Software Licensing: Legal Issues with Business Consequences

    By Nicole J. Harrell

    You have assembled a team that has spent months researching and selecting the appropriate software and provider for your business. Nearing the end of the process, your team is ready to move on and sign the license agreement so that the software can be installed and used.

    The software provider’s sales representative e-mails the license agreement to you in a PDF format and asks you to sign the agreement and return it so the deal can be closed and you can start the process of installing the software and converting over to using it.

    You take a quick read of the license agreement, think it’s generally OK to execute, but figure you should probably have your attorney review it for any big-picture issues.

    So you send it by email to your attorney and ask her to review it by the end of the day and get it back to you with any comments because the software provider’s sales representative is pressing you to get the transaction completed since the end of the commission cycle is tomorrow.

    Your attorney opens the PDF file only to find an 18-page license agreement with the 8-point font text in two columns that run all the way across the page so there is barely any margin and that contains links and references to other documents that neither of you have seen. And the software provider’s sales representative needs the signed agreement back tomorrow or you will lose your negotiated pricing. Sound familiar?

    The license agreement for software is as equally important as selecting the right vendor and software for your business. On the surface, the license agreement may appear fairly innocuous. It sets forth the length of the term, obligations of each party, such as who is responsible for installing the software and converting data from the old software to the new software, payment terms, termination provisions, governing law, force majeure, limitations of liability and other legal terms that you have seen in other contracts. But these legal terms can have significant business consequences if the relationship goes awry.

    The list of issues below are critical to your business and not just legal issues that can be glossed over.

    Warranties: Software providers are generally loathe to provide warranties, but at a minimum, a software provider should warrant that the software will perform in accordance with specifications agreed upon by the parties and the documentation that was provided to you, be free from errors and defects that materially affect the performance of the software, and will not infringe the rights of any third parties. The term of the warranty with respect to performance should take into account the length of the installation period before the software is used in a live setting or not commence until you are using the software in a live setting. Otherwise, you run the risk of having the warranty period expire before the software is operational or shortly thereafter.

    Remedies: After the software is installed it may be difficult (and costly) for you to exercise your right to revoke the software and receive a refund. The software provider should be required to use whatever efforts necessary to resolve the problems. In that regard, service level response times should be established commensurate with the severity of the problem. If the software provider cannot resolve the problem within the specified time frame, it should provide a work around so that you can continue to use the software substantially as you anticipated. In addition, you should be able to get a refund of the fees paid for implementation, training and use of the software if the software provider cannot correct the problem or replace the defective software with a functional equivalent within a reasonable period of time. The agreement should provide for equitable remedies, such as injunction, as well, since money damages are not always adequate in the event of a breach.

    Limitation of liability and indemnification: These provisions are highly likely to be written only in favor of the software provider with little or no protection for you if there is a problem or a breach. The software provider will limit its liability to the fullest extent, but you should insist on carve outs for your confidential information and infringement, for which there should be no limit. Some carve outs to their indemnifications obligations are appropriate, such as your modification of the software without their consent or approval or your misuse of the software. Further, the limitation of liability provisions should be mutual.

    Your breach of the agreement: In the event you breach your license agreement, or any other agreement (as they are likely to have cross-default provisions), with the software provider, the agreement probably allows the software provider to terminate the agreement with little or no notice to you. You should insist on a notice and cure period, such as 30 days, to allow a period of time in which you can cure the breach. Without this notice and cure period, you could find your company without critical software overnight.

    Payment terms: The amount of fees is likely an area where you are focused from a business perspective, but when the payments are due is often an overlooked area. If installation is required, then you should request that payments be spread over a particular period of time or tied to certain events, such as initial installation, data transfer, successful testing and go live. The same should apply to development where payment can be tied to milestones, completion of various phases and acceptance of the work completed. The due date of these fees is an important consideration – 30 days after delivery is quite different than 30 days after acceptance, in which case you would have the opportunity to test the software and ensure that it is working before you pay. Ongoing fees, such as license fees and service fees should be separated so that in the event the software provider becomes bankrupt, you can stop paying for services you are no longer receiving and continue paying license fees. Regardless of the fees to be paid, your agreement should contain a provision that allows you to withhold payment, without penalty and without being deemed in breach of the agreement, for fees that you dispute in good faith.

    Infringement: Another area where software providers are likely to balk – providing an ownership warranty. You are likely to hear from the software provider that they cannot be sure their product does not infringe on another patent or proprietary right, and to a certain extent that’s a valid argument. But the ownership warranty is about allocation of risk and the software provider is in a much better position to create safeguards and do patent searches.

    The software provider should bear the legal risk that its product does not infringe the rights of a third party. The other part of the infringement warranty is the software provider stating that it has the right to license the software to you, that no other party will come along and keep you from using the software.

    Escrow/source code: If the software you are licensing is vital to your business, you should insist on a source code escrow. The escrow can come into play if the software provider goes out of business or breaches its service obligations. In the escrow clause, the software provider will agree to give a third party a copy of the source code and any supporting documentation. The escrow agent will hold the source code and documentation for your benefit in the event a release event occurs.

    Release conditions typically include the software provider bankruptcy or breach of its service obligations. The conditions are important because if the software provider has breached its service obligations, it may very well breach any obligation to turn over source code, or if the software provider is bankrupt, applicable law may relieve it of certain contractual obligations.

    The escrow provisions should cover the specific materials to be deposited and include verification procedures so that the escrow agent can attempt to determine if the correct materials have been deposited. The release provisions are equally as important. If you claim a release condition has occurred and the software provider disputes that claim, then the escrow agent does not have to release the source code to you. To avoid the escrow agent being caught in the middle for a prolonged period of time, you should consider an expedited dispute resolution provision.

    So when your attorney calls you back and says, ‘This may take some time,’ you can now see why these provisions, although legal in nature, can have business consequences and should be an important focus of your review of a software license agreement.

    The software for your business is an investment similar to others that you would otherwise make, and taking the time to get adequate protection on the front end may be to your benefit when your software provider goes out of business or stops providing services, or the software just does not perform as the provider said it would.

    Nicole Harrell is a partner with the law firm of Kaufman & Canoles. Her commercial practice includes entity formation, corporate law, mergers and acquisitions, supply and distribution agreements and contract negotiation.

    This article originally appeared in the August 10, 2012 issue of Inside Business and is reprinted with permission. 

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.