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ISC v. ALTECH

June 25, 1990

ISC--BUNKER RAMO CORPORATION, Plaintiff,
v.
ALTECH, INC., Defendant


George M. Marovich, United States District Judge.


The opinion of the court was delivered by: MAROVICH

GEORGE M. MAROVICH, UNITED STATES DISTRICT JUDGE

 Plaintiff ISC-Bunker Ramo Corporation ("ISC") designs and sells computer systems for use in financial institutions, and has its principal place of business in the state of Washington. Defendant Altech, Inc. ("Altech") services computer equipment and purchases and sells used computer equipment. Its principal place of business is located in St. Louis, Missouri. Before the court are Altech's objections to the report and recommendation of Magistrate Balog recommending the issuance of a preliminary injunction prohibiting Altech from infringing on several of ISC's copyrights, misappropriating certain trade secrets, and interfering with certain employment agreements. Magistrate Balog made his ruling after holding a hearing on May 2, 3, and 4, 1990. For the following reasons, we adopt the magistrate's report and recommendation, and issue the injunction as proposed.

 Altech objects to virtually every finding in fact and conclusion of law in the magistrate's report. The purported basis for the vast majority of its objections is that the magistrate's findings are "unsupported by the evidence." We have considered all of Altech's objections and find all to be without merit. Most significantly, all of the magistrate's conclusions find support in the record; many are supported by overwhelming evidence. The magistrate clearly based his report and recommendation on careful consideration of all the evidence in the record and, while we specifically address most of Altech's objections, we will not comment on each and every one.

  Altech's initial contention is that certain depositions of its employees were not offered into evidence and are not part of the record. The magistrate's report clearly refutes this contention, and in fact both sides referred to deposition testimony in their pre-hearing memoranda. Rep. 2; *fn1" ISC Pre-Hearing Memorandum at 5, 6, 7, 10, 14, 20; Altech Pre-Hearing Memorandum at 2, 3, 8. Altech has not demonstrated why these depositions should not be considered, though so much evidence supports the magistrate's findings that it scarcely matters whether we consider them or not.

 Altech's first objection concerns copyright infringement and trade secret misappropriation relating to ISC's computer programs. Altech contends that ISC is not entitled to protection of these programs under the "first sale" doctrine, which provides that the owner of a copy of copyrighted material can sell the copy without permission of the copyright owner. 17 U.S.C. § 109. Altech contends that the "first sale" doctrine applies here because ISC sold disks containing its copyrighted programs to its customers and these customers in turn sold the copies to Altech. The evidence demonstrated, however, that ISC did not sell copies of its software to its customers; it only licensed them, making the "first sale" doctrine inapplicable. PX 109; Tr. 558-60. Altech contends that, while the software was licensed, ISC sold hard drives containing the programs to its customers. Before Altech could use an ISC program contained on a hard drive, however, it would have to copy the program on to a floppy disk. See Deposition of Gary Beyer at 114, 117-20. Sale of these hard drives thus did not constitute a sale of a copy of the copyrighted program.

 With respect to Altech's infringement of ISC's field service manuals, Altech contends that ISC failed to prove that the information contained in the manual found in Altech's possession was substantially similar to the works protected by ISC's copyrights. In fact, the evidence conclusively demonstrated that Altech's manual was directly copied from ISC's manuals. PX 5, 5a, 5c, 5e, 20; Tr. 86-90. Altech objects to the findings on copyright infringement of ISC's disks, also on the grounds that there is no evidence that Altech's disks were substantially similar to ISC's. ISC presented detailed testimony demonstrating that Altech's disks were directly copied from ISC's disks. Tr. 248-265.

 Altech further objects to the copyright infringement findings on the grounds that certain of the infringed programs were not copyrighted. See 17 U.S.C. § 411. The evidence showed, however, that these copies of non-registered programs also infringed on the prior copyrighted works from which they were derived. See Tr. 265. Altech also contends that the magistrate erred in taking the fact that Altech's disks contained errors as evidence that it improperly copied the disks. Rep. 26-27. We agree with the magistrate that Altech's possession of multiple copies of a defective disk suggests that the copies were made by Altech rather than by a customer of ISC's, as a customer would have access to a mistake-free copy of the disk. Id. In any event, whether Altech actually made copies of the copyrighted disks or not, it improperly used them. The disks were merely licensed to ISC's customers, so at the very least Altech would be liable as a contributory infringer. See American Int'l Pictures, Inc. v. Foreman, 576 F.2d 661, 664 (5th Cir. 1978).

 Altech objects to several aspects of the magistrate's findings on Altech's misappropriation of trade secrets and interference with the contractual relations between ISC and its employees. First, Altech argues that ISC did not present any evidence that any employee or former employees had access to trade secrets. In fact, there was a substantial body of evidence on this point. PX 92, 93; Affidavit of David Hardy, paras. 11-15; Tr. 148-159. Second, Altech argues that the non-disclosure clause of the ISC employee agreement is so broad that it makes the entire agreement unenforceable. Altech bases this argument exclusively on Illinois case law, despite the fact that the agreements specifically provide that they are to be interpreted under Washington law. Exhibit B to Altech's Objections to Magistrate's Report. Altech has not informed us why we should ignore the parties' selection of Washington law, which was reasonable given the fact that ISC's headquarters is located in Washington. See Sarnoff v. American Home Products Corp., 798 F.2d 1075 (7th Cir. 1986). Even under Illinois law, though, we find that the employment agreements are enforceable. Altech argues that the agreements are unlimited as to time and geographical territory. The agreements in fact do contain what amounts to a reasonable time limitation because the disclosure is only prohibited while the information remains confidential. The absence of a geographical limitation is reasonable because ISC is a nationwide corporation.

 Third, Altech objects to the magistrate's findings on interference with contractual relations because it contends that ISC has not shown that failure to issue an injunction will result in irreparable harm. To the contrary, ISC has demonstrated that Altech has hired former ISC employees with confidential information and, taking advantage of its lack of training costs, plans to expand into the Chicago area to compete with ISC. Estimating ISC's loss of business from the threatened expansion would involve speculation, so that ISC's injury cannot be adequately compensated with money damages. While Altech contends that ISC's alleged unreasonable delay in bringing suit negates a finding of irreparable harm, this suit was not unreasonably delayed. ISC filed suit in November of 1989 and moved for a preliminary injunction on April 17, 1990. Sixteen of Altech's employees were hired after the fall of 1989.

 Altech argues that most of the items which the magistrate found were trade secrets were actually matters of general knowledge. In support of this contention Altech invites us to review "the testimony of all witnesses presented." We decline this invitation, as a great deal of relevant evidence demonstrates that ISC's software and technical information are entitled to trade secret protection. Affidavit of Marc Lewis at paras. 2-10, 14-16; Affidavit of Joseph Taylor at paras. 7-9; Hardy Affidavit at para. 6; Affidavit of Scott Schmidtman at paras. 2-7.

 Altech also objects to the magistrate's trade secret findings on the grounds that no contractual relationship existed between itself and ISC, but presents no case law in support of this proposition. Similarly, while Altech contends that the injunction must be limited to the state of Illinois, the case law is to the contrary. See Instrumentalist Co. v. Marine Corps League, 509 F. Supp. 323 (N.D. Ill. 1981). The magistrate's findings were amply supported by the evidence, and his proposed order is necessary to protect ISC from irreparable harm. We therefore adopt the magistrate's report and recommendation, which is attached to this opinion. We also will issue the magistrate's proposed order.

 REPORT AND RECOMMENDATION

 BALOG

 This matter was referred to the undersigned Magistrate to hear the plaintiff's ISC-Bunker Ramo Corporation ("ISC") motion for preliminary injunction and thereafter to submit a report and recommendation. A hearing was held on May 2, 3, and 4, 1990.

 The evidence consists of (i) exhibits specifically admitted into evidence; and (ii) oral testimony at the hearing, from Joe Taylor, Marc Lewis, David Hardy and Scott Schmidtman, who were called by ISC, and James Ulsenheimer and Terry Weatherby, who were called by the respondent, Altech, Inc. ("Altech").

 The record also consists of 22 affidavits and accompanying exhibits. ISC presented four affidavits prior to the hearing (a portion of the affidavit of Scott Schmidtman was struck), and then called each of those four affiants as live witnesses, and each was then subject to cross-examination by Altech.

 Altech submitted eighteen affidavits. Of those affiants, Altech called only one to give live testimony, Mr. Ulsenheimer. The only other live witness called by Altech was Mr. Weatherby (from whom no affidavit had been previously submitted).

 Finally, the record consists of the depositions of Altech's owners and senior management, Gary Fries, Gary Beyer, and William H. Simpson. Messrs. Fries and Beyer were at the hearing, identified by Altech as possible witnesses, but were not called to testify.

 I now submit the following:

 I. PROPOSED FINDINGS OF FACT

 A.

 JURISDICTIONAL FINDINGS

 1. ISC is a Washington corporation, headquartered in Spokane, Washington. It does business with customers located throughout the United States and in foreign countries. It has several regional offices, one of which is located in Oak Brook, Illinois. ISC has many present and potential future customers located in the Northern District of Illinois.

 2. Altech is a Missouri corporation with its principal place of business in St. Louis, Missouri. Altech is doing business in various areas throughout the United States, including Illinois. Starting in or about September, 1989, Altech appointed Jim Ulsenheimer as its sales manager for the Chicago area, and began actively soliciting business in this District. By the time of the hearing, on May 2, 1990, Altech had made 14 written proposals to financial institutions in the Chicago area, and had already begun servicing one of those institutions on a trial basis, namely the Enterprise Savings Bank on Wacker Drive, in Chicago. In addition, Altech services several financial institutions in other cities in Illinois.

 B.

 BACKGROUND FACTS ABOUT ISC'S BUSINESS

 3. ISC produces complex computer systems specifically intended for financial institutions such as banks and savings and loans. ISC designs, manufactures, installs, updates, maintains and services these systems. *fn1"

 4. ISC's computer systems are designed to enable financial institutions and their employees to perform many banking transactions efficiently, such as making journal entries, cashing checks, recording deposits, or generating loan documents.

 5. ISC competes with such computer industry giants as IBM, NCR, and UNISYS and consequently, ISC invests a substantial amount of money not only on the original design of its systems, but also on the continual update, refinement and improvement of those systems. In this manner, ISC seeks to make its systems the most efficient, the most reliable, and, thus, the most desirable to the financial community.

 6. ISC began designing its computer systems in 1977. It was a small company, which by 1979 still had only about 70 employees. ISC designed what is referred to in the industry as a "proprietary architecture" computer system, which means that ISC did not make the design of its computer system available to outsiders so that they could create software to run on the system. While most of the component parts used as the "building blocks" of the ISC computers are generally available on the open market (microprocessors, proms, switches, cabling, and the like), the design of the use and interrelationships of the components is original to ISC and kept confidential.

 7. (a) ISC also creates original computer programs to operate its computer systems. Such programs, which consist of instructions to the computer telling it what to do, are generally referred to as "software." The instructions are written in different types of computer language. The most basic language is referred to as "object code," which the computer can read, but which is virtually unintelligible to people.

 (b) People, in contrast, generally write programs in "source code," which is a language comprised of words and symbols that resemble English. A device exists (with its own conversion "program") which automatically converts "source code," that people can work with, to "object code," that a computer can read.

 8. Since its inception, ISC has been heavily dependent on the creative efforts and technical advancements of its engineers. As the company's employment force grew over the years to between 1,000 and 2,000 employees, it hired and trained hundreds of engineers. These engineers were employed in essentially three separate groups. One group designs and develops the "hardware," which comprises the computer system. Another group designs and develops the software. And still another group is devoted to product support; it develops the service manuals, diagnostic software, and training programs so that ISC's systems can be effectively and efficiently installed, maintained, repaired, and improved.

 C.

 THE EVOLUTION OF ISC'S COMPUTER SYSTEMS

 9. Over the past twelve years, ISC has developed five basic computer systems. One of ISC's earliest systems was called the "8-Window" system. It allowed eight bank tellers to each have a video screen and input keyboard. All of the data going to and from each teller was processed by one central data processing device, referred to as a "CPU" (i.e. "central processing unit").

 10. ISC's engineers next developed a system that could service more than eight tellers at a time. It is called "Pinnacle." Instead of one central processing unit, which could only handle "eight windows," the engineers built data processing capability into each teller's machine. Now the system was no longer limited by the capacity of a single "central" processing unit. The system could service many more tellers, whose terminals performed their own data processing. Instead of a CPU, the Pinnacle system used a central "branch concentrator" which, in effect, "concentrated" the data that was being processed at each teller terminal.

 11. ISC's first Pinnacle system, which included ISC's first branch concentrator ("BCI") and first workstation ("WPI"), was then improved and expanded by ISC's engineers. The next generation of the Pinnacle system consisted of a re-designed branch concentrator ("BCII"), and re-designed teller "workstations," called "WPII/SWP," "WPIII," and "WPIV."

 12. Thereafter, ISC developed another variant of its Pinnacle computer system, which it called "PSP," for "Pinnacle Shared Processor." This newly designed "processor" allowed ISC customers who had the original "8-Window" system to expand those systems by marrying them to the newer "Pinnacle" systems.

 13. Finally, in or about early 1988, ISC introduced its newest computer system called "Pinnacle Plus." It has a newly designed branch concentrator, referred to as "BCIII," and a new teller "workstation," referred to as "WPV." The evolution of ISC's computer systems during the twelve years from 1978 to 1990 is shown on PX 98. *fn2"

 D.

 THE DEVELOPMENT OF ISC'S SOFTWARE

 14. The development of new "hardware" systems requires the development of "software." As the hardware design changes, new programs must be written, or existing programs modified, in order to accommodate (or take advantage of) the hardware developments. Also, developments in software design allow new hardware to be designed to take advantage of the additional software capability.

 15. Consequently, as ISC developed each new computer system, it had to develop new "software" to operate those systems. Moreover, ISC had to develop various kinds of software for each system. Software is commonly developed to be used in layers. The basic "layer" is referred to as the "operating system." This tells the computer how to perform basic functions necessary to achieve the end results that the customer needs. Additional programs are then written, to be used "on top of" the operating system, which tells the computer how to perform the finished tasks that a customer desires, whether it be the recording of journal entries, the preparation of a spread-sheet, or the creation of loan documents. These specific programs are called "application" software.

 16. Initially, for its "8-Window" computer system, ISC developed an operating system, and also developed customer application programs to run with it. The "8-Window" system needed only one such "operating" system because it had only one central processing unit. But the Pinnacle system needed several operating systems, because each different computing device capable of processing information required its own unique operating system. Thus, for example, as part of its Pinnacle system, ISC had to develop separate operating systems and accompanying application programs for the BCI branch concentrator, the BCII branch concentrator, the BCIII branch concentrator, and for each of the workstations, i.e., WPI, WPII/SWP, WPIII, WPIV, and WPV.

 17. (a) ISC also developed a completely separate category of software for its computer systems, referred to as "diagnostic" and "development" software. These programs do not instruct the computer on how to process information for the customer's use. That is the function of the operating systems and customer application programs previously discussed.

 (b) Rather, ISC developed a completely separate group of programs which instruct the computer on how to locate, diagnose, and even correct malfunctions. And again, this software is developed to work in layers. There is an underlying "operating system" used for these special diagnostic and development purposes, which is known as "IDOS" (i.e., "ISC Development Operating System"). In addition, ISC's engineers developed a group of diagnostic utility programs to run on top of IDOS, which include such programs as "WINUTIL," "WINGEN," "WINMAP," and "WINCHESTER UTILITY," "VE," "EL UTILITY 180," "UT-VERSION 175D." (See, PX103)

 (c) As ISC's computer hardware has evolved, the diagnostic software (like the "application" programs and operating systems) has also had to be modified and re-designed.

 E.

 THE DEVELOPMENT OF ISC'S SERVICE MANUALS AND TECHNICAL BULLETINS

 18. In addition to hardware and software, ISC's "product support" group has had to develop the tools and expertise necessary to support the installation, repair, maintenance and improvement of ISC's hardware systems and software. Among other things, they develop all of the service manuals and technical bulletins on how to properly and efficiently install, repair, maintain, and upgrade ISC computer systems. They also develop and implement extensive formal training programs and procedures, in order to teach the conventionally skilled computer service engineer all of the special knowledge, skills and procedures they need in order to work with ISC's systems. In this regard, ISC maintains more than 400 field service engineers ("FSE's") located throughout the country, each of whom has been given up to seven weeks of specialized training on ISC computer systems at ISC's training facility in Spokane, Washington.

 20. The service manuals for ISC's computer hardware, alone, are voluminous. They would substantially fill the trunk of a FSE's automobile, and are far too voluminous for ready access and use. As a result, starting in 1985, ISC's support engineers created a separate compilation which contains the technical information from all of the service manuals that a FSE would most commonly need in performing installation, repair and maintenance services. This compilation is called the Field Service Pocket Reference Guide sometimes referred to as the "The Guide" or the "Pocket Guide". It has gone through several revisions to accommodate the changes and updates to ISC's computer systems. The most recent version of The Guide (i.e., "Rev. 4, Change B"), was released in January, 1989.

 F.

 ISC'S TRAINING PROGRAMS

 21. As previously stated, ISC has a formal training program to teach the special skill and knowledge necessary to effectively install, service, repair and up-grade its computer systems. ISC has an entire book of outlines for the training courses available to its FSE's. The course outlines also state the extent of prior experience and training required as a pre-requisite to ISC's special training programs. In this regard, ISC does not teach basic electronics, or repair and maintenance skills. Its FSE's are required to have a basic education in electronics (mostly from technical schools, or the armed services), and some general experience, skill and knowledge in computer repair and maintenance. ISC's courses then teach the special knowledge and skills one must learn in order to effectively and efficiently service, install and maintain ISC's unique systems.

 22. ISC's training school issues and uses ISC's field service manuals and The Guide as reference materials for the FSE's. Each course outline details the ISC reference manuals to be used in that training curriculum. The FSE's are given classroom lectures from those manuals, and are then given "laboratory" work where they learn to apply the instructions to ISC's computer systems.

 G.

 ISC'S INVESTMENT IN ITS TECHNOLOGY

 23. ISC has made, and continues to make, a significant investment in the development, improvement and updating of its (i) computer systems, (ii) software for customer applications, operating systems and diagnostics, (iii) service manuals and technical bulletins, and (iv) training of FSE's.

 24. The development and updating of the IDOS operating system, alone, which is used for diagnostic purposes, has required tens of thousands of hours of engineering time. ISC has invested still more time, effort, and resources in the development of its service manuals, The Guide, and its continuing programs to isolate and solve service and maintenance problems, which are reflected in the update versions of the service manuals and The Guide. ISC has invested substantial additional sums of money in training the more than 400 FSE's that it employs throughout the country. It maintains a separate facility for training, including a staff of instructors and technical writers, and pays the salary, room, board and traveling expenses of the FSE's as they attend school. Each FSE is normally sent to Spokane for specialized training within weeks of being hired by ISC. And, as new systems are introduced by ISC, its existing FSE's are typically brought back to Spokane for additional training.

 H.

 THE CATEGORIES OF TECHNOLOGY WHICH ARE THE SUBJECT OF THIS LAWSUIT

 25. The technology created by ISC which is the subject of this lawsuit, can be summarized as follows:

 (a). Computer Programs (i.e., "Software")

 This category of technology includes the special operating system written for diagnostic and development purposes by ISC, known as IDOS, and the special diagnostic utility programs written by ISC that run "on top of" IDOS. This category of technology also includes certain of the special operating systems that ISC wrote for use in running customer applications.

 (b). Service Manuals, Technical Bulletins, and The Guide

 This category includes the written compilations, and the special technical information contained in them, all of which was developed by ISC for use in installing, servicing, repairing and upgrading its equipment.

 (c). Training Programs and Materials

 This category includes the special skill, knowledge and training provided by ISC to its FSE's. They obtain this special skill and knowledge during ISC's formal training programs, which include the information contained in ISC's service manuals, technical bulletins and The Guide. Thereafter the FSE's use the information taught to them, and continually obtain updated information, which is available from technical bulletins and updated versions of ISC's Guide and service manuals. In addition, technical information and procedures are regularly exchanged among ISC's FSE's and support engineers.

 26. ISC protects the technology which it has developed under the federal Copyright Act, and as trade secrets and confidential information under state law. As more fully discussed in the "Conclusions of Law" section below, these laws protect innovating companies from misappropriation and unauthorized use and disclosure of their technological advancements, so that they can recover, and thus economically justify, the investments required to generate the technology in the first instance.

 I.

 PROTECTION UNDER THE FEDERAL COPYRIGHT ACT 27. Each of the computer programs identified below is an original work (or a derivative of an original work), created by ISC's employees. Each is subject to protection under the federal Copyright Act, 17 U.S.C. § 101 et seq. ISC has applied for Certificates of Registration from the Registrar of Copyrights for each of the programs. Certificates have been issued for the programs as indicated immediately below, and applications are pending for the others: (a). IDOS Operating Programs For Diagnostic Use (See, PX102): Work Cert. of Reg. No. Date Issued IDOS V1.2 TXU-396-031 01/03/90 B3 IDOS 937 and 437 TXU-396-029 01/03/90 B3 IDOS 940 and 440 Application filed 04/23/90 B3 IDOS 950 and 450 TXU-396-026 01/03/90 B3 IDOS 960 Application filed 04/23/90 B3 IDOS 460 TXU-402-607 02/28/90 (b). IDOS Utility Programs For Diagnostic Purposes (See, PX103): Work Cert. of Reg. No. Date Issued Makeprom, Trancomp, Tranxref, FTRNMAIN, DESCMAIN, DA TXU-396-032 01/03/90 B3 WINUTIL, WINGEN, WINMAP TXU-396-030 01/03/90 B3 WINCHESTER UTILITY, VE, EL UTILITY 180, VT-VERSION Separate applications filed 04/23/90 B3 (c). ISC Workstation Operating Systems (See, PX104): Work Cert. of Reg. No. Date Issued B3 Version 401A Application filed 4/23/90 B3 Version 405A TXU-396-028 01/03/90 B3 Version 405E TXU-396-027 01/03/90 B3 Version 410A Application filed 4/23/90 B3 (d). ISC Field Service Pocket Reference Guide ("The Guide") (See, PX100): Work Cert. of Rev. No. Date Issued Original Release of The Guide TXU-402-612 02/28/90 B3 Revision 1, July, 1985 TXU-402-611 02/28/90 B3 Revision 2, November, 1986 TXU-402-605 02/28/90 B3 Revision 3, January, 1987 TXU-402-610 02/28/90 B3 Revision 4, March, 1988 TXU-402-609 02/28/90 B3 Revision 4, Change "A", August, 1988 TXU-402-608 02/28/90 B3 Revision 4, Change "B", January, 1989 TXU-402-606 02/28/90 -- -- --

  J.

 PROTECTION UNDER THE UNIFORM TRADE SECRETS ACT

 (a). ISC's Guide, Service Manuals, and Technical Bulletins

 28. ISC's Guide (PX20) Service Manuals (PX93(a) through 93(g)), and technical bulletins (PX96) are compilations of valuable technical information and procedures. They have been compiled at great effort and expense by ISC, and are extremely useful tools for its business. As such, and as discussed more fully in the Conclusions of Law, these compilations fall squarely within the definition of a trade secret. See, e.g., Ill.Rev.Stat., ch. 140 para. 352(d) (A "trade secret" is "a ... compilation, formula, ... data.").

 30. ISC has undertaken reasonable efforts to keep its compilations, technical information, and procedures from becoming generally known outside of ISC and those third-parties who by contract (i.e., "license"), custom and usage, or fiduciary duty are obligated not to use or disclose such information without ISC's consent.

 31. ISC's efforts to keep secret its service manuals, The Guide, technical information, and procedures include the following:

 (a) As a matter of policy and practice, documents which contain trade secrets or other confidential information are marked as "proprietary" to ISC. ISC explains in legends on documents, and in training ...


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