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Reports from Today's SCO Bankruptcy Hearing - Updated 7Xs
Wednesday, March 02 2011 @ 05:50 PM EST

I have our first report from the courtroom in today's SCO bankruptcy hearing in Delaware regarding whether or not SCO can sell essentially all its assets.

It sounds absolutely awful, frankly, but the judge has taken it under advisement, with Novell indicating it will appeal if it does not prevail. We'll be updating this article as more reports arrive. We had two reporters there today.

Here are our reporter RFD's first notes, with more to come later:

SCO Hearing
March 2, 2011

2:08 - Oracle agreement
Nortel
HP resolved
Dinkumware--overruled

2:18 - "Main Show" Summary of this case.

2:24 - Bruce Comer proffered testimony (OPA)
History of negotiations.

2:34 - Mr. Comer to stand--Mr. Lewis cross-examined.
Auction, other bidder complained of irregularities.
No attempt to value warrants.
Estate is administratively insolvent.
Nothing to unsecured creditors.
No operating assets will exist after sale.

2:49 - Ms. Fatell redirect.
Litigation assets will remain with SCO.

2:52 - Ms. Fatell--Proffer of Mr. Bolandz, CEO of buyer.

2:58 - Mr. Bolandz to stand--Mr. Lewis cross.
Understanding of sublicense
Total assets $600,000
No attempt to work with Novell.

3:08 - Ms. Fatell re-direct.
Clarify letters of intent.
He believes financing will come through if sale is approved

3:12 - Mr. Broderick to stand--Ms. Fatell direct
USL then to Novell to Santa Cruz to Caldera.
Worked as a contractor with Caldera/SCO
Declaration handed to witness.

3:31 - Mr. Lewis cross
Nature of sublicense.

3:45 - Recess

3:58 - Closing arguments--Ms.Fatell

4:21 - Mr. Lewis.
No assurance of future performance.

4:34 - Ms. Fatell
Not executory because Novell has no ongoing obligation to SCO.

4:42 - Mr. Lewis. APA is executory!

4:45 - Back and forth over contract issue
Mr. Lewis--Novell may appeal if ruling goes against them

4:55 - Judge Gross takes motion under advisement.

It was clear at the close that the question "Is the APA executory?" is the issue that must be resolved.

"Not executory because Novell has no ongoing obligation to SCO"??!! Aside from being shocking, the fact is Novell does have ongoing obligations to SCO. For example, under the APA [PDF], it has to pay 5% of all monies SCO collects on SVRX as an administrative fee.

Update: Here's a report from MikeD, with a promise of more details to follow:

It was a cold brisk day in Delaware. The hearing was about three hours long. I am struggling on how to write this one up. It was a difficult hearing to follow.

The objections of most of the parties were quickly dispatched. Most agreed for the most part, but reserved their rights to object in the future as more details are known.

Dinkumware was overruled by the judge. They may file a formal objection if they desire.

As RFD pointed out. It all comes down to "Is the APA executory?"

Ms. Fatell and Mr. Lewis locked horns on this. Ms. Fatell admitted that the courts have ruled that they don't own the copyrights. Of course, she got her plug in that it's under appeal.

But the copyrights don't matter.

SCO's side opined about how this business had been sold several times without any objections from Novell. Therefore, they should be able to sell it again without their consent. They went on and on about how it's been this way for 16 years.

SCO assumed the APA from Novell (through Santa Cruz). They are authorized to sell Unix products to customers under this agreement.

They are not assigning the APA to Unxis. They are simply giving them the same rights they gave all their other customers to use their license to the code.

What happens to the APA? Well, that stays with SCO. But they all admit that SCO will be out of business except for all the litigation, which they are keeping. They will have no people and no assets other than the litigation. The APA is ignored, and Unxis continues with a license to use and expand the business just as other companies that bought this business in the past have done.

They side-stepped the SVRX licenses and royalties completely at the hearing.

[MikeD note: remember Darl saying SCO has the right, but not the obligation, to collect royalties ..?]

Neat trick if the Judge allows it. Don't puke yet. There is another side.

UnXis has paid $600,000 into escrow and has committed another $50,000 for secured creditors. They have Letters of Intent from several investors. They are not binding contracts, and those people can walk away at any time.

Novell has a different view on all this.

Novell is owed some $3,000,000. They would get essentially nothing under this proposed sale. Their consent is needed to assign the APA, and they do not consent. Mr. Lewis pointed out the absurdity of the argument. He asked the witnesses numerous times what the sublicense is a license of. You can't just sell a sublicense and pretend the underlying license does not exist.

Here is where the "Is the APA executory" arguments were fought.

Novell's position is they have to sell the whole APA, with their consent, and they do not consent.

SCO argued that they can too do this. Ms. Fatell quoted a couple of cases where an ongoing relationship is required between the parties for it to be an executory contract. There has not been such an ongoing relationship. She argued that Novell never objected before when the business was sold. There had to be an implied license that was transferred. She has nothing in writing that proves this, but it must be so, because it always has been this way.

Mr. Lewis argued that there was no need for "daily contact when things were going well". Things are not going well now, as evidenced by this litigation. Now they have a reason to object, and they are indeed objecting. They do not consent.

Ms. Fatell's other argument was that the sale price is poor, but winding down the business would be more expensive. It could cost $500,000+ to lay off all the employees (now 30) and shutter the business. They admitted several times that SCO is now insolvent for all practical purposes. UnXis is taking on the employees. SCO's customers would be put in a bad way if SCO went under. There were the usual descriptions of goverments, McDonalds, CVS, and all the other people that would be inconvenienced if they go under.

Mr. Lewis countered that what happens to the customers is not even a consideration. To summarize, if the customers have not been planning contingencies for the past three years, they must be living under a rock.

In one of the few moments of humor, the Judge remarked his court computer runs on Unix.

The battle was hard fought on both sides on these points. Mr. Lewis did a great job of succinctly making his points. His point is that the law dictates what needs to be done, not what SCO thinks was implied in past relationships.

The judge asked about the appeal. There was a brief explanation from Mr. Lewis on the points of the appeal. Mr. Lewis would not opine on what or when the Appeals Court will decide.

There was a brief mention from Mr. Lewis that if this ruling did not reflect established law, there could be an appeal. The judge commented on making sure he had it right. He took it all under advisement and said he would try and get a ruling out this week.

Novell had powerful arguments today through Mr. Lewis. Ms. Fatell basically said the sale was the best they could do, and it should be approved.

The sale is due to be concluded by March 30 with the court's approval, should it approve.

I would not hazard a guess how Judge Gross will rule.

What I get from this report is that the judge will rule quickly, apparently within the week, which tells me he has an inkling now how he will rule. Also, I take Mr. Lewis' comment about an appeal as letting the judge know that there are limits to what nonsense he will be able to get away with, should he try. And nonsense is what SCO was dishing out.

That's a very nice and polite word for what it was.

I really want to say thank you to our faithful Delaware reporters RFD and MikeD. The Delaware bankruptcy hearings are the most depressing of all the hearings to attend. And year in and year out, since the fall of 2007, these guys have been there for us. So, thank you very much.

Update 2: We think the judge is mistaken about his court running on Unix. This job listing [PDF] shows that what they ask for is knowledge of Microsoft products. The position is for a Network Systems Engineer who "coordinates and oversees the court unit’s information technology networks."

Also, this business was not sold several times. After Novell sold to Santa Cruz, there was only one sale after that, a sale of lesser assets, from Santa Cruz to Caldera, and SCO Group always pretends they are the same company.

Update 3: I thought of something about SCO's argument about the APA not being executory. If that were the case, what basis does SCO have in the appeal now before the 10th Circuit to ask, in the alternative, for specific performance, that Novell be compelled to hand over the copyrights now? It relies on Amendment 2 for that requested relief. But if Novell has no current obligations under the APA, as SCO just argued in bankruptcy court, I think it must drop its request for that alternative relief in the appeal. It is saying two different things simultaneously in two different courts.

Nothing ever improves with these people. Here's SCO's brief [PDF] asking for that relief if the court doesn't find that the copyrights already transferred.

Also, I heard from a court IT staffer. He confirms that servers are Windows and Linux, but the PACER/EMC part of the court system is all Red Hat Linux, not UnixWare or OpenServer. There are some running Solaris. But if SCO were swallowed up by an earthquake, which some of us would view as a fitting punishment from God, Judge Gross would never know it or feel it. Perhaps he thinks Red Hat is Unix. It's not.

Update 4: We have more details now from RDF:

Yesterday's hearing consisted of:
1. Introductions

2. The disposition of objections except for Novell's.

3. Testimony by three witnesses for the SCO Trustee, with cross-examination by Mr. Lewis for Novell.

4. Closing arguments

5. Brief discussion of timing and form of the proposed order.

6. Judge Gross took the matter under advisement.

The testimony of SCO's witnesses (#3) consisted of the rather dull reading into the record of the proffered testimony of Mr. Comer of OPA and Mr. Bolandz, CEO of the proposed buyer. The proffered testimony seemed to pretty much follow the declarations of these two witnesses--Mr. Lewis had them authenticate their declarations and then did his cross-examination based on those declarations. Mr. Broderick then took the stand and adopted his declaration.

Mr. Lewis made some interesting points during cross-examination.

According to Mr. Comer, SCO is "administratively insolvent" and unsecured creditors will get nothing from this sale. Also, once OPA gets its $150,000 finder's fee and other administrative expenses are deducted, the net proceeds from the sale will be considerably less than $600,000. Mr. Lewis seemed to be challenging Mr. Comer's assertion that the proposed sale is a sound business decision.

In cross-examination of Mr. Borlandz, Mr. Lewis established that the buyer has no employees, no assets beyond the purchase price, and no legally binding commitment for further investments. The issue seems to be whether SCO has established that the proposed buyer is capable of performing its obligations under any assigned contracts. As far as Novell is concerned, this would be significant if the Novell/Santa Cruz APA is an executory contract, as Novell is arguing.

Mr. Broderick's testimony tried to establish "course of conduct" of the parties which seems to be the basis for SCO's assertion that it can give the buyer a sub-license to use Novell's copyrights.

After a short recess, closing arguments began. The real issue is the interpretation Novell/Santa Cruz APA. The issues and arguments closely parallel those in the jury trial in Utah with SCO and Novell offering competing interpretations, although the legal issues are not identical.

During discussion of the proposed order, Mr. Lewis noted that, although he had no objections to the form of the proposed order, should the ruling go against Novell, he did object to the order waiving the 10-day automatic stay, since Novell might wish to appeal. I don't know if he needed to object in order to preserve Novell's right to appeal. The objection was not in the form of a threat, but clearly the significance was not lost on Judge Gross.

Judge Gross remarked that before the hearing, he thought he had a pretty good understanding of the issues but that the hearing raised some doubts in his mind. My impression is that he finally realized he has a hard issue to decide and that he has no easy way out.

It seemed to me that the mood at the SCO table seemed rather subdued. Mr. Cahn, the Trustee, appeared by phone, but except for saying hello during the introductions, said nothing. Ms. Fatell seemed rather unenthusiastic as she repeated the same response to every point made by Mr. Lewis. I think she may realize the end is near. Even if Judge Gross approves the sale, an appeal by Novell could cause enough delay for the deal to collapse.

Update 5: Here's what Netcraft says Delaware courts run on, Apache servers with Linux OS and Windows. The EMC/PACER system runs on Linux. Did SCO tell the judge that his court runs on Unix, I wonder? If so, it's apparently not correct information.

Update 6: Groklaw's Steve Martin did some research, and he points out that SCO already listed the 1995 APA as an executory contract last October, in Exhibit A-2, titled "Exhibit A: Assumed Contracts (Packaged Product Related)" with a cure amount to Novell for UNIX SVRX royalties of $73,436.91. And in the oral argument on the appeal, one of the judges asked if there was a cutoff on this obligation, and the answer given was no.

Update 7: MikeD has now sent us his more detailed notes, and they are worth the wait:

This was the most difficult hearing to follow to date. Ms. Fatell and Mr. Tarr both read extensively from documents.

I have paraphrased a great deal of this. I tried to capture as much as I could. There are areas I missed, or just could not understand enough to put into English. IANAL.

Mr. Tarr spoke on behalf of Mr. Chan. They started off with objections from the various parties. These were basically resolved with most parties reserving the right to object in the future. These included:

Oracle (including BA and Sun)

EMC

Nortel

HP

Dinkumware had filed an informal objection and had no representation at the hearing. Ms. Fatell objected and the judge overruled Dinkumware's objection. They may file a formal objection if they wish.

Mr. Tarr continued with his assertion that the sale, procedures, and underlying reasons were fair, adequate, and reasonable; that the sale meets the provisions of sections 363 and 365 of the Bankruptcy Code.

Mr. Tarr gave the background of the situation from the beginning of the litigation and of the sale efforts and procedures to now. He said the Trustee must move to stem the cash flow issue. He detailed how the bidding procedures were developed and followed.

Mr. Tarr then gave the background and bio of Bruce Comer - Founder of OPA. Mr. Comer then took the stand. He was first questioned by Mr. Tarr or Ms. Fatell (not clear from notes).

Mr. Comer went into great detail on the bidding process.

Mr. Comer has been involved since 2009.

93 potential bidders were identified. 18 signed NDA's. Two of the bidders were not acceptable or qualified.

By the October deadline, only five bids had been received. They were not acceptable.

By Dec. 10 only two out of 3 bids were received.

UnXis was one of the two.

  • They bid $600,000 and placed that amount in escrow
  • They proposed 2 year warrants
  • They would pay up to $50,000 of cure costs to secured creditors
The other bid was $18.

Mr. Comer testified that 75% of SCO's current expenses are employee- and benefit-related. The Trustee has reduced the employee head count from 60 to 30 employees.

Mr. Comer went on to tell how SCO is a key software provider to governments, retailers, and major companies. There would be irreparable harm to the software business if SCO is not sold.

Mr. Lewis from Novell took over questioning. His questions were primarily based on Mr. Comer's declaration:

  • Asked about the $600,000. -- It is now in escrow.

  • Asked if there was a "success fee to OPA is the sale goes through. -- Yes, $150,000, plus other fee considerations.

  • Did Mr. Comer have any other business with Unxis? -- No.

  • At auction did another bidder decline to bid due to irregularities? -- Yes, but they declined to bid before the auction. A concern of this bidder was getting their deposit back.

  • Were the warrants valued? -- No, not a crux issue
    • difficult to determine value
    • Unxis offers $600k/$50k
    • $18 bid was a vulture bid -- they declined to bid more

  • So the sale price is $600k? -- Yes, but they are taking on the employees. The Trustee considered the cost of laying off employees without this sale.

  • So the estate is insolvent now? -- Yes, and has been for some time.

  • There is no money for unsecured creditors? -- Correct. Sale at this price is better/cheaper than winding down employees.

  • Mr. Lewis asked about $2 million loan and lender benefit to admin and employees -- ????

  • So nothing for unsecured creditors? -- Correct.

  • What will debtor be left with after sale? -- $600k; A/R (to be collected by buyer); cash balance (to offer cures).

  • What is going to buyer? -- IP; employees; license.

  • Seller will have have no assets when done, correct? -- Correct.

  • What is being sublicensed to buyer? -- Ms. Fatell objects - Mr. Comer not qualified. But judge overrules.

  • What is the sublicense a license of? -- SCO does not own copyrights (per court ruling), so unXis gets an implied license, same as been passed through various companies for decades -- long chain of licenses over 30 years.

  • Will Senior management go to unXis? -- Yes, several of them.
Ms. Fatell recross:
  • Has buyer had any discussions with employees? -- No.

  • Will proceeds go to $2 million lender? -- No.

  • Please explain. -- It's "complex"; some $$$ will go to lender.

  • Is the litigation an asset? -- Yes.

  • Is SCO retaining litigation? -- Yes. Are all litigation claims excluded? -- Yes.
Mr. Comer was excused.

Ms. Fatell introduces Alex Bolandz and his CVA. He is sworn in and takes the stand. Fatell:

  • What is your role? -- CEO of unXis.

  • How long in this type of business? -- 20 years.

  • What are unXis' plans? -- Business will continue; will oversee a substantial infusion of capital; they will be taking the CTO/CFO from SCO.

  • When did you come into this role? -- 2009; unXis formed to buy this company; main investors are Stephen Norris and Mr. Le Blan/Merchant Bridge.

  • When is this deal scheduled to close? -- Want to close by March 30, sooner if possible. Irreparable harm to customers if not sold soon.
[MikeD note - Judge Gross seemed to be listening carefully to above.]

Mr. Lewis on Cross:

  • Mr. Lewis states: I will be using his declaration for most of the examination.

  • Is this sublicense nonexclusive? -- Not sure; rights to continue as SCO/Caldera have done; same as all companies have done going back to AT&T.

  • Do you get exclusive rights, or will SCO retain rights? -- SCO will cease to exist; no employees.

  • Who will directors be? -- Le Blan, Norris, himself.

  • You plan to fund operations out of cash flow? -- Yes, in short term.

  • How long? -- 6 months.

  • Have you done an analysis and business plan? -- It's underway; basics done.

  • What funding do you have? -- $600k; unXis was funding specifically for this.

  • Any other funding? -- Letters of Intent (LOI); once unXis has ownership.

  • So other funding could walk away? -- Yes.

  • Other than the $600k, there is no other funding? -- Correct, except for LOI.

  • Mr. Lewis asked about shares/warrants: Do you understand them? -- Yes, he has an understanding of them.
    [MikeD note: The above seemed to irritate Mr. Bolandz. He looked at Ms. Fatell for a second, as if hoping for some help. He then made a comment that "to understand is to know". The SCO table was silent.]

    Mr. Lewis continued:

  • Has anyone from unXis reached out to Novell? -- No.

  • Why not? -- Because unXis will be a competitor to Novell and Microsoft.
  • Mr. Bolandz was then excused.

    Ms. Fatell called Mr. William Broderick to the stand:

  • The financing is $600k? -- Yes.

  • What is Merchant Bridge/Norris' involvement? -- They have been involved for years in trying to buy SCO.

  • Do you believe you will have funding going forward? -- Yes, if we get the assets; yes, based on Mr. Norris' long-time relationships.

    Describe your background. -- Unix > AT&T > Novell > Santa Cruz > Caldera > SCO; Director of Software licensing; on contract now (not employee); contract only through end of this month [laughter in courtroom].

  • Describe types of customers. -- Governments; McDonalds; CVS; Wall Street.

  • Fatell asks about paragraphs 13 and 14 of his Declaration: These are 3rd party license agreements? -- Yes. SCO gets source and creates binaries.

    Paragraph 14: describe sublicense. -- Same as they have been from AT&T through SCO.

  • Has Novell ever told you that you could not create these sublicenses? -- No.

  • Do SCO and Novell have a current business agreement? -- No.

  • Any payment to Novell other than SVRX? -- No; only payments for SVRX earlier than v 2.1.

  • Does SCO provide reports to Novell, excluding SVRX? -- No.

  • If SCO cannot transfer these assets to unXis, what will happen? -- Installed base will lose needed support.

  • Why can't companies just switch to another OS? -- Have to rewrite code.
  • Mr. Lewis begins Cross:
    Will you be with unXis? -- No; no contractl unemployed after 4/1.

  • What is sublicense to unXis? -- Copyrights and licenses even though courts said they do not own licenses, they have right to sublicense like it's been done all the way back to AT&T.

  • Has SCO been in default to Novell? -- - Since litigation began.

  • This is being called an "ordinary course transaction". When has this been done before? -- Caldera to SCO. [PJ note: I wonder if he means SCO to Caldera?]

  • License of sublicense, ever been done when the company goes out of business before? -- It's happened to me 3 times now. [PJ: AT&T and Santa Cruz did not go out of business, nor did Novell or Caldera.]

    Has this ever been done where the selling company puts itself out of business? [MikeD note: Brain hurt here. Mr. Lewis kept pounding on a company sublicensing and then putting itself out of business. Mr. Broderick kept saying it's the same as it's always been done. They went back and forth on this for a while.]

  • Ms. Fatell Recross:
    • When Novell sold to SCO, SCO continued just as Novell had? -- Yes; we even used their contracts; just changed name on contracts.

    • When Santa Cruz sold to Caldera, did they remain in this business? -- No. [PJ: Note they did remain in business, changing their name to Tarantella. They didn't continue in the two business units they sold to Caldera.]

    • SCO will not be able to continue under the APA. This is the point!
    End of testimonial evidence.

    Ms. Fatell moves to put declarations into evidence with no objection.

    Mr. Lewis moves to put their documents (?) into evidence without objection.

    Closings:

    Ms. Fatell:

    • We are here to authorize sales of assets.
    • Burden is on Novell to prove good reason why it should not happen.
    • Mr. Comer testified that winding down will be expensive.
    • Mr. Broderick testified companies big and small will be impacted.
    • Admits company is administratively insolvent.
    • Believes company should be sold.
    • Secured creditors have no objections.
    • Sales process was very involved and continued until legit buyer found.
    • $18 bidder complained about irregularities but they were not a serious bidder.
    • Unxis' was the best bid.
    • There are no issues, except one with assumption of contracts.
    • There has been a great legal battle with Novell; SCO lost jury trial on copyrights; it's under appeal.
    • Novell insists that sale assumption/assignment cannot be assigned without their consent. They do not consent.
    • SCO has been done what all the companies have done since AT&T.
    • There is no written license about how these copyrights are used.
    • There was testimony that said "just change the name of the contracts."
    • Novell insists buyer need a copyright license.
    • Novell had right of first refusal and did not bid.
    • Every time business transferred in the past, the license to use transferred.
    • (Gives strange analogy about brownie/baker business - then recipe maker pulls license to recipe).
    • There is now written license to use that anyone has found.
    • Novell owns the copyrights.
    • We have right to use license - same as last 16 years.
    Judge Gross - To find an implied license, I must find that Novell implied this.

    Ms. Fatell: They have for the last 16 years. Novell insists it is an executory contract. They insist buyer must assume, and Novell assigns. Novell does not consent to assign. Novel is wrong. Quotes Exide decision. They are not transferring SVRX licenses and royalties. Does not know why Novell is objecting. We have an implied license to use.

    Mr. Lewis:

    • This is a Section 363/365 sale.
    • 363 - not our problem (customer support) if SCO dies.
    • 365 - SCO accuses us of pussyfooting. THEY are the ones doing it.
    • It's about licenses of copyrights they got from Novell.
    • If you don't have express consent, you cannot assign.
    • You have to have a license.
    • SCO is not assigning APA; they say they will develop under APA; they WILL NOT develop under this agreement; they will cease to exist.
    • They owe us $3,000,000.
    • This is NOT the same as past sales of the business.
    • UnXis = same old cast of characters.
    • They say they are confident they can raise money. But there are no binding agreements for funding; they plan to operate business from current cash flow for 6 months; it's all speculation.
    • Public interest is irrelevant
    • Trustee tried to reach settlement with Novell; could not agree on acceptable settlement.
    • Sublicense of a license which is an executory agreement.
    • They must cure $3 million owed to Novell.
    • Under the circumstances consent cannot be, and is not, given.
    Judge Gross asks about appeal. Mr. Lewis briefly explains issues being appealed. No idea on outcome or timing.

    Ms. Fatell:

    • Novell argues that 365 is a continuing provision and executory contract.
    • It is not an executory contract.
    • There is no material obligation between parties
    Judge Gross: But the APA says there is an obligation to operate the business. It will not operate after the sale.

    Ms Fatell: It's up to Novell to prove it's an executory contract. There is no language what the license is.

    Judge Gross: But now there is a big change in circumstances from past sales.

    Ms. Fatell: But there was implied intent. Sale is adequate under 363.

    [MikeD note: Judge seemed to me to be almost laughing at Ms. Fatell at above exchange.]

    Mr. Lewis:

    • This is an executory contract.
    • If we told them they could not sell any licenses, they would scream.
    • "Ordinary course of conduct" -- past sales are not the same as what is going on today.
    • We do not have to consent -- They owe us $3 million.
    • We reserve rights to appeal.
    • We are applying our rights
    Ms. Fatell: It's not an executory contract; no ongoing material relationship (referring to Exide decision).

    Mr. Lewis: Is so an executory contract. There is no need to have daily contact with a company when things are going well -- clearly things are not going well now.

    End of closing arguments.

    Judge Gross: Excellent arguments.

    Had an inkling which way he was going before today's arguments; now needs to go back and look at it.

    Understands need for quick decision with pending sale by end of March.

    Needs to give Novell time to avoid running across street with an emergency appeal.

    4 issues he needs to decide.

    Hopes to have decision within a week.

    Here's the Exide case mentioned, and here's an explanation by Skadden Arps. Here's a snip from the ruling:
    Quoting its prior decisions, the Third Circuit panel instructed that an executory contract is a contract under which, as of the commencement of a Chapter 11 case, “the obligation of both the bankrupt and the other party to the contract are so far underperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.” Thus, “unless both parties have unperformed obligations that would constitute a material breach if not performed, the contract is not executory” under Section 365 of the Bankruptcy Code. “[T]he time for testing whether there are material unperformed obligations on both sides is when the bankruptcy petition is filed,” and the inquiry requires consideration of “contract principles under relevant nonbankruptcy law.”

    In vacating the District Court that affirmed the Bankruptcy Court order authorizing Exide’s rejection of the trademark license to EnerSys, the Third Circuit applied New York8 contract law, including its “substantial performance” doctrine, to determine whether a breach by EnerSys of its remaining obligations under the license would constitute a material breach that would excuse Exide from further performance of its obligations.9 The Third Circuit observed that under New York law, when a breaching party “has substantially performed” before breaching, “the other party’s performance is not excused.” Citing Hadden v. Consolidated Edison Co., 312 N.E.2d 445 (N.Y. 1974), the Third Circuit recognized and applied the multi-factor test in New York for determining when a party has rendered substantial performance. That test considers “the ratio of the performance already rendered to that unperformed, the quantitative character of the default, the degree to which the purpose of the contract has been frustrated, the willfulness of the default, and the extent to which the aggrieved party has already received the substantial benefit of the promised performance.”

    The Third Circuit decided that the Bankruptcy Court had “failed to properly measure whether either party had substantially performed” under New York law. Based upon the record on appeal, the appellate panel determined that “EnerSys has substantially performed its obligations” under the 1991 trademark license agreement because, among other things, EnerSys had paid the $135 million purchase price in the 1991 transaction, had operated and used the licensed “Exide” mark for 10 years, and had assumed certain Exide liabilities as part of the 1991 transaction. The Third Circuit rejected Exide’s argument that EnerSys’ ongoing, unperformed obligations under the trademark license (including a limitation on use of the Exide mark to industrial batteries, a quality control requirement, and certain indemnification and further assurances obligations) outweighed the importance of EnerSys’ performance prior to the bankruptcy petition date. Accordingly, the Third Circuit concluded that the license agreement was not executory and could not be rejected by Exide as a Chapter 11 debtor-in-possession.


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