EC gets MS to change contract

Adding to a long list of investigations into its competitive practices, Microsoft (MSFT) agreed today to modify a controversial 1987 contract affecting rival Santa Cruz Operation (SCOC) after the European Commission found that Microsoft had infringed European competition laws.

The decade-old contract forced SCO to continue including outdated Microsoft code in its Unix operating system and to pay steep royalties on that code. The contract stated that SCO had to include code which provides compatibility with 286 and 386 processors in perpetuity. The EC found that this contractual obligation prevented SCO's Unix operating system from competing with Microsoft's operating system.

SCO welcomed the EC decision and said it believes that removing Microsoft's outdated code will result in lower development costs that will have a positive impact on customers.

"SCO has borne a dual burden," Doug Michels, SCO's executive vice president and chief technology officer, said in a statement. "SCO has been paying substantial royalties to Microsoft. Moreover, we were contractually obligated to ensure that the code remained fully functional with a constantly evolving software environment. The engineering costs of providing such a quality assurance are significant, impacting our time-to-market and reducing the resources we can apply to product innovation."

The commission said in a statement that Microsoft agreed to change the contract so that SCO "can now design its future Unix products as it wishes, is not obliged to use any Microsoft intellectual property in future Unix products, and has the option...to use the Microsoft IP involved at a set royalty."

David McCrabb, senior vice president market planning at SCO, said SCO's first action will be to stop using the code and stop paying royalties. The next step will involve looking at whether the company can recover money paid under the now illegal agreement, which amounted to $4 million in 1996 or 8 cents a share.

Microsoft owns 4.2 million shares in SCO, or an 11 percent stake, making it the company's second largest shareholder with a seat on the board.

"Perhaps the lesson from this is that the first rule when dealing with the devil is: don't," a cynical McCrabb added.

The dispute began after SCO requested, a year ago, the nullification of the 1987 contract, which it inherited from Novell (NOVL), which in turn inherited it from AT&T (T). Microsoft denied the request. As a result, SCO filed a complaint with the European Commission last January, and the EC issued its statement of objections to Microsoft the following May.

SCO said that it turned to both the EC and the antitrust division of the U.S. Justice Department, and, although both organizations worked together closely as they have in the past regarding Microsoft, the EC took the lead in pursuing the matter.

"We were very pleased that the EC took the lead," said Steve Sabbath, SCO's vice president, law and corporate affairs. "Although the DOJ provided advice, it was tied up in another big Microsoft case. The EC was a little more available and the European process can allow for a more streamlined process."

Sabbath added, "Microsoft's lifting of these technical and financial obligations applies not only in Europe, but in all our global markets."

Although in a statement Microsoft lauded the EC decision, which it says preserves Microsoft's right to receive royalties, Sabbath argues that the only issue in front of the EC was whether SCO could remove the code.

"On November 4, Microsoft conceded this, one week prior to a final hearing, and elected to settle the issue without a hearing," Sabbath added. "There was no ruling on whether SCO should pay any royalties or whether Microsoft should pay back the royalties SCO already paid under the contract."

Reuters contributed to this story.