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Unrestricted License Agreement Permits Customer to Create Derivative Work from Copyrighted Classification System

LES Insights
January 3, 2012

Paul, John C., Kacedon, D. Brian

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Authored by Amanda Joy Dittmar, D. Brian Kacedon, and John C. Paul

Companies that provide software or database services often enter into license agreements with their customers to provide them with rights under the copyrights covering the software or databases. Those drafting these contracts must consider not only how to grant the rights necessary to allow the customer to use the services provided, but also how to protect against the unintended use of those rights by those customers. In Edgenet, Inc. v. Home Depot U.S.A. Inc., No. 10-13335 (7th Cir., Sept. 2, 2011),1 the Seventh Circuit reviewed a dispute over a license agreement and found that a customer's use of a licensor's copyrighted work to create a derivative work was authorized by the language of the agreement and was therefore not an act of copyright infringement or a breach of contract.

The Edgenet v. Home Depot Decision

In Edgenet v. Home Depot, the Seventh Circuit affirmed a district court's ruling that Home Depot did not infringe Edgenet's copyright of a database "taxonomy" because Home Depot held a valid license for the system.

In 2004, Edgenet and Home Depot entered into a contract in which Edgenet would develop a classification system, "taxonomy," to organize Home Depot's product database. The contract provided that Home Depot could use the taxonomy but Edgenet would own any intellectual-property rights to the taxonomy and the products' manufacturers would own the intellectual property rights to "wares' attributes." A 2006 supplemental agreement provided Home Depot with a no-cost license to use the "the product collection taxonomy" as long as Edgenet remained Home Depot's "data-pool vendor" and Home Depot continued to pay for services. The agreement also required that upon termination of the contract, Home Depot must either "immediately" stop using the taxonomy or exercise its option to purchase a perpetual license.

In 2008, Home Depot began incorporating the taxonomy Edgenet created, into a new in-house database. In response to this, Edgenet registered the taxonomy as the copyright, "Big Hammer Master Collection Taxonomy and Attributes 2008." Home Depot informed Edgenet on February 26, 2009, that the end of the business relationship was imminent and sent Edgenet a check for the stipulated amount required to purchase the perpetual license through the contractual option. Edgenet returned the check to Home Depot and filed a copyright-infringement suit in district court. There the judge dismissed the case, holding that the 2006 supplemental agreement along with Home Depot's payment for the perpetual license resulted in Home Depot's legally having the right to use the taxonomy Edgenet created. Edgenet then appealed this decision to the Seventh Circuit.

The Seventh Circuit first had to determine whether federal courts even had jurisdiction over the controversy at hand. Federal courts may decide cases if the controversy arises under federal law or if the parties have diversity of citizenship. In this case, both litigants were incorporated in Delaware, so the Court analyzed whether the controversy arose under federal law. The two main issues were the enforcement of the Edgenet's copyright and Home Depot's alleged breach of contract. Like patent-infringement claims, copyrights are covered by federal laws. But contracts are covered by state law, and therefore, federal courts do not have subject-matter jurisdiction to decide contract disputes. The Court found that because the initial complaint filed by Edgenet contained claims arising only out of copyright law and the contract was not in dispute until Home Depot invoked it as an affirmative defense, federal courts have subject-matter jurisdiction and the Seventh Circuit could decide the case on its merits.

Having dealt with the jurisdictional issues, the Court discussed the merits of the copyright case. Home Depot admitted to the Court that it uses the taxonomy Edgenet created in its in-house database, and the in-house database was therefore a derivative work. Home Depot argued that because it had the option in the contract to purchase a perpetual license and exercised that option by tendering the payment to Edgenet, it had a license to use the taxonomy and therefore, could not be held liable for copyright infringement. Edgenet countered Home Depot's position with three main arguments. First, the option was invalidated by Home Depot's infringement of the copyright before the payment. Second, the 2006 supplemental agreement to license "the product collection taxonomy" did not cover the taxonomy Edgenet copyrighted in 2008, because "the product collection taxonomy" referred to the taxonomy created for the initial project in 2004, not the 2008 updated version. Third, the contract required both Home Depot USA and Home Depot Canada to use Edgenet's services, and since Home Depot Canada ceased to use Edgenet's taxonomy in 2008 and failed to immediately tender payment to exercise the option, it breached the contract and forfeited its option to acquire a perpetual license.

The Court disagreed on all three points, finding that Home Depot did not infringe the copyright before exercising its option, the contract was still intact when it did, and the contract covered the copyrighted taxonomy. Although Home Depot admittedly copied the taxonomy Edgenet created, the Court explained, as long as Home Depot was using Edgenet as its service provider, both the 2004 and 2006 contracts gave Home Depot permission to employ the taxonomy. Since Home Depot was using Edgenet as its service provider the entire time it was developing its in-house database, Edgenet's first argument was moot. The unrestricted license meant that Home Depot had the contractual right to use the taxonomy as it pleased and therefore could not be infringing the copyright. The court specifically noted that the contracts failed to limit the way in which Home Depot used the taxonomy and that "exclusive rights under copyright law (unlike patent law) do not attach to the product into which a copyrighted work may be incorporated."

Edgenet's second argument was also unconvincing, as the Court determined that "the product collection taxonomy" included all versions of the taxonomy created by Edgenet for Home Depot. Home Depot continually added and removed products from the database making the taxonomy a constant "work in progress" and therefore could not be a 2004, 2006, 2008 version. Further, the 2006 supplement agreement used the term "the product collection taxonomy," meaning that under Edgenet's definition, Home Depot would have the right to use only the old version. At that time, Home Depot was not using the original 2004 version but an updated one and would therefore have been infringing the copyright even with the newly signed agreement. Finally, the Court noted that even though the contract cited "the product collection taxonomy" (emphasis added) and that "the" is "appropriate only if there is just one taxonomy," the contract must have used that term to refer to the current version of the software. Thus, Home Depot was entitled to license for the future whatever it was entitled to use while the contract was in force.

Finally, the Court determined that Home Depot Canada's alleged beach of the contract because it stopped using Edgenet's services did not affect Home Depot's ability to exercise its option to purchase a perpetual license. Edgenet, the Court pointed out, could have treated this as a breach of contract and revoked the license, but instead continued to operate under the contract with respect to Home Depot USA. The Court's rationale also rested on the organization of the contract, pointing out that the requirement to use Edgenet's services was in section 5, while the option to take the perpetual license was in section 2 of the contract. The court found that the "immediate" exercise of the option was not required until after the termination of the contract and since Home Depot Canada's actions did not result in a termination of the contract, Home Depot was still within its rights to exercise the option to purchase the perpetual license.

After rejecting all three of Edgenet's arguments, the Court found that "Home Depot has not been in violation of the copyright laws for even one day" and affirmed the lower court's decision.

Endnotes

1 The Edgenet v. Home Depot decision: http://scholar.google.com/scholar_case?case=3064787396241939833&hl=en&as_sdt=2&as_vis=1&oi=scholarr.

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