IPC Overturns Arbitrazh Decision in Flight Simulator Software Case

The Intellectual Property Court (IPC) recently overturned a US$ 49.5 million award by the 9th Arbitrazh Appellate Court (9th AAC) as compensation for alleged infringements by Doosan Infracore and Korea Aerospace of rights in software created by PKBM (Penzenskoye Konstruktorskoye Byuro modelirovaniya) for Daewoo Heavy Industries. In its 40-page ruling, the IPC agreed that the dispute could be resolved in Russia under domestic law, but it disagreed with the 9th AAC’s analysis of the evidence in the case.

The Moscow Arbitrazh Court and the 9th AAC had previously decided in favor of PKBM, which led Doosan Infracore and Korea Aerospace to request review by the Intellectual Property Court.

Do the Russian courts have jurisdiction to hear the case?

The Korean companies argued before the 9th AAC that the Russian courts lacked jurisdiction because the operations that caused the alleged damages, if they occurred at all, were outside Russia. They pointed out that both countries operate under Korean law. Conflicts of laws principles, which include alleged violations of intellectual property rights, favored the application of South Korean law. They also cited the international legal principle of lex loci delicti commissi, under which the law of the location of the alleged offense is that law that governs. The Korean companies based much of their jurisdictional argument on the principles the Max Planck Group on Conflicts of Laws in Intellectual Property developed that would apply the law of the state where the alleged offense occurred.

The Korean companies also pointed out that they did not have a physical presence in the Russian Federation until after the initial suit had been filed. Korea Aerospace still has no office in Russia, and Doosan Infracore did not open a representative office in Russia until 2004.

The Intellectual Property Court disagreed with the Korean companies. The Planck Group principles, the IPC said, were not as clear as the Doosan Infracore and Korea Aerospace contended, and they permitted a court to determine that the “place of damage” was the location where “the harmful consequences have taken place.” Moreover, under Article 247 of the Arbitrazh Procedure Code of the Russian Federation, arbitrazh courts may hear disputes "alternatively" if "the action that led to the injury to property" took place in Russia, or if the resulting damages occurred in Russian territory.

Applying these tests, the IPC ruled that there is a sufficiently close relationship between the controversy and the territory of Russia to confer jurisdiction. The court made short work of the Korean companies’ argument that they had insufficient presence in the Russian Federation. The IPC pointed out that Daewoo Heavy Industries had operated in the Russian Federation before it was liquidated. The parties therefore “could have and should have reasonably foreseen that, in the absence of the prorogation or derogation agreements, the dispute can be extended to the Russian arbitrazh courts’ jurisdiction . . .even if the parties’ location has [subsequently] changed.”

Was the case barred by the period of limitation of actions?

This was the second preliminary issue. The Korean companies pointed out that the software that was the subject of the case was written between 1994 and 1998; therefore, the controversy was too old to be brought to court.

The IPC also ruled against the Korean companies on this issue, stating, ”There is no objective information that the plaintiff could have known about the violation of his rights earlier than [11 January 2001].“ Using this date would bring the filing of the suit in the Moscow Arbitrazh Court within the permitted period.

PKBM filed the action only after it employees learned from the press that what appeared to be a modification their KTX software had been installed in flight simulators that the Korean companies had begun to deliver to the armed forces of South Korea and Indonesia. The Korean companies contested the factual basis of this claim and contended that the software that they installed, known as KT, was the independent result of work by Korean Aerospace and their colleagues. The court ruled that the period of limitation began when the PKBM first learned of a possible claim against the Korean companies, not when the software was developed.

Which law applies to the merits of the case: Russian or Korean?

The Korean companies did not want to litigate in Russia. They argued at the 9th AAC that Korean substantive law should apply. PKBM argued for the application of Russian law. The facts of the case, however, made it difficult to decide which law applied to the determination of the origin and the appurtenance of the exclusive rights in the software. The IPC observed that neither the international contracts among the parties nor Russian law contain usable norms to guide that decision. However, under the totality of the circumstances, the IPC concluded that Russian law was the better choice to resolve the merits of the case.

The IPC therefore agreed with the 9th AAC that Russian law should apply because the party responsible for the performance of the original contract (the development and delivery of the software) was located in Russia.

PKBM appeared to have won the purely legal issues of jurisdiction, limitation of actions, and the applicable law. Their fortunes changed, however, when the IPC turned to the merits of the case.

Leo Tolstoy loses his case.

Even Leo Tolstoy got into the case.

PKBM argued that it had completely created the software that was included in the flight simulators the two Korean companies had sold and that PKBM, therefore, had exclusive rights to it. During oral argument of the case, the IPC judges asked counsel for PKBM how it can prove this contention.

“How should Leo Tolstoy prove that it is his work?” PKBM’s lawyer responded.

Doosan Infracore and Korea Aerospace argued that the Russian programmers wrote only a small portion of the files, and their files are incapable of working separately. Only 21 of the 138 program files name PKBM employees as authors. All the other files list Korean authors or no author at all. PKBM replied that the absence of the marks on most software files constitutes a "common practice” in the industry. The Intellectual Property Court, however, pointed out that there was no evidence that the files the PKBM employees created constituted a stand-alone program and did not have as their purpose “the achievement of a certain result” that is required for their separate protection under Russian law.

Other flaws

The IPC devoted a significant part of its 40-page opinion to procedural and analytical defects in the case in the arbitrazh system. For example:

• The presumption of the exclusive rights does not extend to persons who are not the author of the work, but the persons purported to be co-authors of the software were not brought into the proceedings.
• PKBM did not meet its burden to produce evidence needed to support its claim, such as:
  • files that meet the requirements of a computer program under intellectual property law;
  • evidence that PKBM created a program or a runnable part of it; and
  • evidence that the PDKM employees involved in the creation of the program acted in the performance of their official duties or on the instructions of their employer.
• Without explaining their reasons, the 9th ACC did not receive the affidavit of a Korean lawyer concerning the partial succession between Daewoo Heavy Industries and Doosan.
• The IPC was not satisfied with the sufficiency of the evidence of the actual value of the contracts. The case materials included an estimate by the Federal Service for Military Technical Cooperation of US$ 49.6 million, which is 6 percent of the total value of the contracts. This estimate was based on “international experience” and “open sources of information in the Internet.” The Korean companies presented documents of the real value of the shipments in the 9th AAC. Their counsel represented that the delay was due to “coordination at the highest level,” as they involved military contracts, but that court disallowed them. The IPC disagreed with the decision to disallow this documentary evidence and noted that the experts’ conclusions, upon which the arbitration courts had relied, were irrelevant.
• The case also presented an interesting issue about the calculation of damages in U.S. currency. The Korean companies objected to the calculation of damages in U.S. currency, as this was not the unit of payment. PKBM noted that no Russian banks offered accounts in Korean won and that Russian law does not prohibit transactions between non-residents in a foreign currency.

Why this case is important

Aside from being interesting reading for lawyers, this case could have lasting significance in the development of Russian law in the areas of arbitration and intellectual property:

• The case recognizes the jurisdiction of Russian arbitrazh courts, even if the defendants are located abroad, with no physical presence in Russia.
• The IPC appeared to open new legal territory by ruling that the authors of software files, which are incapable of running as a program, do not possess intellectual property rights to their work. This is consistent with Russian legislation, but judicial decision had not confirmed it.
• As a policy matter, the IPC decision could build the confidence of foreign investors in the objectivity and maturity of the Russian judicial system.

For more information

Artur Zurabyan, of ART DE LEX, and two of his colleagues represented Korea Aerospace in this case. Mr. Zurabyan’s e-mail address is a.zurabyan@artdelex.ru.