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Digital Equipment Corporation v. Uniq Digital Technologies

January 16, 1996

DIGITAL EQUIPMENT CORPORATION,

PLAINTIFF-APPELLEE,

v.

UNIQ DIGITAL TECHNOLOGIES, INC.,

DEFENDANT-APPELLANT.



Appeal from the United States District Court for the Northern District of Illinois, Eastern Division.

No. 88 C 644--Ruben Castillo, Judge.

Before CUDAHY, FLAUM, and EASTERBROOK, Circuit Judges.

EASTERBROOK, Circuit Judge.

ARGUED SEPTEMBER 6, 1995

DECIDED JANUARY 16, 1996

Between 1977 and 1986 Uniq Digital Technologies sold Digital Equipment Corporation (DEC) computers equipped with Unix operating systems. The operating system mediates between application programs and the computer's hardware. Unix, an operating system developed by Bell Laboratories at AT&T, was and is widely used for scientific and networking functions. Each central processing unit (the calculating engine of a computer) needs an operating system customized to its requirements, and Unix is adaptable. AT&T has licensed other firms to develop versions of Unix suited to different CPUs. Uniq "ported" the Unix-V system to DEC's computers. This enabled DEC machines to run many of the same application programs that customers had used on other manufacturers' computers. DEC gave Uniq a discount available only to distributors ("value added resellers" or "original equipment manufacturers," abbreviated VAR and OEM) that added value to the equipment, and DEC treated the Unix operating system as added value. In 1985 DEC, which by then had developed its own version of Unix, told Uniq that the OEM discount would no longer be available to resellers whose only contribution was Unix. Uniq proposed, and DEC accepted, a marketing plan that omitted Unix as an element of added value; Uniq sells and services suites of applications and treated these as the added value. But in 1987 Uniq did not sell a single DEC computer, leading to the cancellation of the distributorship agreement. DEC filed this diversity action in 1988 seeking to collect a note for $67,000. Lengthy delay ensued while the district court addressed Uniq's antitrust counterclaim, which it eventually dismissed (along with all of Uniq's contractual defenses) in advance of trial. Entry of judgment on DEC's claim followed ineluctably. 1995 U.S. Dist. LEXIS 2637.

The contract governing the parties' dealings was a "standard volume agreement" (the "OEM agreement"). This contract ran from year to year and could be terminated by either party. Several addenda to this contract were negotiated over the years; one of these, the "authorized digital computer distributor addendum" (the "ADCD addendum"), entitled Uniq to use Digital's trademarks in promotion and to participate in a cooperative advertising program. The ADCD addendum was to last indefinitely, but not longer than the OEM agreement; sec. 8.3 of the ADCD addendum provides that, "[s]hould the [OEM] Agreement be terminated for any reason, this appointment shall also terminate concurrently." The ADCD addendum also ended automatically if sales fell below a threshold, and Uniq's failure to sell a single DEC computer for one year is what terminated the ADCD addendum on October 1987. In light of this, Uniq's argument that DEC broke its promise by failing to extend the ADCD addendum is untenable. DEC ended the OEM agreement, and the ADCD addendum would have ended with it, had it not ended earlier because of Uniq's decline in sales. Unless the termination of Uniq's status as an OEM was wrongful--Judge Castillo held not, see 1995 U.S. Dist. LEXIS 190--Uniq's contractual defenses fail.

Uniq believes that its termination as an OEM was wrongful because DEC "was obliged to renew Uniq's contract on the same terms" every year; and by "same terms" Uniq means "with the same things treated as 'added value.' " For several years DEC treated the Unix operating system as added value, and that course of dealings "transcended the written agreements", Uniq tells us. Judge Castillo thought that Illinois law (which the parties agree governs) offered no support for that argument--and he was right. Illinois enforces written contracts, and Uniq agreed, in writing, to a contract that allowed DEC to terminate at the end of any year. Under the OEM agreement, Uniq had to propose a marketing plan every year. This plan had to be satisfactory to DEC; and what was satisfactory in one year might prove unsatisfactory in another, as market conditions and technology changed; that was the whole point of making renewal annual, rather than giving Uniq a right to OEM status for a longer term. Contributions valuable to both DEC and customers in one year might be old hat the next. A firm anxious to press forward technologically insists that its vendors come up with new products and services if they want to get an extra discount. For that discount is what an OEM agreement is about. It sets price, and nothing else. Uniq was (and is) eligible for an ordinary wholesale price. The lower OEM price is a subvention for extra services, and DEC, as the "buyer" of those services, is entitled to determine whether it is getting what it is paying for. In arguing that DEC "was obliged to renew Uniq's contract on the same terms" every year, Uniq really is arguing that DEC must pay the same price for Uniq's inputs in perpetuity, without regard to changes in their market value.

Trying to get past this obstacle, Uniq repackages its contention as an invocation of the "duty of good faith." Although Uniq proposed (and DEC accepted) a marketing plan in which Unix did not count as added value, Uniq tells us that this agreement should be ignored because DEC did not act in good faith when demanding that concession. "Good faith" is a ringing term, but there is no abstract "duty of good faith" even in the law of fiduciary obligations--and Uniq does not argue that DEC was its fiduciary. Some parts of the law create discrete duties to do things in good faith; labor law, for example, creates a duty of good faith bargaining, but even that branch of law does not require either side to make concessions. 29 U.S.C. sec. 158(d). Employers may take a hard line and may insist on give-backs; unions may demand large wage increases and comfortable working conditions; and if one side's bargaining position does not suit the other, each retains its economic options. In the law of contract between merchants, there is no comparable duty; the Uniform Commercial Code defines "good faith" as "honesty in fact in the conduct or transaction concerned." UCC sec. 1-201(19); see also PSI Energy, Inc. v. Exxon Coal USA, Inc., 17 F.3d 969 (7th Cir. 1994); Kham & Nate's Shoes No. 2 v. First Bank of Whiting, 908 F.2d 1351 (7th Cir. 1990). There is no duty to be kind, or considerate, or make concessions in bargaining. So we held, applying Illinois law, in First National Bank of Chicago v. Atlantic Tele-Network Co., 946 F.2d 516, 520 (7th Cir. 1991). No state case decided since then has expressed any doubt about that holding.

Limiting the parties' ability to change the definition of "added value" would be the functional equivalent of forbidding vertical integration by any firm that initially buys inputs in the market. From one perspective an OEM or VAR is a manufacturer, buying inputs, reworking them (the "added value"), and selling the results. But for many purposes it is more helpful to think of a VAR as a vendor to the manufacturer. For example, IBM can equip its computers with disk drives in one of three ways: (i) it can buy disk drives from vendors such as Conner and put those third-party drives in its machines; (ii) it can make disk drives in its own plants, and package those with its machines; or (iii) it can sell disk-drive-less computers to third parties, who add them and resell the resulting bundle. In each case IBM pays for the drive--in cash to Conner if it buys before manufacture, in cash to its employees if it makes the drives, and in discounted prices if it has a VAR add the drive later. Most manufacturers use a combination of these methods, according to the costs of production and the demands of consumers. (There is a fourth option: sell a machine without a disk drive and let the consumer add one or not. Most producers use that option, too, for some fraction of their output.)

Features that few customers want--or that everyone wants a little differently--are added by VARs. That way the manufacturer can take advantage of economies of scale in production, while allowing specialists to add distinctive features. If every customer wants a feature, or if large numbers want a similar configuration, the manufacturer adds it. Thus General Motors builds the engine, chassis, and body for all of its cars; but for trucks and locomotives, GM builds only the engine and chassis, sending the product to VARs who add bodies customized to customers' desires. For limousines, GM does a little of each. When few drivers wanted compact disc audio systems, Ford and GM left these to the aftermarket; as demand rose, the auto companies started adding this feature on the assembly line. In the computer business... When few customers of DEC systems wanted Unix, DEC hired firms like Uniq to add Unix later and sell the system. As demand rose, DEC developed its own Unix operating system. Data General, Prime, Pyramid, Unisys, Wang, IBM, and DEC's many other competitors followed a similar path. After developing its own Unix operating system-- that is, after vertical integration into the production of Unix operating systems--DEC had no need to pay Uniq for the same input.

This would be clear enough if the DEC-Uniq arrangement had begun as the sale of Unix by Uniq to DEC, followed by DEC's sale of Unix-equipped computers to consumers. Uniq could not expect to continue selling Unix to DEC indefinitely on the ground that, once the sales began, the "duty of good faith" meant that DEC had to renew on the same terms indefinitely, even though the contract provided for termination at the end of any year. Uniq stresses that it invested $1 million in "porting" Unix to DEC computers. Such investments are common; Goodyear invests many millions in designing tires for use on GM's cars, but it cannot complain if at the end of the contract term GM starts buying from Firestone--or starts making its own tires. Uniq has no greater complaint when DEC decides to stop buying Unix through the OEM discount. Firms protect their sunk costs through contracts long enough to recover them, or through buyout clauses. As it happens, a year was enough to recover the investment (in 1984 alone, Uniq had margins exceeding $2 million on DEC computers). Whether a year was long enough or not, however, the length of dealings is for the market rather than the courts to establish. See Industrial Representatives, Inc. v. CP Clare Corp., No. 95-2555 (7th Cir. Jan. 3, 1996) (Illinois law).

Illinois does not leave things entirely to the market in franchise transactions. If Uniq was a "franchisee," as 815 ILCS 705/3 defines that term, then it has some additional entitlements, which DEC may not have honored. Judge Holderman concluded that Uniq was not a franchisee. 1993 U.S. Dist. LEXIS 12136, 1993-2 Trade Cas. para. 70,378. (Judge Holderman also resolved the antitrust counterclaims, before the case was transferred to Judge Castillo. All further discussion in this opinion concerns Judge Holderman's portion of the case.) One ingredient of a franchise relation in Illinois is a franchise fee. The district court held that DEC did not charge Uniq a franchise fee. Because that decision is well supported, we need not canvass the district court's other grounds.

Uniq paid for computers; there was no fee for being a dealer. So much is agreed. Relying on cases under Indiana's franchise act, Uniq argues that it bore an "indirect" franchise fee: the cost of inventory. We explained in Wright-Moore Corp. v. Ricoh Corp., 908 F.2d 128, 136 (7th Cir. 1990), that an obligation to carry a large inventory can be the economic equivalent of a franchise fee. An excessively large inventory transfers cash to the seller without producing benefits for the buyer; and the interest the seller earns by making the sales earlier is a kind of fee. Like a cash payment, it transfers wealth from buyer to seller (one can speak of a "transfer" because, by hypothesis, the buyer gets no benefit from the inventory). We may assume that Illinois would take this approach to the definition of a franchise fee under 815 ILCS 705/3(c), (14). This does not assist Uniq, because the OEM agreement does not require it to carry any inventory of DEC's products. It does establish a 12-month lag between order and delivery. Delay meant that Uniq had to order on the hope of selling, and what it could not ...


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