by Ronald N. Weikers, Esq.

Background

"Clean room" procedures are useful for two very different activities: computer code development, and due diligence investigation prior to a merger or acquisition. The term "clean room" as used in the high technology industry was previously given to semiconductor manufacturers' particle-free manufacturing chambers, and it was recently borrowed to describe a method of developing computer code which duplicates the functionality of a competitor's code, while avoiding the access prong of a circumstantial evidence test of copyright infringement. This technique is also being practiced by corporate suitors during the due diligence phase to avoid potential liability for misappropriation of target companies' high-, low- and even non-technology trade secrets, in the event that M&A negotiations should dissolve.

Cost-Benefit Analysis

Before deciding whether to obtain a license from one's competitor, create the code independently, or reverse engineer the code by following a clean room procedure, a developer must balance the costs and benefits expected from the proposed development. The variables involved are: 1) Litigation risks, including damage awards, attorneys' fees and diminution of goodwill; 2) R&D charges for independent and clean room development, versus perpetually increased costs-of-goods under a licensing scheme, each of which will have a different effect on the developer's financials and market value over different time periods; 3) Ownership of the developed code versus a license interest which can change due to license termination, acquisition or bankruptcy by the licensor; and 4) other variables. After performing this analysis, should the developer choose to follow a clean room procedure, it should perform the following steps.

Codes, Clean Rooms and Copyrights

Group-1 consists of a team of analysts from Company-1 who are given a legally obtained copy of Company-2's software or chip. Group-1 disassembles, decompiles, "peels" or otherwise reverse engineers the software or chip, and develops a code flow chart which is pared down to its essential, "functional" elements. During this reduction process, Group-1 must guard against duplication of "non-functional" routines, sub-routines, comments, initials, security systems and perhaps even needless code which was intentionally buried by Company-2 amid functional code. Group-1 then creates specifications from the flow chart, which will be used to develop Company-1's version of the code. The specifications are sent to an independent third-party -- perhaps an industry consultant -- for safekeeping. All of these and the remaining clean room steps must be documented, notarized and/or provable by a paper trail.

A lay jury is likely to find "substantial similarity" between code designed for the same purpose by equally competent programmers in the same language, thereby proving the first prong of a circumstantial evidence test of copyright infringement. Exact duplication of non-functional features must therefore be avoided at all costs, because it may tend to prove the second, access prong. This is the essence of Group-1's task.

Group-2 consists of another team of analysts from Company-1, which is provably isolated from Group-1 and all others who may been exposed to Company-2's code. The third-party re-transmits Group-1's specifications to Group-2, and Group-2 develops Company-1's new source code pursuant to Group-1's functional specifications.

Critical questions will likely arise. However, Group-2's questions and Group-1's answers must be communicated through the third-party, and Group-1 must continue to insure that its answers are merely functional. Alternatively, the third-party may have to assume responsibility for "translating" any non-functional answers, if necessary. When Group-2's source code is complete, it is compiled.

M&A Due Diligence, Clean Rooms and Trade Secrets

A variation of the clean room procedure may be used during the due diligence investigation that is typically engaged in during M&A negotiations, regardless whether the companies are high-tech, non-tech or something in between. In a typical transaction, Company-1 desires to merge with Company-2, or to acquire all or part of its assets. Company-1 also seeks to avoid litigation over potential misappropriation of Company-2's trade secrets, should their negotiations break down.

At Company-1's request, Company-2 provides to a mutually agreed-upon, independent third-party commercially sensitive, confidential documents such as customer lists, major contracts and other trade secrets. The third-party then translates the non-functional components of trade secrets into generic terms, and transmits the resulting information to Company-1. Thus: 1) pseudonyms or descriptions are substituted for major customers, sources, licensees, key employees and sensitive geographic areas; 2) irrelevant but sensitive numbers are excised; and 3) strategic plans are diluted.

In cases involving trade secrets that are the sole assets of Company-2, or where Company-2 is regarded as highly litigious, Company-2 may be required to approve of the third-party's translations prior to their retransmission to Company-1, thus depriving Company-2 of a subsequent argument that the third-party was biased or did an improper translation job. This appears to deprive the third-party of its function, but oftentimes the target company is reluctant to become involved in this additional step, and the third-party must assume the additional task of acting as a disinterested promoter. Also, Company-1's questions regarding trade secrets are routed through the third-party, who must then ferret out the non-functional components of Company-2's answers.

Conclusion

Clean room procedures pertain to: computer code development in order to avoid copyright litigation; and M&A due diligence investigation in order to avoid trade secret litigation for transactions involving companies in almost any industry. "Clean rooming" does not prevent other developers or spurned targets from litigating in order to seek redress for their hurt feelings, but this relatively inexpensive process does present major legal obstacles to their success.