SCO Grp v. Novell Inc

Filing 472

NOTICE of Delaware Bankruptcy Court's Memorandum Opinion and Order Granting Novell's Motion for Relief from the Automatic Stay to Proceed with the Lawsuit by Novell, Inc. (Attachments: # 1 Exhibit A# 2 Exhibit B)(Sneddon, Heather)

S C O Grp v. Novell Inc

D o c . 472 Att. 1

I N THE UNITED STATES BANKRUPTCY COURT F O R THE DISTRICT OF DELAWARE In re: T H E SCO GROUP, INC., et al., D e b to rs . ) ) ) ) ) ) C h a p te r 11 C a s e No. 07-11337 (KG) (J o in tly Administered) R e la te d Docket No.: 89

M E M O R A N D U M OPINION 1 T h e matter before the Court is the Motion of Novell, Inc. for Relief from the A u to m a tic Stay Pursuant to Section 362(d) of the Bankruptcy Code to Proceed with a District C o u rt Action to (I) Apportion Revenue from SCOSource Licenses and (II) Determine SCO's A u th o rity to Enter into SCOSource Licenses, Etc. (the "Motion") [D.I. 89]. The Motion m a tc h e s the fundamental protection of the automatic stay against the necessity and timing o f the adjudication of an issue that is essential in the administration of the bankruptcy case. A f te r careful analysis of the facts and legal standards, the Court will grant the Motion, as set f o rth below. I. BACKGROUND A . The Debtor O n September 14, 2007, the SCO Group, Inc. ("SCO") and its affiliate, SCO O p e ra tio n s , Inc. (collectively the "Debtors"), filed voluntary petitions for relief under

This Memorandum Opinion constitutes the findings of fact and conclusions of law required by Federal Rule of Bankruptcy Procedure 7052, made applicable to contested matters by Bankruptcy Rule 9014.

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Dockets.Justia.com

C h a p te r 11 of the Bankruptcy Code.2 The Court ordered the cases to be jointly administered [ D .I . 2]. Debtors are currently operating and managing their businesses as debtors in

p o s s e ss io n pursuant to §§ 1107 and 1108. S C O is a provider of Linux software technology for distributed, embedded, networkb a s e d , and mobile systems, offering SCO OpenServer for small to medium sized businesses, b ra n c h offices and franchisees of Fortune 1000 companies, UnixWare, and SCO Mobile S e r v e r for enterprise applications and digital network services. SCO Operations, Inc. is a D e la w a re corporation that is wholly owned by SCO Group and operates the research, d e v e lo p m e n t, sales and implementation of technology owned by SCO Group. Declaration o f Darl C. McBride, Chief Executive Officer, in Support of First Day Pleadings [D.I. 3]. B . The Novell Litigation O n January 20, 2004, SCO filed a lawsuit in Utah state court against Novell, Inc. (" N o v e ll" ). The case was removed by Novell to the United States District Court for the D is tric t of Utah ("the District Court") and is captioned The SCO Group, Inc. v. Novell, Inc., C a se No. 2:04-CV-00139 ("the Lawsuit"). The Lawsuit is one of a number of litigations in v o lv in g SCO and the UNIX property rights. The Lawsuit concerns a dispute over an Asset Purchase Agreement, dated September 1 9 , 1995 (the "APA"), between Novell and SCO's predecessor, The Santa Cruz Operation,

11 U.S.C. §§ 101 et seq. Hereinafter, references to statutory provisions by section number only are to provisions of the Bankruptcy Code, unless the context requires otherwise. -2-

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In c . ("Santa Cruz").3 Pursuant to the APA, Novell transferred all of its UNIX SVRX s o f tw a re licenses (the "SVRX Licenses") to Santa Cruz. SCO subsequently entered into a lic e n s in g campaign, "SCOSource," based on the SVRX Licenses. In the Lawsuit, SCO asserted a claim for slander of title and interference with the U N IX copyrights. Novell, claiming that it retained all UNIX copyrights under the APA, c o u n te rc la im e d against SCO alleging breaches of the APA and seeking various forms of re lie f . SCO subsequently amended its complaint to include claims against Novell for c o p yrig h t infringement, unfair competition and breach of a technology licensing agreement. F inally, in September of 2006, Novell filed an amended counterclaim alleging that SCO's r e t e n t i o n of funds from certain SCOSource licenses constituted breach of fiduciary duty, b re a ch of contract and conversion. B o th SCO and Novell filed multiple motions for summary judgment on their re sp e c tiv e claims and counterclaims. On August 10, 2007, the District Court issued its d ec isio n 4 denying SCO's motion for summary judgment and granting, in part, Novell's m o tio n s for summary judgment. The District Court concluded that: (1) Novell retained o w n e rsh ip of the UNIX copyrights; and (2) Novell is entitled to royalties from certain S C O S o u r c e licenses that the District Court determined to be SVRX Licenses. The District

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Santa Cruz was subsequently purchased by Caldera Systems, Inc. which changed its name

to SCO. The learned District Court issued a thorough 105-page opinion carefully analyzing the facts and law. The District Court's mastery of the facts and law pertaining to the Lawsuit is a powerfully important consideration in the Court's decision to lift the stay. -34

C o u rt declined to impose a constructive trust until it could determine the appropriate amount o f royalties to which Novell is entitled. As a result of the ruling, the District Court dismissed s e v e ra l of SCO's claims against Novell, including the original allegation of slander of title. F o llo w in g the District Court's decision, the parties were poised to begin a trial to re so lv e the following issues:5 (1) the amount of the royalties to which Novell is entitled from c e rta in SCOSource licenses that the District Court determined to be SVRX Licenses and any a d d itio n a l licenses that are determined to be SVRX Licenses; (2) whether SCO had the a u th o rity to enter into licensing agreements with Microsoft Corporations and Sun M ic ro s ys t em s ; and (3) the amount of funds held by SCO that are subject to a constructive tru s t. The trial was scheduled to begin on Monday, September 17, 2007, until SCO filed for b a n k ru p tc y on Friday, September 14, 2007. N o v e ll filed the instant Motion on October 4, 2007 contending that relief from the a u to m a tic stay is warranted for cause. The Motion was set for hearing on November 6, 2007. I I . JURISDICTION T h is is a core proceeding which invests the Court with jurisdiction pursuant to 28 U .S .C . § 157(b)(2)(G).

The first two issues are hereinafter referred to as "the Liability Issues." The third issue is hereinafter referred to as "the Constructive Trust Issue." -4-

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I I I. ANALYSIS A . The Law T h e automatic stay is one of the most fundamental protections provided to the debtor u n d e r the Bankruptcy Code. Midlantic Nat'l Bank v. New Jersey Dept. of Envtl. Protection, 4 7 4 U.S. 494, 503, 106 S. Ct. 755 (1986) reh'g denied 475 U.S. 1090, 106 S. Ct. 1482. The p u rp o s e of the automatic stay is "to prevent certain creditors from gaining a preference for th e ir claims against the debtor; to forestall the depletion of the debtor's assets due to legal c o sts in defending proceedings against it; and, in general, to avoid interference with the o rd e rly liquidation or rehabilitation of the debtor." St. Croix Condominium Owners v. St. C r o ix Hotel, 682 F.2d 446, 448 (3d Cir. 1982). However, the automatic stay is not meant to be absolute, and in appropriate instances re lie f may be granted. Wedgewood Inv. Fund, Ltd. v. Wedgewood Realty Group, Ltd. (In re W e d g e w o o d ), 878 F.2d 693, 697 (3d Cir. 1989). Section 362(d)(1) of the Bankruptcy Code p ro v id e s that: O n request of a party in interest and after notice and a hearing, th e court shall grant relief from the stay provided under s u b s e c tio n (a) of this section, such as by terminating, annulling, m o d if yin g or conditioning such stay­ (1 ) for cause, including the lack of adequate p ro tec tio n of an interest in property of such party in interest. . . . E x c e p t for lack of adequate protection, "cause" is not defined by § 362(d)(1). Cause is a flexible concept and courts often conduct a fact intensive, case-by-case balancing test, -5-

e x a m in in g the totality of the circumstances to determine whether sufficient cause exists to lift the stay. See Baldino v. Wilson (In re Wilson), 116 F.3d 87, 90 (3d Cir. 1997); In re L a g u n a Assocs. Ltd., 30 F.3d 734, 737 (7th Cir. 1994); American Airlines, Inc. v. Continental A ir lin e s , Inc. (In re Continental Airlines, Inc.), 152 B.R. 420, 424 (D. Del. 1993). T h e legislative history to section 362(d)(1) emphasizes the section's applicability to p ro c e e d in g s in another tribunal. "It will often be more appropriate to permit proceedings to c o n tin u e in their place of origin, when no great prejudice to the bankruptcy estate would resu lt, in order to leave the parties to their chosen forum and to relieve the bankruptcy court f ro m any duties that may be handled elsewhere." H.R. Rep. No. 595, 95th Cong., 1st Sess., 3 4 1 (1977). Most courts follow this logic and apply an equitable balancing test to determine if cause exists to lift the stay to allow pending litigation to proceed or continue in another f o ru m . T h is Court has developed a three-prong balancing test to determine whether to grant re lie f from the stay: 1 . Whether any great prejudice to either the bankrupt estate or th e debtor will result from continuation of the civil suit; 2 . Whether the hardship to the non-bankrupt party by m a in ten a n c e of the stay considerably outweighs the hardship to th e debtor; and 3. The probability of the creditor prevailing on the merits. Iz z a r e lli v. Rexene (In re Rexene Prods. Co.), 141 B.R. 574, 576 (Bankr. D. Del. 1992).

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T h is Court has also considered general policies underlying the automatic stay when d e c id in g whether to grant a motion to lift the stay. These policies, which have been outlined b y the United States Court of Appeals for the Second Circuit, are: 1 ) whether relief would result in a partial or complete resolution o f the issues; 2) lack of any connection with or interference with t h e bankruptcy case; 3) whether the other proceeding involves th e debtor as a fiduciary; 4) whether a specialized tribunal with th e necessary expertise has been established to hear the cause of a c tio n ; 5) whether the debtor's insurer has assumed full re sp o n sib ility for defending it; 6) whether the action primarily in v o lv e s third parties; 7) whether litigation in another forum w o u ld prejudice the interests of other creditors; 8) whether the ju d g m e n t claim arising from the other action is subject to e q u ita b l e subordination; 9) whether the moving party's success in the other proceeding would result in a judicial lien avoidable b y the debtor; 10) the interests of judicial economy and the e x p e d itio u s and economical resolution of litigation; 11) whether th e parties are ready for trial in the other proceeding; and 12) im p a c t of the stay on the parties and the balance of the harms. I n re Sonnax Indus., Inc. v. Tri Component Prods. Corp., 907 F.2d 1280, 1287 (2d Cir. 1 9 9 0 ). B . Application B e f o re analyzing the applicable law, the Court notes that the circumstances s u rro u n d in g this case are unusual. In particular, the parties were on the door-step of b e g in n in g a five-day trial of complex issues when the Debtors filed their petitions. Another c o u r t has extensive knowledge of the facts and issues and has already made detailed findings.

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A s Novell pointed out in its motion papers, relief from the stay may be granted "when n e c es s a ry to permit litigation to be concluded in another forum, particularly if the n o n b a n k ru p tc y suit involves multiple parties or is ready for trial." Lawrence P. King, Collier o n Bankruptcy 362.07[3][a] (15th ed. 2006). Moreover, as noted above, the legislative h is to ry of section 362(d)(1) emphasizes the importance of allowing a case to continue in the o rig in a l tribunal so long as there is no prejudice to the estate. In applying the three-prong b a la n c in g test, considering the policies set forth in Sonnax, and finding that lifting the stay w ill not result in prejudice to the debtor and, therefore, it is appropriate to allow the trial to c o m m e n c e before the District Court. 1. Application of the Three-Prong Balancing Test T h e first factor the Court must consider in determining whether to grant relief from th e automatic stay for "cause" using the three-prong balancing test is whether the lifting of th e stay will result in harm to the debtor or the estate. On the facts of this case, it does not a p p e a r that lifting the stay will unduly prejudice SCO. The Debtors argue that allowing the trial to go forward would require the Debtors and th e ir top management to focus all of their attention on the trial, to the detriment and exclusion o f the reorganization efforts at a critical stage in the bankruptcy case. The Court does not a g re e . While the trial will likely require the attendance of SCO's primary officers and d ire c to rs , SCO's attention to the Lawsuit will certainly not harm the estate.

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S C O has separate litigation counsel who had already completed its extensive trial p re p a ra tio n prior to the petition date. Thus, the trial preparation will not be burdensome to t h e Debtors. In addition, because this bankruptcy case was filed on the eve of trial, both p a rtie s have already spent all of the necessary time and resources in preparation.6 The longer th e trial is delayed, the more burdensome it is to both parties to ready themselves again. The Debtors also argue that the estate will be greatly burdened if the Court permits th e trial to proceed because the imposition of a constructive trust on funds that are presently p rop erty of the estate would effectively kill the chapter 11 case at its inception. However, w h i le the stay will be lifted in order to enable the District Court to determine the License Is s u e s, this Court will determine whether a constructive trust is appropriate because it is the v e ry essence of a bankruptcy court's jurisdiction to decide what is property of the estate. See In re Continental Airlines, 138 B.R.442, 445 (the determination of what constitutes property o f the debtor's estate is one of the core proceedings arising under Title 11 and is inherently a n issue to be determined by the bankruptcy court). As explained in In re Flanigan, 503 F.3d 1 7 1 , 180-11(2d Cir. 2007): T h e effect of a constructive trust in bankruptcy is profound. W h ile the bankruptcy estate is defined very broadly under § 5 4 1 (a )( 1 ) of the Bankruptcy Code to include all legal or e q u ita b le interests of the debtor, any property that the debtor h o ld s in constructive trust for another is excluded from the e sta te pursuant to § 541(d), which states

Debtors' trial counsel in the Lawsuit is being compensated on a contingency fee basis and therefore the expense of the trial will not unduly burden Debtors. -9-

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P r o p e rty in which the debtor holds, as of the c o m m e n c em e n t of the case, only legal title and n o t an equitable interest. . . becomes property of th e estate. . . only to the extent of the debtor's le g a l title to such property, but not to the extent of a n y equitable interest in such property that the d e b to r does not hold. 1 1 U.S.C. § 541(a)(1), (d), see also Sanyo Elec., Inc. v. H o w a r d 's Appliance Corp. (In re Howard's Appliance Corp.), 8 7 4 F.2d 88, 93 (2d Cir. 1989). A constructive trust thus places its beneficiary ahead of other creditors with respect to the trust r e s. G ra n tin g Novell stay relief will not result in the imposition of a constructive trust and, th e re f o re , neither Debtors nor the estate will be prejudiced. A f te r determining whether relief from the stay will result in any harm to the debtor o r the estate, the Court must balance that hardship with any hardship that the movant will s u f f er as a result of the stay being enforced. Here again, the Court finds the equities favor N o v e ll. Hardship will result to Novell from denying relief, whereas the prejudice to SCO in denying relief, as discussed in the analysis of the first prong, is slight. Novell has already prepared extensively for a trial that was to take place in S ep tem b er. Novell will be burdened by further delay and the fact that it will have to prepare a g a in . Novell has already spent significant time and resources preparing for the trial in the L a w s u it. In addition, without a ruling on the Liability Issues, Novell's rights in these b a n k ru p tc y cases remains undetermined and the value of Novell's claim will remain a tr o u b l in g issue for the Court, Novell and Debtors.

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T h e Debtors urge this Court to follow the holding of the Bankruptcy Court for the S o u th e rn District of New York in In re Northwest Airlines Corp., 2006 Bankr. LEXIS 477 (B a n k r. S.D.N.Y. 2006) when balancing the hardships of the parties. In Northwest Airlines, th e court found that the burden to the estate greatly outweighed that of the creditor and d e n ie d a motion for stay relief because (1) the debtors were at a critical stage of the re o rg a n iz a tio n ; (2) the trial would take management attention away from the reorganization; (3 ) the creditors had not shown any unusual prejudice; and (4) there was no "issue of public h e a lth or safety and no indication that the Movants' claims must be resolved before the D e b to rs can file a feasible plan." Id. at *2. The Debtors argue that the very same reasons to deny the Motion. The Court, h o w e v e r, finds that the fourth point is not present here. As Novell has pointed out in its p a p e rs , the Debtors simply cannot file a confirmable plan of reorganization until they know w h a t liability they have to Novell. The resolution of the issues remaining in the District C o u rt litigation will assist the Debtors, not burden them.7 F in a l ly, the Court must consider whether the movant has some probability of success o n the merits of the pending litigation. Even a slight probability of success on the merits may b e sufficient to support lifting an automatic stay in an appropriate case. Int'l Business

An example of Novell's dilemma, and the Court's, arose recently in the bankruptcy cases. Debtors moved to sell substantially all of their assets. Without a ruling on the Liability Issues it was unclear if the sale would adversely affect Novell's rights. Debtors subsequently withdrew the sale motion, but the problem remains. -11-

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M a c h in e s v. Fernstrom Storage & Van Co. (In re Fernstrom Storage & Van Co.), 938 F.2d 7 3 1 , 737 (7th Cir. 1991); Rexene 141 B.R. at 578. Novell argues that "probability" has already solidified into actual success on the m e rits and the issues remaining are merely damage calculations. The Debtors contend that N o v e ll has failed to demonstrate that it will prevail on the other remaining issues: whether S C O had the authority to enter into licensing agreements with Microsoft Corporations and S u n Microsystems; and the amount of funds held by SCO that are subject to a constructive tru s t. As the Court stated earlier, the stay will not be lifted and, therefore, the Constructive T ru s t Issue will not proceed in the District Court. It is therefore not necessary to analyze w h e th e r Novell is likely to succeed on the Constructive Trust Issue. As for the Liability Issu es, the Court finds that there is sufficient evidence, including the District Court's d e c i sio n , to support a finding of a reasonable probability of success on the merits. 2 . Application of the Sonnax Policies T h e Court has also considered several of the policies listed in Sonnax in reaching its d e c is io n . Of particular importance to the Court are the specialized knowledge that the D is tric t Court has developed in presiding over the Lawsuit for four years, the interests of ju d ic ia l economy and the expeditious and economical resolution of litigation and, as stated e a rlier , the fact that the parties are ready for trial.8

Lifting the stay may also benefit Debtors who have made it clear that they will appeal the District Court's decision. Until the Lawsuit can proceed to final judgment, the adverse ruling is a "Sword of Damocles" over Debtors. -12-

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It is undeniable that the Lawsuit involves many highly technical issues that the District C o u rt has already addressed and mastered. Debtors concede that it is unreasonable to expect th is Court to spend a significant amount of time learning and resolving the Liability Issues w h e n the District Court already has the knowledge required to adjudicate the Liability Issues. M o re o v e r, to do so would be economically inefficient and unnecessarily time consuming. I V . CONCLUSION A f te r an analysis of the facts and equitable considerations, the Court concludes that re lief from stay is justified.9 An Order in accordance with the Memorandum Opinion is a tta c h e d .

Dated: November 27, 2007 K E V I N GROSS, U.S.B.J.

The Court does not presume that the busy District Court will be able immediately to schedule the anticipated five day trial in the Lawsuit, and respectfully defers to the District Court on scheduling. -13-

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