Clackmannanshire had an existing Select agreement with Microsoft, which provides a volume discount on Microsoft software.
However, when the council needed more desktops, a vendor offered it extra licences more cheaply than they would be under the Select agreement. However, the deal turned sour when a software audit revealed that the new licences were counterfeit.
The council was fined £42,500 and forced to purchase 470 Microsoft Office XP licences at a cost of £102,229, despite co-operating in the software audit.
In a move that will shock many users, the Business Software Alliance (BSA) - the IT vendors' anti-piracy organisation - and Microsoft took action against the council ahead of acting against the supplier of the fake licences.
The council was not only fined but also named and shamed by the BSA.
Mike Newton, programme manager at the BSA said: "I have a degree of sympathy for [Clackmannanshire] as it did not know the software was counterfeit."
It was up to Microsoft, he said, to take action against the supplier and he warned users to watch out for deals that were too good to be true. "Buying consortia such as the Office of Government Commerce's GCAT tend to get the best price," he said.
The supplier is under police investigation but Microsoft has not yet confirmed that it has begun a civil action against the firm.
Users purchasing counterfeit software licences are caught between a rock and a hard place.
In buying counterfeit licences for Microsoft software, Clackmannanshire council contravened the 1988 Copyright Act, said Mark Finn, an associate at law firm Osborne Clark.
Clackmannanshire installed extra copies of Microsoft Office beyond its existing Select contract, which was "a primary infringement of copyright," said Finn.
"I am surprised the council did not get off on an innocence defence. It does however have a legal claim against the supplier," he told CW360.com.
In another twist, the supplier of the counterfeit licence may not necessarily be in breach of copyright law. Jon Fell, a partner at Masons, said: "All the supplier has done is give Clackmannanshire a piece of [worthless] paper. It is probably guilty of fraud."
In a situation such as this Fell said, once the council knew the licences were invalid it should have gone straight to Microsoft to acquire legitimate software licences. "The principal here is that Microsoft owns the software," he added.
Counterfeit Microsoft software is a major problem for the software giant. Caroline Smith, channel anti-piracy marketing manager at Microsoft, advised concerned users to look for "trusted sources" when buying software.
Microsoft UK lists approved distributors and resellers on its Web site.