Opinion
C.A. No. 19043-NC
Date Submitted: September 11, 2001
Date Decided: September 28, 2001
Kevin G. Abrams and Srinivas M. Raju, Esquires of RICHARDS LAYTON FINGER, Wilmington, Delaware; and John D. Donovan, Jr., Richard D. Batchelder, Jr. and Michele T. Perillo, Esquires of ROPES GRAY, Boston, Massachusetts; Attorneys for Plaintiff
Michael F. Bonkowski and Kimberly L. Gattuso, Esquires of SAUL EWING REMICK SAUL, LLP, Wilmington, Delaware; and Raymond B. LaDriere, II, Margaret Donahue Hall and Kathleen V. Galloway, Esquires of LOCKE LIDDELL SAPP, LLP, Dallas, Texas; Attorneys for Defendant
MEMORANDUM OPINION
Pending is a motion for a preliminary injunction by Pegasystems, Inc., the plaintiff ("Pega" or "plaintiff'), to prohibit the defendant, Carreker Corporation ("Carreker" or "defendant"), from engaging in alleged ongoing breaches of an agreement those parties entered into on May 5, 1999. In that agreement, the parties undertook to form a strategic alliance jointly to develop, market and sell certain "exception management" products for the banking industry. The exception management ("EM") market includes automated systems designed to assist the processing of checks that are excepted from a financial institution's normal check processing procedures. Since Pega and Carreker were competitors in the EM industry, they contracted for a fixed term of five years in order to make the alliance work. During that time they would be required to use their best efforts to market and to sell the jointly developed products in their area of exclusivity. Those parties also agreed to refrain from any development activities or alliances that would create competing products.
Examples of exception management would be processing a check encoded with an incorrect dollar amount, copying a check requested by a customer, or processing an account having insufficient funds.
Only two years after the alliance was created, Carreker acquired Check Solutions Company ("Check Solutions"), a direct competitor of the Pega/Carreker alliance. Check Solutions was developing an EM product that would directly compete with the products being created by that alliance. Carreker started its efforts to acquire Check Solutions in the fall of 1999 (only five months after the Pega/Carreker agreement was executed), and it signed a letter of intent to acquire Check Solutions on March 20, 2001. Carreker never informed its ally, Pega, of these activities, however, until May 23, 2001, the day after Carreker signed the definitive agreement to acquire Check Solutions and publicly announced the deal. Shortly thereafter, Carreker ceased its efforts to market the products developed through its alliance with Pega, and began marketing the competitive product of Check Solutions, which Carreker now owned.
In this action and on this motion, Pega seeks a preliminary injunction prohibiting Carreker from marketing and selling products that are competitive with products that have been, and will be, developed and marketed by the alliance. For the reasons set forth in this Opinion, I conclude that an injunction should issue.
I. RELEVANT FACTS
Next described are the facts that are material to the issues presented on this motion. Other facts are discussed in the sections of this Opinion to which they pertain. Except where noted, the critical facts are undisputed.
A. The Parties
Pega, a Massachusetts-based company, is a provider of rules-driven process automation technology, including EM products (the PegaCHECK line) that are driven by Pega's "workflow engine" technology. Carreker, a Dallas, Texas-based company, offers software and consulting services to the financial industry. Carreker's business includes assisting financial institutions in improving efficiency and revenues through automation of services.
Although Pega and Carreker were competitors in the EM market (each offering different software directed to that market), in 1999 the two companies decided to join forces in a strategic alliance. They did so because each company brought "to the table" different but complementary and potentially synergistic assets. Pega contributed its experience with workflow-based technology and products based thereon, while Carreker contributed its superior marketing and business capabilities and its large list of customers. Ultimately, the parties entered into a Product Development, Distribution and Sublicensing Agreement (the "Agreement") on May 5, 1999. Because of the importance of that Agreement to the claims being asserted here, the key terms of that Agreement, which define the relationship between the parties, are next summarized.
B. The Key Terms of the Agreement
The general purpose of the strategic alliance, as reflected in the Agreement's recitals, was to enable Pega and Carreker jointly "to develop backroom banking products employing [Pega's] workflow products as core components." The initial term of the Agreement runs from May 5, 1999 through December 31, 2004. There is an automatic three year extension unless between July 1 and December 31, 2002, one party notifies the other in writing of its intent not to renew. The Agreement can be terminated in only two limited circumstances. The first is if either party becomes insolvent, in which event the other party becomes entitled to terminate. The second is if Carreker is acquired by another party and Pega determines, in good faith, that Carreker has materially changed the intent of the Agreement or failed to comply with its obligations under the Agreement.
Agreement § 14.1.
Id. § 14.5.
Id. § 3.3.
These limited termination rights were not accidental. Indeed, as Carreker's Michael Harris recognized, they were specifically "INTENDED TO BE DIFFICULT FOR BOTH PARTIES AND USED AS A LAST RESORT," in order to "allow both parties to have enough time to successfully operate their successful businesses."
Harris Dep., Exh. 4 at 2-3 (emphasis in original).
Because the jointly developed EM products would be based upon Pega's workflow product technology, the Agreement required Carreker to purchase from Pega (i) for $1 million dollars, a development license for the workflow products and (ii) for $300,000, the right to sublicense Pega's workflow products and certain other EM application-specific components through derivative works developed under the Agreement. The Agreement also gave each party the right to sublicense the other's EM application-specific components.
Under Section 7 of the Agreement, Pega continues to own its workflow products and EM application-specific components, Carreker continues to own its EM application-specific components, and Pega and Carreker jointly own all Products, which are defined in Section 1.11 as "all Code, Documentation and other materials directed to the EM Market jointly developed by the parties under the terms of [the] Agreement."
Agreement § 3.
The Agreement provides that Carreker would be the marketing lead, having exclusive worldwide marketing and sublicensing rights during the term of the Agreement for the EM Market. The only exceptions are the countries that constitute Pega's exclusive market, namely, Australia, New Zealand, Singapore, South Africa and Continental Europe. In agreeing to this arrangement, Pega gave up the right to sell "Pega Workflow Products with Products to the EM Market in areas where [Carreker] has exclusivity, although the Agreement did preserve for each party, "the right to service and honor all terms of agreements with existing Customers."
Id. §§ 4.1, 4.2, 3.2, 3.4. "EM Market" is a defined term. Id. § 1.7.
Id. § 4.2.
Id. §§ 4.1, 4.2.
The Agreement requires both parties to "exercise their best efforts to market and sell the Products in areas where they have exclusivity." The Agreement also provides, with one exception not relevant here, that "during the term of this Agreement, both parties shall refrain from any development activities or alliances which would create competing products, unless otherwise agreed to in writing by the Steering Committee."
Id. § 4.3.
The basic management structure under the Agreement is the Steering Committee, which consists of an equal number of senior management personnel from each party, chosen by representatives of the parties named in the Agreement (the "Executive Sponsors"). The Steering Committee is responsible for "originating, controlling and managing [EM]/backroom banking products developed within the scope of this agreement." No material issue can be decided without all Steering Committee members voting; moreover, the Steering Committee may act only by a vote of a majority of all its members, as opposed to a majority vote of those members who attend a meeting.
Id. § 2.2.
Id.
Important for this case, the Agreement provides that if either party breaches the Agreement, the breach "shall be brought to the attention of the Steering Committee, which shall work to cure such breach." The Agreement further provides that "should the Steering Committee fail to reach agreement, the breach shall be handled in accordance with Sections 2.2, 2.3, and 15.l0." Section 2.2 relevantly provides that the Steering Committee "may adopt and change rules for its governance, " including decisions that "create or modify a party's duty to the other." Section 2.3 covers enhancements by Carreker to the Pega Workflow Products, and, Section 15.10 requires the Steering Committee to attempt to resolve any dispute concerning the Agreement. Failing that, Section 15.10 requires both parties' Executive Sponsors to attempt to resolve the dispute, and failing that, for the dispute to be mediated. If that fails, then the Agreement requires an arbitration of the dispute. Thus, the Agreement provides for a four-tiered dispute resolution process.
Id. § 14.2.
Id.
That Section also provides that nothing in the Agreement "shall limit or affect a Party's right to seek injunctive or other equitable relief from any court of competent jurisdiction to enjoin or remedy any breach or threatened breach of this Agreement." The Agreement also provides that it shall be "governed by and construed according to the laws of the State of Texas." Agreement § 15.7.
With respect to the allocation of operational authority, the Agreement makes Carreker responsible for both the overall management of the project and for providing subject matter expert resources, technical communication and training resources, testing and installation resources, and technical design assistance resources. Pega, by contrast, is to provide "professional development, training and support services to assist in the creation and support of capabilities for the EM market," and to provide those services at thirty percent below its then-current rates. Carreker clearly understood that its responsibilities included vision and subject matter expertise and product management, with Pega to provide consulting assistance. Pega's responsibility, on the other hand, included the "technical architecture and tools for the Next Generation Products," and the "infrastructure and workflow construction of the Next Generation Systems." The responsibility for designating the replacement Products as being fit for general release to the EM market, however, resided in the Steering Committee.
Id. at Exh. J.
Id. § 3.5.
Davis Dep. Exh. 14; Appendix to Plaintiffs' Opening Br., Exh 12 at 2.
Agreement, Exh. J.
The last relevant issue addressed by the Agreement is the functionality of Pega's Workflow Products, which were to be the core components for the "next generation" of products jointly developed by the parties. To assure that Pega's Workflow engine remained competitive, the Agreement entitled Carreker to request "new functionality" to Pega's Workflow Products if new functionality was needed "from a competitive standpoint." If Pega refused to honor that request, Carreker had the right to bring the matter to a Third Party Evaluator, who could require Pega to add such functionality. If Pega failed to do that, Carreker could then use technology of its choice to provide the functionality, and sell the enhancement without paying royalties to Pega, all without running afoul of the Agreement's non-compete provision. There is no evidence that Carreker ever invoked that procedure.
Id. §§ 2.3, 2.4. Carreker never requested any enhancements to the functionality of Pega's Workflow Products, nor did it ever invoke Section 2.3 or 2.4 of the Agreement.
C. The Parties' Initial Efforts Under the Agreement
Under the Agreement, both parties committed, as the "initial focus of the joint development efforts," to "make best efforts to develop replacement Products to be ready for beta installation at a customer site by February 29, 2000." "Beta installation" is an industry term of art that refers to the first installations of a new product at customer sites.
Id. at Exh. J.
Although the reasons are disputed, it is uncontroverted that during the first few months of the parties' relationship, little progress was made toward the goal of developing replacement products that would be ready for beta installation by February 29, 2000. Despite that, Carreker decided to move up the intended installation date of a jointly developed product for Firstar Bank, N.A. of Milwaukee, Wisconsin ("Firstar"), the parties' first joint customer, to January 31, 2000. This was done to enable Carreker to recognize, before the end of its fiscal year, the revenue from the license fee payable to Carreker under its January 31, 2000 end-user agreement for the license of Check Flow Suite to Firstar.
Harris Dep. at 72; Davis Dep., Exh. 20 at 6; Carreker Dep. at 66.
Similarly, in late September 2000, Carreker executed a second end-user agreement licensing CheckFlow Suite to KeyBank of Cleveland, Ohio ("KeyBank"). Carreker also recognized $920,000 of revenue from the KeyBank contract.
Appendix to Plaintiffs Opening Brief, Exh. 20; Carreker Dep. at 89 and Exh. 12.
That revenue recognition was significant, because as a legal and accounting matter, Carreker could not recognize revenue from delivered software licenses if any essential element of the software was not functional. Thus, by recognizing revenue from the license for the software it had delivered to Firstar and KeyBank, Carreker implicitly conceded the functionality of that software.
Carreker recognized 75% of the license revenue from Firstar as of January 31, 2000, and the remaining 25%, for the quarter ended April 30, 2000. Harris Dep. at 84; Davis Dep at 170. According to its Form 10-K filed with the U.S. Securities and Exchange Commission on May 1, 2000, Carreker recognizes its software license revenues in accordance with the American Institute of Certified Public Accountants' Statement of Position ("SOP") 97-2. Carreker Dep., Exh. 8 at 218-19. One criterion for revenue recognition under SOP 97-2 is that "delivery" must have occurred. Delivery of an element of software is not considered to have occurred if there are undelivered elements that are essential to the functionality of any delivered elements. Davis Dep., Exh. 22; Harris Dep. at 50-52.
D. The Parties Amend the Agreement and Reaffirm Their Relationship
During the first year of the parties' relationship, there arose billing disputes which led to the first of two amendments of the Agreement. Under Section 3.5 of the Agreement, Carreker, as project manager, agreed to contract with Pega for development, training, and support services to create products that would run on the Pega workflow engine. Upon rendering these services, Pega would invoice Carreker for them at thirty percent below Pega's then-current billing rate. Carreker's failure to pay these invoices on several occasions led to billing disputes. Those disputes were resolved by the parties amending the Agreement on June 30, 2000 to provide that Pega would accept $1 million as an advance on Carreker's obligation to pay license fees to Pega.
Davis Dep., Exh. 29 ("Amendment No. 1").
On October 31, 2000, the parties modified the Agreement once again, this time to broaden the definition of the EM Market and to add to the scope of the Agreement decision-processing technology ("eRM"). Pega paid Carreker a $750,000 fee in connection with those modifications.
Davis Dep., Exh. 41 ("Amendment No. 2").
Id.
Besides expanding its relationship with Pega in this manner, Carreker reaffirmed that relationship in its dealings with the public. In December, 2000, John D. Carreker, Jr., Carreker's Chief Executive Officer, spoke favorably of Pega at Pega's important conference, PegaVISION 2000. In January, 2001, Mr. Carreker expressed his interest in doing another deal together with Pega and a company called Exchange. Mr. Carreker asked Pega's President and Chief Operating Officer and Pega's Executive Vice President of Sales, to fly to Dallas to meet with him and representatives of Exchange to discuss a possible deal. Although no deal resulted from that meeting, any consummated deal would have involved the same Pega workflow engine upon which the CheckFlow Suite products were built.
Carreker Dep. at 122.
Id. at 124-125.
The foregoing is not intended to suggest that the Pega/Carreker relationship was trouble-free. In March, 2001, at a meeting among Pega, Carreker, and Firstar, a Firstar senior executive expressed his commitment to the CheckFlow Suite product and the project. Nonetheless, Firstar was unhappy because problems remained with the installation of the software, and understandably it wanted those problems fixed as soon as possible.
Harris Dep. at 259-60; Davis Dep., Exh. 27.
Three weeks later, Pega and Carreker met at the annual Bank Administration Institute ("BAI") conference to address, among other things, ways to make Firstar and KeyBank (the alliance's other customer) satisfied. During that meeting, Pega's representative offered to place four Pega employees on site at Firstar full-time for 90 days to work exclusively (and at a price below fair market value) to fix any remaining problems with the Firstar installation. That offer was formalized in a letter to Carreker dated May 21, 2001. Carreker decided, however, to reject that offer. Although Carreker contends that it rejected the offer because Pega attached unreasonable conditions to it, it is highly relevant that on the very next day, May 22, 2001, Carreker announced that it had formally entered into a contract to acquire Check Solutions.
Harris Dep. at 187-190; Hansen Dep., Exh. 4.
Hansen Dep., Exh. 4.
Davis Dep., Exh. 38.
E. Carreker's Check Solutions Acquisition
Carreker's effort to acquire Check Solutions began in the fall of 1999 — only months after the Pega/Carreker alliance was created. Carreker sent a letter of intent to Check Solutions before the end of 2000, and Carreker and Check Solutions signed a letter of intent on March 20, 2001.
Rowell Dep. at 38-39; Harris Dep., Exh. 1.
At that time Carreker knew that Check Solutions was developing a product that would overlap and compete directly with the joint Pega/Carreker CheckFlow Suite product. Although Carreker now contends that the Check Solutions product is not competitive, its contention is belied by the testimony of its own Chief Executive Officer and of other Carreker officials. On that subject, Mr. Carreker testified as follows:
Q. You knew that Check Solutions was developing a product that would compete with the CheckFlow Suite product?
Carreker Dep. at 98-99. The testimony of other Carreker officials was to the same effect. Hansen Dep. at 69; Davis Dep. at 188; Harris Dep. at 141-142.
Not only did Carreker intentionally conceal its efforts to acquire Check Solutions from Pega, but also it actively misled Pega about its strategy with regard to Check Solutions. During the April, 2001 BAI conference (a major conference for players in the EM market), Check Solutions used that gathering as an opportunity to launch "Adjustments/Express," the product Carreker knew Check Solutions was developing to compete with Check Flow Suite. The public announcement of that competing product was a topic that Pega and Carreker discussed and about which they reached agreement concerning how best to react to Check Solutions and its new product. That agreement was memorialized in a memorandum dated April 4, 2001, which was distributed to Pega and Carreker and which stated that:
Despite the fact that it was generally agreed that a 3-way partnership between Pega, Carreker, and Check Solutions might be inevitable, it was agreed that both organizations would not actively engage Check Solutions at this time. . . . [To do so] might be interpreted by [Check Solutions] as a sign of weakness or even capitulation. It was agreed that the organizations would wait to approach Check Solutions until:
— Checkflow was happily installed at Key and 1st Star, — BofA made its decision about Chaseflow, — Bankone has gone through lease renewal negotiations — There was evidence of success/failure of new Check Solution products within its development partner customers.
Hansen Dep., Exh. 3 at 009492.
With the benefit of hindsight, it now is apparent that Carreker never intended to abide by this agreement, and that moreover, Carreker was actively misleading Pega about its intentions. That inference is inescapable, because only two weeks before, Carreker had executed a letter of intent to acquire Check Solutions — a decision that Carreker was concealing from Pega and that was incompatible with the strategy to which Carreker had agreed in the "BAI conference" memorandum.
It now is also apparent (again, with the aid of hindsight) why Carreker was not forthcoming with Pega, its strategic ally. The acquisition of Check Solutions and its new competitive product was incompatible with the Agreement as then written, because the Check Solutions' Adjustment/Express and the CheckFlow Suite products clearly overlapped. The only way to resolve that conflict would be to renegotiate (or, in Carreker's terms, "reset") the Agreement. Had Carreker intended to pursue that course of action, then presumably it would have informed Pega of its plans and attempted to renegotiate the Agreement before signing a definitive acquisition contract with Check Solutions. But Carreker did not disclose its plans to acquire Check Solutions until May, 2001, and it never attempted to renegotiate the Agreement until after it had completed its acquisition of Check Solutions on June 6, 2001.
Hansen Dep. at 81, 95. Mr. Carreker admittedly understood that the Agreement would have to be renegotiated to accommodate the Check Solutions acquisition, Carreker Dep. at 99, and Mr. Harris knew as early as February 2001 that a renegotiation would be required. Harris Dep. at 95.
F. Carreker's Post-Acquisition Activities
That Carreker was willing to risk jeopardizing its strategic alliance with Pega in this way (there being no guarantee that Pega would agree to renegotiate, post-acquisition), evidences that Carreker believed its interests would be better served by developing and marketing the competitive Check Solutions' product (which it then owned) rather than by abiding by its contractual undertakings to Pega in the Agreement. That supposition is borne out by Carreker's post-acquisition conduct.
It is undisputed that Carreker is continuing to create and develop its new Adjustments/Express product. Carreker is also marketing that product both to the alliance's CheckFlow customers and to Pega's own customers. For example, although Carreker knew that Wells Fargo was a Pega customer, between June 6 and June 13, 2001 Carreker made a sales pitch to Wells Fargo comparing the strengths and weaknesses of CheckFlow Suite and Adjustments/Express. On August 20, 2001 Carreker made another sales call on Wells Fargo, where again Carreker touted the Exceptions/Express product.
Hansen Dep. at 76-77.
Hansen Dep. at 243 and Exh. 22.
After it acquired Check Solutions, Carreker also made sales presentations to two existing CheckFlow customers, Firstar and KeyBank. At those presentations Carreker offered those customers a "choice" between CheckFlow Suite and the competing Check Solutions product, allowing them to decide what system was best for their needs. It is Pega's position that those "customer choice" presentations cannot be reconciled with Carreker's covenant not to compete or with its contractual obligation to use its best efforts to market and sell the products jointly developed by Pega and Carreker.
Id. at 45.
G. The Filing of This Action and Carreker's Response
After Pega learned that Carreker was selling EM products in competition with the jointly developed products, it attempted over the next several weeks to negotiate a resolution of the dispute. Those negotiations were unsuccessful, and as a result Pega filed this action in August of this year. In this action Pega seeks an injunction to restrain Carreker from developing, marketing, licensing, advertising, leasing or selling any competing products and any EM products or services other than those jointly developed by Pega and Carreker under the Agreement.
In response to the filing of this action, during the course of discovery, Carreker sent Pega two letters upon which Carreker rests its primary defense. The first is a letter entitled "Notice of Intent to Arbitrate." The second is a letter, dated August 27, 2001, entitled "Notice of Default and Termination of Agreement." In that second letter, Carreker claims that Pega materially breached the Agreement by (i) misrepresenting, at the time the Agreement was executed, that its current customers' software leases would expire within the next five years and were not renewable, and (2) breaching its warranty relating to the functionality of the CheckFlow Suite products. On this basis, Carreker took the position that the Agreement is now terminated. At no time before it issued that letter did Carreker ever claim that Pega had breached the Agreement in these or in any other respects.
Appendix to Plaintiffs' Opening Br. at Tab. 31.
Id. at Tab. 30.
II. LEGAL ANALYSIS
To earn a preliminary injunction, the moving party must demonstrate a reasonable probability of success on the merits of its claims, a threat of imminent, irreparable harm if injunctive relief is denied, and a balance of equities that favors the grant of injunctive relief. Because the parties advance a multiplicity of contentions addressed to each of these elements, their contentions are not summarized in a single place, but, rather, are addressed in those segments of the analysis where they are relevant.
Unitrin, Inc .v. American General Corp., Del. Supr., 651 A.2d 1361, 1371 (1995); Sealy Mattress Co. of New Jersey v. Sealy, Inc., Del. Ch., 532 A.2d 1324, 1342 (1987).
A. Pega's Probability of Success On The Merits
Pega claims that Carreker has violated three separate provisions of the Agreement, and that it has established a reasonable likelihood of success on all three claims. First, Pega claims that Carreker has violated the "noncompete" provision of the Agreement, which, under the Texas Covenant Not to Compete Act (the "Texas Act") entitles Pega to injunctive relief without any need to show irreparable harm or a favorable balance of the equities. Second, Pega contends that Carreker violated the Agreement's "no conflict" provision, which prohibits either party from "assum[ing] any. . .obligation or restriction that does or would in any way interfere or conflict with or that does or would present a conflict of interest concerning the performance of this Agreement." Third, Pega claims that Carreker has breached the "best efforts" clause, which requires both parties to "exercise their best efforts to market and sell the Products in areas where they have exclusivity." I conclude, for the reasons next discussed, that Pega has established probable success on the merits of all three claims.
Section 4.3 provides (with one exception not relevant here) that "both parties shall refrain from any development activities or alliances which would create competing products, unless otherwise agreed to in writing by the Steering Committee."
Tex. Bus. Com. Code Ann. § 15.50-52 (Vernon 2001). Section 15.7 of the Agreement provides that "[t]his Agreement shall be governed by and construed according to the laws of the State of Texas."
Agreement § 11.1.
Id. § 4.3.
Pega further claims that the same conduct that is violative of these contract provisions also constitutes unfair competition and a breach of Carreker's implied covenant of good faith and fair dealing. Because the Court finds that Pega has established a probability of success on its contractual (and statutory) claims, it does not reach Pega's common law claims of unfair competition or breach of the implied covenant of fair dealing.
1. Pega's Claim Under The Texas Act Based on Carreker's Breach of The Noncompete Clause of the Agreement
The undisputed facts establish (at least preliminarily) that Carreker violated its obligation under Section 4.3 to "refrain from any development activities or alliances which would create competing products, unless otherwise agreed to in writing by the Steering Committee." Carreker acquired Check Solutions (an "alliance") which Carreker knew was developing Adjustments/Express (a "competing product"). Thereafter, Carreker continued to create and develop that competing product. Carreker never sought to obtain written permission from the Steering Committee to engage in this competitive activity. Instead, Carreker concealed what it was doing, apparently hoping that it could negotiate a resolution with Pega. That hope turned out to be misconceived.That conduct, established preliminarily on this record, constitutes a violation of the noncompete clause of the Agreement. It also constitutes a violation of the Texas Act, which authorizes injunctive relief without any need to show irreparable harm or to balance the equities.
Carreker insists that the noncompete provision is not a "covenant not to compete" within the meaning of the Texas Act, and (alternatively), even if it is, the Court must still balance the equities in considering Pega's motion for injunctive relief. These contentions lack merit. In substance the noncompete provision is a covenant not to compete. That the provision is not labeled as such makes no difference, because nothing in the Texas Act restricts its coverage to provisions that are labeled as "covenants not to compete." Moreover, Mr. Hansen, Carreker's Vice Chairman acknowledged that Section 4.3 was a covenant not to compete. Hansen Dep. at 160 (Q: "Well, there was a noncompete in the original agreement, correct?" A. "Correct."). And, Section 15.52 of the Texas Act explicitly preempts the common law criteria for the grant of injunctive relief, including the requirement that the moving party show an irreparable injury. Butler v. Arrow Mirror Glass, Inc., Tex. App, C.A. No. 01-00-00445-CV, 2001 WL 699935, at *3 (June 21, 2001).
2. The Claim That Carreker Breached The No-Conflict Provision of the Agreement
The same conduct that violates (preliminarily) the non-compete provision of the Agreement and the Texas Act, also violates Section 11.1 of the Agreement, which prohibits Carreker from assuming any obligation or restriction that does or would interfere or conflict with its performance of the Agreement. Carreker's acquisition of Check Solutions constitutes an explicit breach of this provision.Before it was acquired by Carreker, Check Solutions had announced its new Adjustments/Express products. Check Solutions had also announced that it had signed up four customers for these products, including at least one (First Union) that had been considering the CheckFlow Suite products. When Carreker acquired Check Solutions, it assumed the obligations Check Solutions had to these customers — obligations that interfere with Carreker's performance under the Agreement, as they prevent Carreker from (among other things) using its best efforts to market and sell the jointly developed products.
3. The Claim That Carreker Has Breached The Best Efforts Clause of the Agreement
The undisputed facts also establish (again, preliminarily) that Carreker has breached the clause of the Agreement that requires the parties to "exercise their best efforts to market and sell the Products in areas where they have exclusivity." Mr. Carreker conceded that Carreker has made no efforts to sell or market the CheckFlow products since June 6, 2001. Moreover, Carreker made at least two sales presentations of Check Solutions products to Wells Fargo — a Pega customer — instead of the jointly developed products. With respect to the two existing customers of the jointly developed products, Carreker has also taken a "customer choice" approach by giving those customers a choice between the jointly developed products or the competing Check Solutions products.
Carreker Dep. at 128.
That conduct violates the best efforts clause of the Agreement.
See Precision Dynamics Corp. v. American Hosp. Supply Corp., 241 F. Supp. 436, 447 (S.D. Cal. 1965) (holding that the defendant breached a contract with the plaintiff by entering into an exclusive distribution agreement with the codefendant when defendant agreed to use its "best efforts" to distribute plaintiffs similar products).
4. Carreker's Defenses
Because the above-described claims are based on undisputed facts, Carreker cannot, and does not, argue that its conduct is permitted by the Agreement. Instead, to avoid the legal consequences of its conduct Carreker raises a plethora of defenses which, it argues, preclude the grant of any relief, including injunctive relief, against it. Thus, Carreker argues that (I) even if the noncompete provision is a covenant not to compete within the meaning of the Texas Act, and was violated, that provision is no longer enforceable because Carreker sent Pega a notice purporting to terminate the Agreement; (2) Carreker acted in good faith, honored its business commitments to Pega, and attempted to work out a business plan with Pega after it acquired Check Solutions, and (3) Pega committed prior material breaches of the Agreement that excuse Carreker from further performance under the Agreement.For the reasons next discussed, none of these defenses has been shown to be meritorious.
(a) The Contract Termination Defense
This defense lacks merit because under the Agreement Carreker had no contractual right to terminate. As earlier explained, the Agreement recognizes only two grounds for termination, neither of which is implicated here: (i) the insolvency of either party or (ii) Carreker being acquired by a third party. Therefore, Carreker's notice of termination — sent only after this litigation was commenced — has no legal force.
Agreement § 14.5
Id. § 3.3
Carreker contends, nonetheless, that it is entitled to terminate under Section 14.2 (entitled "Termination — Breach") and Section 14.3 (entitled "Post-Termination Rights"). Neither provision supports Carreker' s argument. Section 14.2 directs the parties to bring any breach of the Agreement to the attention of the Steering Committee, "which shall work to cure such breach." If the Steering Committee fails to reach agreement, the breach is to be handled in accordance with (inter alia) Section 15.10, the Agreement's alternative dispute mechanism. Carreker never brought before the Steering Committee any claim that Pega breached the Agreement, nor did it ever avail itself of those dispute resolution procedures. Carreker cannot now argue that it has the right to terminate the Agreement for a breach that it never brought to the attention of the Steering Committee, or that such "termination" forecloses Pega from seeking to enforce the covenant not to compete.
See, e.g., Harris Dep. at 57-59 (Q. "Did you ever participate in any steering committee meeting in which the steering committee worked to cure a breach brought to its attention? A. I was in numerous steering committee meetings where issues were brought affecting sales, marketing, development and capability, but in none of those meetings was the term "breach" used. The discussions were over business issues on those topics.")
Any other conclusion would totally eviscerate Section 15.10 of the Agreement (which expressly allows a party to seek injunctive relief to enjoin a breach of the Agreement), since that right could be extinguished by the breaching party at the stroke of a pen.
Section 14.3, the other provision upon which Carreker relies, simply lists the post-termination rights of the parties. By its very nature, such a provision could only be triggered by a valid termination of the Agreement, as opposed to a unilateral notice of termination cobbled together by one party in an attempt to stave off an injunction.
(b) Carreker's Defense That It Acted in Good Faith And Discharged Its Obligations Under The Agreement
Similarly lacking in merit is Carreker's defense that it honored its obligations under the Agreement and attempted in good faith to work out a business solution with Pega after acquiring Check Solutions. On the contrary, Pega has demonstrated probable success on its claim that Carreker has breached its obligations under the Agreement. Moreover, Carreker's conduct in acquiring Check Solutions, knowing that unless the Agreement was "reset" Carreker could not develop, market, or sell the competing Check Solutions product, is inconsistent with its claim of good faith. Carreker never sought to renegotiate the Agreement before it acquired Check Solutions, and thereafter, Carreker proceeded to develop, market and sell the competing product without resetting the Agreement with Pega. In these circumstances, that Carreker may have attempted, after the fact and unsuccessfully, to renegotiate the Agreement with Pega, is of no legal significance.
(c) Carreker's Defense that Pega Breached The Agreement
Finally, Carreker contends that its breach is excused by three separate breaches of the Agreement committed by Pega, namely, (i) Pega's failure to deliver timely the functionality Pega represented it could deliver, (ii) Pega's failure timely to provide Code as warranted in the Agreement, and (iii) Pega's marketing of product upgrades to its own customers (to the C++ platform). None of these arguments has been shown to have any merit, let alone probable merit.
Carreker cites no provision of the Agreement that Pega breached by allegedly failing "to deliver the functionality it represented it would." By itself, that omission is sufficient to defeat the claim of breach. Carreker's sole basis for this argument is a functionality "matrix" that Pega created five months after the Agreement was signed. Carreker now contends that that the matrix included false representations that Pega's software could meet Carreker's requirements. This argument, however, is inconsistent with Carreker's own contemporaneous conduct and with the representations it made to the public.
See Martin v. Ford Motor Co., S.D. Tex., C.A. No. G-95-225, 1995 WL 1554361 at *5 (1995) (finding no plausible breach of contract claim where the plaintiff failed to identify any contract term that was breached).
The software, which Carreker now contends did not meet its requirements, was installed (by Carreker) at Firstar in January, 2000 and at KeyBank in September, 2000. The software apparently passed Carreker's quality assurance testing. Most important, Carreker recognized millions of dollars of revenue in connection with the sale of the software, which it could not legally have done that if there were "undelivered elements that were essential to the functionality of the delivered element." Moreover, Carreker internal documents show that the Pega product was delivered and worked as Pega designed. As Carreker's Mr. Harris confirmed, "[i]n all five cases [referring to the top five problems Carreker had previously identified], the functionality is here and works as PEGA designed. . . . Functionally, we have a system we can deliver and install into production." Lastly, Carreker's representations to the public belie its "nonfunctionality" claim. In November, 2000, Carreker offered for sale two million shares of its common stock. In the prospectus Carreker filed with the SEC in connection with that offering, Carreker touted CheckFlow First Edition, the very product that Carreker now claims was nonfunctional. No credible evidence supports the claim of breach on the ground that Pega's software was not functional as represented.
According to its Form 10K filed with the SEC on May 1, 2000, Carreker recognizes its software license revenues in accordance with SOP 97-2, "Software Revenue Recognition." SOP 97-2 precludes such revenue recognition if the delivered elements lack functionality.
Harris Dep., Exh. 15. When questioned about this document by his own counsel, Mr. Harris admitted that Firstar received the functionality that it wanted. Harris Dep. at 255.
Tab 2 to Appendix to Plaintiffs Reply Brief, at 42.
The only document upon which Carreker relies is an attachment to a July 6, 2001 e-mail from Mr. Tutunjian to Mr. Friscia, which Carreker argues is an admission by Pega that it was "still far from completing a product with full functionality." Defendant's Ans. Br. at 32. Carreker misreads the document, which is not related in any way to the functionality of the CheckFlow Suite products. The point the author was trying to make was that if Carreker continued to breach the Agreement, Pega would be forced to develop its own product from scratch in order to compete in the check EM market. Tutunjian Affidavit ¶¶ 5, 7.
Carreker next argues that Pega failed to provide Code as warranted in Section 11.3 of the Agreement, which relevantly provides:
Each party to this Agreement represents and warrants to the other that each parties [sic] respective Code will operate substantially according to its documentation. In the event it does not, the responsible party will correct all material defects according to its documentation within ninety (90) days after written notice of such defect.
The only evidence cited to support the argument that Pega breached this provision is the affidavit of Mr. Mike Snow, Carreker's Chief Technology Officer, who says that the Code delivered by Pega was "very poor." But Carreker nowhere shows, in Mr. Snow's affidavit or elsewhere, that the Code did not operate "substantially in accordance with its documentation," that Carreker provided Pega written notice that the code was materially defective, or that Pega failed to correct all material defects according to its documentation within ninety days of its receipt of such notice. Moreover, if Carreker truly believed Pega had committed such a breach, the Agreement required it to bring the breach to the attention of the Steering Committee. Carreker never did. Carreker therefore cannot be heard to contend that it is entitled to use a breach that it never brought to the attention of the Steering Committee as a basis to terminate the Agreement and to cease performing under the Agreement.
Carreker advances the related argument that the jointly developed products would be fit for general release to the EM market by February 29, 2000, which they were not. The record does not support this argument. The parties agreed that they would use their "best efforts to develop replacement Products to be ready for beta installation at a customer site by February 29. 2000." Agreement, Exh. J. Beta installation does not mean product completion. Beta testers assist software manufacturers in working out glitches or suggesting improvements in the software before it is released to the general public. Berkla v. Corel Corp., 66 F. Supp.2d 1129, 1134 n. 8 (E.D. Cal. 1999).
Lastly, Carreker contends that Pega breached the third sentence of Section 4.2 of the Agreement, by allegedly marketing product upgrades to the C++ platform in direct competition with the CheckFlow products that were to be developed under the Agreement. That argument is also a nonstarter because, the third sentence of Section 4.2 prohibits Pega from selling Workflow Products to the EM market only in areas where Carreker has exclusivity. Marketing product upgrades to the C++ platform to Pega's existing customers was not prohibited by the third sentence of Section 4.2; indeed, Pega's customers were entitled to such upgrades under the first two sentences of that provision.
* * *
Because Pega has demonstrated preliminarily that Carreker has breached the Agreement in several respects, and because Carreker has failed to establish any defense that excuses those breaches, I conclude that Pega has established a probability of success on the merits of its claims. Having so concluded, I next turn to the elements of irreparable harm and the balance of hardships.
B. Irreparable Harm
1. Pega's Showing of Threatened Harm
Pega has also established to my satisfaction that it will suffer imminent irreparable harm if preliminary injunctive relief is not granted. When Pega entered into the Agreement, it committed to — and did — forfeit its sales force, disclose the inner workings and technology of its product and information about its customers, and stopped further development of its EM products. Now, over two years later, because Pega has been funneling its efforts into the jointly developed products, Pega's own EM products are no longer as current or cutting edge as they were initially. Specifically, in reliance on the Agreement, Pega's previous technological and marketing resources in this area have intentionally been allowed to atrophy. As a consequence, absent preliminary injunctive relief Carreker will be allowed unfairly to take advantage of the position in which Pega has placed itself and to sweep the EM market with Check Solutions products, while Pega must scramble to rebuild its formerly superior products. Armed with Pega's confidential customer and technical information, and competing against a former ally to whom it had contracted away its competitive resources, Carreker would be able to dispatch Pega as a competitor in the EM market quickly and with little effort. Indeed, Carreker's recent presentations to Wells Fargo and its efforts to market Check Solutions products to joint customers, indicate that Carreker is now engaged in a full-scale effort to capture that market during the pendency of this action.
As Mr. Friscia testified in his deposition, Pega is now in a situation in which "I don't have expertise, I don't have sales capabilities, I haven't developed my product, and now I have no alliance with Carreker. So my clients are going to be looking for alternatives that I've put myself in a very bad position to compete." Friscia Dep. at 74.
Moreover, Pega uses EM products and services to market and sell other Pega products and services. If Carreker is allowed to continue on its present course, Pega is under threat to lose customers for these other products and services as well.
All of the foregoing translates to irreparable harm, because money cannot adequately compensate Pega for being shut out of this important and evolving market — a market where current decisions by customers to use a particular product will, as a practical matter, shut out all competitive products for several years into the future.
2. Carreker's Contrary Arguments
Carreker advances four arguments to support its position that Pega is not threatened with immediate irreparable harm. Carreker argues that: (i) Pega's delay in filing this lawsuit shows that Pega is not facing irreparable harm, (2) the CheckFlow products are "dead" in the EM market, (iii) Check Solutions would be marketing its products whether or not it was acquired, and (iv) money damages are an adequate remedy. None of these arguments, in my view, withstands scrutiny.
The argument that Pega delayed bringing suit is without factual foundation. Carreker intentionally concealed from Pega its plans to acquire Check Solutions until the day the acquisition was publicly announced. Carreker also led Pega to believe that its interests would not be harmed. The parties spent next two months attempting to resolve the dispute without litigation. As soon as it became evident that those attempts would not work, Pega promptly filed this lawsuit. Consequently, Pega's two month delay in filing this action is not probative of Carreker's position that Pega does not face irreparable harm; nor is that delay legally probative of Carreker's assertion that Pega is guilty of laches, especially given the absence of any proof that Carreker was injured as a result of the delay.
See Huff v. Tippit, Tex. Civ.App., 452 S.W.2d 523, 525 (1970) (delay did not support defense of laches where there was no evidence that the delay, while plaintiff was seeking extra-judicial means of dissuading the defendant from continuing his actions, resulted in any injury to the defendant).
Carreker's second no-irreparable-harm argument is that because the CheckFlow product is "dead" (i.e., so technologically backward compared to the "state of the art)," no injunction could revive the moribund patient. While it may be that CheckFlow is not as state of the art as it was initially, it does not follow that that product is "dead." But even if CheckFlow were dead, that still would not afford Carreker any ground to terminate the Agreement, because the parties thereto agreed to develop products jointly during the Agreement's entire term. The Agreement does not permit a party to pronounce the joint product "dead" in midstream because a more lucrative opportunity to market a competing product suddenly materializes. On the contrary, if there are problems with CheckFlow, it is Carreker's obligation under the Agreement to work jointly with Pega to fix those problems. That was the parties' contract, and if the result now appears to be a bad deal for Carreker, that affords Carreker no legal basis to exit its alliance with Pega.
See Cross Timbers Oil Co. v. Exxon Corp., Tex. App., 22 S.W.3d 24, 26-27 (2000) ("For a court to change the parties' agreement. ., because one of the parties subsequently found it distasteful, would be to undermine not only the sanctity afforded the contract but also the expectations of those who created and relied upon it.").
Carreker next argues that no additional harm is threatened by its acquisition of Check Solutions, because Check Solutions would be marketing its products whether or not the acquisition took place. That argument ignores the fact that had there been no acquisition, Carreker would have been Pega's ally in competing against Check Solutions. Now that Check Solutions has joined forces with Carreker, the combined companies are an even more formidable competitor. Therefore, from an irreparable harm standpoint, the acquisition of Check Solutions, unless remedied by an injunction, will leave Pega in a worse, rather than (as Carreker argues) in the same, position as before.
Lastly Carreker argues that money damages would be adequate, because (i) Pega engaged in negotiations looking to a money settlement of this matter before it initiated this lawsuit, and (ii) Pega could pursue an arbitration to prove its entitlement to royalties for sales of Check Solutions products. Neither contention is adequate to carry the day. The fact that a possible monetary settlement was considered during negotiations leading to a possible settlement of this lawsuit does not constitute an admission that money damages are an adequate remedy. Indeed, statements made in the course of settlement negotiations may not even be considered as evidence on that issue.
See D.R.E. 408 ("Evidence of conduct or statements made in compromise negotiations is. . . not admissible.")
Nor does the fact that Pega might be entitled to royalties for the sale of Check Solutions products by Carreker establish that royalties would be an adequate remedy for Carreker's breach of the Agreement. In allowing a party to seek injunctive relief to enjoin or remedy any breach, the Agreement expressly contemplates that the payment of money may not be an adequate remedy. Moreover, in these particular circumstances money will not adequately compensate Pega for being shut out of the check EM market, where customer decisions to use a particular product will, as a practical matter, shut out all competitive products for several years. That harm would be exacerbated by the fact that Pega uses EM products as a way to market and sell other Pega products and services. Unless injunctive relief is granted, Pega stands to lose customers for these other products and services as well.
C. The Balance of Hardships
Lastly, Carreker contends that in all events a preliminary injunction should be denied because the balance of equities or hardships weighs in its favor. Specifically, Carreker contends that (i) the harm to Carreker from a grant of injunctive relief outweighs the harm to Pega if an injunction is denied, and (ii) the entry of an injunction would negatively affect customers of the Check Solutions products, including Firstar and KeyBank, and also would limit customer choice in the EM market. Neither argument is persuasive.
Carreker's first argument — that the harm to it from granting an injunction outweighs the harm to Pega occasioned by its denial — is convoluted and flawed. By entering into and operating under an alliance with Carreker wherein Carreker had the responsibility for marketing, Pega relinquished much of its market and marketing capability to Carreker, including giving up its sales force. Unless Carreker's breach is enjoined, Pega will be required to "completely retool" its sales capacity. Moreover, Pega's level of expertise in the check EM market has been allowed to erode, and Pega has been promoting Carreker as the "preeminent solution" to Pega's customers. To say it differently, Pega's ability to survive independently in the EM market has been allowed to atrophy in reliance on the assumption that Carreker would honor its commitments to Pega under the Agreement. Denying injunctive relief in these circumstances would leave Pega unable to market its product effectively, would force Pega to operate in the shadow of the combined Carreker/Check Solutions entity, and would create an unacceptable risk of effectively shutting Pega out of the EM market.
Friscia Dep. at 72.
Id at 73.
Carreker, on the other hand, will not be shut out of the EM market if an injunction issues. Carreker will still be able to develop EM products under the Agreement. All that an injunction will accomplish is to require Carreker to do that which it has already promised: to develop jointly products with Pega for the EM market, and to refrain from developing competing products. Nor, it appears, would an injunction materially deprive Carreker of the benefit of its acquisition of Check Solutions. The EM market represents only seven percent of Check Solutions' business, whereas for the Pega/Carreker alliance the EM market is the sine qua non. Carreker's argument that losing seven percent of the business of its acquisition will inflict a greater hardship than that would befall Pega if its alliance with Carreker were abandoned, does not even pass the blush test.
Carreker's argument that the $110 million and countless employee hours spent to acquire Check Solutions would be jeopardized by an injunction also stands the whole balance of harms calculus on its head. Accepting that position would reward Carreker for making an acquisition that it knew would violate its Agreement with Pega. Carreker argues that an injunction would interfere with its "resolution" of software problems with Firstar, i.e., allowing Firstar to choose between the jointly developed products and Check Solutions products. That resolution, however is built on a foundation of breach. Carreker cannot be heard to avoid injunctive relief by interposing as an obstacle thereto adverse consequences that can arise only as a result of Carreker's own violations of the Agreement.
Equally unpersuasive is Carreker's argument that preliminary injunctive relief should be denied because of its potential impact on innocent third parties, such as current customers of Check Solutions' products (including four "Developing Customer Partner Banks") and Firstar and KeyBank. That argument also stands the "balance of harms" calculus on its head. When Carreker agreed to purchase Check Solutions, it knew that certain banks had already invested in the development of Check Solutions products. Carreker also knew that the Agreement would have to be "reset" to accommodate the acquisition of Check Solutions. Carreker knew or should have known that by proceeding as it did, it was putting those relationships, and its relationships with Firstar and KeyBank, at risk. Carreker cannot now be permitted to hide behind those customers in an effort to shield itself from injunctive relief.
Moreover, as the President of the Check Solutions Group at Carreker acknowledges, First Union (the first of the four "Developing Customer Partner Banks" scheduled to begin live production of the Check Solutions products) is not scheduled to go "live" until October 4, 2001. Rowell Affidavit ¶ 16. Accordingly, the effect of an injunction would be merely to preserve the status quo at those banks.