First published in LES Insights

In license negotiations, licensees may want their affiliates or subsidiaries to be included in the scope of its license. While such provisions are often drafted with careful consideration as to what degree of control is required for an entity to be a licensed affiliate or subsidiary, it can also useful to consider specifying at what time such control must exist. Specifically, given the length of many license agreements, it is likely that during the term of an agreement new subsidiaries or affiliates may be created or acquired and existing affiliates and subsidiaries may be spun out. A recent case in the U.S. District Court for the Central District of California, nQueue v. Control Systems (USA),1 illustrates issues relating to defining a licensee's related entities.

Background

Both nQueue and Equitrac Corporation develop software designed for multifunction photocopy machines. In 2011, nQueue sued Equitrac for patent infringement. The case settled on July 19, 2012, pursuant to a settlement agreement, in which nQueue granted a license to Equitrac.

Section 2.4 of the settlement agreement granted "to Equitrac and its Affiliates," a license under the Patents-in-Suit for Licensed Products, including the right to convey to any customer of Equitrac or its Affiliate the rights to use and resell Licensed Products. Section 1.2 of the agreement defined an "Affiliate" as any entity that controls, is controlled by, or is under common control with that Party, directly or indirectly, as of the Effective Date of the agreement. Section 1.4 of the settlement agreement, however, defined "Licensed Products" as products of any entity acquired by a Party or Affiliate without reference to a specific date. Section 1.4 further provided that products acquired by a Party or Affiliate would not be licensed if they were "materially different" then the Licensed Products sold by Equitrac as of the date of its acquisition.

In August 2012, after execution of the settlement agreement with Equitrac, nQueue sued another software developer, Control Systems, for infringement of the same patent nQueue had asserted against Equitrac. Control Systems had developed a software program called Copitrak, which was similar to that sold by Equitrac. Shortly thereafter, in December 2012, an entity named 0956899 B.C. Unlimited Liability Company ("B.C."), an indirect, wholly owned subsidiary of Equitrac, acquired Control Systems' parent corporation. As a result of this acquisition, Control Systems contended that it became an "entity acquired by a Party" as set forth in the definition of Licensed Products. Control Systems further argued that its Copitrak product was not materially different from nQueue's products. Accordingly, Control Systems filed a motion for partial summary judgment asserting that it could not be liable to nQueue because Copitrak is a Licensed Product.

Decision

In opposition to Control Systems' motion for summary judgment, nQueue argued that Copitrak is not a Licensed Product because: (1) Control Systems did not establish that it is an "entity acquired by a Party of Affiliate"; and (2) Copitrak is materially different from the Licensed Products. nQueue futher argued that the license provision was inapplicable because Control Systems is not Equitrac or one of its suppliers, nor is Control Systems a customer of Equitrac or one of its Affiliates. Applying the principles of California contract law, the court held that, although Control Systems' products were Licensed Products, Control Systems itself did not qualify as a licensee under the agreement.

In determining that Control Systems' products, including Copitrak, were Licensed Products, the court rejected nQueue's argument that Control Systems is not "an entity acquired by" Equitrac or its Affiliates in accordance with Section 1.4 of the agreement. Control Systems provided evidence that, at the time of the court's decision, it was an indirect, wholly owned subsidiary of Equitrac and is therefore indeed an entity acquired by a Party or Affiliate. Specifically, while the connection was rather convoluted, Control Systems proved that it was a wholly owned subsidiary of Nuance Copitrak B.C. Unlimited Company ("Nuance"), and that Nuance was a direct, wholly owned subsidiary of Equitrac. Therefore, the court held that the transitive relationship of the parties supported the conclusion that Control Systems was an indirect, wholly owned subsidiary of Equitrac. As such, Control Systems was an "entity acquired by a Party" to the settlement agreement, and its products were therefore Licensed Products under Section 1.4.

Although the court found that Control Systems' products were Licensed Products, it determined that Control Systems was not a licensee under the grant clause in Section 2.4 of the settlement agreement. According to the plain language of Section 2.4, Control Systems received the benefit of the agreement only if it was an "Affiliate" of Equitrac, or a customer or supplier. As discussed above, Section 1.2 defined Affiliate as any entity that controls, is controlled by, or is under common control with that Party, directly or indirectly, as of the Effective Date of the agreement. That effective date was when nQueue and Equitrac signed the agreement—July 19, 2012. In its motion, Control Systems admitted that Equitrac did not acquire Control Systems' parent corporation, Nuance, until December 31, 2012. Therefore, the court explained that Control Systems could not be an Affiliate of either Equitrac or Nuance because it was not under the control of either as of the Effective Date of the Agreement.

Control Systems argued that, even if it was not an Affiliate of Equitrac, it was a customer of Licensed Products of Equitrac because it resold Licensed Products acquired from Equitrac's subsidiary. The court rejected this argument because it viewed Control Systems' interpretation of the term "customer" as unfair and unreasonable, particularly in light of the contract specifically including resale as a right granted under the agreement, separate from customer rights.

Further, the court concluded, even if it deemed Control Systems a "customer" under the agreement, Control Systems was not a customer of Equitrac or its Affiliates. In particular, because the agreement limited Affiliates to those existing as of the date of the agreement, Control Systems' parent corporation, Nuance, could not qualify. The court refused to interpret the agreement in way that would nullify the express definition of Affiliate.

Finally, the court rejected Control Systems' argument that the scope of Section 2.4 (regarding which company was licensed) must be commensurate with the scope of Section 1.4 (regarding the scope of licensed products). With this argument, Control Systems contended that because the court held that its products were indeed Licensed Products under Section 1.4, Control Systems was necessarily one of the qualified entities listed in the grant clause of Section 2.4 The court rejected this argument and explained that it was not unreasonable for nQueue and Equitrac to have intended that only Equitrac could sell products made by a company it acquired. Under that result, nQueue retained more control over infringing sales, which the court presumed was reflected in the settlement bargain. Stated otherwise, the court did not view its interpretation as absurd or unreasonable because it could think of a logical explanation for the plain language.

Strategy and Conclusion

The treatment of related entities—such as parent companies, subsidiaries, later acquisitions, or customers—is often a consideration when parties strike a deal. This case demonstrates the importance of drafting provisions that address such entities in a manner that takes into account not only what degree of control is required for an entity to be a licensed entity but at what point in time such control must exist.