A blockbuster $1.6 billion judgment against IBM appeared to be on shaky ground Tuesday before a Fifth Circuit panel, with one judge implying she is loath to accept a finding that IBM is guilty of fraud.

Houston-based BMC Software Inc. develops software for clients to run their mainframe computers and makes money from licensing its software.

IBM, short for International Business Machines Corporation, is headquartered in Armonk, New York, and develops mainframe software too. It is also one of the world’s largest IT-service contractors.

The companies’ different offerings led them to a love triangle of sorts, with telecom giant AT&T in the middle. And like most love triangles, one of the romantic rivals would eventually be spurned.

Here is how it happened: For decades, BMC and IBM both had AT&T as a client. IBM supplied it with mainframe hardware, while BMC licensed it software needed to run its mainframes.

In 2007, AT&T contracted IBM to operate its mainframes. There was a problem, however: IBM needed access to AT&T’s software licenses, including those from BMC, in order to service AT&T.

Acknowledging its dependence on BMC’s software to manage AT&T’s computer systems, IBM worked out a contract with BMC in which, according to BMC, it agreed not to replace BMC’s software with its own.

Making claims of breach of contract, trade secret theft and tortious interference, BMC sued IBM in July 2017, alleging it had done just that: swapped in its own software for 14 BMC software products AT&T was using.

Following a two-week bench trial, Senior U.S. District Judge Gray Miller in May 2022 found IBM had fraudulently induced BMC to enter into their contract. The judge awarded BMC $717 million in unpaid license fees and an equal amount of punitive damages.

IBM appealed to the Fifth Circuit and a three-judge panel of the New Orleans-based appellate court heard arguments Tuesday.

Representing IBM, Paul Clement, of the Virginia firm Clement & Murphy, argued the case boils down to a disagreement over the contract’s terms.

He said IBM agreed that, if it persuaded AT&T to change to its software, it would have to pay BMC licensing fees for BMC software needed to effectuate the switchover.

But AT&T believed it could displace BMC’s software with its own, so long as AT&T initiated the replacement, which AT&T did. Hence, IBM maintains, it did not have to pay BMC licensing fees: It could use AT&T’s license for BMC’s software.

“The decision below converted an ordinary contract dispute, governed by strict damage caps, into a $1.6 billion windfall,” Clement began.

BMC’s attorney, Jeffrey Oldham of Bracewell LLP’s Houston office, framed the case in terms of intellectual property. He said Judge Miller, a George W. Bush appointee, had rightly determined IBM had no right to use AT&T’s licenses for BMC’s software.

“And that’s obviously correct,” Oldham said. “The fact that I buy Microsoft Office and install it on my computer doesn’t mean that I can just give it to you, and you can install it. You all have to pay for your own rights to licenses.”

U.S. Circuit Judge Edith Jones was unconvinced.

“Well, this is a completely different situation than a consumer purchase,” she said.

The appellate judge questioned if, under New York law, which governs the contract, the agreement would violate statutes against restrictive covenants because it restrained IBM from competing against BMC in providing software.

Jones, a Ronald Reagan appointee, also said she was skeptical of BMC’s contention that IBM knew the contract was unambiguous — that it could not replace BMC’s software with its own, unless it paid BMC licensing fees — despite bickering with BMC over that same contract provision for five years before they signed the deal.

“The parties are arguing for five years on both sides of an ambiguous contract, then how can they be guilty of fraud if the contract is ambiguous?” Jones asked BMC attorney Oldham.

Oldham in response said Miller had determined that IBM was lying all along, misrepresenting that it had perceived the terms as ambiguous. “Those things they were saying were smokescreens, they were throwing out smokescreens from the beginning,” he argued.

U.S. Circuit Judge Kyle Duncan, a Donald Trump appointee, was incredulous that IBM would have had to pay BMC $717 million in software licenses — the basis for Miller’s judgment — to carry out the swap of AT&T moving from BMC’s software to its own.

Oldham explained the license fees stemmed from AT&T’s status as the “world’s largest mainframe user.” He said the price goes up or down, based on a formula, depending on the mainframe size.

IBM “thought they could bully a smaller competitor for pennies on the dollar,” Oldham argued.

U.S. Circuit Judge Carl Stewart, a Bill Clinton appointee and the final panel judge, said he could not make sense of the huge judgment, especially the $717 million in punitive damages.

“How do you get punitives on top?” he asked. “Ordinarily in a breach of contract, you get whatever the contract provides, assuming your argument is right. But how do you get from that to skullduggery, conspiracy, fraud, punitives, all from paper?”

Clement, IBM’s lawyer, argued in closing that the contract included a $5 million damages cap.

He also said Miller had erred in basing the damages award on the full license fees, when BMC had agreed to sell them to IBM at a discount.

Clement urged the panel to deem the contract ambiguous and vacate Miller’s judgment that it entitles BMC to $717 million in license fees.

“If you say that,” he predicted, “then this case will settle.”

The judges gave no timeline for a decision.