The lawyer's letter threatening libel  is simply a smokescreen - a lawyer's way of blowing smoke and a diversionary tactic. I was once the recipient of such a letter with a veiled threat over my communicating a preservation problem to another colleague - so I well understand the anxiety that this can cause. There's no need to beat yourself up over a letter that you forgot to draft. It seems to me that your institution has the weight of law on your side with your signed first-use permission and agreement. The fact is that these folks broke a signed agreement with your institution, got caught,  and are now attempting to rationalise their way out of it.

The best thing, of course, is to get your own legal cousel to look over all of the documentation and to respond. But my inclination is to suggest that your institution calmly stick to it's guns over this issue and protect your property. The issue isn't so much the monetary value of the use of the image but the wanton distribution of it by those seeking profits without prior permission.

Cheers!
Dave

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