Alcatel USA, Inc. v. DGI Technologies, Inc. was litigation between two companies in the telecom-equipment industry. DSC Communications (identified in the opinion as the former name of Alcatel USA) made telephone switches controlled by its copyrighted operating system. DGI Technologies made expansion cards that work with DSC switches. DSC sued in 1994 for trade-secret misappropriation and unfair competition, and in 1995 added copyright claims. DGI counterclaimed under section 2 of the Sherman Act and for tortious interference and unfair competition.[1]
Background
DSC sold its switches but licensed, rather than sold, the operating system software. The agreement provided that the software remained DSC’s property, that the customer could use it only to operate its switch, that copying and disclosure to third parties were prohibited, and that customers could use it only with DSC-manufactured equipment.[1]
Before 1989 DSC was the only maker of expansion cards for its own switches. DGI, founded that year, obtained a used DSC switch and manuals from an investor, then designed compatible cards. A microprocessor card controls the switch’s boot-up and downloads DSC’s operating system into its memory. For some time DGI sold used DSC microprocessor cards together with its own cards. When a 1995 software revision required a new DSC card (the MP-8), few used ones were available, and DGI developed its own microprocessor card, the DMP-2800.[1]
The dispute
To build the DMP-2800, DGI removed the firmware from a purchased MP-8 and disassembled it. Its engineers also took an MP-8 to a DSC licensee, NTS Communications, where an NTS employee who also consulted for DGI copied the operating system from the NTS switch to a laptop. DGI later used a modified “snooper” card to watch the download. DSC said this copying infringed its copyrights and misappropriated trade secrets. DGI said it was reverse engineering and that DSC had tried to thwart its market entry, including by a software patch and a letter threatening to void customers’ warranties.[1]
After a three-week trial the jury returned a mixed verdict. The district court entered a set-off judgment of US$300,000 for DSC, after awards of US$4.3 million actual and US$7 million punitive damages to DSC and US$2 million actual and US$9 million punitive damages to DGI. It dismissed DGI’s antitrust claim and permanently enjoined DGI from developing new microprocessor cards with the help of DSC’s operating system and from selling its other microprocessor cards designed to use that software.[1]
Decision or outcome
The Fifth Circuit held:[1]
| Issue | Holding |
|---|---|
| DGI’s Sherman Act claim | Judgment as a matter of law for DSC affirmed |
| Direct and contributory copyright infringement | Infringement established. DGI copied the operating system at NTS, and each boot of a DGI card copies it. The jury found DGI had not proved that switch owners owned their copies, so section 117 did not protect them |
| Copyright misuse | DSC’s licence, which let customers use the software only with DSC hardware, was misuse here, because testing a competing card necessarily copies the software. The copyright-based injunction was reversed |
| Trade secrets | Damages and the injunction, to the extent based on this claim, affirmed |
| State unfair competition by misappropriation | Preempted by the Copyright Act; relief vacated |
| DGI’s tortious interference and unfair competition awards | Reversed for lack of evidence |
| Damages | Remanded because the award was not itemised enough to modify |
The court said that, without the freedom to test its cards with DSC’s software, DGI was effectively prevented from developing its product, which gave DSC a limited monopoly over cards it had not patented. It reached that conclusion despite the jury’s finding that DGI acted with unclean hands.[1]
Significance for software licensing and SAM practice
- Hardware-locked software licences. The restriction that the operating system may be used only with the vendor’s hardware was central. The court held it amounted to misuse when enforced to stop compatibility testing.[1]
- Licensee versus owner. Switch owners who held a licence were not shown to be owners of copies of the software under section 117, which kept contributory-infringement liability alive for a vendor of third-party cards.[1]
Lessons learned
- A licence limiting software to the vendor’s own hardware can be copyright misuse when used to block competing hardware. The Fifth Circuit reversed the copyright injunction on that ground.[1]
- Licensees are not owners of the copy for section 117 purposes. Third parties whose products make licensees copy the software can face contributory-infringement claims.[1]
- Compatibility work that involves copying a customer’s installed software is risky even with the customer’s cooperation. The trade-secret judgment and an injunction partly based on it were affirmed.[1]
Out of scope
This article does not cover the damages recalculation on remand, the earlier preliminary-injunction appeal, or the detail of the market-definition analysis on the antitrust claim.