VMware Virtualization and the Oracle Audit: What Every Oracle Customer Needs to Know About the "Installed and/or Running" Language of the Processor Definition
From public documents, we know that the standard Oracle License and Services Agreement (“OLSA”) and the newer Oracle Master Agreement (“OMA”) typically provide Oracle with the right to audit the use of Oracle software by its customers, provided that the audit does not unreasonably interfere with the customer’s normal business operations. The contract allows Oracle to, in effect, take a snapshot of a customer’s Oracle software usage at a certain point in time, but it does not allow Oracle to go rummaging around and looking through other customer systems and data, which have no relation to Oracle software. Under the OLSA, customers pay Oracle a licensing fee only on those processors where Oracle software is used; i.e. where it is “installed” or is “running”. Although the OLSA does not entitle Oracle to audit servers not running Oracle, in the last few years Oracle has sought to stretch the “installed and/or running” language of the processor definition when a customer is running a software product by VMware, which allows customers to run multiple “virtual servers” on one physical server. Oracle claims that all servers running the VMware software require an Oracle license even when there is no Oracle software installed on them.
For example, in Fall 2015, Oracle threatened to terminate a license agreement that it had with global confectioner, Mars Corporation. Mars and Oracle battled it out for months via email during the audit over the meaning of the “installed and/or running” language of the processor definition, until Oracle finally pulled out the big guns and threatened to terminate the license. Mars responded by filing a lawsuit for injunctive and declaratory relief in San Francisco County Superior Court. The case did not last long, but it resulted in a treasure trove of Oracle-related documents coming into the public domain.
In correspondence, Oracle took the position that Mars needed to purchase licenses for all servers running VMware, even where the Oracle software was not “installed” or “running”. A letter from Chad Russell, Senior Counsel in Oracle’s Legal Department, is instructive. According to Mr. Russell, “Oracle programs are installed on any processors where the programs are available for use. Third party VMware technology specifically is designed for the purpose of allowing live migration of programs to all processors across the entire environment. Thus, Oracle Enterprise Edition is installed and available for use on all processors in a V-Center.” Exhibit 11 to Declaration of Eloise Backer, Mars v. Oracle, San Francisco Superior Court, Case No. CGC-15 -548606. Essentially, Oracle took the position that the mere fact that Oracle software might possibly be installed and run on one of these processors at some indeterminate time in the future, constituted a use of Oracle software and a licensing event for which Mars would need to pay a royalty at the time of the audit. Would a California court construe the mere possibility of a future event that may never occur as an actual “use” of Oracle software so as to trigger a royalty obligation? We think it highly unlikely. Moreover, Oracle may think it highly unlikely as well, which is why, to our knowledge, Oracle has never filed a lawsuit against any customer based upon its expansive interpretation of the “installed and/or running” language.
Based on the public correspondence filed in the Mars case, it appears that Oracle was unable to point to any actual contractual support in the OLSA for its novel definition of “installed” or what it means to “use” Oracle software. And, after defending multiple software audits on behalf of Oracle customers, we too are unaware of any language in the OLSA, which would support Oracle’s position. In fact, just the opposite is true. The fully integrated agreement does not contain contractual language or incorporate other documents or URLs, related to use of a product like VMware, upon which to base such an assertion. Further, to the extent Oracle is using its limited audit rights to gain access to confidential customer information about servers where no Oracle software is installed and/or running, a California court could find that such actions constitute a breach of the audit clause, as well as an unfair trade practice under California law. This is especially true if Oracle attempts to use the improperly obtained information to threaten license termination in order to pressure its customers to buy cloud credits or other Oracle software. And to the extent that Oracle succeeds in using its expansive interpretation of the “installed and/or running” language to move its customers out of VMware, Oracle customers may have a claim against Oracle for intentional interference with contract and other related torts.
California Civil Code Section 1638 provides that "the language of a contract is to govern its interpretation, if the language is clear and explicit, and does not involve an absurdity." See also People ex rel. Lockyer v. R.J. Reynolds Tobacco Co. (2003) 107 Cal. App. 4th 516, 525. Oracle's interpretation of the “installed and/or running” language cannot be deemed either clear or explicit and, in fact, is absurd. Indeed, just reading Mr. Russell’s lengthy and labored three sentence explanation of what it means to be “installed” shows the fatal flaw with this argument. Oracle, as the drafter of the OLSA, had the opportunity and burden to specifically define "installed" if it wanted to interpret it in this manner and not in its usual sense as “installed” is used in the software industry. It did not do so. Under California Civil Code Section 1644, "[t]he words of a contract are to be understood in their ordinary and popular sense, rather than according to their strict legal meaning; unless used by the parties in a technical sense, or unless a special meaning is given to them by usage, in which case the latter must be followed." Id. at 525-26.
Even if a court were to find the language ambiguous, California law requires that ambiguities be interpreted against the drafter of the contract, which is Oracle. See Cal. Civ. Code §1654 (contract should be interpreted most strongly against the drafting party); see also San Pasqual Band of Mission Indians v. State of Cal. (2015) 241 Cal. App. 4th 746, 761-62 (“In cases of uncertainty . . . the language of a contract should be interpreted most strongly against the party who caused the uncertainty to exist.” ). Finally, Oracle’s position that its programs are installed on any processors where the programs are available for use, if accepted, would lead to an absurd result, as it would require Oracle customers to pay a license fee for a speculative future event that may never happen. The license grant covers a customer’s actual use of the software, and not a potential use in the future.
Under California Civil Code Section 1636, "a contract must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting;" see also DVD Copy Control Ass'n, Inc. v. Kaleidescape, Inc. (2009) 176 Cal. App. 4th 697, 712 (“interpretation of the License Agreement is guided by the principle that it “must be so interpreted as to give effect to the mutual intention of the parties as it existed at the time of contracting, so far as the same is ascertainable and lawful.”). Indeed, most likely Mars (and we suspect other Oracle customers) would have never entered into the license agreement, if it had known of Oracle's overbroad interpretation of "installed" and what Oracle contends it means in the context of VMware virtualization. Although Oracle’s “installed and/or running” language has been in place since the early 2000s, in 2009 when Mars and Oracle entered into their licensing agreement, the present VMware virtualization technology was not in widespread use by customers with their Oracle database, meaning Oracle’s novel interpretation of “installed” could not possibly have been mutually intended by the parties.
If your company has been notified of an Oracle audit, or you are under audit now, do not delay before seeking experienced legal counsel to assist you. Likewise if you have been audited by Oracle and have purchased additional software or paid money based upon Oracle’s assertions around VMware, you may have legal options to recoup some of those costs. In any event, do not go up against Oracle without knowing your legal rights. What you do not know, could and will most assuredly, hurt you.
With the November 8, 2016 passage of Proposition 64 known as the Control, Regulate and Tax Adult Use of Marijuana Act (referred to hereafter as “Prop 64”), it is time for many homeowners associations (HOAs) and residential landlords to take a fresh look at smoking restrictions put in place to address secondhand smoke and odor concerns in Declarations of Covenants, Conditions and Restrictions (CC&Rs) and leases, respectively, to ensure compliance with Prop 64 and local regulations and to minimize the risk of nuisance claims.
Prop 64 is a multifaceted and lengthy Act, but here are a couple of key provisions for HOAs and residential landlords to pay special attention to:
Fulmer Ware LLP is a San Francisco based law firm. Our lawyers have experience litigating and advising on all types of real estate, construction and commercial matters from the negotiation and preparation of documents, risk management, pre-litigation counseling, alternative dispute resolution and all phases of litigation from insurance tenders to trials and appeals.
Lawyers at Fulmer Ware LLP have litigated all types of breach of contract cases over the years. One area of a contract that is ripe for dispute involves “efforts” clauses. These clauses can be found in license agreements and almost any kind of commercial contracts. This blog post offers practical advice on how in-house counsel and business people can draft these clauses to mitigate the risk of disputes later on.
WHAT IS AN EFFORTS CLAUSE?
Efforts clauses require a party to a contract to commit to use a certain level of effort to achieve a stated goal. Such clauses include “best efforts”, “reasonable efforts” and “commercially reasonable efforts”. Some attorneys view these clauses to require different levels of effort, e.g., “best efforts” being the most exacting standard, followed by “reasonable efforts” and then “commercially reasonable efforts” being the least demanding of all. Case law and the UCC, however, do not support such a hierarchy. In fact, there are no universally accepted standards or definitions for these terms.
THE LAW CAN DIFFER DRASTICALLY BY STATE
Courts in New York have treated “best efforts” and “reasonable efforts” interchangeably. These courts have found that such efforts (1) impose an obligation to act with good faith in light of one's own capabilities; (2) give promising parties the right to give reasonable consideration to their own interests; and (3) permit promising parties to rely on their good faith business judgment. (See Soroof Trading Dev. Co. v. GE Fuel Cell Sys. LLC, 842 F. Supp. 2d 502, 511 (S.D.N.Y. 2012); Bd. of Managers of Chocolate Factory Condo v. Chocolate Partners, LLC, 992 N.Y.S. 2d 157 (N.Y. Sup. Ct. 2014)). Other New York courts have found a hierarchy with best efforts being the most exacting standard. See In re Chateaugay Corp., 198 B.R. 848, 854 (S.D.N.Y. 1996).
California courts on the other hand have found that a promise to use best efforts creates a more exacting standard than a promise to use good faith. California Pines Prop. Owners Ass'n v. Pedotti, (2012) 206 Cal. App. 4th 384, 394-95. The California Pines court found that best efforts requires diligence within the bounds of reasonableness, which leaves the hierarchy between best efforts and reasonable efforts unclear. According to the court, “we do not agree that a promise to use best efforts creates an obligation equivalent to a fiduciary duty. Instead, we agree with the courts from other jurisdictions that when a contract does not define the phrase ‘best efforts,’ the promisor must use the diligence of a reasonable person under comparable circumstances. Diligence is certainly required, but the obligation is framed within the bounds of reasonableness.” Likewise, in Delaware, a US District Court has similarly found that a best efforts clause requires the promising party to undertake its contractual obligations diligently and with reasonable effort. Crum & Crum Enter., Inc., v. NDC California, L.P., No. 09-145, 2010 WL 4668456 (D. Del. Nov. 3, 2010). Whatever standard a court may use, it is a fact-intensive inquiry.
PRACTICAL ADVICE AND TIPS
So how can in-house counsel protect their client when utilizing such clauses? Here are a few ideas to consider.
Define the Term in the Contract
One way to avoid a fight over efforts clauses is to specifically define and set forth what level of effort is required in the contract. A court interpreting such a provision will look first to the contract and how the parties chose to define the efforts clause. Work hard to eliminate any ambiguity in the definition, which would allow a court to look outside the four corners of the agreement. Be careful not to guarantee an outcome in the definition; yet, don’t make the definition so specific that you unnecessarily limit your client.
Consider Including Carve-Outs
Another strategy is to consider including carve-outs where the efforts term is undefined or broad. Such carve-outs describe the kind of efforts that the promising party is not obligated to take. Carve-outs can provide that the promising party is not required to (1) spend a specified dollar amount where the dollar amount is not already included in the contract; (2) engage in conduct that would have a materially adverse effect on the promising party; (3) take any action that would cause the promising party to incur costs or suffer any other detriment that is out of reasonable proportion to its benefits under the agreement; (4) take any action that would subject it to liabilities; (5) disregard its own business strategy and economic interests; (6) take illegal actions or (7) take any action that would harm its existence or solvency.
Use Effort Terms Consistently
The parties should take great pains to use the terms consistently throughout a contract. If the contract includes definitions of efforts terms, the parties should use the terms only according to their defined meanings. Failure to use terms consistently will create confusion and suggest that the parties themselves do not value the differences between the terms, which only invites the court to substitute its own interpretation for that of the parties
Use Objective Criteria
Parties to a contract should consider using objective criteria to provide standards against which efforts can be measured. One such criteria is to provide a timeframe such as “promptly”, or in the “most expeditious matter practicable” or within a specific number of days or weeks or a specified term. The parties can also include a triggering event at which point best efforts are triggered, or when a certain quantity or production level is met.
Consider Making the Conduct an Obligation Instead of Subject to an Efforts Provision
If you get to the point in your contract negotiation where you have defined what the effort would be with specificity, set the carve-outs and used objective criteria to define the standard, consider forgoing the efforts clause and instead making the conduct an express obligation under the agreement.
Fulmer Ware LLP is a San Francisco based law firm. Our lawyers have experience litigating and advising on all type of contract matters, including matters involving interpretation of “efforts clauses”.
On May 11, 2016 President Obama signed into law the Defend Trade Secrets Act (“DTSA”), which went into effect immediately. The Act creates a federal cause of action for trade secret misappropriation, which is meant to supplement and not preempt state trade secret law.
The DTSA provides litigants with a number of remedies including ex-parte seizure orders , damages for actual loss and unjust enrichment, or instead of damages, a reasonable royalty for unauthorized use or disclosure. Exemplary damages for willful or malicious misappropriation can also be awarded as well attorneys’ fees and injunctive relief.
Whistleblower Protections Require Immediate Action
Importantly, the Act contains new whistleblower provisions that require companies to take immediate action to be able to take advantage of the Act. Employees, independent contractors and consultants who disclose trade secrets are protected from prosecution if the disclosure was made to report or investigate an alleged violation of law. If the employee’s disclosure of highly sensitive company information is made in confidence to "a Federal, State, or local government official…or to an attorney…solely for the purpose of reporting or investigating a suspected violation of the law" or as part of a legal proceeding, then that disclosure cannot form the basis for a misappropriation claim against the employee. This safe harbor extends immunity to both state and federal trade secret claims.
What You Must Do.
Employers must include notice of this immunity in any agreements entered into or amended on or after May 12, 2016 with employees, contractors or consultants that govern the use of confidential or trade secret information. Failure to include the notice would preclude the employer from being awarded attorneys’ fees or exemplary damages in any lawsuit against the employee. The notice requirement applies to all employee proprietary information and invention agreements, nondisclosure and contractor and consulting agreements with individuals. At Fulmer Ware LLP we advise our clients on how to comply with the notice requirement and other steps to protect their valuable trade secrets.
Pam Fulmer is a member of the Standing Committee on Trade Secrets of the Intellectual Property Owner’s Association. The Committee supported the passage of the Defend Trade Secrets Act.
Over the years we have advised numerous clients on contract issues and handled many breach of contract cases in the courts and in arbitral forums around the country. Often, we see many of the same issues arise time and again. One area that is ripe for dispute involves the termination provision of a contract. What looks crystal clear on the first read often ends up being more complicated.
Extreme care must be taken when terminating a contract, and the business person or in-house lawyer responsible for the termination needs to ensure that he or she complies with the requirements of the termination provision exactly. Otherwise, the termination may be ineffective and lead to expensive and time consuming litigation, and the terminating party may find itself in breach.
Many of the cases that we have litigated contain language requiring 30-days’ notice and an opportunity to cure before the contract may be terminated. Read these provisions very carefully and follow them exactly, if you want to perfect your right to terminate.
I remember very clearly litigating a multi-million dollar breach of contract case in an arbitration. The other side claimed that a letter they had sent my client was a cure notice, and I argued that it was not. The arbitrator, a former California appellate justice, glowered at my opponent and in a booming voice dismissed the notion that the letter was a cure notice. He said something to this effect: “Counsel, this is not a cure notice. A cure notice is plainly labeled as such in the Re line of the document. It cites to the relevant provision, and is delivered in accordance with the notice provision of the contract. It specifically identifies the provisions of the contract, which have been breached, and for which a cure must be effectuated. It provides a date certain when the cure must be made, or else risk termination of the contract.” We won a $33 million-dollar arbitration award for our client, and were also awarded attorneys’ fees in that case. Sweating the details does matter.
Another error that seems to occur frequently is failure by the party terminating the contract to comply with the notice provision of the agreement. Most termination clauses require written notice of the breach and the opportunity to cure, but they may not specifically reference the notice provision, which appears elsewhere in the contract and/or relevant statutory provisions. As a result, many people overlook the manner by which notice must be given. It is very important before sending the cure notice or the termination letter to check and see if the contract contains such a notice provision or if there is an applicable statutory requirement. If there is, make sure that you comply fully, and do not take any short cuts.
Today, most parties to a contract communicate via email. However, notice provisions may be copied from older contracts and require personal delivery or via overnight or certified mail. Same for statutory requirements. Make sure that you are sending the correspondence to the designated persons at the designated address using the proper method of delivery, and if there are time limits or other procedural requirements in the termination provision, be sure to comply with these as well.
If you are considering terminating a contract, or if your company receives a cure or termination notice, Fulmer Ware LLP is here to help and to guide you through the process.
When responding to any software audit, companies must look to the terms of the license agreement that governs the relationship between the parties. As a threshold matter, it is vitally important to keep all of the actual contractual documents and Order forms together in one place for ease of reference. Also emails and other written communications between the licensor’s audit team and the business being audited should be retained as well. Often what we have found is that the licensor’s audit team tends to correspond in emails and other writings with our clients who are being audited. The licensor is making a written record and demanding documents and other information, and may be doing so in a way so as to cast the company being audited in a negative light in the event of later litigation.
We have also found that although the licensor’s audit teams tend to rely on writings as they attempt to make a record of non-cooperation by the licensee, the licensor’s sales teams, which the licensor may be concurrently deploying will often use the phone and leave voicemail messages, so as not to create a paper trail, which can later be used against the licensor. We recommend that such voicemail messages be transcribed, and if possible an audio recording of the voicemail preserved for use as evidence later on should litigation be initiated.
For example, in the first public filing against Oracle Corporation relating to the VMware virtualization issue in the Mars vs. Oracle case, Mars was able to make use of the written record to support its position that Oracle was in breach of the license agreement by exceeding its audit rights. Care must be taken in any discussions with the licensor, to view every communication to the licensor, with a lens as to how a Judge or jury might view the communication in the event of litigation.
We know from the public filings in the Mars vs. Oracle lawsuit that the contract at issue in that case had a choice of law provision selecting California law, and that the venue selected was San Francisco. As a result, when choosing counsel, companies may want to consider retaining lawyers who are familiar with relevant law and with the local courts and jury pool, in the venue specified in the operative license agreement. We are California lawyers who have been practicing California law in the venue for almost 25 years.
The public filings in the Mars vs. Oracle case also demonstrate how a licensor may attempt to use its audit rights to obtain documents and other information that it might not be entitled to under the license agreement. Licensees may want to weigh whether and to what extent to grant the licensor access to their confidential and proprietary information. Such issues need to be explored very carefully, as the technical and legal teams work closely together to prepare their response strategy.
Over the last year, the media has reported an uptick in compliance audits by Oracle Corporation for its enterprise software customers. See articles here and here. Clients are seeking our guidance on how to deal with these audits and want to understand their legal options.
The story is a familiar one. A company’s IT manager receives a notice from Oracle that the company has been selected for an audit. Oracle seeks commencement of an audit quickly and asks for large amounts of information from the client. The information sought may go well beyond the technology actually licensed from Oracle and may involve third party vendors such as VMware or others. The company protests about the wide-ranging scope of the audit, and Oracle personnel may contend that the company is trying to hide its non-compliance with the license by refusing to cooperate. The rhetoric increases, more documents are demanded, additional forms must be filled out and then the final audit report is issued. The number that Oracle contends represents the amount of the overage may be staggering to the company, and for some companies, simply impossible to pay. Almost concurrently with the issuance of the audit report, Oracle sales representatives are reaching out and leaving messages that they have other, less costly solutions. All the company needs to do is buy more Oracle products. While the company is frantically trying to figure out its options, it receives a 30-day notice of breach letter that the license will, or may, be terminated if the company does not have a plan in place for compliance by the end of the 30-day period.
This is a scenario that is happening to an increasing number of companies. If you are a big company and think Oracle would never do this to you because you are an important customer, do not be complacent. According to reports in the media, Oracle likes to target companies that are large and have used its software widely because it knows how difficult it would be to switch enterprise software mid-stream. If you think you are too small to be targeted for an audit, do not be too sure either. According to the business press, Oracle appears to be pursuing this strategy to increase its cloud-based sales involving companies of all sizes.
So, what should IT professionals do if they receive such an audit letter from Oracle? If your company has a legal department, you should report the issue to your in-house counsel immediately. If you do not have a legal department, you should retain outside counsel to assist you with your response to the audit. Oracle salespeople and audit personnel are aggressive in their pursuit of higher margins and sales. Licensees often need professional legal help to balance the ongoing dialogue and gain leverage in the negotiation by understanding their true legal rights, rather than accepting what is being represented by Oracle’s sales and audit teams.
Our lawyers have advised clients on how to best position themselves for a favorable outcome after an Oracle audit. We have implemented legal strategies that have resolved the situation, without the necessity for lengthy and protracted litigation. We also have advised clients on how to respond to audits initiated by other software providers such as Autodesk and others. Our team is experienced in these situations and here to help, if you find yourself subject to a software audit.