Fifth Circuit Saves IBM $1.6 Billion by Finding that “Displace” and “Discontinue” Mean the Same Thing

This case made me really angry when I read it. It was a pure, unadulterated, apolitical anger. I don’t have a stake of any kind in the outcome of this case. As between two commercial parties, I don’t care who wins. The case makes me angry because the Fifth Circuit’s manages to be incompetent, arrogant, and disrespectful of the trial court’s work. I shared my pointed opinions with colleagues, and they disagreed with me, as law professors are wont to do. I will refrain from investigating whether their portfolios include IBM stock. They may be right. Perhaps I am incompetent, arrogant and disrespectful of the hard work of the appellate court. Here I stand. I cannot do otherwise. Actually, I could, but haters gonna hate, and so must I. I should heed Timothy Steele and his Sapphics Against Anger, but I also find truth in his wise (unpublished so far as I know) observation, “We none of us can help our natures.” 

BMC Software, Inc. (BMC) licenses software for use in running, managing, and securing mainframe computers. Although BMC and the International Business Machines Company (IBM) compete, the parties entered into the Outsourcing Attachments in 2008, which were renewed in 2013 and again in 2015 (the OA). 

The OA allowed IBM “to use, access, install, and have operational responsibility of the BMC Customer Licenses” for the purposes of supporting BMC customers that own licenses to use BMC software. The language at the heart of the case comes in the OA’s § 5.4, which relates to IBM’s right to “displace” or “discontinue” use of the BMC licenses. “[W]hile [IBM] cannot displace any BMC Customer Licenses with [IBM] products, [IBM] may discontinue use of BMC Customer Licenses for other valid business reasons.”

Beginning in 2013, IBM and AT&T began cooperating on a project designed to replace BMC software on AT&T’s mainframes with a new product. When BMC learned of this plan, it sued IBM. Some of its claims were dismissed, but the District Court awarded BMC nearly $800 million on a breach of contract claim, finding that the OA in § 5.4 precluded “access and use of [IBM] licenses to displace BMC products.” The trial court then doubled the damages to $1.6 billion because it found that IBM had fraudulently induced BMC to renew the OA in 2015 at a time when it was already plotting to violate its terms.

In April, in BMC Software Inc. v. International Business Machines Corporation, a Fifth Circuit panel unanimously reversed. Two factors seem to have influenced the Fifth Circuit’s decision to reverse. First, the Fifth Circuit found it significant that AT&T reached out to IBM to switch software providers, bringing it within the ambit of the “other valid business reasons” exception to the prohibition on discontinuing use of BMC’s products. Second, IBM argued and the Fifth Circuit agreed that the OA gave IBM access to BMC’s software only for the purposes of serving BMC’s customers. But here, the Fifth Circuit emphasized, AT&T no longer wanted to be a customer. Surely, the license could not be read to preclude a customer from choosing to switch providers. And there’s the heart of the matter. It does not preclude AT&T from switching providers; it precludes AT&T from switching to IBM. These are big boys, and that is what they agreed to.

In support of its position, the Fifth Circuit offers three arguments. First, it is not enough, says the Fifth Circuit that “discontinue” and “displace” mean different things according to the dictionary. I certainly agree that, standing alone, dictionaries provide only a toehold for a ruling. However, reading the provision in context, I think the District Court was right to read the provision as distinguishing in a meaningful way between ending the relationship and leveraging the relations to gain a commercial advantage at the expense of its contractual counterparty.  The agreement limited IBM’s ability to terminate the agreement.  It needed to identify its “valid business reasons” for doing so. But under no circumstances could it displace BMC’s software with its own.  And yet, that is what it did. A keen-eyed colleague pointed out that § 5.4 allows IBM to discontinue the licenses. Literally, all that means is that IBM could choose to stop getting access to BMC software for free. That drafting may be intentional, but I think the courts likely were right to assume that discontinuing the licenses would also entail discontinuing the OA relationship.

Next.

Second, the Fifth Circuit maintains that the District Court’s reading renders the language “other valid business reasons” superfluous. No, it doesn’t. For some reason, the Fifth Circuit cannot imagine that the parties agreed that IBM could not displace BMC’s software with its own software for any reason but it could discontinue its access to the BMC licenses for other valid business reasons. In other words, the language in question relates to discontinuance, not to displacement, and it is not rendered superfluous on the District Court’s reading. The language places a small limitation on IBM’s right to terminate the agreement, but IBM still has no right to replace BMC’s software with its own.

The Fifth Circuit claims that IBM replacing BMC software with is own, at AT&T’s request, is just IBM complying with the OA, which obligates it to “assist BMC’s customers with their broad range of needs and requests.” Talk about rendering contractual language superfluous! Section 5.4 is an obvious limitation on IBM’s powers under the agreement. IBM cannot “assist” BMC’s clients by helping them to switch over to becoming IBM’s clients. Even without § 5.4, doing so would constitute a breach of the duty of good faith and fair dealing.

That last part makes me Lewis Black level angry (he voices the Anger character in Pixar’s Inside Out franchise, but I couldn’t post an image of the character, for IP reasons).

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The Fifth Circuit then contends that the District Court’s “cramped” reading of § 5.4 would lead to two absurd results. First, “it would allow IBM to replace BMC’s software with any other competing software at AT&T’s request, so long as the competing software is not that of IBM.” Well, that’s not absurd at all. IBM gained competitive advantages through the OA with respect to BMC’s software and the needs of its clients. It is understandable that BMC would want contractual protections against IBM, a competitor, leveraging those advantages to squeeze out BMC. There is no reason to think IBM would be motivated to do so in order to assist another competitor. The other absurdity is that a customer would have to terminate IBM as its IT outsources if it decided to switch software providers, but only if it chose to replace BMC with IBM. That is not absurd for the reasons given above.

Moreover, AT&T and IBM began negotiating their arrangement in 2013. IBM could have just terminated its agreement with BMC then, and then by the time IBM and AT&T renewed their collaboration in 2015, IBM would have been free from its obligations under the OA. It chose not to do so, and so it was still bound not to displace BMC software with its own. The Fifth Circuit finds such an agreement commercially unreasonable, but I find its position far more so. Why would BMC agree to give a competitor access to its proprietary software without some contractual guarantee that the competitor would use that access to compete?

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Finally, the least absurd part of the Fifth Circuit’s analysis is that, read as the District Court proposes, § 5.4 is anti-competitive, because it prevents AT&T from switching software providers from BMC to IBM at a time when AT&T had decided to move away from BMC in any case. The weakness in this argument is that it assumes facts not in evidence. Namely, it assumes that AT&T would have dropped BMC even if IBM were not available and even if IBM had not been able to establish a relationship with AT&T through its role facilitated by the OA.

The Fifth Circuit lays great weight on the District Court’s factual finding that  “AT&T independently decided to displace BMC software,” and therefore, “AT&T’s decisions and conduct—not IBM’s—are most consequentially tied to BMC’s lost profits from AT&T.” But these quotations taken out of context do not square with the District Court’s more-detailed description of how the transition took place. It was a collaborative project between AT&T and IBM, first named Project Swallowtail and then named Project Cirrus. For years, IBM was engaged in developing software that would displace BMC’s software in violation of § 5.4, and  it even renewed the OA after it began plotting to violate it. 

There may be other doctrines at play here. Perhaps the agreement between BMC and IBM is anti-competitive and thus violates antitrust laws, as one colleague suggested. I lack the expertise to judge that one. All I know is that the Fifth Circuit’s reasoning is unpersuasive, to me at least, as a matter of contracts interpretation.