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Tuesday, 26 August 2014

Cold Comfort Farmers Cards: Californians feel New Zealand chill

From Katfriend and long-time respected IP commentator Ken Moon (AJPark) comes news of a 13 August ruling of the New Zealand Court of Appeal (Harrison and Miller JJ) in a software copyright and trade secrets dispute, Karum Group LLC v Fisher & Paykel Finance [2014] NZCA 389, which was heard this June.  Ken takes us through the IP aspects of this dispute as follows:

This case, which relates to alleged copying and misuse of confidential information arising from a system integration and data migration project, is the first New Zealand case on non-literal software copyright infringement. In short, the Court of Appeal upheld the judgment of the High Court that Fisher & Paykel Finance (FPF), in modifying its own credit software, had not infringed any copyright in Karum’s CMS software; nor had Karum proved a claim of breach of confidence through FPF incorporating Karum's trade secrets into its own software.


In 2004 FPF purchased Retail Financial Services (RFS) from Farmers Trading Company, principally to acquire the business of "Farmers Card", a private label credit card. The legacy software supporting Farmers Card, called "CMS" and written in COBOL, had been supplied by California based Karum in 1994. FPF secured a licence from Karum to continue to operate CMS temporarily on RFS mainframes while FPF modified its own credit system software called "Lending" (written in Ingres) to support Farmers Card functionality and allow the two business systems to be integrated.

The court's reasoning

The Court of Appeal noted the duration of the trial in the High Court – eight weeks with numerous expert witnesses – and the complexity of the action due to its technical detail and the ‘novelty of the copyright claim’. The latter remark arose because Karum did not claim its CMS source code had been copied, but rather that FPF had copied non-literal design elements and logic.


• The underlying factor in deciding whether copyright protection could extend to something beyond or more abstract than program code was observed to be the principle that copyright did not protect ideas, but rather protected the expression of ideas. While this was trite law it was reinforced by the TRIPS Agreement, to which New Zealand had been a signatory since 1994.

• Since there was no New Zealand authority on non-literal copyright infringement it was germane to consider English and United States authorities on non-literal software copyright infringement. In this respect the Court of Appeal made reference to the 1992 US case of Computer Associates v Altai which had agreed that, just as in traditional literary works, copyright could in principle extend beyond code to cover 'structure', although only to the extent that it was limited to structure as such and did not extend to any ideas or functions behind the structure – or for that matter at any other level of abstraction. The US Court of Appeals also said 'structure' referred to 'the functions of the modules in a program together with each module's relationships to other modules'.

• The judgments in SAS Institute v World Programming were then considered and the Court of Appeal observed that while the courts of England and Wales [here and, on appeal, here] and the Court of Justice of the European Union [here] had admitted the possibility of copyright protection for non-literal elements such as structure, the copied functionality in that case was not protectable expression.

• The Court of Appeal observed that claims of an analogy between the plot of a traditional literary work and some non-literal element of a computer program had been rejected by the High Court, England and Wales, in Navitaire v easyJet [here] because a computer program has no plot, merely a set of operations intended to achieve desired functionality: that Court had held that such functionality may be replicated precisely in another program because functionality is not protected by copyright as it lies on the ideas side of the line between idea and expression. And nor were business rules or business logic, these not being original to the programmer and in any event falling into the category of functions or ideas.

• In summarising the English and US cases the Court of Appeal concluded that the scope of any copyright in non-literal elements is constrained: a plaintiff would likely find it difficult to distinguish expression from idea or to prove specified elements were not mere functionality or business rules.

• Applying this law to what Karum had claimed were copied by FPF (namely character string displays of payment and delinquency calendars, and the use of 'buckets' for storing aged debt with payments being assigned to the bucket containing the oldest debt), the Court said that the CMS calendars and aged debt module were no more than mere functionality or business rules as the codes used to represent age of debt or payments as a proportion to debt were not distinctive and were not literary works whether taken singly or together.

• In particular, on the facts this case could not be distinguished from the English cases even though -- unlike those cases -- FPF did have access to the CMS source code. The Court categorised this as 'a distinction without a difference' as the CMS source was not copied by FPF.

• The Court concluded its findings on copyright infringement by observing that, for copyright to be infringed, the Copyright Act required that a substantial part of the work must be copied. In this case, even if FPF had copied any original expression in CMS software, it was not a substantial part of the CMS software package.

Breach of confidence

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• In addition to the calendars and aged debt, Karum's claim extended to FPF's use of what it called 'special codes' and 'intercept codes'. The first were some of the codes used in a customer account to indicate the status of the account, examples being '4' meaning 'account with a collection agency' and '7' meaning 'closed'. Some of the claimed codes were in fact mapped into CMS during the changeover from the Farmers previous software, F-Credit. The Court held all these codes to be non-substantive content: they were simply arbitrary characters representing business rules and did not amount to trade secrets.

• The intercept codes were codes sent with customer statements electronically to the agency retained to print and mail out the statements, such as '54' indicating hold the statement (and not mail it). FPF did use some of these codes because it used the same interface file with the printing agency that Farmers had used. There was no proof that the interface file format was owned by Karum as it was an agreed format worked out with the print agency by Farmers.

• The Court observed that Karum had chosen to sue FPF for breach of confidence in equity and had itself expressly cited the three-step test established in the 1969 English case of Coco v AN Clark (Engineers) [noted here] which had been long adopted by New Zealand courts.
[Merpel adds: the Coco v Clark three-step test is as follows: (i) the information itself must have the necessary quality of confidence about it; (ii) that information must have been imparted in circumstances importing an obligation of confidence; (iii) there must be an unauthorised use of that information to the detriment of the party communicating it.  This is hardly rocket science and it's scarcely even a test, but judges, lawyers and litigants alike have clung to it like limpets for generations, almost to the point of making excuses for it when it doesn't quite fit ...].
It therefore rejected Karum's argument that establishing the necessary quality of confidence for the first step should solely be carried out by interpreting the relevant trade secret stipulations in the CMS software licence (which formed part of the settlement agreement). The Court added that, while the licence clauses should be taken into account, the determination was ultimately a question for the court, taking into account policy considerations as in Yates Circuit Foil Co v Electrofoils Ltd [1976] FSR 345.

• The Court found that there was no disagreement between the parties that FPF was entitled to examine CMS for the purpose of identifying business rules and functionality and that entitlement extended to testing both systems to ensure nothing was lost in translation. In any event the Court agreed with the High Court judge that there was nothing confidential about the codes -- which were arbitrary and trivial, both singly and collectively.

• In assessing the third Coco test, misuse of information to Karum's detriment, the Court confirmed that equity would require a showing of detriment in commercial cases, as in such cases it was the normal measure of fairness. The Court did not accept that Karum had suffered detriment because equity would not intervene where FPF only did what it had the right to do so.

Brief comments

It was not surprising that the idea/expression dichotomy dominated the reasoning for the first time in New Zealand copyright case instead of the usual subsistence and infringement considerations. However, the Court of Appeal rejected the opportunity to elaborate on what protectable expression might lie above source and object code, simply holding that the non-literal elements of software it was presented with fell on the idea side of the dividing line as being either functionality or business rules. 
On breach of confidence it could be argued that the Court of Appeal has raised the bar in New Zealand for the first Coco test in appearing to require a higher quality of confidence than simply that the information be more than mere trivia. The Court has ruled that at least for commercial cases in New Zealand, a showing of detriment is a required part of the third Coco test. It was interesting also that the Court of Appeal recognised that, in the interests of commercial efficiency courts should resist 'the attempts of legacy system owners to leverage intellectual property rights so as to inhibit competition from second comers'. 
There are still a lot of legacy banking systems requiring replacement over the coming few years because of brittle over-modified third generation code and/or mainframe hardware well past its use-by date.
Disclaimer of personal interest: Ken was part of the legal team representing Fisher & Paykel Finance.

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