SCO’s legal strategy

September 27, 2007, 4:16 PM UTC

With the recent publication of the transcript of the September 18 hearing in SCO’s Chapter 11 proceeding in U.S. Bankruptcy Court in Delaware, it’s now possible to piece together what SCO’s (SCOX) legal strategy apparently was in filing for Chapter 11 protection on the eve of its scheduled trial against Novell (NOVL).

At that trial — drastically narrowed in scope by Judge Dale Kimball’s August 10 ruling throwing out most of SCO’s claims without letting them reach a jury (see earlier post, here) — Kimball would not only have determined what percentage of SCO’s revenue from its SCOsource program he thought properly belonged to Novell, but he also planned to impose a “constructive trust” on SCO to protect Novell’s recovery of that sum. It appears to have been the constructive trust that SCO feared most, since it might have taken immediate effect, even before SCO had an opportunity to appeal Kimball’s rulings. If Kimball found all or a large amount to be owing — and, with prejudgment interest, the $26 million SCO received from licensing agreements with Sun Microsystems (JAVA) and Microsoft (MSFT) could alone have run to more than $37 million — and decided to freeze SCO assets in an attempt to preserve that money, it could have blocked SCO’s ability to continue ordinary business operations. (SCO CEO Darl McBride had earlier alluded to this possibility in an affidavit he submitted in the bankruptcy court on September 14. Here’s the affidavit. See paragraphs 48-49.)

At the September 18 hearing (here’s the transcript) SCO lawyer Arthur Spector (a former bankruptcy judge in Michigan) shed light on exactly what SCO does and does not expect to achieve by having moved the case to bankruptcy court. He appeared to acknowledge that the automatic stay on the Novell trial would need to be lifted and that, when it was, the case would go back to Judge Kimball for trial. He even hinted that SCO might be willing to reach an agreed upon order to that effect with Novell. (See pages 24-25.)Judge Kimball would then arrive upon some dollar amount allegedly owed to Novell.

But Spector also said this: “Once that’s decided, whatever that number is — 10 million, 15 million — then the next question is how much of the money still in the hands of [SCO] is traceable to those, quote, ‘tainted funds.’ That, Your Honor, is the core of bankruptcy jurisdiction. What is and is not property of the estate. We think it’s going to be this, this Court’s determination on that question when the rubber meets the road.” (See page 24.)

So it is the decisions surrounding the constructive trust portion of the case that SCO realistically hopes to wrest from Kimball’s hands and place into bankruptcy judge Kevin Gross’s. Evidently, SCO’s position will be that even if Kimball computes some large sum to be owing, that Novell can impose a trust only on “tainted funds” or funds “traceable” to them, which might be a much smaller number. In other words, if SCO has already spent all the money that it received from Sun and Microsoft, or all but a small portion of it, Novell might only be able to impose a constructive trust on that amount or account, which would not prevent SCO from continuing to do business while it appealed all of Kimball’s rulings to a federal appeals court.

Evidently, SCO believes the constructive trust law in this situation favors such a narrow interpretation, and it trusts a bankruptcy judge to reach that conclusion, while it does not trust Judge Kimball to.