By Roger Parloff
November 29, 2007

[For visitors from Groklaw, see addendum at bottom.]

A U.S. bankruptcy judge in Delaware lifted a stay Tuesday that has been postponing momentous litigation in federal court in Utah between The SCO Group (SCOX) and Novell (NOVL).

At the same time, U.S. Bankruptcy Judge Kevin Gross granted SCO’s request — evidently one of SCO’s key objectives in filing for bankruptcy in the first place — to retain control over one crucial piece of the case that had posed particular dangers for SCO. The opinion is here.

SCO voluntarily sought Chapter 11 bankruptcy protection on September 14, on the eve of a trial in which U.S. District Judge Dale Kimball, of Salt Lake City, was set to determine how much SCO owes Novell in licensing revenues SCO had previously received from Sun Microsystems (JAVA), Microsoft (MSFT), and others — a sum that Novell contends could amount to up to $30 million. SCO contends it owes nothing, but in earlier rulings Kimball rejected several of its bases for taking that position.

Novell was also asking Kimball to impose a “constructive trust” upon SCO — an order effectively freezing any funds that he ultimately determines to be owed to Novell and that can be traced to the disputed licensing revenues.

The constructive trust — which could take effect even before SCO would have had a chance to appeal Judge Kimball’s other rulings — could have interfered with SCO’s ability to continue its normal business operations.

Judging from statements SCO’s lawyers have made at the bankruptcy hearings, SCO filed its bankruptcy petition in significant part in order to yank this crucial constructive trust determination out of the hands of Judge Kimball and place it into that of a federal bankruptcy judge.

On August 10 Judge Kimball had surprised SCO by issuing a sweeping ruling granting, by summary judgment — i.e., without letting a jury consider the matter — most of Novell’s key contentions in the litigation, including its claim to own the copyrights underlying Unix operating system software as it existed in 1995. (He rejected SCO’s contention that Novell sold the entire Unix business, including copyrights, to SCO’s predecessor in 1995, retaining only the right to receive royalty streams from certain then-existing license agreements.) That ruling is here.

SCO is struggling to remain operational long enough to appeal Judge Kimball’s ruling to the U.S. Court of Appeals for the Tenth Circuit, where it hopes to win a reversal that would restore its right to have a jury hear its claims.

The ultimate significance of the Novell litigation, however, is its impact on SCO’s other litigation and potential litigation, most importantly its multibillion-dollar claims against IBM (IBM), which are also pending before Judge Kimball. Kimball’s August 10 ruling in the Novell case, if upheld on appeal, would gut SCO’s case against IBM, or possibly end it entirely.

In the IBM case, SCO alleges, among other things, that IBM improperly donated to the free Linux operating system crucial enterprise-grade software code that had ultimately been derived from Unix code, and which, in SCO’s view, was therefore still subject to contractual obligations owed by IBM to the owner of the Unix business, which SCO says is SCO.

In his August 10 order, however, Judge Kimball ruled that Novell — not SCO — retained the ultimate power to determine whether to hold IBM to those contractual obligations (whatever they might be). Since a large part of Novell’s business now revolves around selling subscription services relating to Linux, it has no objection to IBM donating the code in question, regardless of whether doing so might have violated any past contractual obligation.

(In separate suits and threatened suits, SCO has also claimed that various users of Linux code are violating Unix copyrights, though these claims and suits, again, hinge on first overturning Judge Kimball’s finding that SCO, and not Novell, owns those copyrights.)

On balance, SCO’s prospects remain dicey at best. Though I have previously noted (see here) that Judge Kimball’s August 10 ruling looks vulnerable on appeal — since, among other things, he appears to have passed judgment on the relative credibility of various witnesses, which judges are not permitted to do in ruling on a summary judgment motion — even if SCO wins reversal it would still only win the right to make its case to a jury, which could still possibly reach the same conclusions Judge Kimball did.

In a footnote to Tuesday’s order lifting the stay, Bankruptcy Judge Gross alluded to Judge Kimball’s August 10 ruling: “The learned District Court [i.e., Judge Kimball] issued a thorough 105-page opinion carefully analyzing the facts and law. The District Court’s mastery of the facts and law pertaining to the Lawsuit is a powerfully important consideration in the Court’s decision to lift the stay.” Although this could be read as an endorsement of the substance of Judge Kimball’s ruling, and is being so interpreted by some, I believe it represents, instead, the usual courtesies that judges are careful to extend to other judges so as to leave no impression of disrespect. Since Judge Gross is retaining control of the constructive trust issue, I believe he is conveying, in effect, that he is not keeping it out of any lack of trust in Judge Kimball’s ability to correctly decide those issues, but rather simply to fulfill his statutory obligation to retain “core” bankruptcy issues. He is also explaining why he is not retaining the whole case — it would make no sense for him to try to bring himself up to speed with the enormous record that Judge Kimball is already steeped in — which is something even SCO had not asked him to do.

A Novell spokesman, commenting on the lifting of the stay, said “We are pleased that the bankruptcy court is allowing the Utah case to proceed.” A SCO spokesman declined any comment.

ADDENDUM FOR VISITORS FROM GROKLAW

I very belatedly noticed that some people are linking to this post from a “Groklaw Latest News Picks” link marked “Saturday, December 01 2007 @ 02:16 AM EST.” It begins with an introduction/disclaimer that says: “As usual, this account is so off it isn’t even wrong. I include it only because of a desire for a complete record. Just as one example, [1] Novell was not asking for a constructive trust at trial. Or as another, [2] SCO very much did ask the bankruptcy court to take over the litigation. In fact, more than that SCO asked that the bankruptcy court rule fresh on issues that the Utah court had already decided.” (Bracketed numbers are mine.)

I’ll discuss Groklaw’s two misimpressions in sequence:

Groklaw misimpression 1: “Novell was not asking for a constructive trust at trial.”

Yes it was. Novell was asking Judge Kimball to impose a constructive trust (in its 6th claim for relief in its amended counterclaims, here, page 29) and that’s what SCO was evidently most concerned about. They apparently thought he’d run off the tracks with his summary judgment ruling, and they feared that if he ran off the tracks again with the constructive trust ruling he could put SCO out of business before it ever had a chance to appeal.
Novell originally sought imposition of a constructive trust in its motion for partial summary judgment. In his ruling of August 10, Judge Kimball indicated (on pages 97-98) that Novell would probably be entitled to such a trust, but there were additional facts that would have to be established first before he could assess the amount of it. Accordingly, he denied the summary judgment on that issue, and it was clear to all that imposition of the trust was one of the things that remained for Judge Kimball to do in the case.

Mechanically, Novell envisioned that it would not formally seek imposition of the trust until after the trial was over, and that it would do so via a post-trial motion. Some additional factual findings might be necessary at that stage, but they could be based on a paper record, without further witness testimony. Whether you call that “at trial” or “after the trial” is an irrelevant quibble; Novell was asking Kimball to impose a constructive trust and that is what SCO feared. Accordingly, SCO asked the bankruptcy judge to decide that issue instead of letting Kimball do it, and the bankruptcy judge agreed to do so.

Here’s the passage (p. 97-98) in the Judge Kimball’s ruling, here, relating to the constructive trust:
“Although the court finds that Novell meets the requirements for the imposition of a constructive trust, the question of fact as to the SVRX portion of the 2003 Sun and Microsoft Agreements precludes the court from imposing a trust for the appropriate amount. Furthermore, despite Novell’s fears regarding its ability to collect its royalties, the appropriate amount of SVRX Royalties can be determined at trial. Because of the question of fact, the court denies both Novell’s and SCO’s motions for summary judgment on Novell’s Sixth Claim for Relief for constructive trust.”

At the bankruptcy hearing on November 6, 2007, Novell attorney Adam Lewis reiterated Novell’s desire to have Judge Kimball proceed to impose a constructive trust once the case was returned to Utah.

On page 90 of the transcript of November 6, 2007, here, he says:

There’s the whole constructive trust issue that remains to be decided although Judge Kimball has found that the conditions for a constructive trust exists.

[Then again on page 91]
So what the judge, Judge Kimball has said plainly in his opinion, which I take to be law of good case, is that the criteria for the imposition of a constructive trust have been proven in the summary judgment motion. The only remaining issue is how much, that is the tracing, of the funds.

[And again on page 94]
The passage I just read you, Your Honor, indicates that Judge Kimball has made findings on the factual predicates for everything about a constructive trust except applying the lowest intermediate balance rule to decide what the exact dollars are.

In the following passage, Novell attorney Mike Jacobs explains that he envisions seeking imposition of the trust shortly after the trial:

[page 102]
Then there was going to have to be subsequent phase in which we would address the exact amount of the constructive trust. We anticipated doing that on motion. The two are severable in that sense. What Judge Kimball would be deciding is the gross amounts, if we went back to him for trial. And then we would be going back to him and saying, okay, apply the lowest intermediate balance rule and figure out how much is in the bank account that’s traceable and that’s our constructive trust. That is, we think, fairly mechanical.

Groklaw misimpression 2: “SCO very much did ask the bankruptcy court to take over the litigation … and to rule fresh on issues the Utah court had already decided”

No it didn’t. SCO asked the judge to take over the constructive trust issue only, which is what Judge Gross did. There was some quibbling between the parties about precisely what information would be required in order to decide the “constructive trust issue,” but there was no effort to have Judge Gross redecide issues already decided by Kimball.

At the November 6 hearing, here, SCO lawyer Arthur Spector says:
[page 104]
The judge ruled otherwise. [i.e., against SCO on all the copyright issues.] That’s the law of the case. We have to live with that until and unless its reversed on appeal.

[and again on pages 108-109]
What is it for this Court [i.e., the bankruptcy court] to do if the Court were inclined to do anything with regard to this case? Well, we would say, you take everything that precedes, [i.e., you take AS A GIVEN everything that preceded this point; not that you rehear it and decide it all from scratch], we grit our teeth and bear it, and then you say, okay, there’s going to be a constructive trust in the amount of whatever its been determined elsewhere, whatever that number is. And here’s how much of that is now being held by SCO. And that’s how much, through the lowest intermediate balance test, that’s how much would be potentially set asideable, if that were a word, for Novell. … This Court could do that. It doesn’t need to reinvent the wheel. It doesn’t have to pour [sic] through 1500 pages of summary judgment briefing or anything else. … And as I said before, we don’t contest it, I’ve said it enough times.
THE COURT: Now, you mentioned that I would essentially take the allocation determined — is that how you stated it? Determined elsewhere.
MR. SPECTOR: Yeah, we’re not asking you to do that, Your Honor.
THE COURT: Okay.
MR. SPECTOR: I mean, we’re not being ridiculous. They’re right. Its simply, we don’t fight everything. They’re right.

ADDENDUM TO ADDENDUM

Novell’s “motion for relief from the automatic stay” in the bankruptcy court is here. On page 14 you’ll see that Novell asks that the stay be lifted “so that Novell may proceed with all remaining issues in the District Court….” That includes the constructive trust.

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