California Court of Appeal, 6th District, August 12, 2009

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  • California Court of Appeal reverses trial court’s decision and holds that defendant, who licensed CSS technology from plaintiff DVD CCA and developed a home entertainment system that allows a user to play a movie without the physical DVD, was bound by the General Specifications provided by plaintiff, even though that document was not specifically referenced in the DVD CCA standard license agreement; appeal court instructs trial court to determine if defendant breached the license agreement and whether to issue a permanent injunction Plaintiff DVD Copy Control Association (DVD CCA) is a not-for-profit organization consisting of companies in the motion picture, consumer electronics and computer industries. It licenses encryption technology called Content Scramble System (CSS) which is used to prevent unauthorized copying of movies and other copyrighted content stored on DVDs.

Defendant Kaleidescape, Inc. licensed CSS from DVD CCA in order to develop a home entertainment system for viewing movies distributed on DVD. The system Kaleidescape developed (with a retail price of about $10,000) is capable of storing and organizing content from thousands of DVDs. Once stored in the Kaleidescape system, the DVD content may be played back at any time in any room, without the need to reinsert the physical DVD.

DVD CCA provides a standard License Agreement to every licensee that states “Licensee shall comply with the CSS Specifications” and CSS Specifications is defined as “the documentation relating to CSS entitled ‘CSS Specifications’ (including the Procedural Specifications and the Technical Specifications) that Licensor makes available to Licensee.” After executing the License Agreement and paying the administrative fee, Kaleidescape received a master key, specifications for Descramblers, specifications for Authenticators, and General Specifications (which requires that the physical DVD be present in the device when the movie is played).

When DVD CAA learned that Kalediscape’s system allows users to play a movie without inserting the physical DVD, it sued for breach of contract. Kaleidescape asserted that the document titled General Specifications was not part of the License Agreement because it was not referenced or incorporated by the License Agreement. The trial court agreed with Kaleidescape’s analysis and ruled in its favor. The trial court also stated that it was not offering any opinion about whether Kaleidescape actually breached the contract.

The trial court also ruled on the issue of specific performance. Prior to trial, DVD CCA abandoned any claim for damages and sought only specific performance or preliminary injunction. The trial court held that the terms of the License Agreement were not sufficiently definite to allow for specific performance, and injunctive relief was unavailable because DVD CCA had not shown it would suffer irreparable harm.

The California Court of Appeal reversed and remanded. Regarding the breach of contract claim, the court concluded that “the mutual intent of the parties at the time the License Agreement was signed was that DVD CCA would grant Kaleidescape permission to use CSS in exchange for the payment of an administrative fee and Kaleidescape’s promise to build its system according to specifications that DVD CCA would later provide. This promise is express and complete on the face of the License Agreement. The undisputed extrinsic evidence shows that General Specifications was one set of specifications that DVD CCA provided to Kaleidescape pursuant to this arrangement.”

The Court of Appeals began by stating that the incorporation-by-reference doctrine is inapplicable under the circumstances. According to the court, the general rule is that the terms of an extrinsic document may be incorporated by reference in a contract so long as (1) the reference is clear and unequivocal, (2) the reference is called to the attention of the other party and he consents thereto, and (3) the terms of the incorporated document are known or easily available to the contracting parties. However, the court explained that applying this doctrine would be “directly contrary to the unambiguous intent of the parties as expressed in the License Agreement, which was that the licensee would comply with the specifications that DVD CCA provided after the agreement was signed.”

The court acknowledged that DVD CCA had an interest in not disclosing the CSS technology until after a licensee signed a License Agreement. According to the court, “[t]he overarching and undisputed intent of the License Agreement was to allow Kaleidescape to produce a DVD device utilizing CSS to access DVD content while maintaining the confidentiality of the CSS technology. DVDCCA could not distribute confidential information pertaining to CSS absent Kaleidescape’s promise to maintain its confidentiality. Thus, the agreement was made under circumstances that required DVD CCA to withhold the confidential specifications until after Kaleidescape signed the confidentiality provisions contained in the License Agreement. Both parties understood that technical specifications would be provided after the License Agreement was executed. Kaleidescape knew that it was taking a risk that the undisclosed specifications might preclude the type of device it planned to make. All three sets of specifications, identically formatted, were delivered together, along with the master key, promptly after the agreement was executed, indicating that General Specifications was one set of CSS specifications that DVDCCA was providing pursuant to the License Agreement.”

The court also examined the extrinsic evidence to determine whether the agreement was reasonably susceptible to the meaning Kaleidescape asserted. The court noted that Kaleidescape’s compliance memo to DVD CCA after receiving the various specification documents showed that, before this litigation began, Kaleidescape understood that General Specifications was included among the undisclosed specifications to which the License Agreement referred.

The court concluded that “under the License Agreement, Kaleidescape promised to comply with the technical specifications pertaining to CSS that DVDCCA would provide. General Specifications falls within the scope of that promise and, therefore, Kaleidescape is obligated to comply with its requirements insofar as they are pertinent to its system.” The court also stated that it was not offering any opinion about whether Kaleidescape actually breached the contract and remanded that issue back to the trial court.

The Court of Appeal also reversed the trial court’s conclusion that it could not order specific performance because the terms of the contract were not sufficiently definite for the court to know what to enforce. The Court of Appeal held that a specific performance order cannot be crafted unless and until the trial court decides that Kaleidescape is in breach; “[r]esolution of that issue will clarify the meaning of the terms.”

The Court of Appeal also reversed the trial court’s conclusion that DVD CCA had suffered no irreparable harm, a necessary element for obtaining a permanent injunction. The License Agreement stated that “in the event that Licensee breaches its obligations . . . , money damages alone will not adequately compensate an injured party . . . [and DVD CCA] will be entitled to specific performance or other temporary, preliminary, or permanent injunctive relief.” DVD CAA urged the court to treat the stipulation as a liquidated damages clause or a consent decree. According to the court, there is no published California case holding that such stipulations are enforceable, and DVD CCA’s approach would be “the prudent approach.” The court concluded that the trial court must first determine if Kaleidescape breached the License Agreement, and the nature and extent of the harm, and whether DVD CCA can be remedied in damages. If not, the Court of Appeal said the trial court should enforce the stipulation stating that a breach would result in irreparable harm.