Advanced Management Systems Ltd v Attorney-General HC Auckland CP371/00
[2001] NZHC 1167
•30 November 2001
IN THE HIGH COURT OF NEW ZEALAND
AUCKLAND REGISTRY CP371/00
BETWEEN ADVANCED MANAGEMENT SYSTEMS LTD
Plaintiff
AND THE ATTORNEY-GENERAL FOR NEW ZEALAND
First Defendant
AND NEW ZEALAND PAYROLL SOFTWARE SYSTEMS LTD
Second Defendant
Hearing: 1 to 4 October 2001
8 to 12 October 2001
15 to 18 October 2001
Counsel: A C Sorrell and M J McCartney for Plaintiff
M T Parker for First Defendant
H B Rennie QC, P Scott and A E McDonald for Second Defendant
Judgment: 30 November 2001
INTERIM RESERVED JUDGMENT OF RANDERSON J
Solicitors:
G Cockroft, Cockroft d’Young Moorehouse, P O Box 32018, Devonport, Auckland 9 for Plaintiff
Crown Law Office, P O Box 5012, Wellington for First Defendant
Baldwin Shelston Waters, P O Box 582, Wellington for Second Defendant
INDEX
Paragraph
Introduction [1]
The plaintiff’s contentions [8]
The contentions of the Crown and NZPSS [9]
The issues
A. Ownership and copyright
B. Royalties
C. Assignment
D. Other claims against the Crown
E. Separate claims against NZPSS
F. Separate counterclaim by the Crown
The relevant facts [12]
The development of LEADER [13]
Contract P2010 [14]
Contract P2085 [16]
Negotiations for the marketing agreement [22]
Conclusion of the ownership issue [46]
The meetings of 20 and 22 March 1989 [50]
Conclusions on the royalty waiver [78]
Events after the execution of the marketing rights agreement [81]
Marketing efforts and licence arrangements [83]
Further debate over ownership issues [106]
Sales of LEADER reach $250,000 [114]
Events in 1999/2000 including the assignment [123]
Approach to construction of the contracts [143]
A. Ownership and copyright
Does the Crown have exclusive copyright in the LEADER software as developed under P2085 as well as the subsequent modifications and enhancements? [150]
Ownership of copyright in the modifications and enhancements [163]
The originality argument [183]
What work did AMS carry out to modify or enhance LEADER and was it such as to attract copyright protection? [195]
Conclusions on originality and proportion of ownership of LEADER copyright [216]
B. Royalties
Is the Crown entitled to rectification of the terms of clause 4 of the marketing rights agreement or relief under the Contractual Mistakes Act? [217]
Has AMS accounted correctly for royalties on sales? [226]
Apportionment between original LEADER and later modifications [227]
Apportionment between LEADER and AMPS [228]
Annual fees [239]
C. Assignment [249]
D. Confidential information
Did the Crown owe any duty of confidentiality to AMS and, if so, did it breach any such duty? [273]
E. Breach of copyright and the separate claims against NZPSS [277]
F. Separate counterclaim by the Crown [281]
G. Summary of findings [282]
Introduction
[1] Twelve years ago, the plaintiff AMS completed the development of computer software for a payroll and personnel system known as LEADER. It was intended to be used initially at the Naval Dockyard at Auckland and was developed under a contract with the Crown at a cost of over $1 million. LEADER was installed in 1989 with an associated operating system previously developed by AMS and known as AMPS. All agree that LEADER has operated satisfactorily and there are no complaints about its quality or effectiveness.
[2] During the course of the development of LEADER, AMS and the Crown negotiated a marketing rights agreement conferring upon AMS the exclusive right to sell LEADER to others. The construction and application of the marketing rights agreement lies at the heart of the dispute between the parties. A copy of it is annexed to this judgment.
[3] During the period leading up to the signing of the marketing rights agreement, it was recognised that modifications and enhancements to LEADER would be required over time to ensure its on-going operation and marketability. It was agreed that AMS would undertake any such modifications and enhancements at its own cost. In the intervening period from 1989 to the present, AMS says it has been responsible for a large number of changes to LEADER and maintains that it is entitled to copyright in those changes. While AMS acknowledges that the Crown owns copyright in LEADER as originally developed and installed in 1989, it says subsequent changes to the system are such that it should now be regarded as owning 85% of the copyright in LEADER with the Crown owning the remaining 15%.
[4] The marketing rights agreement also provided for the payment of royalties by AMS to the Crown amounting to 15% of the retail value achieved for each sale of LEADER. As well, it provided that the Crown would waive its rights to the first $250,000 of royalties in recognition of certain expenses incurred or to be incurred by AMS. The construction of the royalty waiver provision and whether it correctly reflected the party’s pre-contractual agreement or understanding is another important issue in this case.
[5] By an agreement dated 24 July 2000, without any prior notice to AMS, the Crown assigned all its interest in LEADER and in its agreements with AMS to the second defendant, New Zealand Payroll Software Systems Ltd (NZPSS). That company is a subsidiary of New Zealand Payroll Ltd, which is a provider of payroll services through a bureau system.
[6] AMS first became aware of the assignment when it received advice to that effect from the Crown and NZPSS. This spurred AMS into taking urgent proceedings to assert its rights. Initially the Attorney-General, both the New Zealand Payroll companies, and a director of those companies (Mr M J Gleeson) were joined as defendants. However, AMS later discontinued against New Zealand Payroll Ltd and Mr Gleeson so that the claim is now brought solely against the Attorney-General (representing the Chief of the Defence Force) and NZPSS.
[7] The issue of proceedings by AMS caused the Crown and NZPSS to raise a number of issues by way of counterclaim against AMS. Although some of these issues had been raised some years earlier by the Crown, none of them had been pursued with any vigour or at all until AMS began to assert its rights after the assignment to NZPSS. Indeed, at the time of the assignment, the Crown did not place any more than a nominal value on its interests in LEADER and its agreements with AMS, disposing of them to NZPSS for $10,000. It is evident that any benefit which may be obtained by the defendants from the proceeding will accrue to NZPSS which has adopted the dominant role in the proceedings and has indemnified the Crown against any costs incurred or liability resulting.
The plaintiff’s contentions
[8] In summary, AMS contends that:
[a] It is entitled to a declaration that it owns 85% of the copyright in LEADER with the Crown owning the remaining 15%.
[b] The Crown was not entitled to assign its interests in the marketing rights agreement or the original development contract (P2085) without the consent of AMS.
[c] The Crown has:
[i] Breached AMS’s copyright in LEADER; and
[ii] Breached duties of confidentiality owed to AMS.
[d] NZPSS has, in addition:
[i] Induced a breach of the marketing rights agreement;
[ii] Knowingly received the LEADER source code which is alleged to be property held in trust for AMS;
[iii] Breached the Fair Trading Act.
[iv] Infringed AMS’s copyright in LEADER.
The contentions of the Crown and NZPSS
[9] In summary, the defendants contend that:
[a] The Crown owns 100% of LEADER including all modifications and enhancements.
[b] The Crown was entitled to assign its interest in LEADER and the relevant contracts.
[c] They are not in breach of copyright or any other duty owed to AMS.
[d] Clause 4 of the marketing rights agreement does not correctly record the parties’ prior agreement or understanding about the waiver of royalties. In particular, it is contended that the parties’ agreement or common intention was not that royalties of $250,000 would be waived but rather that royalties on the first $250,000 of sales would be waived. Relief is sought by way of rectification in equity or under the Contractual Mistakes Act 1977.
[e] AMS under-reported royalties payable under the marketing rights agreement by:
[i] Failing to provide a proper sales ledger.
[ii] Confining the reporting of sales to the initial fees charged on sales and excluding annual fees and other charges payable thereafter.
[iii] Incorrectly apportioning the total sales between the LEADER and AMPS systems.
[iv] Accounting only for a portion of the sales based on its assessment of the share in ownership of LEADER as between AMS and the Crown.
[f] A claim by the Crown alone that, but for the under-reporting, it would have sold LEADER for $285,000 and not $10,000.
[10] I record that during the hearing, counsel for the Crown and NZPSS formally withdrew all claims of fraud or dishonesty as alleged in the fifth and sixth counterclaims by the Crown and the fourth and fifth counterclaims of NZPSS.
The issues
[11] Arising from the competing contentions, it is convenient to define the issues as follows:
A. Ownership and copyright
[i] Does the Crown have exclusive copyright in the LEADER software as developed under the contract P2085 as well as the subsequent modifications and enhancements?
[ii] If not, does AMS own the copyright in such modifications and enhancements and if so, what proportion does AMS’s copyright bear to the total copyright in the LEADER software?
B. Royalties
[iii] Is the Crown entitled to equitable rectification of clause 4 of the marketing rights agreement or relief under the Contractual Mistakes Act 1977 such that the waiver applies to royalties on the first $250,000 of LEADER sales rather than the first $250,000 of royalties?
[iv] Has AMS accounted correctly for royalties on sales?
[v] If not, did any failure to account correctly amount to a repudiation by AMS of the marketing rights agreement?
[vi] What amount, if any, is now due to the Crown for royalties?
C. Assignment
[vii] Was the Crown entitled to assign its interest in the LEADER software and associated contracts to NZPSS without the consent of AMS?
D. Other claims against the Crown
[viii] Did the Crown owe any duty of confidentiality to AMS and if so, was it in breach of any such duty?
[ix] Has the Crown breached AMS’s copyright in LEADER
E. Separate claims against NZPSS
[x] Did NZPSS induce a breach of the marketing rights agreement?
[xi] Is NZPSS guilty of knowing receipt of property which the Crown holds in trust for AMS, namely the LEADER source code?
[xii] Is NZPSS guilty of a breach of the Fair Trading Act by its conduct and representations in relation to LEADER?
[xiii] Has NZPSS infringed AMS’s copyright?
F. Separate counterclaim by the Crown
[xiv] Is the Crown entitled to damages against AMS on the basis that, but for the alleged under-reporting by AMS, the Crown would have sold LEADER for $285,000 rather than $10,000?
The relevant facts
[12] I propose to review the facts generally in chronological order. Consideration will be given to the correspondence and other documents surrounding the various contracts bearing in mind the difficulties in construction (particularly of the marketing rights agreement) and the claim for rectification. Because of the delay of some twelve years since the marketing rights agreement was entered into, my factual conclusions will be guided principally by the contemporaneous documents rather than the recollection of witnesses.
The development of LEADER
[13] AMS was formed in February 1979. Its principal shareholders are Mr N S Reid and Mr R J Tomes. The company carries on business as a provider of software including both application and systems software. The former refers to software specific to an organisation’s needs and the latter to software used to run computer programmes and to write them. In 1984, AMS developed the AMPS systems software which includes a specific programming language. AMS generally uses AMPS for most of the software it writes for its clients and licenses them to use the system.
Contract P2010
[14] On 6 March 1987, AMS entered into a contract with the Crown (acting through the Secretary for Defence) to develop a specification for a new payroll system for HMNZ Dockyard to be known as LEADER. The contract was known as P2010 and specified a sum of $425,333. The process of systems definition and specification under P2010 was treated as stage I of the project. The contract provided that at the completion of stage I, if the Crown wished to continue to use the services of AMS, a revised schedule of work would be prepared to complete stage II. Other contractual terms were that all work performed under the agreement would be the Crown’s exclusive property (paragraph 21); the terms of contract and the work carried out under it were to be kept confidential to the parties (paragraph 27); and “neither party was to cede, assign, pledge, or transfer its rights, duties or obligations under this Agreement without the prior written consent of the other party” (paragraph 31). The latter provision was replicated as clause 31.1 of the later contract entered into between AMS and the Crown and known as P2085.
[15] Under P2010, the Crown also agreed to provide certain personnel for the duration of the project, including representatives of the Dockyard and the Electronic Data Processing Unit of the Ministry of Defence. AMS agreed to provide the personnel, as well as the use of its premises, computers, and the AMPS software. At the completion of stage I, the Crown had the option of entering into licences to use AMPS.
Contract P2085
[16] Following the successful completion of stage I of the LEADER project under contract P2010, AMS was awarded the contract for stages II and III which involved the design and development of the LEADER system and its implementation. The contract was signed on behalf of the Crown on 30 August 1988 and on behalf of AMS on 6 September 1998. The contract sum was $1,020,000 comprising labour costs of $730,000 and costs of hire and purchase of equipment not to exceed $290,000. Thirty-nine weeks was allowed for system design and development and a further ten weeks for the implementation phase. Work was to commence on 20 June 1988 with completion by 30 May 1989.
[17] AMS vas required to report to the Director of Electronic Data Processing at the Ministry of Defence and to the Captain Superintendent of the Naval Dockyard. As with the earlier contract, AMS was to provide personnel, premises, and the use of its computer equipment and software, including the AMPS system. A monthly rate was stipulated for use of the AMPS system under licence from AMS with the option for the Crown to purchase an AMPS licence and pay the standard licence fees at a later stage if it wished to do so. The AMPS licence contained standard provisions for an initial payment as well as annual payments amounting to 20% of the initial charge. Plainly, the Crown was aware from this early stage that AMS usually charged both initial and annual fees under its software licences, a practice I understand to be usual in the industry.
[18] Of importance for present purposes are the following provisions of P2085:
“16.1 All work performed under this Agreement shall be the exclusive property of the Secretary. Without the prior written consent of the Secretary, AMS shall not make or remove any copies of material produced except for backup purposes as described in clause 27.1.
16.2 At the completion of the project AMS may negotiate with the Crown, the possibility of promoting and marketing the payroll software produced. Any agreements reached would be the subject of a separate contract.
. . .
31.1 Neither party shall cede, assign, pledge, or transfer its rights, duties or obligations under this Agreement without the prior written consent of the other party.”
[19] AMS accepts that the Crown has the ownership of and copyright in all work performed under P2085, ie, the design and implementation of the LEADER software system in the form in which it existed at the time of official acceptance of the system by the Crown in November 1989. The system as it then stood has been variously described in the evidence as original, basic, or core LEADER. AMS also accepts that clause 16.2 did not confer upon it any enforceable rights to promote and market the LEADER software once developed. However, clause 16.2 clearly envisaged AMS having the prospect of reaching a separate agreement with the Crown for the promotion and marketing of the LEADER software. Plainly, the opportunity to secure the marketing rights was important to AMS. Mr Reid has sworn on its behalf that clause 31.1 was also important to AMS to preserve the opportunity to negotiate with the Crown (as distinct from some other party).
[20] It was also important to AMS that the Crown should retain ownership and copyright in original LEADER, bearing in mind the prospect that AMS would have on-going responsibilities and opportunities to develop and enhance the LEADER system after its completion for the Dockyard. AMS plainly had in mind marketing opportunities for LEADER in other government departments or Crown entities, as well as elsewhere. Retaining the Crown’s ownership of the copyright in original LEADER was part of that strategy.
[21] Other provisions of P2085 prohibited the disclosure of information regarding the LEADER project without the consent of the opposite party (clause 22.1); provided that the AMPS software system would be lodged in escrow with an independent party for security purposes and would not be used for any other purpose other than to support the operation and running of LEADER (clause 25); imposed a twelve month warranty by AMS following the acceptance date (clause 26) and provided for acceptance testing (clause 28).
Negotiations for the marketing agreement
[22] As early as 7 September 1988, Mr Reid wrote to Mr J M Hawke of the Ministry of Defence expressing his interest in negotiating a marketing rights agreement for LEADER. Mr Hawke had overall responsibility for the LEADER project but shared that responsibility with the Captain Superintendent of the Naval Dockyard. Mr Reid advised Mr Hawke at that time that AMS had recently appointed a marketing and sales manager (Mr W J Sims) and both were of the view there were considerable opportunities for the on-sale of LEADER software.
[23] Thereafter, a steady stream of correspondence flowed, meetings were held and various drafts of the agreement exchanged. The marketing rights agreement was finally executed by the Crown on 17 April 1989 and by AMS on 4 May 1989. During that time, proposals and counter proposals were made and there was substantial debate over the royalty provisions, as well as the ownership of the software.
[24] The initial proposal by AMS conveyed in its letter to the Ministry of 28 September 1988 was:
[a] AMS would undertake the responsibility, preparation and sale of LEADER.
[b] AMS would pay the Crown a royalty of 25% of the retail value for each sale.
[c] AMS would have the right to set the retail price of LEADER.
[d] There would be no royalties payable until $50,000 of sales of LEADER had been achieved “in recognition of the expense AMS will incur bringing LEADER to market”.
[e] The Crown would transfer ownership of the software upon receiving $508,500 of royalties representing one half the development cost to the Crown of the LEADER software.
[25] A draft marketing rights agreement was sent with the AMS letter. While there is evidence that legal advice was at least available to the then Ministry of Defence, there is no evidence that AMS obtained any legal advice in relation to the marketing rights agreement. The agreement in its final form is inelegant in a number of respects and does not reflect the hand of lawyers in its drafting.
[26] Mr Hawke’s deputy at the time was Lieutenant Commander S P Corich whose official title was Deputy Director, Policy and Planning, Defence Computer Services Division. He was involved in the LEADER development project from the inception until his retirement in 1991. Mr Hawke assigned Mr Corich to undertake negotiations for the marketing rights agreement along with Mr P J Blundell who, at that time, was the Acting Defence Contracts and Tenders Officer for the Ministry. He was involved with the LEADER project over the period 1988 until mid-1989. I am satisfied on the evidence that the various drafts of the agreement were circulated amongst the relevant Defence staff who were all kept aware of developments.
[27] Mr Blundell had reservations about the Crown conceding any ownership rights and he advised Mr Sims on 7 November 1988 that the Crown wished to receive royalties beyond $508,500, although possibly at a different rate. In response, Mr Sims wrote to Mr Blundell on the same day, drawing specific attention to the chances to the source code of LEADER which would be needed to meet the future market needs of the system. Those modifications might not necessarily be required by the Ministry which raised questions. Mr Sims said, about the ownership of the changed portion of the code, the royalties on that portion, and who would pay for the modifications. Mr Sims stated:
“It would not be beyond one’s imagination that the two systems were as much as 50% different by the time $508,500 Royalties had be (sic) remitted.”
[28] Mr Sims also indicated that AMS wished to have joint ownership “at that point” which presumably referred to the time when the Crown had recovered half its development costs by way of royalties.
[29] Mr Sims wrote again to Mr Hawke on 24 November 1988 apparently having received advice from the Crown that it wished to recover the full costs of LEADER by way of royalties. Mr Sims acknowledged the Crown’s requirement and proposed that there be no royalty payments on the first $50,000 of sales. Thereafter, the royalties would be at the rate of 15% of sales until 35% of the LEADER development costs were recovered, and then an increasing rate of royalty until the whole of the development costs were recovered after which no further royalties would be due. Mr Sims raised again the future changes which would inevitably be required to maintain the marketability of LEADER and to tailor it to the particular needs of customers. He advised that AMS envisaged such changes and additions to the source code would belong to AMS given that the Ministry would not be required to pay any of the costs of such extra features. In those circumstances, AMS proposed joint ownership of the LEADER source code from the time when full cost recovery had occurred. Alternatively, AMS proposed that “Defence could retain ownership with AMS having the unencumbered right to use and sell the source in conjunction with the source for AMS-developed LEADER extensions/enhancements that AMS would have owned from the time those extensions/enhancements were made”.
[30] Mr Hawke’s response was by letter of 6 December 1988. Defence accepted that the first $50,000 of sales would not be liable to royalty payments but proposed a different graduated scale of royalties until the full LEADER development costs were recovered. Mr Hawke stipulated that royalties were to be paid as a percentage of the full sale price and that any enhancements made by AMS would not reduce the amount of royalty being paid. The use of the “core” LEADER software would be classified as a sale. I pause to note that there is an apparent inconsistency between these last two remarks of Mr Hawke.
[31] As to the joint ownership issue raised by AMS, Mr Hawke advised:
“Defence would not be prepared to agree to joint ownership of the Software. The proposal whereby Defence retains ownership for the basic LEADER system and AMS would have the unencumbered right to use and Sell the Source would be acceptable.”
[32] Again, there is some inconsistency in Mr Hawke’s comments when he refers to the use of the “basic” LEADER system. Whether he had in mind that the Crown would retain sole ownership of original LEADER with modifications and enhancements being owned by AMS is not clear from the letter. However, in his evidence Mr Hawke stated that any form of joint ownership of the LEADER system was not acceptable to the Ministry. That may have been so at that stage but later developments suggest differently.
[33] Mr Sims’ response was by letter of 8 December 1988. His letter debated the royalty rates which were to apply after the first $50,000 of sales. As well, the letter raised issues about the interpretation of the sale price and what would be included in it. Mr Sims raised again the cost of specific enhancements of a “one-off’ nature for specific clients and general enhancements which would apply to all software packages sold. He proposed that as AMS would be meeting the cost of any such enhancements, they should be excluded for royalty purposes. Alternatively, he suggested that the Ministry could fund the general enhancements and recoup the costs in due course from royalties in addition to the development costs of original LEADER. As to the joint ownership issue. Mr Sims advised that AMS accepted this could be resolved by the grant to AMS of an unencumbered right to use and sell the source code once the Crown had recovered its full cost of developing LEADER. However, the ownership issue was revisited in February as I shortly relate.
[34] On 21 December 1988 Messrs Hawke and Corich met with Messrs Reid and Sims to discuss the outstanding issues about the marketing rights for LEADER. Mr Sims recorded his understanding of the matters resolved at the meeting in a letter the following day and also sent a revised draft agreement. The key issues of royalties were described by Mr Sims as having been resolved as follows:
“1. The royalty rate payable to the Ministry of Defence will be 25% commencing at $50,001 of LEADER sales until the entire development cost of $1,017,000 has been remitted. Thereafter, it is agreed that no further royalties will be payable.
2. LEADER software constitutes those features and functions being created for the HMNZ Dockyard. Enhancements and modifications carried out by AMS either for general release or for customer specific requirements are excluded from Royalty payments.
. . .”
[35] Mr Sims then indicated that AMS saw considerable benefits accruing to both parties if AMS were awarded the contract for support of LEADER software. That would enable AMS to be fully informed about any new features or enhancements introduced to LEADER and would also enable AMS to “offer back to the MOD at below cost, enhancements made at the request of specific new clients, or as a result of legislative changes”.
[36] The draft agreement enclosed with Mr Sims’ letter of 22 December excluded for royalty purposes, enhancements and modifications carried out by AMS and paid for by it or purchasers of LEADER. It provided for a royalty of 25%. Royalties would not be payable until $50,000 sales of LEADER had been achieved. Under a further provision, the Crown was to confer on AMS “an unencumbered right to use and to sell the Source Code upon receiving the full development cost (budgeted to be $1,017,000) in royalties”. At this stage, there was no provision equivalent to clause 11 as ultimately included in the agreement.
[37] By the meeting on 21 December, Mr Reid was indicating to the Ministry officials that he was concerned about meeting the installation completion date and about cost overruns. Mr Reid wrote to Mr Hawke on 25 January 1989 confirming his pre-Christmas advice and outlining the problems as AMS saw them. He noted that more programmes of greater size and complexity were required than originally anticipated which would take longer to complete. As to budgetary matters, he raised three factors which he considered would result in a project cost overrun. These were the cost of providing two extra features (Windows and Colour facilities); requirements for system testing not previously anticipated; and the number of Defence personnel working at AMS’s premises and renting AMS equipment. Mr Reid sought the approval of the Ministry to the use of a further staff member to take responsibility for system testing alongside the Defence personnel.
[38] Mr Corich responded to Mr Reid’s letter on 1 February 1989 in uncompromising terms, making it clear that the budget and time schedules for completion of the project had to be met. Nor was the Ministry prepared to fund the cost of an extra consultant. Following a meeting on 8 February between Messrs Hawke and Reid, Mr Reid wrote to Mr Hawke on 10 February setting out “best estimates” of the cost of the budget items identified in his earlier letter. In summary, these were:
Colour and Windows $37,000
System testing $25,000
Facilities charges $40,000
Total $102,000
[39] Mr Reid advised he would like to meet Mr Hawke as soon as possible. In the meantime, AMS would halt work on the colour facilities.
[40] Around this time, a further draft of the proposed marketing rights agreement was prepared. Mr S J F Perrott (then a clerk in the contracts section of the Ministry) prepared the draft which was passed to Messrs Hawke and Blundell for comment. A minute prepared by Mr Perrott at this time suggests he did not have any confidence that AMS would accept the change he proposed which was that AMS should provide to the Crown, without charge, any enhancements and modifications to LEADER. He suggested as an alternative that all enhancements should be offered to the Crown with the price to be mutually agreed between the parties. Such costs were to be deleted or deducted from the royalty payments due. He noted that “we do not in effect pay any money whatsoever”.
[41] Mr Blundell then sent a facsimile to Mr Sims on 7 February advising the proposed changes to the agreement. In particular, Mr Blundell drew Mr Sims’ attentions to a new clause 10 which picked up Mr Perrott’s first suggestion and provided:
“AMS shall provide the Crown, free of charge, all further enhancements and modifications carried out for LEADER.”
[42] Mr Blundell commented that this would mean the reference in the earlier draft to excluding for royalty purposes further enhancements and modifications carried out by AMS and paid for by others, would need to be deleted. The royalty figure remained at 25% with the Crown agreeing that no royalties would be paid until $50,000 of LEADER sales had been achieved.
[43] It appears from an agenda and supporting details prepared by AMS that progress with the development of LEADER was to be reviewed at a meeting at the Dockyard on 17 February. The written material is silent as to who may have attended that meeting but it is probable Mr Reid attended the meeting because the next day he sent to Mr Corich the material he had prepared for the meeting. It is evident from the material prepared by AMS that they had continuing concerns about the completion date and budget overruns for the project. The three specific areas already identified by AMS were mentioned again, as was the proposed introduction of a further consultant to reduce the workload.
[44] I accept Mr Reid’s evidence that he had concerns which went beyond the three identified items and included the extra cost which would be incurred by AMS if the additional consultant were employed, as well as the cost of the additional time then anticipated for completion of the contract.
[45] Mr Sims and Mr Reid continued actively to progress the proposed marketing rights agreement and the cost overrun issue. On 21 February, Mr Reid and Mr Hawke met. Mr Reid wrote the following day to Mr Hawke detailing what he believed had been agreed. First, he recorded that Mr Hawke had decided to treat the facilities charges as external to the LEADER software development budget. A schedule was attached indicating that the monthly facilities charges to the end of January 1989 were then of the order of $65,000. Second, he noted that favourable consideration would be given to AMS’s concerns about the additional cost of system testing and in particular the requirement for “parallel runs’’. Third, he noted that the colour/windows issue had not been resolved. Finally, he stated that the costs referred to in the AMS letter of 10 February 1989 were those incurred to that date and did not include an allowance for the additional consultant’s involvement or the on-going costs of other personnel. This letter confirms Mr Reid’s evidence that AMS’s concerns were not limited to the sum of $102,000 being the total of the specific sums referred to in his letter of 10 February.
The conclusion of the ownership issue
[46] By this time, Mr Sims had received from Mr Blundell the marketing rights agreement as revised by the Crown. He wrote to Mr Blundell on 21 February 1989 commenting on the changes proposed in the Crown’s draft. Critically for present purposes, Mr Sims noted in relation to the proposed clause 10:
“AMS is unable to accept Clause 10 because the ownership of any modification or enhancement made by AMS on behalf of a client or for itself resides elsewhere other than with the MOD. There is a commercial value to these alterations which must be recognised and it would be unacceptable for AMS to enter into a prior contract disposing of those rights of ownership.”
[47] This letter makes it clear that AMS was continuing to assert that ownership of modifications or enhancements made by AMS for others (or of its own volition) belonged to AMS. Mr Blundell responded by letter of 28 February in a manner important to the resolution of the ownership of future changes to the LEADER system:
“Your comments on Clause 10 are noted and accepted. The following alternative is proposed:
“10. All enhancements and modifications carried out by AMS and paid by either AMS or purchasers of “LEADER” shall be offered to the Crown with a cost to be mutually agreed between the parties. The cost of all enhancements and modifications shall be deducted from any Royalty Payments due.”
[48] The form of clause 10 then proposed by the Crown was carried forward into the executed agreement as clause 11 with the addition of the concluding words:
“. . . and should the cost exceed the royalties due, the Crown shall pay the difference on the 20th of the invoiced month.”
[49] There was no further debate about the form of clause 10/11 or the issue of the ownership of modifications and enhancements to LEADER between the date of this important exchange of correspondence between Mr Blundell and Mr Sims, and the execution of the marketing rights agreement in its final form.
The meetings of 20 and 22 March 1989
[50] Much attention was given in the evidence to two meetings which took place on these dates, the first in Wellington and the second in Auckland. Minutes were kept by Mr Lawrence for the first meeting but not for the second. Although witnesses on each side claimed to recall at least aspects of the meeting, I find it difficult to accept that any of them now has any independent recollection of the details of meetings which took place over twelve years ago. Accordingly, as with other matters, I am guided in my findings almost exclusively by the written material surrounding these meetings and the drawing of such inferences as I consider proper from the relevant documents.
[51] Those present at the meeting on 20 March were Messrs Reid, Dickson and Sims representing AMS and Messrs Hawke, Corich and Lawrence representing the Ministry. Also present was the administration manager of the Dockyard, a Mr Curson. Prior to the meeting, Mr Reid had sent to Mr Hawke the latest facility charges as at the end of February which had increased by this time to nearly $74,000. In addition, he proposed certain agenda items for the meeting, focusing on budget items and the completion of the LEADER marketing rights agreement.
[52] Both Mr Gleeson and Mr Reid produced schedules designed to show the extent to which the budget under contract P2085 had been spent by the time of the meetings in March 1989. Mr Reid’s assessment takes into account work actually performed up to the end of March 1989 even though that work was not invoiced until April. Mr Reid’s figures show that by the end of March 1989, $702,896.18 had been spent in development work with a further $261,889.30 on hardware. This left only $27,103.82 in the development budget and $28,110.70 in the hardware budget. As it happens, when the March invoices are taken into account, Mr Gleeson’s figure for total expenditure to the end of March is not very different from Mr Reid’s. Mr Reid’s figure is $964,785 whereas Mr Gleeson’s is $952,947. It is evident from the analyses of the invoices that the development costs (software budget) were running at about $60,000 to $90,000 per month as well as the on-going costs for facilities and premises already mentioned. Although Mr Sorrell for AMS attempted to persuade me that the P2085 contract was for a fixed price, I am not satisfied that is so. It certainly was not the view adopted by the Defence officials at the time who were clearly pressuring AMS to keep within the budget.
[53] The minutes of the meeting on 20 March show there was a discussion of a revised schedule for testing, including “parallel running” which meant operating the LEADER system alongside the existing payroll system at the Dockyard. It was estimated that testing would be restarted on 22 March and the final parallel run would be completed on 7 July. These estimates may be compared with the contract period of 49 weeks in total which was originally scheduled to conclude on 30 May 1989. Mr Corich accepted in evidence that the decision to include parallel running in the testing programme significantly extended the period contemplated when the contract was executed. Mr Lawrence’s minutes indicate that he was sceptical about whether the 7 July date could even be met. Mr Reid’s evidence was that, at the time of this meeting, he did not expect the contract to be completed until August. As it happened, the system did not go live until November.
[54] I accept that at the time of the meetings of 20 and 22 March 1989 the original budget under P2085 was nearly exhausted; that there were anticipated delays in completing the contract of two to three months with costs running at approximately $70,000 to $90,000 per month; and that Mr Reid had concerns about the budget which went well beyond the items mentioned specifically in his letter of 10 February. Those items totalled about $100,000. In addition, AMS was facing additional costs of up to $200,000 with little prospect they would be recovered in full by direct payments from the Crown.
[55] The minutes of the meeting on 20 March confirm that AMS was “now certain that the LEADER development will cost more than the approved contract budget”. The minutes also record that AMS put forward the three specific items which they felt were outside the original contract. In response, the Secretary for Defence had stated that contractors were expected to complete on schedule and on budget or no further contracts would be granted to them. There was an indication that $40,000 could be approved to defray the cost of the colour monitors but it was not possible to get approval from the Systems Review Board for any more. It is recorded that AMS proposed to complete the development and the implementation of LEADER and then “recover cost overruns by massaging the figures in the marketing agreement”. The minutes show the meeting was adjourned to allow AMS to produce a marketing proposal for discussion.
[56] These minutes confirm that the Crown was continuing to maintain a tough stance on budgetary matters and that there was little prospect of AMS recovering anything other than a further $40,000 in respect of the additional costs of the colour facilities. Mr Reid, not unnaturally, turned his attention to attempting to recover the additional costs of developing LEADER by obtaining a better deal under the marketing agreement.
[57] On 22 March 1989, Messrs Reid and Sims met with Mr Hawke in Wellington. Mr Corich was not present. Regrettably no minutes of the meeting were kept and the discovery process has not revealed any notes kept by any of the participants. The accounts given by those involved are markedly different. Mr Reid’s account was that Mr Hawke agreed to reduce the royalty rate from 25% to 15% and also agreed that the Crown would waive the first $250,000 of royalties. Mr Reid pointed out that if the Crown’s contention were accepted, ie, that it agreed only to waive royalties on the first $250,000 of sales, then at the royalty rate of 15% the benefit to AMS would have been only $37,500.
[58] Mr Hawke was equally adamant in his evidence that he only agreed to a waiver of royalties on the first $250,000 of sales. It was submitted for the defendants that if Mr Reid’s version of the agreement were accepted, then sales of $1,667,000 would be required before royalties began to flow to the Crown although there is no evidence of any discussion in those terms about the level of sales required. It was further submitted that on Mr Reid’s version of events, AMS would be receiving the benefit of a reduction in royalty rate from 25% to 15% as well as a far more substantial waiver before royalty payments would begin to flow.
[59] Mr Hawke also referred in his evidence to other matters which he said supported his version of the agreement. He took each of the three cost items set out in the letter from AMS of 10 February 1989 and said they were dealt with as follows:
[a] The extra cost of facilities was met by providing $40,000 from an alternative Defence budget.
[b] The Ministry refused to accept the additional costs of $37,000 for the colour and windows facilities.
[c] The $25,000 additional costs for system testing would be met by reducing the royalty from 25% to 15% but raising the LEADER sales figure before royalties were payable from $50,000 to $250,000. The effect of these two changes raised the benefit to AMS from $12,500 (25% of sales of $50,000 as previously proposed) to $37,500 (being 15% of $250,000 of sales).
[60] Other than the additional $40,000 approved to cover the increased facilities costs, there is no documentary evidence to support Mr Hawke’s account. In particular, there is nothing to suggest that an additional $25,000 was made available by the combined steps of reducing the royalty percentage but increasing the sales figure before royalties would become payable. As well, even on the Crown’s version of what was agreed, the changes made to the royalty arrangements would not simply reflect a one-off benefit to AMS of $25,000 because the reduction in the royalty rate would give an on-going benefit to AMS even after the waiver period had ended.
[61] It was an unusual feature of this case that NZPSS called all but one of the Defence staff who had been involved with the contract negotiations in 1988/1989. These were Messrs Hawke, Blundell and Corich, all of whom have since retired from Defence. The Crown called two current Defence staff. These were Mr Perrott and another witness whose evidence related solely to the recent assignment to NZPSS. In addition, NZPSS called Mr Sims who was employed by AMS until early 1998. It was apparent on the evidence that Mr Sims left after a disagreement with AMS. I cannot regard Mr Sims’ evidence as reliable given the plain animosity he displayed towards Mr Reid, as well as the disability common to all the witnesses in remembering events so long ago.
[62] Nor should it be overlooked that Mr Sims was an employee of AMS and was not a director of that company but only of a subsidiary company. Mr Reid was a director of AMS and was acknowledged by the Ministry officials as the senior person having the ultimate authority to commit AMS. It was also accepted that any arrangement between the parties would be embodied in a written document.
[63] Mr Sims generally supported the Crown’s view of what had been agreed at the meeting on 22 March. He gave evidence to very similar effect to that of Mr Hawke. But, during the hearing an issue arose in relation to the preparation of the briefs of evidence for Messrs Sims, Corich, Hawke and Blundell which caused me to have doubts about the reliability of their written evidence except to the extent it was supported by the contemporaneous documents. It became evident that there was a striking similarity between the briefs of evidence of those four persons. My questioning of Mr Blundell on this issue, revealed that key phrases in his evidence were not his words but those of Mr Gleeson and that his brief had very largely been prepared by Mr Gleeson himself. This fact had hitherto, been unknown to senior counsel for NZPSS who caused inquiries to be made.
[64] I permitted Mr Gleeson to be recalled if he wished to answer my concerns over the preparation of the briefs. It emerged that Mr Sims’ brief was prepared by Mr Gleeson and a solicitor acting for NZPSS but the later briefs of Messrs Hawke, Corich and Blundell were prepared by Mr Gleeson without any material input or assistance from solicitor or counsel. It became clear that Mr Sims’ brief had effectively been used as a template for the preparation of the subsequent briefs. This resulted in the striking similarity of wording on key issues which I have just referred to. Amongst other things, it also resulted in witnesses (such as Messrs Corich and Blundell) purporting to give evidence in their prepared briefs about what had happened at meetings they did not attend.
[65] Importantly, Mr Gleeson admitted at first that the formula outlined in Mr Sims’ brief of evidence (whereby adjustments to the royalty and waiver arrangements resulted in a claimed benefit to AMS of $25,000) had originated from Mr Corich. Yet Mr Corich was not present at the relevant meeting. Mr Gleeson then appeared to shift from this position to say the formula came from Mr Sims. I formed the clear impression from Mr Sims’ oral evidence that he could not say that the formula had been discussed with the Defence officials in the way he described it in his written brief.
[66] While I accept Mr Gleeson made available to the witnesses copies of the relevant documents and sent to them drafts of their briefs of evidence for comment and correction before completion, I was left with the clear impression that the account given by Messrs Hawke and Sims as to what happened at the meeting on 22 March is substantially an ex post facto reconstruction of events not supported by any contemporaneous written record.
[67] I have reservations about Mr Sims’ evidence for the reasons already given. While I accept Mr Hawke did his best honestly to recall the events, I am not satisfied in view of the lapse of time and his involvement with many other matters at the relevant time, that he could now have any clear recollection to the level of detail expressed in his brief. Indeed, he accepted he could not recall either of the meetings of 20 and 22 March in detail. I accept that with the benefit of the minutes from the earlier meeting, his memory of that meeting could have been refreshed to a degree but he did not have the benefit of any contemporaneous record of the critical meeting in March.
[68] Equally, I accept Mr Reid is most unlikely to have any detailed recollection of the 22 March meeting. However, I accept Mr Reid as an honest witness, an assessment which Mr Hawke fairly conceded himself. He also acknowledged that Mr Reid was a person who was “pernickety” as to detail. Having had the opportunity of seeing and hearing Mr Reid myself over a significant period of time, I agree with that assessment which is supported by his detailed correspondence at the time.
[69] On the day following the meeting of 22 March, Mr Reid sent a facsimile to Mr Corich advising:
“As agreed with Mr Hawke yesterday, please find enclosed new wordings for clauses 3 and 4 of the LEADER Marketing Rights for Mr Blundell.”
[70] The wording attached was as follows:
“3. AMS will remit a royalty payment amounting to 15% of the retail value achieved for each sale of “LEADER” on the 20th of the month following the invoice of such sale.
4. The Secretary hereby agrees to waive rights to the first $250,000 royalties in recognition of the expenses AMS will incur bringing “LEADER” to market, and the costs borne by AMS in developing LEADER.”
[71] The reference in the covering letter to an agreement with Mr Hawke reached the previous day is arguably ambiguous. It could refer to Mr Reid’s belief that he had reached an agreement with Mr Hawke the previous day on the matters at issue or it could simply reflect Mr Reid’s agreement that he would send a revised wording. Either way, the revised wording was sent and it was open for the Crown to accept or reject it. The defendants did not submit there was any ambiguity in the revised wording of clauses 3 and 4 which were carried forward in that form to the executed agreement. It is clear on the face of the revised clause 4 that the waiver related to the first $250,000 of royalties and not to the first $250,000 of sales. As well, the wording supports Mr Reid’s account that the additional figure was intended to compensate AMS not only for the cost of bringing LEADER to market (as in the previous wording of the clause) but was also intended to address “the costs borne by AMS in developing LEADER” (those words being added in the revised wording).
[72] While the changes to the royalty percentage and the waiver provision were substantial, they were not beyond the bounds of commercial reality as viewed at the time. It was accepted that there were sale prospects of several millions of dollars, including the possibility of the sale of the system to the Defence Force in Australia. Sales may have taken some time to negotiate but they were certainly in prospect at that time. As matters transpired, the hopes for substantial and early sales were overly optimistic and, in retrospect, the prospects of recovery of the Crown’s development costs are now remote. Indeed, if AMS’s view of the royalty provisions is correct, no royalties are yet due to the Crown.
[73] The Crown was not being asked to pay any further sum in cash. By the time the development of LEADER had been completed, the Crown would have received what they had bargained and paid for and any recoveries made on future sales would have been a windfall. So long as sales continued satisfactorily, the Crown had the prospect of recovering the development costs incurred for LEADER and the effect of the altered royalty and waiver arrangements was simply to postpone the time when recoveries would be made.
[74] There was some suggestion that Mr Reid had attempted to steal a march by sending the letter of 23 March to Mr Corich (who was not present at the meeting) rather than to Mr Hawke. However, I accept Mr Reid’s explanation that he did so because he was aware that Mr Hawke was about to go away on leave, a fact mentioned by Mr Reid in a letter he wrote to Mr Hawke on 28 March. I am satisfied that Mr Hawke and other members of the Defence staff in Wellington had ample time to review the proposed wording. Not only did they have Mr Reid’s facsimile of 23 March but they also had the agreement itself which was sent by Mr Sims to Mr Corich in its final form on 7 April, signed by Mr Blundell on behalf of the Crown on 17 April and returned to AMS the same day by Mr Perrott. It was then signed by Mr Reid on behalf of AMS on 4 May.
[75] I accept that in the intervening period between 23 March and Mr Sims’ letter of 7 April, there were some arguably ambiguous formulations in correspondence or memoranda of what had been concluded at the meeting on 22 March. For example, in Mr Reid’s letter of 28 March to Mr Hawke, he referred to the agreement in terms of being “15% royalties and $250,000 waiver before royalty payments begin to flow to Defence . . .”. However in the same paragraph, he also refers to the revised wordings which he sent to Mr Corich on 23 March. As well, in minutes of an AMS management meeting on 28 March 1989 attended by Mr Sims but not by Mr Reid, Mr Sims’ view of the arrangements made with Mr Hawke were recorded as “the LEADER Marketing Agreement will be altered to reflect a Royalty holiday up to $250k and reduction of Royalty percentage from 25 to 15% thereafter”. This also is an arguably ambiguous view but was followed by Mr Sims’ letter of 7 April enclosing the revised agreement in the form in which it was ultimately executed.
[76] There was also a potentially ambiguous minute from Mr Corich to Mr Blundell of 10 April in which he describes the agreed changes as:
(a) The percentage figure for royalty payment was changed from 25% to 15%; and
(b) The amount that was agreed to be waivered (sic) was increased from $50 to $250,000.
[77] The reference to $50 rather than $50,000 appears to be in error but the minute may support Mr Corich’s evidence that he believed the arrangement was to relate to sales rather than royalties. Mr Sims also drew to the Court’s attention a hand written change he had made on a copy of some minutes prepared by Mr Reid of an internal meeting at AMS on 30 May 1989, after the marketing rights agreement was signed. He said this change supported his view of what had been agreed about the royalty waiver. However, he was unclear whether he drew this change to Mr Reid’s attention and I do not place any significant weight on it in view of the sequence of events prior to the agreement being executed.
Conclusions on royalty waiver
[78] My conclusions in relation to the royalty waiver issue are that Mr Reid honestly believed Mr Hawke had agreed at the meeting on 22 March both to reduce the royalty percentage from 25% to 15% and to waive the Crown’s rights to the first $250,000 of royalties. Given the fact that correspondence prior to that date had always referred to a waiver of royalties on sales of $50,000, I am prepared to accept that Mr Hawke may have believed that the waiver applied to royalties on the first $250,000 of sales. That is the most favourable construction I could put on the relevant events from the Crown’s point of view. On that view, there was simply a misunderstanding between those present at the meeting on 22 March with Mr Reid and Mr Hawke holding different but honest views of what had been agreed.
[79] I am not prepared to accept on the evidence that there was an agreement or common understanding that the waiver related only to royalties on the first $250,000 of sales. On the most favourable construction to the Crown, there was simply no common agreement or understanding and no meeting of minds on the issue.
[80] I further find as a fact that there was no reason for Mr Reid to believe that the Crown had any misunderstanding of the arrangements. He immediately provided revised wording of the relevant provisions for the Crown’s consideration which was clear in its terms and reflected his understanding of what had been agreed. The Crown had ample time to raise any concerns which they had if they considered the revised wording did not reflect the agreement reached. So did Mr Sims who prepared the final form of agreement and sent it to the Crown including the revised wording. If he had any concerns that it did not reflect the agreement, he could have drawn that to Mr Reid’s attention. Neither he nor anyone in the Ministry did so. In the circumstances, Mr Reid had every reason to believe the Crown had agreed to a waiver of $250,000 of royalties as he understood at the time of the meeting of 22 March.
Events after the execution of the marketing rights agreement
[81] Discussions continued about the budget for P2085. A scheme of arrangement was agreed at a meeting on 29 June 1989 between Messrs Corich, Reid and Sims. Overall, the Crown agreed to increase the original budget of $1,020,000 to $1,126,300. The agreement was conditional on the parties not going to arbitration and all making their best efforts to achieve an early “go live” date which was then set at 1 August 1989. Mr Corich was to look into the possibility of Defence releasing AMS from its warranty obligations. As well, it was agreed:
“All enhancements and modifications agreed by Defence and AMS as being outside the contract are outside this arrangement.”
[82] In the event, the system finally went live in November 1989 and in recognition of the extended system testing carried out by AMS (involving an increase from 13 to 20 weeks), the twelve month warranty period was later reduced to four months by written amendment to P2085 dated 4 December 1989.
Marketing efforts and licence arrangements
[83] Before the completion of the development of LEADER, AMS turned its attention to marketing the system to others and to the terms of the end-user licences which would be issued by AMS for that purpose. By letter of 30 August 1989, Mr Sims advised Mr Corich that AMS intended to offer LEADER at $4000 per visual display unit (VDU). He also confirmed that AMS intended to “bundle” the LEADER and AMPS prices into one. This was a reference to the desirability from a marketing point of view of having a single charge for both the LEADER application software and the AMPS systems software. As well, Mr Sims advised Mr Corich that AMS intended to provide purchasers of the system with an on-going service for maintenance, support, and updating for which clients would pay an annual fee. AMS relies on this letter (amongst others) as informing the Crown at an early stage that both initial and annual charges would be made and of the intention to bundle the AMPS and LEADER prices.
[84] By December 1989, AMS was ready to enter into the first LEADER end user licence with a company based in the North Island. On 12 December 1989, Mr Reid sent to Mr Blundell two versions of the proposed end-user licence, the first of which was to be executed the following day by the customer. Mr Reid reiterated that there would be two forms of pricing: lump sum or “per VDU” pricing, depending on the number of computers required for any particular customer. Importantly, Mr Reid confirmed:
“These licence agreements have been revised, and so will be more up-to-date than any copies you already hold. To meet market demand, we have included an annual “maintenance fee”, which is not part of the LEADER licence fee, or subject to royalty payments.”
[85] In a letter the following day, he confirmed Mr Sims’ earlier advice that the end-user licences would incorporate both the licence fee and the annual “maintenance fee”.
[86] The LEADER end-user licence contained the following recital:
“WHEREAS
AMS has agreed to provide the Customer with the Personnel/Payroll Application System (known as LEADER, and defined herein) and is authorised by the Crown to grant to Customer a non-transferable and non-exclusive licence to use LEADER on the terms and conditions set out below”
[87] This first version of the end-user licence did not refer to the AMPS system although later versions did. The licence entered into with the first customer, provided specifically for an initial payment based on the VDU price already notified to the Crown and an annual fee equivalent to 20% of the initial payment. The total initial fee was apportioned 57.8% to LEADER and 42.2% to AMPS.
[88] This first licence contained a warranty by AMS that it was authorised by the Crown to licence LEADER (clause 6.1) and an acknowledgement that the intellectual property rights to LEADER, including copyright, “shall be and remain the sole property of the Crown” (clause 7.1).
[89] Thereafter, further correspondence was shared between the Ministry and AMS about the wording of the end-user licences. It was re-emphasised in an AMS letter of 26 January 1990 that annual payments were not envisaged to be within the royalty arrangements because they were to provide support and any future AMS-funded enhancements. The payments were seen by AMS as relating to the provision of specific services by AMS and not the sale of the right to use the software. Accordingly, AMS advised it did not consider the annual payments to be royalty bearing. The Ministry did not cavil with that suggestion. Indeed, a discovered document shows that a Ministry official noted in the margin opposite the relevant part of the AMS letter “Yes agreed”.
[90] On 30 May 1990, AMS entered into a licence with the Crown acting through the New Zealand Defence Force for the installation of LEADER at the Naval Supply Depot in Devonport. The licence authorised the use of the LEADER and AMPS systems for three VDUs with a bundled price for both systems. The recital to the licence provided:
[268] In addition, this is a case where at least some of the Crown’s obligations under the marketing rights agreement are inextricably linked with the Crown’s rights. Not only was the right to receive royalties subject to the strict confidentiality obligations already mentioned, but there was also the obligation to make the source code available to AMS upon recovery of the total development costs. The assignment of the Crown’s interest in LEADER would include the right to the source code (or a share in it). Any assignment of that right would carry with it the associated obligation to make the source code available in due course. The assignment of a contractual benefit with an associated contractual burden is not generally permitted at law, especially where the parties have expressly or impliedly stipulated that the contract is to be treated as personal to the original contracting parties.
[269] As well, the marketing rights agreement contemplated that changes to LEADER would be owned by AMS so that shared ownership of LEADER would occur over time. The parties could scarcely have contemplated disposal of their own share in LEADER without reference to the other. From a practical and commercial stand point, the assignment of a part interest in LEADER would have been unrealistic.
[270] One final factor, not discussed in argument, is the purported assignment of the AMPS software which is undisputedly owned by AMS. The recitals to the assignment agreement refer to the Crown as assignor being in possession of licences from third parties to use “the underlying software”. The latter is defined as including “all that software owned by third parties which is essential or useful to the functioning of the LEADER software as may be used by the assignor as at the date of his contract and in relation to which the assignor has a licence to use, explicit or implied”. Schedule A of the contract of assignment refers to the rights assigned as including “such rights as may exist at the date of this agreement for the benefit of the assignor by way of licences to use the underlying software”. This provision undoubtedly embraces the AMPS software which is essential (or at least useful) to the operation of LEADER. The Crown could not have been entitled to assign copyright in AMPS because it did not own it and its licence prohibited it from making the system available to anyone else.
[271] In summary, my conclusion is that the Crown was not entitled to assign its interest in LEADER or any of the associated or underlying software. Nor was it entitled to assign its rights and obligations under the marketing rights agreement. Even if it were, the Crown could assign no more than its 25% interest in LEADER which would be of doubtful practical value and would continue to diminish over time. LEADER is an integrated system and the physical separation of source code between the respective owners would be impossible. The stance taken by NZPSS immediately after the assignment also demonstrates the potential for dispute between co-owners and the need for co-operation between them to manage successfully the development and marketing of the product.
[272] I do not overlook Mr Sorrell’s argument for AMS that the Crown’s share in the LEADER source code was held in trust for AMS. It was submitted that this followed from clause 5 of the marketing rights agreement. As the Crown was obliged to confer on AMS the unencumbered right to sell and use the source code upon recovering the full development cost, it must have been obliged, so the argument went, to hold the source code in trust pending that event. It is unnecessary for me to determine this issue but I see little room for the imposition of a trust of the kind suggested given the clear contractual obligations on the Crown.
D. Confidential information
Did the Crown owe any duty of confidentiality to AMS and if so, did it breach any such duty?
[273] AMS pleads that the Crown was in breach of a duty of confidentiality arising from the last numbered clause 1 in the marketing rights agreement in terms of which the Crown agreed that information contained in the sales ledgers provided by AMS to the Crown would “be treated in the utmost confidence by the Crown”. In the course of the due diligence process prior to the assignment to NZPSS, the Crown made available to Mr Gleeson its LEADER file which contained the relevant contracts, correspondence and sales ledgers. Although the due diligence agreement contained restrictions preventing New Zealand Payroll from taking any copies or verbatim transcripts of the material and required New Zealand Payroll to keep the information confidential to itself and not to use it for any purpose other than making an offer to purchase the rights for LEADER, the Crown was nevertheless in breach of its confidentiality obligations under the marketing rights agreement. To treat the sales ledgers with the “utmost confidence” does not permit the obligee to reveal the information to third parties provided they agree to keep it confidential. The contract means what it says. The Crown is to keep the information to itself and its authorised employees.
[274] There was some debate about whether AMS and New Zealand Payroll were truly competitors. While they do operate in different segments of the market for payroll services, Mr Gleeson acknowledged that there was at least some degree of crossover between them and I am satisfied that NZP and NZPSS could be regarded as competitors. Mr Gleeson said the information, or at least some of it, was already known to him. Through the LEADER users group, he knew a number of the customers and he was also aware of pricing from his own company’s dealings with AMS. However, the revelation of the sales ledgers would have given Mr Gleeson full details of all the customers of AMS and the prices charged to each of them. It is reasonable to conclude that there must have been at least some material in the sales ledgers which would not have been known to Mr Gleeson.
[275] Of course, once the assignment was complete, Mr Gleeson wrote to all the customers of AMS informing them that NZPSS had acquired the Crown’s copyright in LEADER. By then, it is reasonable to assume he had received all the relevant documentation from the Crown relating to its dealings with AMS over the LEADER software contracts. The disclosure of that material was also a breach of the confidential relationship with the Crown.
[276] I am satisfied that the Crown is in breach of a duty of confidentiality owed to AMS. The extent of any losses suffered by AMS as a result should be the subject of an inquiry. The issue of breach of copyright is considered under the next section of this judgment.
E. Breach of copyright and the separate claims against NZPSS
[277] Under this heading, AMS claims that NZPSS is guilty of inducing the Crown to breach the marketing rights agreement; has knowingly received property which the Crown held in trust for AMS namely the LEADER source code; is guilty of a breach of the Fair Trading Act by its conduct and representations in relation to LEADER; and has infringed AMS’s copyright in LEADER. It was also submitted that the Crown had infringed AMS’s copyright by disposing of LEADER to NZPSS.
[278] These issues all raise matters of some complexity. Possibly due to pressure of time at the close of the hearing, counsel did not deal with them in any detail. In the light of my conclusion as to ownership of software and the prohibition against assignment, the Crown could not lawfully have disposed of the software to NZPSS. As well, by assigning all relevant rights in LEADER to NZPSS, the Crown has infringed AMS’s copyright in the system by effectively authorising NZPSS to exercise rights available only to the owners of the copyright. NZPSS is a party to that infringement. Although not pleaded, the assignment may also amount to a conversion of AMS’s interest in LEADER. NZPSS would clearly be a party to such conversion.
[279] The appropriate course is to invite counsel to consider the implications of my findings in this judgment and to make further submissions as to the remedies which should follow.
[280] Prima facie, AMS is entitled to declaratory relief, an order for the return of all material wrongfully assigned to NZPSS, an injunction restraining NZPSS from making use of any such material or information, and an inquiry into any damages sustained by AMS.
F. Separate counterclaim by the Crown
[281] In view of my earlier findings, there is no basis for the Crown’s separate counterclaim against AMS. First, it was not permitted to sell LEADER at all. Second, any under-reporting of royalty bearing sales by AMS is likely to be to so minor that it could not have made any difference to the Crown’s sale price. Third, the evidence on that subject is entirely speculative. This counterclaim should be dismissed accordingly.
G. Summary of findings
[282] The Crown does not have exclusive copyright in the LEADER software.
[283] It is owned as to 75% by AMS and 25% by the Crown.
[284] The Crown is not entitled to rectification in equity or under the Contractual Mistakes Act 1977 in relation to clause 4 of the marketing rights agreement.
[285] AMS has correctly accounted to the Crown for royalties on sales of LEADER except to the following extent:
[a] That it apportioned royalties after 1 October 1998 on the basis of having an 85% interest in LEADER rather than 75%.
[b] That it may not have accounted for royalties on sales of hot back-up systems.
[286] The failure by AMS correctly to account for royalties in those respects was not sufficient to amount to a repudiation of the marketing rights agreement.
[287] The Crown was not entitled to assign its interest in the LEADER software or its rights and obligations under the marketing rights agreement without the consent of AMS.
[288] The assignment amounted to a breach of contract and infringement of copyright by the Crown.
[289] The Crown owed a duty of confidentiality to AMS which it breached by disclosing the sales ledgers to NZPSS as well as other confidential material.
[290] NZPSS was a party to infringing AMS’s copyright in LEADER.
[291] The Crown is not entitled to damages under its separate counterclaim.
[292] Counsel should now confer on the appropriate form of relief and on the issue of costs. Counsel for the plaintiff should file a memorandum prior to the Christmas vacation advising whether agreement has been reached or whether I should convene a brief hearing in the New Year to determine any remaining issues.
LEADER MARKETING RIGHTS AGREEMENT
THIS AGREEMENT is entered into the 17th day of April 1989.
BETWEEN HER MAJESTY THE QUEEN in right of the Government of New Zealand acting by and through the Secretary of Defence (herein called “the Crown”)
AND ADVANCED MANAGEMENT SYSTEMS LIMITED of 11 Huron Street, Takapuna, Auckland, New Zealand (herein called “AMS’’).
WHEREAS:
1. The Crown has agreed to grant AMS exclusive worldwide marketing rights to “LEADER”, the payroll software currently being written on behalf of the HMNZ Dockyard by AMS as stipulated under Contract P2085 Clause 16.2.
2. AMS has agreed to undertake the costs and responsibility of preparation and sale of “LEADER” and to pay royalties to the Crown from the proceeds of each sale.
3. For royalty purposes “LEADER” consists of those software functions and attributes being created for the HMNZ Dockyard and being paid for by the Crown. This specifically excludes further enhancements and modifications carried out by AMS and paid for by either AMS or purchasers of “LEADER”.
NOW THE PARTIES AGREE as follows:
1. AMS is entitled to set the retail price(s) of “LEADER” from time to time according to market forces, and inform the Crown of such prices and changes therein.
Separate prices will be established for:
a) one-time purchase of the software, with separate prices for a PC version with separate modules and possibly limited functionality
b) a software rental (monthly payment basis)
c) an AMS-sponsored bureau basis, with monthly payments.
2. In all instances referred to in 1. above, the source code of LEADER will be made available, subject to the purchaser completing a contract specifying the source code is not to be used or re-sold to any other party (AMPS security features will provide protection to help protect against most breaches).
3. AMS will remit a royalty payment amounting to 15% of the retail value achieved for each sale of “LEADER” on the 20th of the month following the invoice of said sale.
4. The Crown hereby agrees to waive rights to the first $250,000 royalties in recognition of the expenses AMS will incur bringing “LEADER” to market, and the costs borne by AMS in developing LEADER.
5. The Crown further agrees to confer on AMS an unencumbered right to use and to sell the Source Code upon receiving the full development cost (budgeted to be $1,017,000) in royalties.
6. AMS will indemnify the Crown against all claims arising from the sale and performance of “LEADER” to third parties.
7. Any disputes arising in connection with this Agreement which cannot be settled by negotiation between the parties shall be referred to arbitration and shall be finally settled in accordance with the New Zealand Arbitration Act 1908. Pending the reference to arbitration, and thereafter until the arbitrator’s decision is made known, the parties shall continue to perform all their obligations under this Agreement without prejudice.
8. Without the Crown’s prior written consent AMS shall not advertise or publicly announce any matter relating to the existence of this Agreement.
9. AMS may advertise the “LEADER” product in anyway it sees fit, and may refer to HMNZ Dockyard as a user of the system.
10. This Agreement shall be construed and governed according to the laws of New Zealand.
11. All enhancements and modifications carried out by AMS and paid by either AMS or purchasers of “LEADER” shall be offered to the Crown with a cost to be mutually agreed between the parties. The cost of all enhancements and modifications shall be deducted from any Royalty Payments due and should the cost exceed the royalties due, the Crown shall pay the difference on the 20th of the invoiced month.
FURTHERMORE:-
1. AMS undertakes to maintain a separate Sales Ledger which will be audited annually. A copy of the Sales Ledger will be submitted to the Crown quarterly; such information will be treated in the utmost confidence by the Crown. This provision will cease upon the final payment of royalties.
IN WITNESS WHEREOF these presents have been executed the day and year hereinbefore written.
SIGNED FOR AND ON BEHALF OF HER MAJESTY THE QUEEN
. . .
SIGNED FOR AND ON BEHALF OF ADVANCED MANAGEMENT SYSTEMS LIMITED
. . .
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