Question;David vs. Michael;Background;David is a company that runs a successful website hosting;business. It is one of the largest and most;successful website hosting businesses in the;country. David?s key differentiator is that it has a very well;laid out website that allows its customers to upload their;websites, edit them and see traffic statistics.;David?s own website is the so?called ?front end? software;that users see and is widely viewed as being;one of the best in the business. The ?back end?;is the actual servers that host the customer websites.;David was started in 1999 and each year since it started has;added about 30% more traffic to its web;servers. David?s revenues have not grown as;quickly because the price it can get for hosting websites;each year has declined. So its revenues have grown at a more;moderate 5?10% rate with its profits;showing year to year variation just depending on various;investments and costs. I have shown David?s;traffic, revenues and profits in the following table and;graphs.;2005 2006 2007 2008 2009 2010 2011 2012 2013;Traffic (mm pg.) 1,024 1,377 1,859 2,441 3,174 4,244 5,689;7,503 9,921;Revenues ($000) 10,242 11,999 14,405 17,158 20,643 24,227;28,682 34,670 41,140;Profits ($000) 1,599 5,780 10,603 9,763 18,495 514 16,907;8,072 12,940;David started out purchasing web servers ? specialized;computers that are customized to serve web;pages ? but in 2007 decided to develop its own web;servers. The servers it had been purchasing were;based on standard Dell computers but included some;specialized web?serving hardware components;that had to be installed in slots in the;Dells. Thus, these servers were relatively expensive ? around;$6500 each and at the time David had over 100;servers. A single server was capable of serving around;10 million web pages each year. What it hoped to;gain from developing its own servers was reduced;costs. It wanted to eliminate the specialized;hardware components and increase the capacity of the;backend servers. The plan was to replace the;hardware with new software it would develop based;primarily on some other software that it would;license. In 2008, David contracted with Michael to;provide it with the software it would require to develop its;web servers. At the time, Michael was well known;in the industry as providing the best core web server;software. Its software was used by around 30;large companies to manage their websites. David?s plan;was to incorporate Michael?s software onto the Dell servers;along with a bit more software that it would;develop to make the whole package work smoothly and easily;for customers.;The contract between David and Michael called for annual;payments of $300,000 per year. For this;money, David would get rights to use Michael?s software in;an unlimited number of servers and get;support from Michael for any bug fixes. In;addition, David would get any software updates or upgrades;that Michael might release over the term of the;contract. The contract specified that the term was for;seven years (out through 2015) but that, even after the end;of the contract, David would have the rights;to continue to use the software in its products but it would;no longer be entitled to any support;upgrades or updates.;In late 2009 David completed development of its new web;servers and replaced all 120 servers it had at;the time with 90 new servers for a total cost of $1.8;million. The old servers were simply taken off line;and stacked in a closet somewhere. No one at;David was able to testify what had happened to the old;servers.;By late 2009, David was very confident that it has the best;web servers in the world and made;statements to that effect. The servers were fast;and efficient. So David decided to add a line of;business by selling its web servers to other;companies. It hired a couple of sales people and started;trying making sales calls. By 2010 David had sold;25 servers to other companies and was continuing to;pursue some other leads. By 2011, it became;apparent that other companies were not very interested;in purchasing web servers from David. While David;made a few more sales, the other companies were;telling David?s sales people that 1) they weren?t;comfortable buying from a competitor, 2) the price;David was asking was too high, and 3) they were more likely;to purchase webhosting services from;Amazon than install their own equipment. Thus, by;the end of 2011, David fired its sales force and;continued to focus on web hosting as its business.;In 2010, Michael received a buyout offer from MegaCorp for;$30 million. MegaCorp was interested in;Michael?s technology for use in a product that wasn?t web;servers but used much of the same;technology. Some time after the acquisition was;concluded, MegaCorp did two things: 1) it sent notices;terminating the agreements of all the existing customers;and 2) it open?sourced almost all of Michael?s;code.;With the lack of any ongoing support for Michael?s code;many of Michael?s old customers decided to;replace their Michael?s software. The single;biggest beneficiary of this was Michael?s biggest competitor;? Eugene, Inc. Eugene was based in Germany and;had been selling software that functioned very;similarly to Michael?s. Eugene got a flood of;calls from former Michael?s customers to get quotes on;how much it would cost to switch to Eugene?s;code. The price ranged a bit, but the biggest users were;receiving quotes of $650,000 up front and then $80,000 per;year for maintenance and upgrades. There;would be some transition costs ? the companies would have to;spend between $100,000 and $150,000;to revise their own software in addition to paying;Eugene. Some of the companies decided to go a;different direction and implemented the open?source version;of Michael?s code. This turned out to cost;around $500,000 to implement. The advantage to;this was that the companies got full source code andcould customize it to fit;their needs. The disadvantage was that there was no support for any;bug fixes;or future upgrades.;David received the letter terminating its license with;MegaCorp/David in July of 2011. In August of;2011, David sued MegaCorp claiming breach of;contract. Because of the suit, MegaCorp decided to;continue to support to David ? responding to its requests;for bug fixes and giving it some newly?;developed software. The CEO of David continued to;make public statements to the effect that his web;servers were better than anything else out there ? including;Amazon?s ? and David continued to run all;of its growing business on the web servers that included the;Michael?s software.;The Complaint;In its complaint, David alleged that it had been harmed in;three ways;? Insufficient support. It claimed that the;quality of support it received after the MegaCorp;acquisition of Michael was not as good as the support had;been previously. Furthermore, there;were bugs in Michael?s software that David had repeatedly;asked Michael to fix that had never;been fixed. The specific bugs went by the names;ACG, WNP and Speed. The ACG bug was in a;feature that was rarely used and, if turned off, allowed the;software to run just fine. The WNP;problem was very rare and;unpredictable. Michael?s engineers could never replicate it on their;own hardware, it only seemed to occur on David?s;servers. In addition, David claimed that it had;always expected to get 50% more speed from its servers than;it ever did.;? Inability to sell servers. David claimed that;due to the purchase of Michael it was unable to sell;any more webservers because it could not guarantee support;for any servers it did sell.;? Replacement cost. It claimed that, due to the;lack of support from MegaCorp/Michael it was;going to have to replace all of its servers. At;the present time, MegaCorp had 500 servers and it;viewed the only viable server replacement as buying new;servers for $7,500 each from BigBox;Inc. that included the old?style specialized hardware;components.;Dr. Vino?s Opinion;Dr. Vino offered four calculations. In his;deposition, Dr. Vino stated that he performed these;calculations because they were calculations that the CEO of;David had asked him to perform.;1) The total value of the hardware that had been replaced by;David when it installed its new;servers incorporating the Michael software was $905 thousand;broken out as;a. $450 thousand in computers;b. $225 thousand in specialized web server hardware;c. $230 thousand in maintenance and support for the servers;between 2004 and 2009.;2) The total cost to replace the existing 500 servers with;BigBox servers amounted to $12.1 million;broken out as;a. $6.5 million in computers;b. $1.0 million in specialized web server hardware;c. $4.6 million in support over the next five years;3) Loss in business value for David of $15;million. Dr. Vino calculated this $15 million on the basis;that, in 2009, CityCorp had purchased a company for $20;million named Victor that competed;with David both for the provision of web?hosting services;and sales of web?host servers. Dr.Vino deducted the tangible assets;of Victor from the $20 million to arrive at an estimated value;of the goodwill and core technology of Victor of $15;million. He then opined that, since Victor;and David?s sales of web?host servers were similar, David?s;goodwill and core technology must;also be worth $15 million and further, that this was the;value that had been destroyed by the;breaches and termination of the contract.;4) Total cost to fix the alleged problems with Michael?s;software of $165,000 broken out as;a. ACG: $25,000;b. WNP: $32,000;c. Speed: $108,000;Things to Consider;? This is a breach of contract case. What are the;form of damages available for breach of;contract?;? Assume that all of the allegations are true ? how has;David been damaged?;o Additional costs?;o Benefits it didn?t receive?;o Lost Sales? (Both of servers and web?hosting;services).;? What options are available to David to replace its web;servers without Michael?s software?;? The contract was a seven year contract signed in;2008. It is now 2014 and the contract;terminates in 2015.;? How does the fact that MegaCorp continued to support the;Michael?s code affect damages?;? What is the causal link between each of Dr. Vino?s calculations;and any harm suffered by;David?s.;? What effect does ?partial performance? of the contract;have on any calculations of damages?;Assignment;Write a 2 page report replying to Dr. Vino. Your;opinion should address flaws (if any) with each of his;proposed calculations. While you don?t need to;address each of the ?Things to Consider? from above;they will be helpful in your thinking. You should;also propose a damages calculation ? the number that;you believe is most appropriate assuming liability for;breach of contract by MegaCorp / Michael?s.;Follow the discussion forum. Discussing this case;with me and your fellow students will help a lot in;thinking about the response.
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