Filed 11/29/18 Scottish Equity Partners LLP v. Riverbed Technology, Inc. CA1/3

NOT TO BE PUBLISHED IN OFFICIAL REPORTS

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIRST APPELLATE DISTRICT

DIVISION THREE

SCOTTISH EQUITY PARTNERS LLP, et al., Plaintiffs and Respondents, v. RIVERBED TECHNOLOGY, INC., et al., Defendants and Appellants.

A148043 (City & County of San Francisco Super. Ct. No. CGC-12-525496) ORDER MODIFYING OPINION AND DENYING REHEARING; NO CHANGE IN JUDGMENT

THE COURT:

It is ordered that the opinion filed herein on November 2, 2018, be modified as follows:

1. On page 7, line 10, after the sentence ending in the words “is not included,” add as footnote 8 the following footnote:

⁸ In their petition for rehearing, plaintiffs argue that the following entry on schedule 1.6(a)(vii), under the heading “OEM channels,” indicates that the source code for Traffic Manager was listed as a “specified company product”: “We provide custom configurations of Zeus Traffic Manager and Zeus Load Balancer to several OEM partners who either produce local balancing appliances, or incorporate the Zeus software within their own solutions.” While this paragraph indicates that custom configurations of the product provided to OEM partners qualify as a specified company product, it does not indicate that the source code for the configuration is included. In all events, the same entry does not appear on the published price list.”

2. In the concurring opinion on page 2, the last paragraph beginning with the words “Because the license of the source code” is deleted and the following paragraphs, including the footnote, are inserted in its place:

In their rehearing petition, plaintiffs argue that we failed to consider an alternative ground to affirm the trial court: “The Juniper License also qualifies for the earn-out as an “OEM” transaction.” They rely, in part, on the following statement on Schedule 1.6(a)(vii), which they contend would necessarily include the Juniper License: “In addition, through certain channels, the Company currently sells: [¶] . . . [¶] 8. OEM channels: We provide custom configurations of Zeus Traffic Manager and Zeus Load Balancer to several OEM partners who either produce load balancing appliances, or incorporate the Zeus software within their own solutions” (paragraph 8). (Italics added.) They contend that an OEM can include a source code and that “ecause OEM transactions are bespoke to the buyer or licensor, they typically involve configurations of a product that would not be included on a price list at a specified price.”

To accept plaintiffs’ argument we would have to read paragraph 8 to include prospective sales to new customers. That interpretation is not supported by the contract language or by the evidence. The clear language of both the introductory phrase and paragraph 8—italicized above—refers to current sales with existing “OEM partners.” Plaintiffs refer us to testimony about “possible OEMs” (italics added) between Zeus and Juniper and Riverbed’s knowledge of those discussions. They do not identify evidence that Juniper was an OEM partner.^[1] If, as plaintiffs contend, revenue from a future OEM transaction to license the Traffic Manager source code to Juniper was to be included in the earn-out, it would not be necessary to read that meaning into Schedule 1.6(a)(vii) which, as written, does not support that conclusion.

Because the Juniper license of the Zeus Traffic Manager source code does not satisfy the prerequisites of section 1.6 of the share purchase agreement, the revenue derived from the transaction is not includable in the earn-out calculation. For that reason, I concur in the result.

There is no change in judgment. Respondents’ petition for rehearing is denied.

Date: _______________________ Acting P.J.^*

Filed 11/2/18 Scottish Equity Partners LLP v. Riverbed Technology, Inc. CA1/3 (unmodified opinion)

[b]NOT TO BE PUBLISHED IN OFFICIAL REPORTS

IN THE COURT OF APPEAL OF THE STATE OF CALIFORNIA

FIRST APPELLATE DISTRICT

DIVISION THREE

SCOTTISH EQUITY PARTNERS LLP, et al., Plaintiffs and Respondents, v. RIVERBED TECHNOLOGY, INC., et al., Defendants and Appellants.

A148043 (City & County of San Francisco Super. Ct. No. CGC-12-525496)

Defendants Riverbed Technology, Inc. and Riverbed Technology Limited (collectively Riverbed) appeal an adverse judgment, following a bench trial, holding them liable for breach of an agreement under which they purchased a software company, Zeus Technology Limited (Zeus), from its shareholders, plaintiffs Scottish Equity Partners LLP and others (collectively plaintiffs). Under the agreement, Riverbed agreed to pay for the company a base price of $110 million, which it paid, plus an additional contingent sum based on first-year revenues as defined in complex contractual provisions. The controversy centers on whether the proceeds from Riverbed’s license to another company, Juniper Networks (Juniper), during the first year following the purchase, of the source code to one of Zeus’s primary products, the “Zeus Traffic Manager,” qualifies for inclusion in the earn-out formula. The trial court concluded that the proceeds of the license agreement, $75 million, do qualify and that Riverbed therefore owes plaintiffs an additional $27 million under the contractual formula.

Riverbed contends the transaction with Juniper fails to come within the earn-out provisions in several respects, all of which were rejected by the trial court. We conclude that proceeds from the license of the product’s source code do not come within the earn-out provisions for at least one basic reason. It is therefore unnecessary to address the conflicting interpretations of all of the terms about which the parties disagree.

Background

On July 19, 2011, the parties entered a share purchase agreement (SPA) under which the purchase price was $110 million plus, among other things, “the right to receive payments, if any, pursuant to Section 1.6.” Section 1.6, titled “Earn-Out Consideration,” is spread over more than four pages and specifies the manner in which the additional payment is to be calculated, utilizing 10 terms for which complicated definitions are provided.

Simplifying the matter by omitting numerous qualifications that are not relevant to the dispute, the “aggregate earn-out consideration payment” is $2 for each dollar of “one year bookings” in excess of $25 million, not to exceed an additional payout of $27 million.[2] “One year bookings” is defined to include “product bookings,”[3] which in turn is defined to mean “the bookings (as the term ‘bookings’ is commonly understood) . . . that are derived by [Riverbed] . . . solely from the sale or license of any of the company’s products identified on schedule 1.6(a)(vii) . . . only to the extent that such sales or licenses meet the conditions set forth in clauses ‘(A)’ and ‘(B)’ of this sentence: (A) such sales or licenses are made during the one-year period^[[4]] to qualified customers in qualified transactions; and (B) the software and related software keys to enable a fully functional software product under the sale or license from product bookings are delivered to the customer during the one-year period.” (Underline omitted.) “Qualified transactions” in turn are defined to exclude, among other things, “transactions which contain in part or in whole, products or services not on [Riverbed’s] published price list . . . .”

The list of company products specified on schedule 1.6(a)(vii) includes, as the first listed product: “Zeus Traffic Manager,” followed by several “software options: Real-time Analytics, Service Level Monitoring, Bandwidth Management, Application Auto-scaling, Application Firewall Module.” The price list that Riverbed published shortly after the acquisition listed the price for perpetual licenses of several models of the Zeus Traffic Manager at prices ranging from $17,500 to $52,500. Riverbed’s revised price list, dated October 4, 2011, headed “Stingray Traffic Manager,”[5] listed numerous models and options with prices ranging between $5,500 and $63,500.

Absent the disputed transaction with Juniper, bookings during the one year earn-out period totaled only $24.4 million. Thus, if the proceeds of the Juniper transaction are not a qualified transaction within the meaning of the contract, plaintiffs are not entitled to additional compensation.

On June 14, 2012, Riverbed and Juniper entered an “ADC source code license agreement”[6] along with two other agreements.[7] Under this ADC agreement, Riverbed provided Juniper with various products and services, including a perpetual license to the source code to Traffic Manager, for which Juniper paid Riverbed $75 million. Among the several reasons for which Riverbed asserts that this payment is not to be included in calculating the earn-out consideration is that the products referred to on schedule 1.6(a)(vii) and included on the published price lists are the executable, or object code, versions of the various products, and not the source codes from which the computer-readable products are generated. The trial court issued a thoughtful analysis of the numerous issues presented,[8] but we need not consider most of its conclusions because we find one issue dispositive. The trial court ruled, “To count for the earn out, a product must be on SPA’s schedule 1.6(a)(vii). Zeus Traffic Manager is listed ‘on’ there. . . . [¶] . . . [¶] And when we turn to the exclusion language under the qualified transactions language (which in effect requires the products to be on Riverbed’s published price list), we know that Traffic Manager is in fact on that list too.” For the reasons discussed below, we simply cannot agree that the products identified on the product list or the published price list are the source codes from which the executable, computer-readable software products are generated.

Discussion

The rules governing the interpretation of written contracts are not in dispute. “ ‘The fundamental rules of contract interpretation are based on the premise that the interpretation of a contract must give effect to the “mutual intention” of the parties. “Under statutory rules of contract interpretation the mutual intention of the parties at the time the contract is formed governs interpretation. [(Civ. Code, §1636.)] Such intent is to be inferred, if possible, solely from the written provisions of the contract. [(Civ. Code, § 1639.)]” ’ ” (ASP Properties Group, L.P. v. Fard, Inc. (2005) 133 Cal.App.4th 1257, 1269.) If the agreement is ambiguous, parol evidence is admissible to interpret it. (Bill Signs Trucking, LLC v. Signs Family Limited Partnership (2007) 157 Cal.App.4th 1515, 1521.) “The trial court’s threshold finding of ambiguity is a question of law subject to our independent review. The court’s ultimate construction of ambiguous language is subject to our independent review if the extrinsic evidence is not in conflict, even when the parties draw different inferences from the evidence.” (Ibid.)

The contract language in this case arguably is ambiguous in that the earn-out provisions do not state explicitly whether the products to which the provisions refer are only the executable, object code versions of the products or their source codes as well. Linguistically, though perhaps not as a matter of common understanding, the contract language “company’s products” is reasonably susceptible to either interpretation, so that extrinsic evidence may be considered in determining the intended meaning of those terms. (Pacific Gas & E. Co. v. G.W. Thomas Drayage etc. Co. (1968) 69 Cal.2d 33, 37.) However, there is no ambiguity in the language specifying that only proceeds from the sale or license of products listed on schedule 1.6(a)(vii) and Riverbed’s published price list are to be included in the earn-out formula.

Although the parties draw different inferences, there is no significant conflict in the evidence concerning the formation of the contract. There is no suggestion that in the extended negotiations leading to entry of the agreement, there was any discussion of the issue on which the parties now disagree. It is clear that the parties attempted to agree on a purchase price by capitalizing projected earnings but disagreed about the sales volume of Zeus’ products to be anticipated in the coming years. The $110 million base price was a multiple of the revenue that Riverbed projected for the coming year, $25 million. Zeus projected a higher level and the earn-out formula was designed to provide the sellers with additional compensation to the extent that revenue from the sale or license of specified products in the following year exceeded $25 million.

There is also no dispute over the difference between object code and source code. “ ‘The text of programs written in [computer programming] languages is referred to as source code. And whether directly or through the medium of another program, the sets of instructions written in programming languages—the source code—ultimately are translated into machine “readable” strings of 1’s and 0’s, known in the computer world as object code, which typically are executable by the computer.’ ” (DVD Copy Control Assn., Inc. v. Bunner (2003) 31 Cal.4th 864, 872, fn. 2.) The trial court aptly made reference to the explanation of these technical matters in Universal City Studios, Inc. v. Reimerdes (S.D.N.Y. 2000) 111 F.Supp.2d 294, 326, 346, affd. sub nom. Universal City Studios, Inc. v. Corley (2d Cir. 2001) 273 F.3d 429, and confirmed, “As the parties here have considered it, object code is operated on immediately by the computer—it is ‘machine readable’—whereas source code is the program as written and read by humans, which is compiled into object code to be executed by the computer—hence the term ‘executable.’ ”

As described in Riverbed’s appellate brief, without disagreement by plaintiffs: “source code is the blueprint that software companies use to make unlimited copies of the executable software that is sold to the public at modest prices. Once the executable object code is installed on a customer’s computer, it can be used to perform various functions, such as word processing (Microsoft Word), document conversion (Adobe Acrobat), or in the case of Zeus Traffic Manager, website optimization. [¶] Source code is an extremely valuable and highly protected asset—much like the secret recipe for Coke or a formula to a pharmaceutical drug—and companies go to great lengths to protect their source code from disclosure. In fact, source code is often a software company’s most valuable asset. Put simply, source code is the company’s golden goose; copies of the object code are the golden eggs.”

As noted above, there is no dispute that the proceeds of Riverbed’s license to Juniper of the Traffic Manager source code are includable in the calculation of the earn-out consideration payment only if that product was included on the product list attached to the contract as schedule 1.6(a)(vii) and on Riverbed’s published price list. Plaintiffs argue that “ ‘Traffic Manager’ – those words – is undeniably both ‘identified on’ schedule 1.6(a)(vii) as a specified company product eligible for earn-out consideration and ‘on’ Riverbed’s published price list,” so that “[s]ubstantial evidence proves that the Juniper license is a license of ‘Traffic Manager’ meeting” the contractual criteria. The trial court essentially adopted this view. However, we cannot agree that the words “Traffic Manager” on either schedule 1.6(a)(vii) or the published price list can reasonably be understood to encompass the source code to that product.

Under the heading “Zeus Traffic Manager” the schedule 1.6(a)(vii) product list specifies several “software options,” all of which are executable, object code versions of Traffic Manager; “source code” is not included. The published price list similarly lists a number of executable Traffic Manager products for each of which it lists a price; source code is not included and no price is given for the source code. While the prices for the various executable versions appearing on the price list range in the thousands of dollars, it is implausible that the source code that was licensed to Juniper for tens of millions of dollars was implicitly included on that same list, especially when the source code was neither named nor priced.

There are other indications on the published price list that it did not apply to the source code. The full heading over the itemized products on the price list reads, “Stingray Traffic Manager Software sku’s (perpetual licenses).” Plaintiff’s expert acknowledged that “sku’s” are stock keeping units referring to object code versions of the software. The “product bulletin” that accompanied the price list explained that Traffic Manager was available “as a software install for supported servers” and “in a number of functionality performance configurations.” Source code, however, is not installed on servers and does not execute functions. As the trial court stated, source code “is compiled into object code to be executed by the computer.” The product bulletin also explained that “licenses are tied to an IP address” and because it cannot be read by a computer, source code cannot be tied to an IP address.

Moreover, there are still other indications that the source code was not a product the licensing of which was intended to be considered in the earn-out formula. Zeus had been in the business of selling or licensing executable software programs such as the Traffic Manager program. Its revenues for the 12 months preceding the acquisition had been $19 million, entirely from sales of object code licenses and related services. In negotiating the acquisition price for the company, the parties differed as to realistic projections of future revenue for the sale or licensing of these same products. The earn-out formula was designed to provide additional compensation if revenue exceeded the $25 million that Riverbed projected. Nowhere in the record is there any indication that the parties intended the earn-out premium to apply to revenues from anything other than recurring sales or licenses of the executable versions that Zeus had been marketing. Certainly there was no suggestion that the formula would include revenue from licensing the source code, an asset that Zeus had never sold or licensed.

The trial court undoubtedly was correct that “the earn-out provision which lies at the heart of the dispute here was created to bridge the parties’ disagreement about the value of Zeus.” The trial court was also correct that the word “product” is broad enough to encompass both the object code and source code versions of a software product. But the earn-out provision in this contract is not tied to revenue from the sale or licensing of any product, but only to revenue from the sale or license of products listed on the schedule that was part of the contract and on the published price list. While it may or may not be true, as the trial court speculated, that Zeus would have negotiated a higher price for the company had it foreseen the Juniper transaction, the agreement provides for additional compensation only if revenue from the listed products exceeded $25 million. For the many reasons stated above, the mere fact that the words “Traffic Manager” appear as headings on the product list and price list cannot reasonably be understood to indicate that either list was referring to, or included, the source code for the listed Traffic Manager software products.

As indicated previously, Riverbed asserts that there are several other reasons for which no compensation was due under the earn-out provisions. Because we conclude that these provisions do not apply to revenue from the licensing of the Traffic Manager source code, it is not necessary to consider any of the additional contentions.

Disposition

The judgment is reversed. The matter is remanded to the trial court with direction to enter judgment for Riverbed. Riverbed shall recover its costs on appeal.

_________________________

Pollak, Acting P.J.

I concur:

_________________________

Jenkins, J.