized telephone line access via their computer modem.

Discussion

On the first issue of Breach of Contract, Revlon claims that the software did not function properly. Logisticon claimed that they had no leverage with the corporate giant, Revlon, in bargaining for the remainder of $180,000 in payments owed them. Logisticon claimed that the problems or "bugs" were minor and obviously did not affect Revlon's operation to a great degree, because commerce was being conducted using their software. The fact that Revlon was using the software substantially weakens Revlon's claim that software did not perform as intended. Products were being shipped and orders were being processed.⁵ The irony of this claim is that by withholding a substantial amount of the contracted price, $180,000 or 30% of the value of the first phase of the contract, Revlon breached the contract, not Logisticon. Revlon contracted with Logisticon to provide a product to enable them to automatically track and control their inventory as orders were being processed electronically. The preliminary acceptance and use of the program by Revlon for several months indicates that Logisticon did substantially complete their job. Logisticon has established a pattern of completing their work by satisfying some 50 customers in the U.S. and the United Kingdom.⁶ To be penalized 30% is an excessive penalty imposed upon Logisticon by Revlon. Furthermore, the additional condition that Logisticon supply the human readable proprietary source code software listings to Revlon for the final $180,000 payment is so far out of scope of the original contract value of $600,000 as to be considered an unreasonable "request". If Revlon had wanted the software listings in the first place then they should have contracted for them in the first phase of the contract and had Logisticon draw up a licensing agreement. In the current situation, Logisticon could conceivably postulate that Revlon was going to use the "extorted" source code listings to either have another company pick up where they (Logisticon) left off or maintain the software in-house without incurring the significant Research and Development cost that Logisticon had already borne. As indicated before, Logisticon's President, Donald Gallagher, estimated the value of the source code listings as several million dollars.

Under the self-help clause of Repossession in the Uniform Commercial Code (UCC) act, Section 9-503, Logisticon can make the claim that Revlon was in possession of their property (the collateral) and without judicial process, repossess the collateral if this can be done without a breach of the peace. ⁸

The courts have held that entering someone's private residence during the repossession of property constitutes a breach of the peace, but the entry onto business grounds generally does not as long as forced entry is not required.⁹ The question of Logisticon's legitimate access authority versus Revlon's claim of trespass is crucial here. The fact that Judge Ronald Whyte of Santa Clara County declined Revlon's request to issue a temporary restraining order against Logisticon helps strengthen Logisticon's claim of legitimate access ¹⁰

Many states have statutes forbidding telephone access that is out of the scope of the granted privilege.¹¹ Judge Whyte's sympathy with Logisticon seems to weigh the matter of legitimate access up against the legitimate security interest Logisticon has in their intellectual property. In going after their property, was the peace breached here by an unauthorized entry by Logisticon to Revlon's work place? Courts have ruled on this countless times and generally hold if a forced entry is used, such as breaking a lock on a door, then a breach of peace occurred.¹² Here, Logisticon already possessed a legitimate copy of "electronic" keys to the work place. In this case, Logisticon used a previously authorized mode of entry and entered the premises electronically which is discussed later in the third issue of trespass.

The irony of the second claim in the Revlon lawsuit of misappropriation of trade secrets seems to be misplaced. Logisticon might have been in possession of pricing information Revlon uses when shipping, billing and accounting for their cosmetic lines when the software was being developed. Revlon had entrusted Logisticon with the information before, without risking disclosure of this information to Revlon's competitors. The likelihood of such disclosure now still seems remote given Logisticon's fiduciary duty of loyalty to Revlon as an agent of the corporation.¹³ Logisticon was simply trying to get paid for the work they had accomplished. If anything, Revlon should be accused of misappropriation of trade secrets by trying to coerce Logisticon in supplying the source code for free. It is the industry norm to enter into a licensing agreement with a software developer that spells out in great detail beforehand how the licensee may modify and extend its use beyond the capabilities supplied by the vendor. A "last minute" contract modification of this magnitude by Revlon is clearly unreasonable, and coercive behavior on the part of Revlon.

On the third claim by Revlon in its lawsuit of electronic trespassing, the court finds that Revlon has given Logisticon access to their computer system using modems working over telephone lines to conduct normal business operations related to the development of their business application software. The real issue of trespass usually leads one to examine if the owner's property has been interfered with.

On this third lawsuit claim of trespass, we find that the access code given to Logisticon for development and maintenance work on the Inventory Control and Accounting software for Revlon was an authorization to enter Revlon's place of work electronically. The so called computer "hacker" programmers are typically outsiders posing as legitimate users.¹⁴ If Logisticon had damaged the data already belonging to Revlon then the court could uphold the claim that Logisticon had interfered with Revlon property. The Software Engineer at Logisticon responsible for the electronic repossession maneuver was careful enough not to destroy or disturb the data, just render it useless without having an application software program resident on the computer to use it. Revlon's property that they were clearly entitled to possessing remained in place.

Judgment

This court finds that the $180,000 that Revlon withheld citing critical performance problems with Logisticon's software to be excessive (30% of the contract value). Revlon will pay Logisticon $120,000 as progress payments for the work already substantially completed.

Logisticon will resolve the minor bugs or software problems in the system to conventional operating commercial software standards. At such time, Logisticon will be paid the final $60,000.

Any claim for damages by Revlon caused by Logisticon's temporary repossession were clearly undercut by public statements made to the contrary by Revlon's Special Counsel and Vice President of Public Affairs, James Conroy.¹⁵ No damages will be awarded to Revlon in this action.

Court costs will be assessed against Revlon. Attorney fees approved by this court will also be assessed against Revlon.

Concluding Remarks

The Congress of the United States has long held the view that they have distrusted concentrations of economic power. This case has illustrated the use of such power by Revlon with over $3 billion in sales per year that was used over one of their contractors, Logisticon with only $20 million in sales per year. Revlon in this case clearly used their economic power to either intimidate or force Logisticon into an inferior bargaining position.¹⁶ As indicated before, Revlon's actions were clearly intended to force Logisticon in providing more than the services originally contracted for. What started out as a simple breach of contract case might have gone through some modern technological turns but essentially remains a case where a contract was breached.

Exhibit A: Sample Lease Agreement

Logisticon Incorporated
Licensed Programs
Software Development/Lease Agreement

Logisticon Incorporated, a California Corporation, (hereinafter referred to as "Logisticon"), desires to develop and lease to Revlon Group, Inc. (hereinafter referred to as "Company") the licensed program and user documentation, collectively referred to as "Program" under the terms and conditions appearing in this Agreement.

PURPOSE: This Agreement is entered into for the purpose of allowing the Company to evaluate and utilize the Program to be used in their inventory control and accounting activities.

PROTECTION AND SECURITY: The Company will not disclose any information concerning this Agreement or the Program or provide or otherwise make available the Program to any other person, firm or corporation, except as provided in this Agreement. The Company shall have no obligation with respect to information which becomes public through no wrongful act by the Company; or if the information is independently developed by the Company without breach of this Agreement.

PRODUCT DEVELOPMENT: The Program and business/plans disclosed by Logisticon to the Company in connection with the Program are subject to change.

TERMS AND CONDITIONS:

1. LICENSE

Logisticon grants a nonexclusive nontransferable license to the Company to use the Program during the development and evaluation period for the purpose stated in this Agreement. The Company acknowledges that the Program is a trade secret containing substantial valuable know-how developed by Logisticon and agrees that it will not reverse compile or dissemble the Program. The Company agrees not to provide, or otherwise make available, the Program, or portions or copies thereof, including but not limited to, program listings, object code or source code, in any form, to any person other than the Company's employees, without prior written consent from Logisticon, except under the terms and conditions of this Agreement.

2. TRANSPORTATION AND DELIVERY

Logisticon will pay all transportation and shipping costs for the Program to the Company's place of business and for the return upon termination of this Agreement.

3. TITLE, RISK OF LOSS AND DAMAGE

Title to the original and any whole or partial reproductions of the Program shall remain with Logisticon.

The program is intended for normal usage. The Company shall be responsible for any loss or damage to the Program from the time of delivery of the Program to the Company and until its return to Logisticon.

4. WARRANTY

Logisticon warrants that is has the right to grant temporary use by the Company of the Program during the development and evaluation period. Upon acceptance and payment in full by the Company the use shall be granted in full.

5. TERMINATION

This Agreement shall be automatically terminated at the end of the evaluation period or canceled if the Company fails to use the Program for, or uses the Program other than for purposes specified in this Agreement or becomes insolvent or makes an assignment for the benefit or creditors, or in any part thereof is incumbered, pledged, or attached, seized or taken under any judicial process.

The original Program plus any whole or partial reproductions(s) of the Program shall be returned immediately to Logisticon upon termination or cancellation of this Agreement.

6. EXPORT RESTRICTIONS

This program furnished hereunder may be subject to U.S. Export Control Laws and Regulations. Accordingly, The Company shall not transfer such Program directly or indirectly to any third person or firm, country or countries, without the specific authorization from Logisticon.

Endnotes

1. Maureen Molloy, "Small software firm wages war on Revlon order net", NETWORK WORLD, The Newsweekly of User Networking Strategies, Vol 7, Number 44, October 29, 1990, p.61.

2. Sally Cusack, "Revlon Riles Software Vendor", Computerworld, 29 Oct. 1990, p. 6.

3. Maxwell Oppenheimer, Interview via telephone at Venable, Baetjer and Howard, Baltimore, Maryland, April 12 and 15, 1991.

4. 48 CFR (Chapter 1).

5. Molloy, p. 61.

6. Ken Siegmann, "Computer Firm Shuts Down Revlon: Giant cosmetics company sues small software vendor over incident", The San Francisco Chronicle, 25 October 1990, p. A1.

7. Molloy, p. 61.

8. UCC, Section 9-503.

9. James J. White, Robert S. Summers, Handbook, Uniform Commercial Code, Second Edition, Hornbook Series (West Publishing Co., 1980), Section 26-6, pp. 1095-1096.

10. Ken Siegmann, "Software supplier 'repossesses' Revlon computer systems", Chicago Tribune, 28 October 1990, p. 8, Zone: C.

11. Max Oppenheimer Interview, April 15, 1991.

12. White and Summers, p. 1095.

13. F. William McCarty and John W. Bagby, The Legal Environment of Business(Homewood, IL: Irwin, 1990), p. 398.

14. Clifford Stoll, The Cuckoo's Egg (New York: Doubleday, 1989), p.71.

15. Richard Diennor, "Revlon seen unhurt by computer closing; Computer software tampering", Women's Wear Daily, 26 October 1990, Vol. 106, No. 82, p. 10.

16. Louise Kehoe, "Software group sued over alleged hacking", Financial Times, 26 October 1990, Section I, p. 20.

Bibliography

Black's Law Dictionary 1301 (6th ed. 1990)

Code of Federal Regulations, Vol. 48, Chapter 1: Federal Acquisition Regulations

Cusack, Sally. "Revlon Riles Software Vendor", Computerworld, 29 Oct. 1990, p.6

Diennor, Richard. "Revlon seen unhurt by computer closing; Computer software tampering", Women's Wear Daily, 26 Oct. 1990, 106, No. 82, p. 10.

Kehoe, Louise. "Software group sued over alleged hacking", Financial Times, 26 Oct. 1990, Section I, p 20.

McCarty, F. William and John W. Bagby. The Legal Environment of Business. Homewood, IL: Irwin, 1990.

Molloy, Maureen. "Small software firm wages war on Revlon order net" NETWORK WORLD, The Newsweekly of User Networking Strategies, 7, No. 44, 29 Oct. 1990, p. 61.

Oppenheimer, Maxwell. Telephone interview with Logisticon's Lawyer of Venable, Baetjer and Howard, Baltimore, Maryland, April 12 and 15, 1991.

Siegmann, Ken. "Computer Firm Shuts Down Revlon" Giant cosmetics company sues small software vendor over incident", The San Francisco Chronicle, 25 Oct. 1990, p. A1.

Siegmann, Ken. "Software supplier 'repossesses' Revlon computer systems" Chicago Tribune, 28 Oct. 1990, p. 8, Zone: C.

Stoll, Clifford. The Cuckoo's Egg: Tracking a Spy Through the Maze of Computer Espionage. New York: Doubleday, 1989.

UCC, Section 9-503: Secured Party's Right to Take Possession After Default

White, James, J. and Robert S. Summers. Handbook, Uniform Commercial Code. St. Paul, Minn.: West Publishing Co., 1980.

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