Software Audit Essentials – Insurance Coverage

Introduction

When companies get a notice of audit from software companies like Microsoft, Adobe, Oracle, CNC, or Vero software, or from trade organizations and compliance groups such as “software compliance group” or “business software alliance” they often get very concerned about the potential legal liability to both the company, AND its Officers and Directors (who could be sued if a infringement case is filed in federal court).  This blog is general legal information and a reminder to check your insurance policies to see if you might have coverage.  If an insurance carrier refuses to accept the defense when contractually obligated to do so, this could constitute “bad faith” insurance.

Now, in many cases we have NOT found coverage for BSA, Microsoft or Autodesk audits, but nevertheless if you don't like you will never know.  In this software compliance case from Ohio (note we are only licensed to practice law in California and Arizona) one company sought to be covered for losses pertaining to a BSA audit, but the insurer denied it.  The case was reversed, in part, on appeal and sent back to the lower court on the issue of whether or not the BSA letter is a “claim” or not.

Eighth Floor Promotions, LLC v. The Cincinnati Insurance Companies

This case from Ohio deals with whether there is insurance coverage for BSA Audits.   Here are some snippets from the case:

“Eighth Floor is a Nevada limited liability company with its principle place of business in Celina, Ohio. It manufactures and sells sports awards and business gifts. It is managed by a few officers, some of whom also sit on its board of directors.

Eighth Floor is a Nevada limited liability company with its principle place of business in Celina, Ohio. It manufactures and sells sports awards and business gifts. It is managed by a few officers, some of whom also sit on its board of directors.  Eighth Floor's Operating Agreement provides that it will “indemnify and hold harmless” its officers and directors “in any “threatened  claim, action or proceeding to which any officer or any [director] is [a] party or is threatened to be made a party by reason of its or his activities on behalf of [Eighth Floor].”

In 2010, Eighth Floor purchased an insurance policy from Cincinnati Insurance (“the Policy”). The Policy provided that Cincinnati Insurance would “pay on behalf of the ‘company' all ‘loss' which the ‘company' [was] required to pay as indemnification to the ‘individual insureds' resulting from any ‘claim' first made during the ‘policy period' for a ‘wrongful act'”.   The Policy defined “company” as “the ‘insured entity' and any ‘subsidiary' ” and “individual insureds” as “all persons who were, now are, or shall become directors, officers or employees, of the ‘company.”

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The letter from the BSA

The case went on to discuss:

On May 11, 2011, Eighth Floor's Chief Executive Officer, Dave Willis, received the following letter from the Business Software Alliance (“the BSA”):

Dear Mr. Willis:

This firm represents [the BSA] in connection with its investigation of possible instances of illegal duplication of certain software companies' proprietary software products. The BSA represents the interests of [17 software companies]. We recently have been advised that [Eighth Floor] has installed on its computers more copies of [22 software programs] than it is licensed to use. Unauthorized duplication of computer software products constitutes copyright infringement. The Copyright Act (17 U.S.C. § 101 et seq.) provides that copyright owners may recover actual damages or statutory damages. In cases where the infringement is willful statutory damages can reach $150,000 for each copyrighted product that has been infringed.

The copyright owner can also seek attorneys fees.  However, [the] BSA member companies have determined that litigation may not be necessary in this case, especially as senior management may not have had an opportunity to investigate or consider the ramifications of using unlicensed software. The BSA member companies instead wish to resolve this matter amicably by providing Eighth Floor with an opportunity to conduct its own company-wide investigation. To take advantage of this opportunity, Eighth Floor's investigation must include an audit of all of the software published by [the] BSA members (see above) on all of its computers and a review of the software licenses and proofs of purchase for those licenses.

Please understand that while we are contacting you in an effort to avoid litigation, the BSA member companies are not waiving their right to litigate to protect their copyrights if this effort is not successful. We therefore must insist that you contact us by May 31, 2011. At that time we will provide you with specific guidance on how to conduct your audit. In addition, please do not destroy or replace any copies of any of the computer software products published by the above-mentioned companies that are currently installed on Eighth Floor's computers. The software programs installed on Eighth Floor's computers are evidence and therefore must be preserved in case this matter does proceed to litigation. In the meantime, you should not attempt to enter into any negotiations with sales representatives of these companies to purchase computer software products prior to the resolution of this matter. We look forward to your cooperation.

Sincerely, Troutman Sanders LLP

Is a infringement demand letter a “claim”

The case also discussed the claims being made:

“On May 20, 2011, Eighth Floor retained counsel to conduct a software compliance audit and prepare a summary of the results; assist it in its efforts to comply with all applicable software licensing requirements; attempt to negotiate a favorable settlement with the BSA; review its applicable insurance policies; and review proposed software license purchases. On May 26, 2011, Cincinnati Insurance denied coverage for losses incurred in connection with the audit request. It explained that the audit request did not constitute a “claim” under the Policy because it was neither a “written demand for monetary damages or non-monetary relief” nor a “civil proceeding commenced by filing a complaint or similar pleading.” It agreed, however, to treat the audit request as a “notice of circumstances” that may give rise to a claim covered under the Policy but warned that “based on the information currently known,” coverage for a future claim may be limited or precluded under one of the Policy's exclusions.”

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The BSA settlement letter

This case also highlighted what the BSA response letter may look like if you are facing an audit:

Dear Mr. Barnett:

Thank you for investigating the installation and licensing of certain computer software products at [Eighth Floor]. [The] BSA appreciates Eighth Floor's cooperation in this matter. As you may know, unauthorized duplication of computer software products constitutes copyright infringement for which the Federal Copyright Act, specifically 17 U.S.C. § 504(c), allows the recovery of statutory damages ranging up to $150,000 per product for willful conduct.

Even if willful conduct cannot conclusively be established, Section 504 permits the copyright owner to elect an award of nonwillful statutory damages of as much as $30,000 for each work infringed without the necessity of demonstrating actual damages. Additionally, 17 U.S.C. § 505 permits the court to award to the prevailing party its costs and reasonable attorneys' fees. Often when the BSA investigates [sic] company for copyright infringement and discovers unauthorized activity, [the] BSA will seek in settlement an amount equal to several times the full retail value of all unauthorized copies of software products published by the software companies whose interests are represented by [the] BSA.

In this case, however, [the] BSA member companies believe that it is the best interest of all parties to resolve this matter short of litigation. To that end, we have formulated a settlement proposal which takes into account the manufacturer's suggested retail price (“MSRP”) of the unlicensed installations, the cooperation Eighth Floor has exhibited, and all underlying facts. While the amount to be derived from the BSA falls well below Eighth Floor's maximum exposure as set out above, [the] BSA's approach does serve a similar purpose – to deter infringement. After all, if it were possible simply to become compliant once infringement was discovered, there would be no reason to obey the copyright laws in the first place. To the contrary, such a system would create substantial incentive to copy software.

Accordingly, I have been authorized to extend a settlement offer on the following terms, which are documented in the attached Settlement Agreement:

1. Eighth Floor will certify through one of its corporate officers, that

(a) the software inventory report(s) provided during the negotiation of this settlement is true and accurate and contains a complete and accurate list of all copies of all Computer Software Products installed on its computers as of May 11, 2011;

(b) all Computer Software Products installed on Eighth Floor's computers for which it does not have a license have been destroyed;

(c) a sufficient number of licenses for the remaining Computer Software Programs have been purchased to ensure legal use; and

(d) only licensed copies of the Computer Software Products are now and will in the future be installed on Eighth Floor's computers. Documentation of compliance with these provisions will be provided along with the certificate described above.

2. Eighth Floor will agree to execute a Software Code of Ethics and to circulate it to all employees, personnel and affiliated companies.

3. Eighth Floor will agree to permit the BSA to conduct two inspections per year for three years of Eighth Floor's computers to confirm the absence of copyright infringement. The inspections will be at the BSA's option and expense absent any discovery of infringement, and at Eighth Floor's expense if infringement is found to any Computer Software Product.

4. Eighth Floor will make a payment to the BSA in the amount of $179,393.48, a three-time multiplier of the MSRP owed plus attorney's fees. This payment is to resolve Eighth Floor's potential liability for copyright infringement and is in addition to any costs incurred by Eight Floor in complying with item 1 above.

5.  The BSA member companies will forego the filing any lawsuit against Eighth Floor and will release Eighth Floor from any liability related to past infringement of the copyrights in the software products listed below due to Eighth Floor's use and/or installation of those products on Eighth Floor's computers.

This offer is made with the assumption that this case will settle quickly. If it does not, costs will only increase and the potential for a non-litigation resolution will decrease. The remaining terms of the BSA's settlement offer are set out in the enclosed settlement agreement.

Sincerely,

[Troutman Sanders]

Holding of the case

The Court ultimately decided:

THE TRIAL COURT COMMITTED REVERSIBLE ERROR WHEN IT HELD THAT THE LETTERS SENT TO EIGHTH FLOOR THROUGH ITS DIRECTORS AND OFFICERS, WHEN CONSIDERING THE SURROUNDING CIRCUMSTANCES, DID NOT GIVE RISE TO A DUTY FOR CINCINNATI INSURANCE COMPANY TO PROVIDE A DEFENSE TO THE DIRECTORS AND OFFICERS UNDER THE BLUE CHIP POLICY.

Federal Copyright Infringement & Software Law Firm

To discuss your software case in confidence we offer a free initial consultation to companies who have received a demand letter from a compliance group, software company, or an intellectual property law firm alleging copyright infringement or seeking an audit of your internal IT networks.  We have experience helping companies both large and small and across many different industries in seeking to bring these matters to a close.  We have resources who can help you review your insurance policy to see if you may have coverage, and to ascertain whether or not your insurance company may be acting in bad faith.  Call us at (877) 275-5084 or emails us at the address on the right sidebar on this page.  We offer low flat rate legal fees for most non-liitigation / arbitration cases.  We have great client reviews and extensive federal court experience.