According to the courts, Titleserv was well within their rights.
By default, if Titleserv paid for Mr. Krause to develop the software, Titleserv owns the software in its entirety. In this particular case, there is some contention. The decision states
It is undisputed that Titleserv possessed executable copies of all the programs. The parties disagree whether Titleserv owned those copies within the meaning of § 117(a). Krause claims that Titleserv never owned the program copies saved on its file server, but rather possessed the copies as a licensee pursuant to an oral agreement. Titleserv asserts that it owns copies of the programs because it paid Krause a substantial sum to develop them and has an undisputed right to possess and use them permanently.
Mr. Krause's mention of an oral contract tells me that there was no '"as-is" as per a standard contract'.
And there was no violation of copyright laws. The court's decision reads
We conclude in the absence of other evidence that Titleserv’s right, for which it paid substantial sums, to possess and use a copy indefinitely without material restriction, as well as to discard or destroy it at will, gave it sufficient incidents of ownership to make it the owner of the copy for purposes of applying § 117(a).
Titleserv owned the software on its servers.
Under fair use, you are perfectly within your rights to modify your CD for your own use. Heck, I do it all the time. Whenever I rip a CD to my MP3 player, I am modifying the audio content. The flaw in your analogy is when you start assuming redistribution. At no time did Titleserv attempt to redistributed the software, a right which it may or may not have, as redistribution was not part of the case and thus not part of the court's decision. Likewise, I am mindful that I do not have the right to redistribute my MP3 files, so I do not share them.
I do agree that there is some subtext here, and that we do not know the details of that subtext. Important in my mind is the nature of the termination of the relationship between Krause and Titleserv. I have absolutely no proof of this, but I suspect that Krause terminated the relationship unilaterally, thinking that sooner or later Titleserv would have to come crawling to him and grovel at this feet to get him to modify the software. He could then extort whatever favorable deal out of them he wanted.
It probably never occurred to Krause that Titleserv would break into software and upgrade it themselves.
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