166 - Filed & Entered: 10/26/2007
Response (B)
Docket Text: Response to Debtors' Response in Opposition to Novell, Inc.'s Motion for Order Directing the Debtors to Remit Undisputed Future SVRX Royalties to Novell Upon Receipt (related document(s)[90] ) Filed by The SCO Group, Inc. (Attachments: # (1) Certificate of Service and Service List) (O'Neill, James)

167 Filed & Entered: 10/26/2007
Declaration in Support
Docket Text: Declaration in Support Declaration of Jean Acheson in Support of Debtors' Response to Novell, Inc.'s Motion for Order Directing the Debtors to Remit Undisputed Future SVRX Royalties to Novell Upon Receipt (related document(s)[166], [90] ) Filed by The SCO Group, Inc.. (Attachments: # (1) Certificate of Service) (O'Neill, James)

I guess this means Ms. Acheson didn't get the ax when the Finance Department was downsized. She swears there was a verbal agreement with Novell for years that SCO should "simply net their 5% administrative fee and the third-party royalties against the funds due to Novell." A verbal agreement. Then in October of 2003, the two went back to the method outlined in the APA, and then Novell "never once remitted to the Debtors the 5% administrative fee." On that basis, SCO -- surprise! -- accuses Novell of unclean hands. What? No felonies?

Without even knowing if this latest smear is true or not, let's just imagine that it is. Might Novell be thinking that SCO owes them $36 million yet is doing all in its power to avoid paying? You think? Then, making SCO's accusation even more laughable, it claims that Novell breached the agreement first by not paying the 5%. I'm sorry. The bankruptcy judge might not know the history here, but I do. The Sun and Microsoft payments, which the Honorable Dale Kimball has ruled were in part payments that were due to Novell but never paid, were executed long before October of 2003, as you can verify in this transcript of a SCO teleconference in May of 2003. SCO is making the distinction that they never breached the *undisputed* royalties, so they are the good guys. It's pitiful. This has to be the low point in this saga so far. As one reader puts it, "Man, if only these people fought so bitterly and tirelessly for what is good, right, and true."

Update: We have, thanks to fred and Steve Martin, the document now in text. This is our first real look at SCO's new attorneys' style. I guess I'd describe it as just as whiny as Boies Schiller, and just as honest in portraying SCO as the victim, but they are a lot meaner and snarkier.

Because they specialize in bankruptcy, they naturally would be good at procedural aspects and you'd expect them to look for any procedural errors and to be able to cite various sections of the Bankruptcy Code. But what to make of an argument that the judge shouldn't grant Novell's request for immediate payment of the undisputed royalties going forward -- nay, that he lacks the power to do so -- because it would be adding a term to the contract? Then they go on to relate that in fact, that is exactly what the parties did for the most of the years the APA has been in force. It was only in 2003 that they went back to the way the APA says to do it, and yet it would be unthinkable and undoable to go back again to the prior system or something like it. Might SCO's lawyers have forgotten this term of the APA that Novell pointed out in its motion:

SCO is required "to [re]assign any rights to ... any SVRX License to the extent so directed in any manner or respect by" Novell. APA § 4.16(b).

Might the new arrangement in 2003 be because Novell tried and tried to get SCO to provide monthly audit reports, as required under the APA, and couldn't get SCO to do it? You think? As Groklaw member DaveJakement points out in a comment on an earlier article, there were a number of breaches by SCO, as set forth in the Hon. Dale Kimball's August 10 ruling:

Do I recall SCO failing to respond to Novell's requests for an audit? Prior to October 2003?

From the August 10 Ruling:

Novell also seeks the equitable remedy of accounting under its Ninth Claim for Relief. The APA obligates SCO to give detailed monthly reports and to comply with audits. APA §§ 1.2(b), (f). To the extent that SCO has failed to comply with these requirements with respect to the 2003 Sun and Microsoft Agreements, the court notes that it has a continuing duty to fulfill its contractual obligations. Novell also has continuing rights under the APA to conduct audits as to SVRX Royalties.

And:

On February 25, 2003, SCO executed an agreement with Sun in which Sun paid SCO approximately $10 million for the right to use, reproduce, prepare derivative works, market, disclose, make, and sell certain UNIX technology, including source and object (binary) code.

And:

SCO also executed an agreement with Microsoft on April 30, 2003, and several amendments to that agreement over the following three months. Id. Ex. 11, 12 ("2003 Microsfot [sic] Agreement"). Microsoft paid SCO $16,750,000 for the license rights, a liability release, and for options to purchase additional licenses. Id. §§ 1, 3.5, 4.1. Under the Agreement, Microsoft received various rights to UNIX System V technology. SCO agreed to deliver to Microsoft this UNIX System V software in both binary and source form, which includes the same versions of Unix System V software that are expressly referenced as SVRX Licenses in the APA.

SCO did not contact Novell for approval before executing the 2003 Sun Agreement or the 2003 Microsoft Agreement. And Novell did not authorize either agreement. The agreements gave SCO its first profitable year in history. Id. Ex. 7 at 9. SCO never remitted to Novell any monies it received from either of the agreements. Decl. Joseph LaSala at ¶ 4.

On July 11, 2003, when Novell had not received any royalty reports from SCO for over half a year, it sent SCO a letter demanding royalty reports and payments as required by the APA. Id. ¶ 6, Ex. 1. In response, on July 17, 2003, SCO submitted limited royalty payments from November 2002 through May 31, 2003. Id. Ex. 2. These payments did not mention any royalties from the 2003 Sun or Microsoft Agreements. Id. ¶ 6.

To date, SCO has still not provided those audits, despite the APA requiring it to do so every month. So when I read SCO's attorneys arguing that SCO has never failed to make a payment or that Novell has unclean hands, my eyes pop out. As you can see, Novell was not the first to breach the APA (not that there is any evidence that it ever has, other than a SCO employee whose testimony was not viewed as overwhelmingly dispositive in the Utah case and who is listed on the creditors' list), not by a long shot, and there is an historical basis for Novell to be worried about SCO ever paying what the court and the APA say it should.

As for SCO's argument that Novell asking for its money is no different than goods in a warehouse, I see a distinction: SCO is a fiduciary for Novell in the APA arrangement, so none of the money is SCO's from the moment it arrives. That being so, it can hardly argue it needs it for its reorganization or that there is no harm if Novell has to wait a bit. The goods might still be there; but the cash might not, at the rate it is flowing out to lawyers and employees. That's not even going into the new vaporware proposed sale.

Now, the document wouldn't bother me much if they just made the arguments; but the tone throughout is that same mock indignation that we found so offensive in Utah District Court. It didn't work there, but it might here. Things go much faster here in bankruptcy court, and the new judge hasn't got 4 or 5 years to get to know the situation. So here comes SCO, telling it their new way, and who is to say that they are ... well... stretching it? The new story, I gather, is that the APA is so ambiguous a document that the court shouldn't view the Kimball August 10th ruling as meaning much. He didn't find it ambiguous in the least, and I find SCO's new description insulting to another court. For example, SCO says that "Novell has been litigating the import of this ambiguous document for almost four years." Excuse me, but the case is called SCO v. Novell not Novell v. SCO.

It's little touches like that where you get to see the personality of a firm. Cravath, for example, would have said "The parties have been litigating..." Morrison & Foerster would have said, "SCO argued forcefully in District Court that the APA was ambiguous, but the judge found otherwise."

As for the description of the arbitration as an action brought against SCO, when in reality it is merely a branch off of the action SCO started againt Novell, what can I say? The new judge may not know the difference, not having gotten his PhD in SCO the way I have. And SCO needs to say something to justify not paying Novell, and I gather the hook will be that the APA is so hard to comprehend that everyone should take it with a grain of salt until the appeals court can weigh in on it. In short, SCO, having lost in Utah District Court, now wants to start over from scratch. Of course by then, all the money will be gone, preferably, I gather, in severance and bonus packages to management instead of to Novell, but, hey, what are lawyers for?

If you have discerned that I don't admire this performance, you are correct. I don't belong to the school of thought that says that lawyers can say just anything to win.

****************************

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

DEBTORS' RESPONSE IN OPPOSITION TO NOVELL, INC.'S
MOTION FOR ORDER DIRECTING THE DEBTORS TO REMIT
UNDISPUTED FUTURE SVRX ROYALTIES TO NOVELL UPON RECEIPT

(1) The very agreement upon which Novell bases its Motion does not provide for the immediate, on receipt, payment of royalties in the manner Novell now seeks this Court to require by way of an order;

(2) Novell's demand for the Court to use 11 U.S.C. § 105(a) to modify Novell's agreement with the Debtors because of the filing of this Chapter 11 case and "SCO's historical financial performance" is an attempt to impose a non-existent ipso facto clause in a manner explicitly prohibited by ll U.S,C. § 365(e)(l); and

(3) Novell lacks the clean hands required to seek equitable relief because it has been breaching the agreement for years by offsetting the Debtors' 5% administrative fee.

1

FACTUAL BACKGROUND

The Debtors agree with the Motion's² description of the pertinent terms of the Asset Purchase Agreement ("APA").³ Indeed, there is one undisputed crucial fact that Novell cannot ignore: the APA provides that payment to Novell is not due until 45 days after the close of the previous quarter. See section 4.l6(a) of the APA, page 24. Even Novell admits this fact. See Jones Affidavit at 16. Nothing in the APA permits Novell to unilaterally change or modify this payment term, and Novell has not cited a single provision in the APA that provides it with any such authority.

The Debtors also do not disagree that the parties to the APA agreed to denominate the royalties collected by the Debtors as the property of Novell.⁵ But that being said, these funds

2

Analogizing Novell's argument to other settings under the Bankruptcy Code shows the unusual -- and improper -- relief it seeks. When a company that operates a warehouse commences a Chapter 11 case, its customers, who hold title to the goods stored there, cannot demand return of the stored goods when the terms of the underlying storage contract do not so provide. Indeed, when any business files for Chapter 11 relief, the company's equipment lessors, which hold undisputed title to the equipment leased to the debtor, cannot simply demand the return of "their" equipment. Instead, the terms of the storage contracts or leases still apply unless and until they are rejected by the debtor-in-possession. Novell makes no logical argument as to

3

Nowhere in the Motion does Novell state (because it cannot) that the Debtors (or their predecessors in interest) have ever failed to remit the required royalty payments in a timely fashion in the 12 years since the APA was executed. Instead, by making the timely, required post-petition payment of the royalties due for the third quarter of 2007⁶, the Debtors have demonstrated (or will demonstrate) that they intend to perform in accordance with the terms of the APA.

According to Novell, the total annual expected revenues to be paid by the Debtors under the APA is between $500,000 and $800,000. See Jones Afiidavit at § 5. Given the declining revenues that the Debtors have experienced, the Debtors believe that the higher estimate appears to be too high. But even using the high end of Novell's estimate, the next quarterly payment due in February 14, 2008 will be only $200,000. Novell has no factual, historical or other basis to fear, nor has it cited to any in its Motion, that would establish that this relatively small amount of royalties will not be on hand when due.

A. NOVELL IS SEEKING TO HAVE THIS COURT IMPOSE INTO THE APA AN
UNENFORCEABLE IPS0 FACTO CLAUSE

The APA is a long and complex document. Novell has been litigating the import of this ambiguous document for almost four years. If there were an ipso facto clause in the APA, surely Novell would have cited it in the Motion. It did not. Based on the absence of a such a citation, it is fair to assume that there is no ipso facto clause permitting Novell to exercise its right to either

4

terminate the APA or to effectuate any particular change in its terms as a result of SCO's bankruptcy.

Nevertheless, what Novell failed to provide for in the APA — and what was never intended by the parties — it now asks the Court to impose. Such relief, of course, is barred by the Bankruptcy Code. Section 365(e)(1) of the Bankruptcy Code makes clear that an executory contract of the debtor "may not be terminated or modified, and any right or obligation under such contract ... may not be terminated or modified, at any time after commencement of the case solely because of a provision in such contract ... that is conditioned on (A) the insolvency or financial condition of the debtor at any time before the closing of the case; (B) the commencement of a cause under this title [.]" 11 U.S.C. § 365(e)(1) (emphasis added).

Novell asks this Court to do through 11 U.S.C. § 105(a), see Motion at p. 9, that which § 365(a)(1) prohibits. Specifically, Novell seeks to modify the terms of the APA by having this Court change the payment terms from the required 45 days after the prior quarter, to an immediate payment of royalties upon receipt. Novell's only stated reason for such a violent rewrite of that term is because of the Debtors' purported post-bankruptcy financial condition. Respectfully, this Court does not have the authority to do so, even under the "powerful, versatile tool" of 11 U.S.C. § 105(a). Indeed, the Third Circuit case cited by Novell at p. 9 of the Motion makes clear that 11 U.S.C. § 105(a) can be used only to "fashion order(s) in furtherance of Bankruptcy Code provisions." Joubert v. ABN AMRO Mortgage Group, Inc., 411 F.3d 452, 455 (3d Cir. 2005)(emphasis added). It is black letter law that 11 U.S.C. § 105(a) cannot be used to circumvent provisions found elsewhere in the Bankruptcy Code. See, e.g., Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 206 (1988) (a bankruptcy court's general and equitable powers "must and can only be exercised within the confines of the Bankruptcy Code"); In re

5

Momentum Mfg. Corp., 25 F.3d 1132, 1136 n.4 (2nd Cir. 1994) ("a bankruptcy court may not exercise this [§ 105(a)] power in contravention of provisions of the Code"); In re C-L Cartage Co., Inc., 899 F.2d 1490, 1494 (6th Cir. 1990)(bankruptcy courts "cannot use equitable powers to disregard unambiguous statutory language"); In re Vision Metals, Inc., 311 B.R. 692, 700 (Bankr. D. Del. 2004)("We agree that Demang that Debtor cannot utilize section 105 to create a result directly contrary to the express provisions of the [Bankruptcy] Code.").⁷ Therefore, because the only basis cited for Novell for the extraordinary relief it seeks is one prohibited by the Bankruptcy Code itself, 11 U.S.C. § 105(a) cannot be a basis for granting the Motion.

B. NOVELL LACKS THE CLEAN HANDS NECESSARY TO SEEK AND OBTAIN EQUITABLE RELIEF FROM THIS COURT

As attested to by Jean Acheson, the Debtors' Controller (see Exhibit A, the attached Declaration of Jean Acheson), there was a longstanding verbal agreement between Novell and the Debtors' predecessor (continued by the Debtors) that the Debtors should simply net their 5% administrative fee and the third-party royalties⁸ against the funds due to Novell.

In October 2003, this verbal agreement came to an end. The parties then went back to the method set forth in the APA. What Novell failed to explain in the Statement of Facts portion of the Motion was that the APA obligated Novell to repay the Debtors the 5% administrative fee within five days after Novell received the undisputed royalties from the Debtors. See section 4.16(a), p. 24. When the parties returned to the payment protocol under the APA, the Debtors

6

remitted to Novell the undisputed Novell royalties, but Novell never once remitted to the Debtors the 5% administrative fee as it was required to do. Therefore, SCO wound up coming out of pocket to pay the third-party royalties. When there were enough undisputed royalties owed to Novell, the Debtors would offset the amounts due by Novell to the Debtors against the undisputed royalties it then paid to Novell. This method is what has been happening for the last four years.

Because Novell was the party that first breached the APA by failing to remit the 5% administrative fee within the five-day period required, Novell hardly has the right to seek equitable relief now, and certainly when the relief it seeks is not required or even permitted under the APA itself.

[Remainder of page intentionally left blank]

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CONCLUSION

For all of the foregoing reasons, the Court should deny Novell's Motion, and grant the Debtors such other and further relief as the Court deems just.

Dated: October 26, 2007

PACHULSKI STANG ZIEHL & JONES LLP
(signature)
Laura Davis Jones (Bar No. 2436)
James E. O'Neill (Bar No. 4042)
Rachel Lowy Werkheiser (Bar No. 3753)
[address]
[phone]
[fax]
[email addresses]

and

BERGER SINGERMAN, P.A.
Paul Steven Singerman
Arthur J. Spector
Grace E. Robson
[address]
[phone]
[fax]
and [address]
[phone]
[fax]
[email addresses]

Co-Counsel for the Debtors and Debtors-in-Possession

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¹The Debtors and the last four digits of each of the Debtors‚Äô federal tax identification numbers are as follows: (a) The SCO Group, Inc., a Delaware corporation, Fed. Tax Id. #2823; and (b) SCO Operations, Inc., a Delaware corporation, Fed. Tax ID. #7393.

² The Motion is procedurally improper as the relief Novell requests should have been presented in an adversary proceeding. The Motion requests the Court "to order SCO to immediately remit," calling the relief it seeks a request for the Court to use its "equitable powers." Rule 7001(7) of the Federal Rules of Bankruptcy Procedure provides that a litigant must commence an adversary proceeding "to obtain an injunction or other equitable relief." The type of equitable relief that Novell requests is nothing less than a mandatory injunction directing action on the part of another. Bryan A. Garner, editor in chief, Black's Law Dictionary, "injunction -- 'mandatory injunction'", p. 8OO (8th edition 2004)("An injunction that orders an affirmative act or mandates a specified course of conduct."). Accordingly, it is relief that must be sought, if at all, in the form of an adversary proceeding.

Nevertheless, the Debtors, unlike Novell (which, in its subsidiary's response to the Debtor's Motion to Enforce the Automatic Stay, raised technical procedural issues to attempt to block a determination on the merits of whether the automatic stay applies to a pending arbitration in Switzerland that was commenced against SCO Group, Inc.), do not object to Novell's procedural faux pas in making its request by motion.

³ The APA was attached as Exhibit A to the Affidavit of Greg Jones that was attached as Exhibit A to the Motion. Novell's recitation of some of the Utah District Court's rulings, however, is unnecessary to the determination of the issues in this contested matter, and the Debtors neither admit nor deny those allegations.

⁴The Debtors' predecessor-in-interest, The Santa Cruz Operation, Inc., was the original party to the APA.

5 There are good grounds to argue about the efficacy of a pre-petition contractual term describing cash received by, but not segregated by Party A (the debtor), for the benefit of Party B (the creditor), as held in "trust" for the nondebtor party. See, e.g., In re Auto-Train Corp., Inc., 810 F.2d 270, 275 (D.C. Cir. 1987):

In a very limited number of cases involving what would normally be considered a debtor-creditor relation, courts have found specific funds subject to a trust in favor of a creditor. In many of these cases the trust is imposed by virtue of a state statute designed to provide additional protection to certain types of creditors, usually contractors. See, e. g., Selby v. Ford Motor Co., 590 F.2d 642, 647 (6th Cir. 1979); Carrier Corp. v. J.E. Schecter Corp., 347 F.2d 153, 155 (2d Cir. 1965). In cases not involving such a statute, the courts have uniformly required a contract irrevocably obligating the debtor both to segregate the "trust funds" from the debtor's own funds and to deliver the "trust funds" to the creditor. In a footnote, the court stated that the foregoing analysis "is true irrespective of whether the analysis is conducted under the rubric of express trust or constructive trust." Id. at n. 1.

Regardless, the Debtors have been paying -- and plan to continue to pay -- all ordinary course expenses in the ordinary course, and will not discriminate against Novell on account of its overzealousness.

⁶See Exhibit A, Declaration of Jean Acheson, attached hereto.

⁷ In Vision Metals, the debtor filed a motion requesting the Court to use 11 U.S.C. § 105(a) to vacate an earlier order in which the Court approved the assumption of a contract. In holding that it could not use § 105(a) in that fashion, the court reasoned: "If, as the Debtor suggests, section 105 could be used to avoid an assumption order, then section 365(g)(2)(A) would be eviscerated. This is not permitted." Id. at 700.

****************************

IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF DELAWARE

The SCO GROUP, INC., et al.,

Debtors.

___________________

Chapter 11 Cases

Case No. 07-11337 (KG)
(Jointly Administered

DECLARATION OF JEAN ACHESON IN SUPPORT OF DEBT0RS' RESPONSE TO
NOVELL, INC.'S MOTION FOR ORDER DIRECTING THE DEBTORS TO REMIT
UNDISPUTED FUTURE SVRX ROYALTIES TO NOVELL UPON RECEIPT

Jean Acheson declares as follows:

1. I am over the age of 18 years and am competent to give this testimony.

2. I am the controller of The SCO Group, Inc., and the controller of SCO Operations, Inc.

3. I have been employed by The SCO Group, Inc. since its purchase of the UNIX product line in 2001 and before that worked for its predecessor, The Santa Cruz Operation from 1995 to 2001. I am familiar with the matters about which I testify herein.

4. From even before the inception of The SCO Group, Inc., Novell, Inc. and The SCO Group, Inc.'s predecessor, The Santa Cruz Operation, Inc. ("Santa Cruz"), had a verbal agreement and course of dealing whereby, notwithstanding the terms of the Asset Purchase Agreement ("APA") between Novell, Inc. and Santa Cruz, the Debtors (and their predecessor in interest) would net their 5% administrative fee provided for under the APA and the third-party royalties against the undisputed royalties due to Novell under the APA.

5. In October 2003, this course of dealing came to an end.

1

7. As a result of Novell's failure to remit the 5% administrative fee and the third-party royalty reimbursement, the Debtors have been required to come out of pocket to repay third-party royalties.

8. To repay itself, the Debtors have set off against the undisputed royalties the 5% administrative fee and the third-party royalty fees once sufficient royalties were accumulated to do so.

9. This course of dealing has lasted for approximately the last four years.

10. I am preparing for payment to Novell the next royalty check for delivery by November 1, 2007.

11. This concludes my declaration.

I declare under penalty of perjury that the foregoing is true and correct. Executed on October 26, 2007.

____[signature]___
Jean Acheson

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